Standards for Covered Clearing Agencies for U.S. Treasury Securities and Application of the Broker-Dealer Customer Protection Rule With Respect to U.S. Treasury Securities, 2714-2830 [2023-27860]

Download as PDF 2714 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 240 [Release No. 34–99149; File No. S7–23–22] RIN 3235–AN09 Standards for Covered Clearing Agencies for U.S. Treasury Securities and Application of the Broker-Dealer Customer Protection Rule With Respect to U.S. Treasury Securities Securities and Exchange Commission. ACTION: Final rule. AGENCY: The Securities and Exchange Commission (‘‘Commission’’) is adopting rules under the Securities Exchange Act of 1934 (‘‘Exchange Act’’) to amend the standards applicable to covered clearing agencies for U.S. Treasury securities to require that such covered clearing agencies have written policies and procedures reasonably designed to require that every direct participant of the covered clearing agency submit for clearance and settlement all eligible secondary market transactions in U.S. Treasury securities to which it is a counterparty. In addition, the Commission is adopting additional amendments to the Covered Clearing Agency Standards with respect to risk management. These requirements are designed to protect investors, reduce risk, and increase operational efficiency. Finally, the Commission is amending the broker-dealer customer protection rule to permit margin required and on deposit with covered clearing agencies for U.S. Treasury securities to be included as a debit in the reserve formulas for accounts of customers and proprietary accounts of broker-dealers (‘‘PAB’’), subject to certain conditions. DATES: Effective date: March 18, 2024. Compliance date: The applicable compliance dates are discussed in Part III of this release. FOR FURTHER INFORMATION CONTACT: Elizabeth L. Fitzgerald, Assistant Director, and Robert Zak, Special Counsel, Office of Clearance and Settlement at (202) 551–5710, Division of Trading and Markets; Michael A. Macchiaroli, Associate Director, at (202) 551–5525; Thomas K. McGowan, Associate Director, at (202) 551–5521; Randall W. Roy, Deputy Associate Director, at (202) 551–5522; Raymond Lombardo, Assistant Director, at 202– 551–5755; Sheila Dombal Swartz, Senior Special Counsel, at (202) 551– 5545; or Nina Kostyukovsky, Special Counsel, at (202) 551–8833, Office of ddrumheller on DSK120RN23PROD with RULES2 SUMMARY: VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 Broker-Dealer Finances, Division of Trading and Markets; U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–7010. SUPPLEMENTARY INFORMATION: First, the Commission is amending 17 CFR 240.17ad–22(e)(18) (‘‘Rule 17ad– 22(e)(18)’’) to require covered clearing agencies that provide central counterparty (‘‘CCP’’) services for U.S. Treasury securities to establish, implement, maintain and enforce written policies and procedures reasonably designed, as applicable, to establish objective, risk-based and publicly disclosed criteria for participation, which require that any direct participant of such a covered clearing agency submit for clearance and settlement all the eligible secondary market transactions in U.S. Treasury securities to which such direct participant is a counterparty. In addition, these policies and procedures must be reasonably designed, as applicable, to identify and monitor the covered clearing agency’s direct participants’ submission of transactions for clearing as required above, including how the covered clearing agency would address a failure to submit transactions. These policies and procedures must also be reasonably designed, as applicable, to ensure that the covered clearing agency has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the board of directors of such U.S. Treasury securities covered clearing agency (‘‘CCA’’) must review annually. The Commission is defining an eligible secondary market transaction as a secondary market transaction in U.S. Treasury securities of a type accepted for clearing by a registered covered clearing agency that is either a repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities, in which one of the counterparties is a direct participant, or certain specified categories of cash purchase or sale transactions, including certain exclusions for transactions with sovereign entities, international financial institutions, natural persons, inter-affiliate repo transactions, state/ local governments, and other clearing organizations. Second, the Commission is amending 17 CFR 240.17ad– 22(e)(6)(i) (‘‘Rule 17ad–22(e)(6)(i)’’) to require that a covered clearing agency providing central counterparty services for U.S. Treasury securities establish, implement, maintain and enforce written policies and procedures PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 reasonably designed to, as applicable, calculate, collect, and hold margin for transactions in U.S. Treasury securities submitted on behalf of an indirect participant separately from those submitted on behalf of the direct participant. Third, the Commission is amending Rule 17ad–22(e)(18) to require that a covered clearing agency providing central counterparty services for U.S. Treasury securities establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the board of directors of such covered clearing agency reviews annually. In connection with these proposed amendments, the Commission is including as part of 17 CFR 240.17ad– 22(a) (‘‘Rule 17ad–22(a)’’) definitions of ‘‘U.S. Treasury security,’’ ‘‘central bank,’’ ‘‘eligible secondary market transaction,’’ ‘‘international financial institution,’’ ‘‘sovereign entity,’’ ‘‘state and local government,’’ and ‘‘affiliated counterparty.’’ As part of this rulemaking, the Commission is also amending the CFR designation of Rule 17Ad–22 to Rule 17ad–22.1 Fourth, the Commission is amending 17 CFR 240.15c3–3a (‘‘Rule 15c3–3a’’) to permit margin required and on deposit at covered clearing agencies providing central counterparty services for U.S. Treasury securities to be included by broker-dealers as a debit in the customer and PAB reserve formulas, subject to certain conditions. Table of Contents I. Introduction II. Discussion of Comments Received and Final Rules A. U.S. Treasury Securities CCA Membership Requirements 1. Requirement To Clear Eligible Secondary Market Transactions a. Comments Regarding the Requirement To Clear Eligible Secondary Market Transactions b. Comments Regarding the Concentration of Risk in One Covered Clearing Agency c. Final Rule 2. Definition of Eligible Secondary Market Transactions a. Repo Transactions i. Triparty Repo ii. Repos by Registered Funds iii. Repos by Other Clearing Organizations iv. Repos by FCMs v. Repos Involving ‘‘End Users’’ 1 See note 71 infra for further discussion of this amendment. The Commission refers to the redesignated Rule 17ad–22 throughout this release. E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations vi. Interaffiliate Repos vii. Repos by State and Local Governments viii. Other Repo Comments ix. Final Rule b. Purchases and Sales of U.S. Treasury Securities i. Comments Regarding Cash Clearing Generally ii. IDB Transactions iii. Other Cash Transactions iv. Comments Regarding Cash Transactions for Registered Funds v. Final Rule 3. Other Exclusions From the Definition of an Eligible Secondary Market Transaction 4. Policies and Procedures Regarding U.S. Treasury Securities CCA’s Monitoring of Its Direct Participants’ Transactions 5. Alternative Approaches Proposed by Commenters B. Additional Changes to Covered Clearing Agency Standards 1. Netting and Margin Practices for House and Customer Accounts 2. Facilitating Access to U.S. Treasury Securities CCAs a. Comments Supporting the Commission’s Proposed Rule b. Comments Regarding the Commission’s Authority To Require a CCA To Accept Done Away Transactions c. Other Comments Regarding Access d. Final Rule C. Amendments to Rule 15c3–3a 1. Introduction 2. Credit Items 3. New Debit Item 4. Note to New Debit Item a. First Condition—Permitted Collateral b. Second Condition—Customer Position Margin c. Third Condition—Rules of U.S. Treasury Securities CCA d. Fourth Condition—Commission Approval of Rules of U.S. Treasury Securities CCA 5. PAB Reserve Computation III. Compliance Dates IV. Economic Analysis A. Broad Economic Considerations B. Baseline 1. U.S. Treasury Securities 2. U.S. Treasury Repurchase Transactions 3. Clearance and Settlement of U.S. Treasury Security Transactions a. Cash Market i. Interdealer ii. Dealer-to-Customer b. U.S. Treasury Repo Market i. Non-Centrally Cleared Bilateral Repo ii. Centrally Cleared Bilateral Repo iii. Non-Centrally Cleared Repo Settled on a Triparty Platform iv. Centrally Cleared Repo Settled on a Triparty Platform v. Inter-Affiliate Repo 4. Central Clearing in the U.S. Treasury Securities Market 5. Margin Practices in U.S. Treasury Secondary Markets 6. Disruptions in the U.S. Treasury Securities Market a. COVID–19 Shock of March 2020 b. September 2019 Repo Market Disruptions VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 c. October 2014 Flash Rally 7. Affected Parties a. Covered Clearing Agencies for U.S. Treasury Securities: FICC b. Direct Participants at U.S. Treasury Securities CCAs: FICC Netting Members c. Interdealer Brokers d. Other Market Participants i. Broker-Dealers That Are Not Direct Participants/FICC Netting Members ii. Hedge Funds, Family Offices, and Separately Managed Accounts iii. Registered Investment Companies (RICs) Including Money Market Funds, Other Mutual Funds, and ETFs iv. Principal Trading Firms (PTFs) v. State and Local Governments vi. Private Pensions Funds and Insurance Companies e. Triparty Agent: Bank of New York Mellon f. Custodian Banks/Fedwire Securities Service (FSS) C. Analysis of Benefits, Costs, and Impact on Efficiency, Competition, and Capital Formation 1. Benefits a. U.S. Treasury Securities CCA Membership Requirements i. Scope of the Requirement To Clear Eligible Secondary Market Transactions ii. Application of the Requirement To Clear Eligible Repo Transactions iii. Application of the Requirement To Clear Eligible Secondary Market Transactions to Purchases and Sales of U.S. Treasury Securities iv. Exclusions From the Requirement To Clear Eligible Secondary Market Transactions b. Other Changes to Covered Clearing Agency Standards i. Policies and Procedures Regarding Direct Participants’ Transactions ii. Netting and Margin Practices for House and Customer Accounts iii. Facilitating Access to U.S. Treasury Securities CCAs c. Amendments to Rules 15c3–3 and 15c3– 3a 2. Costs a. Costs to FICC and Its Members of the Requirement To Clear Eligible Secondary Market Transactions i. Costs Attendant to an Increase in CCLF ii. Costs of the Requirement To Clear Eligible Secondary Market Transactions in Terms of Increased Margining for Existing FICC Members iii. Other Costs b. Costs to Non-Members of a U.S Treasury Securities CCA as a Result of the Requirement To Clear Eligible Secondary Market Transactions c. Other Changes to Covered Clearing Agency Standards i. Netting and Margin Practices for House and Customer Accounts ii. Facilitating Access to U.S. Treasury Securities CCAs d. Amendments to Rules 15c3–3 and 15c3– 3a e. Other Costs 3. Effect on Efficiency, Competition, and Capital Formation a. Efficiency PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 2715 i. Price Transparency ii. Operational and Balance Sheet Efficiency b. Competition c. Capital Formation D. Reasonable Alternatives 1. Require U.S. Treasury Securities CCAs To Have Policies and Procedures Requiring Only IDB Clearing Members To Submit U.S. Treasury Securities Cash Trades With Non-Members for Central Clearing 2. Require U.S. Treasury Securities CCAs To Have Policies and Procedures Requiring the Submission of All Repurchase Agreements Without Requirements for the Submission of Cash Transactions 3. Include All Cash Transactions Within the Scope of Eligible Secondary Market Transactions With Exceptions for Central Banks, Sovereign Entities, International Financial Institutions, and Natural Persons 4. Require U.S. Treasury Securities CCAs To Change CCA Access Provisions and Netting and Margin Practices for House and Customer Accounts and Rule 15c3– 3 V. Paperwork Reduction Act A. Proposed Changes to Covered Clearing Agency Standards 1. Amendment to Rule 17ad–22(e)(6) 2. Amendment to Rule 17ad–22(e)(18)(iv) B. Broker-Dealers VI. Regulatory Flexibility Act A. Clearing Agencies B. Broker-Dealers C. Certification VII. Other Matters Statutory Authority I. Introduction The Commission is responsible for facilitating the establishment of a national system for the prompt and accurate clearance and settlement of securities transactions.2 This responsibility includes the authority to regulate clearing agencies engaged in the clearance and settlement of government securities transactions, including U.S. Treasury securities.3 This inclusion of government securities, including U.S. Treasury securities, within the Commission’s authority for the national system of clearance and settlement underscores the importance of, among other things, the U.S. Treasury market. U.S. Treasury securities play a critical and unique role in the U.S. and global economy, serving as a significant investment instrument and hedging vehicle for investors, a risk-free benchmark for other financial instruments, and an important mechanism for the Federal Reserve’s 2 See 15 U.S.C. 78q–1. Securities Act of 1986, section 102(a); 15 U.S.C. 78c(a)(12)(B)(i). 3 Government E:\FR\FM\16JAR2.SGM 16JAR2 2716 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 implementation of monetary policy.4 Consequently, confidence in the U.S. Treasury market, and in its ability to function efficiently, even in times of stress, is critical to the stability of the global financial system.5 CCPs provide an important role for securities markets, interposing themselves between the counterparties to securities transactions, acting functionally as the buyer to every seller and the seller to every buyer. The Commission regulates CCPs as covered clearing agencies (‘‘CCA’’).6 The Commission historically has acknowledged the benefits that a CCP brings to the markets it serves. By novating transactions (that is, becoming the counterparty to both sides of a transaction), a CCP addresses concerns about counterparty risk by substituting its own creditworthiness and liquidity for the creditworthiness and liquidity of the counterparties.7 Further, the Commission has recognized that ‘‘the centralization of clearance and settlement activities at covered clearing agencies allows market participants to reduce costs, increase operational efficiency, and manage risks more 4 See, e.g., Staffs of the U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission, Recent Disruptions and Potential Reforms in the U.S. Treasury Market: A Staff Progress Report, at 1 (Nov. 2021), available at https://home.treasury.gov/ system/files/136/IAWG-Treasury-Report.pdf (‘‘InterAgency Working Group for Treasury Market Surveillance (‘‘2021 IAWG Report’’); Staffs of the U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission, Joint Staff Report: The U.S. Treasury Market on October 15, 2014, at 1, 8 (2015), available at https://home.treasury.gov/ system/files/276/joint-staff-report-the-us-treasurymarket-on-10-15-2014.pdf (‘‘Joint Staff Report’’). These reports represent the views of Commission and other Federal regulatory staff. The reports are not a rule, regulation, or statement of the Commission. The Commission has neither approved nor disapproved the content in the reports. These reports, like all staff reports, have no legal force or effect: they do not alter or amend applicable law, and they create no new or additional obligations for any person. 5 Group of Thirty Working Group on Treasury Market Liquidity, U.S. Treasury Markets: Steps Toward Increased Resilience, at 1 (2021), available at https://group30.org/publications/detail/4950 (‘‘G–30 Report’’). 6 See Rule 17ad–22(a) (defining covered clearing agency and central counterparty) and Exchange Act Section 3(a)(23) (defining clearing agency). 7 See, e.g., Order Granting Temporary Exemptions Under the Securities Exchange Act of 1934 in Connection with Request of Liffe Administration and Management and Lch.Clearnet Ltd. Related to Central Clearing of Credit Default Swaps, and Request for Comments, Exchange Act Release No. 59164 (Dec. 24, 2008), 74 FR 139, 140 (Jan. 2, 2009) (‘‘Liffe Order’’). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 effectively.’’ 8 A CCP also provides a centralized system of default management that can mitigate the potential for a single market participant’s failure to destabilize other market participants or the financial system more broadly.9 However, the Commission has also recognized that this centralization of activity at clearing agencies makes risk management at such entities a critical function. Because of the importance of risk management at CCPs and to further the establishment of linked and coordinated facilities for clearance and settlement of securities transactions, in 2016, the Commission adopted the Covered Clearing Agency Standards.10 These standards address all aspects of a CCP’s operations, including financial risk management, operational risk, default management, governance, and participation requirements.11 The Commission has had the opportunity to administer this new regulatory framework, considering many rule filings with respect to proposed rule changes filed by CCAs pursuant to their rule filing obligations as self-regulatory organizations (‘‘SROs’’) under Section 19(b) of the Exchange Act that address how the proposed rule changes are consistent with the Exchange Act and the Covered Clearing Agency Standards thereunder. The Commission also has had the opportunity to observe the U.S. Treasury market, including with respect to the clearance and settlement of U.S. Treasury security transactions in both the cash and repo market. In particular, the Commission understands that the proportion of transactions that are centrally cleared has declined over the past years. One recent analysis by the Treasury Market Practice Group 12 estimates that only 13 percent of the overall volume in U.S. dollars of U.S. Treasury cash transactions were centrally cleared as of the first half of 2017, and that an additional 19 percent were what the TMPG refers to as 8 Covered Clearing Agency Standards Proposing Release, Exchange Act Release No. 71699 (Mar. 12, 2014), 79 FR 29507, 29587 (May 27, 2014) (‘‘CCA Standards Proposing Release’’). 9 See, e.g., Liffe Order, supra note 7, 74 FR 140. 10 See Covered Clearing Agency Standards Adopting Release, Exchange Act Release No. 78961 (Sept. 28, 2016), 81 FR 70786 (Oct. 13, 2016) (‘‘CCA Standards Adopting Release’’). 11 See generally id. 12 The Treasury Market Practices Group (‘‘TMPG’’) is a group of ‘‘market professionals committed to supporting the integrity and efficiency of the Treasury, agency debt, and agency mortgage-backed securities markets.’’ See Treasury Mark Practice Group, About the TMPG, available at https://www.newyorkfed.org/TMPG/. The TMPG is sponsored by the Federal Reserve Bank of New York. Id. PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 ‘‘hybrid’’ clearing, that is, executed on an interdealer broker platform (as discussed in parts II.A.1 and II.A.2.b.ii infra) in which one counterparty is a member of a CCA and submits its transaction with the interdealer broker for central clearing, while the other counterparty is not a member of a CCA and bilaterally clears its transaction with the interdealer broker.13 This use of both centrally cleared and not centrally cleared transactions introduces risk into the market, because bilateral clearing involves varying risk management practices that are less uniform and less transparent to the broader market and may be less efficient with regard to netting exposures and use of collateral as compared to central clearing. Therefore, the Commission proposed amendments to Rule 17ad–22(e)(18) to help reduce contagion risk to the CCA and bring the benefits of central clearing to more transactions involving U.S. Treasury securities, thereby lowering overall systemic risk in the market.14 Specifically, the Commission proposed amendments that would require CCAs for the U.S. Treasury market to establish, implement, maintain and enforce written policies and procedures reasonably designed to require that their direct participants submit for clearance and settlement certain eligible secondary market transactions, both for repos and certain categories of cash transactions. In addition, the Commission proposed amendments to address certain other issues that could help facilitate increased central clearing in the U.S. These proposed changes included amending Rule 17ad– 22(e)(6)(i) to require that a CCA establish, implement, maintain and 13 TMPG, White Paper on Clearing and Settlement in the Secondary Market for U.S. Treasury Securities, at 12 (July 2019), available at https:// www.newyorkfed.org/medialibrary/Microsites/ tmpg/files/CS_FinalPaper_071119.pdf (‘‘TMPG White Paper’’). These estimates use FR2004 data, which are reports provided to the Federal Reserve Bank of New York regarding primary dealer market activity in U.S. Government securities, covering the first half of 2017 and are based on various assumptions specified in the TMPG White Paper. See also FR2004, Government Securities Dealer Reports, available at https:// www.federalreserve.gov/apps/reportforms/ reportdetail.aspx?sOoYJ+5BzDZq2f74T6b1cw. 14 Proposing Release, Standards for Covered Clearing Agencies for U.S. Treasury Securities and Application of the Broker-Dealer Customer Protection Rule With Respect to U.S. Treasury Securities, Exchange Act Release No. 95763 (Sept. 14, 2022), 87 FR 64610 (Oct. 25, 2022) (‘‘Proposing Release’’). See also Report of the Joint TreasuryFederal Reserve Study of the U.S. Government Securities Market (Apr. 1969), available at https:// fraser.stlouisfed.org/title/joint-treasury-federalreserve-study-us-government-securities-market-318/ report-joint-treasury-federal-reserve-study-usgovernment-securities-market-6282. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations enforce written policies and procedures reasonably designed to calculate, collect, and hold proprietary margin separate from customer margin, amending Rule 17ad–22(e)(18) to require that CCAs establish, implement, maintain and enforce written policies and procedures reasonably designed to ensure that they have appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, and amending Rule 15c3–3 to permit margin required and on deposit at covered clearing agencies providing central counterparty services for U.S. Treasury securities to be included by broker-dealers as a debit in the customer and PAB reserve formulas. The Commission received many comments on the proposal.15 Having considered the comments received, the Commission is adopting the proposed new rules and rule amendments with modifications, as discussed further below. II. Discussion of Comments Received and Final Rules A. U.S. Treasury Securities CCA Membership Requirements ddrumheller on DSK120RN23PROD with RULES2 1. Requirement To Clear Eligible Secondary Market Transactions Proposed Rule 17ad–22(e)(18)(iv)(A) would require that U.S. Treasury securities CCAs establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, establish objective, riskbased, and publicly disclosed criteria for participation, which require that the direct participants of such covered clearing agency submit for clearance and settlement all of the eligible secondary market transactions to which they are a counterparty. The proposed amendment would apply to ‘‘direct participants’’ in a U.S. Treasury securities CCA, which distinguishes entities that access a CCA directly (i.e., members of the CCA) from indirect participants who ‘‘rely on the services provided by direct participants to access the covered clearing agency’s payment, clearing or settlement facilities.’’ 16 For purposes of the Covered Clearing Agency Standards, ‘‘participants’’ of a 15 Copies of all comment letters received by the Commission are available at https://www.sec.gov/ comments/s7-23-22/s72322.htm. 16 17 CFR 240.17ad–22(e)(19). See also CCA Standards Proposing Release, supra note 8, at 29553 (noting that some market participants would not meet a covered clearing agency’s direct participation requirements and proposing risk management requirements for indirect and tiered participants). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 CCA are referred to as ‘‘members’’ or ‘‘direct participants’’ to differentiate these entities from ‘‘direct participants’ customers’’ or ‘‘indirect participants.’’ 17 Consequently, for purposes of this amendment and consistent with the terminology already used in the Covered Clearing Agency Standards,18 the term ‘‘direct participants’’ refers to the entities that directly access a U.S. Treasury securities CCA (generally banks and broker-dealers), and the term ‘‘indirect participants’’ would refer to those entities which rely on a direct participant to clear and settle their U.S. Treasury securities transactions with the U.S. Treasury securities CCA (generally their customers or clients, which typically include market participants such as money market funds, hedge funds, other asset managers, and smaller banks or broker-dealers).19 Moreover, persons who provide services in connection with clearance and settlement, such as settlement agent, settlement bank, or clearing bank services, and do not submit trades for clearing to a U.S. Treasury securities CCA would not be ‘‘direct participants’’ or ‘‘indirect participants’’ within the meaning of this amendment and the terminology used in the Covered Clearing Agency Standards.20 17 See, e.g., 17 CFR 240.17ad–22(e)(6) (referring to participants) and (e)(2)(vi) (referring to direct participants’ customers). In addition, the Exchange Act defines a participant of a clearing agency as ‘‘any person who uses a clearing agency to clear or settle securities transactions or to transfer, pledge, lend, or hypothecate securities.’’ 15 U.S.C. 78c(a)(24). Indirect participants are expressly excluded from the Exchange Act definition of a ‘‘participant’’ of a clearing agency because the Exchange Act provides that a person whose only use of a clearing agency is through another person who is a participant or as a pledgee of securities is not a ‘‘participant’’ of the clearing agency. Id. 18 See 17 CFR 240.17ad–22(e)(19) (referring to firms that are indirect participants in a covered clearing agency as those that ‘‘rely on the services provided by direct participants to access the covered clearing agency’s payment, clearing, or settlement facilities’’). 19 For example, FICC maintains the Sponsored Service. See Fixed Income Clearing Corporation, Government Securities Division Rulebook, Rule 3A, available at https://www.dtcc.com/∼/media/Files/ Downloads/legal/rules/ficc_gov_rules.pdf (‘‘FICC Rule’’). Because sponsored members cannot clear or settle government securities transactions without a sponsoring member, the Commission believes that these sponsored members are not ‘‘direct participants.’’ As noted above, such persons are referred to in this release as ‘‘indirect participants’’ or ‘‘customers.’’ 20 The Commission recognizes that some entities may access more limited services of a U.S. Treasury securities CCA without use of its CCP services. For example, FICC provides ‘‘comparison only’’ services for a certain membership type. See FICC Rule 8, supra note 19. Consistent with the definition of a ‘‘participant’’ under the Exchange Act, such entities would not be considered participants of a CCA and therefore would not be subject to any rules with respect to the clearing of PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 2717 In the Proposing Release, the Commission stated that it believes that the requirement to clear eligible secondary market transactions would promote the prompt and accurate clearance and settlement of U.S. Treasury securities transactions, providing several benefits to the market for U.S. Treasury securities as a whole,21 which are summarized briefly here. First, the Commission stated that it believes that the requirement to clear eligible secondary market transactions would decrease the overall amount of counterparty credit risk in the secondary market for U.S. Treasury securities. Because a U.S. Treasury securities CCA would novate and guarantee each transaction submitted for central clearing, it would become a counterparty to each transaction, as the buyer to every seller and the seller to every buyer. The U.S. Treasury securities CCA would be able to risk manage these transactions centrally, pursuant to risk management procedures that the Commission has reviewed and approved,22 and would guarantee settlement of the trade in the event of a direct participant default. In particular, the requirement to clear eligible secondary market transactions is designed to reduce the amount of ‘‘contagion risk’’ to a U.S. Treasury securities CCA arising from what has been described as ‘‘hybrid clearing,’’ as discussed in more detail in part II.A.2.b.iii. With this type of clearing, a direct participant’s transactions that are not submitted for central clearing pose an indirect risk to the covered clearing agency, as any default on a bilaterally settled transaction could impact the direct participant’s financial resources and ability to meet its obligations to the covered clearing agency. The Commission stated that it believes that requiring U.S. Treasury securities CCAs to impose, as a condition of membership, an obligation on their direct participants to submit all eligible secondary market transactions for central clearing should address the transactions most likely to cause contagion risk to the CCA. Second, the Commission stated that it believes that the requirement to clear eligible secondary market transactions would also help any U.S. Treasury securities CCA to avoid a potential disorderly member default. Defaults in bilaterally settled transactions are likely eligible secondary market transactions that a CCA may adopt for its direct participants. 21 See generally Proposing Release, supra note 14, 87 FR 64626–29; see also part IV.C.1 infra. 22 See Section 19(b) of the Exchange Act and Rule 19b–4 thereunder. E:\FR\FM\16JAR2.SGM 16JAR2 2718 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 to be less orderly and subject to variable default management techniques because bilaterally settled transactions are not subject to the default management processes that are required to be in place and publicly disclosed at a CCP.23 Centralized default management is a key feature of central clearing.24 Because the CCP has novated and guaranteed the transactions, it is uniquely positioned to coordinate the default of a member for trades that it has centrally cleared, and the non-defaulting members can rely on the CCP to complete the transactions of the defaulting member and cover any resulting losses using the defaulting member’s resources and/or its default management tools. Even in a situation where two CCPs have to coordinate the default of a joint member, that coordination should result in more efficiency and market confidence than multiple bilateral settlements. Third, the Commission stated that it believes that the requirement to clear eligible secondary market transactions will further the prompt and accurate clearance and settlement of U.S. Treasury securities by increasing the multilateral netting of transactions in these instruments, thereby reducing operational and liquidity risks, among others. Central clearing of transactions nets down gross exposures across participants, which reduces firms’ exposures while positions are open and reduces the magnitude of cash and securities flows required at settlement.25 As the Commission stated in the Proposing Release, FICC’s failure to receive all eligible trading activity of an active market participant reduces the value of its vital multilateral netting process and causes FICC to be less wellsituated to prevent future market crises.26 23 A covered clearing agency, including a U.S. Treasury securities CCA, is required to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure the CCA has the authority and operational capacity to contain losses and liquidity demands and continue to meet its obligations, which must be tested annually, and publicly disclose all relevant rules and material procedures, including key aspects of its default rules and procedures. See Rule 17ad–22(e)(13) and (e)(23)(i). 24 CCA Standards Proposing Release, supra note 8, 79 FR 29545 (a CCP’s default management procedures would provide certainty and predictability about the measures available to a covered clearing agency in the event of a default which would, in turn facilitate the orderly handling of member defaults and would enable members to understand their obligations to the covered clearing agency in extreme circumstances). 25 2021 IAWG Report, supra note 4, at 30. 26 Proposing Release, supra note 14, 87 FR 64628 & n. 182 (citing Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Granting Approval of a Proposed Rule Change Relating to Trade Submission Requirements and Pre-Netting, VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 The benefits of multilateral netting flowing from central clearing can improve market safety by lowering exposure to settlement failures, which would also tend to promote the prompt and accurate clearance and settlement of U.S. Treasury securities transactions.27 Multilateral netting can also reduce the amount of balance sheet required for intermediation and could also enhance dealer capacity to make markets during normal times and stress events because existing bank capital and leverage requirements recognize the riskreducing effects of multilateral netting of trades that CCP clearing accomplishes.28 Fourth, the Commission stated that the potential benefits associated with the multilateral netting of transactions at a CCP that the requirement to clear eligible secondary market transactions is designed to bring about could, in turn, help to unlock further improvements in U.S. Treasury market structure. For example, the increase in clearing and consequent reduction in counterparty credit risk could ‘‘enhance the ability of smaller bank and independent dealers to compete with the incumbent bank dealers.’’ 29 Similarly, decreased counterparty credit risk—and potentially lower costs for intermediation—could result in narrower spreads, thereby enhancing market quality.30 The Commission also stated that increased accessibility of central clearing in U.S. Treasury markets could support movement toward all-to-all trading, even potentially in the repo market, which would further improve market structure and resiliency, although a movement in that direction is not assured.31 This Exchange Act Release No. 51908 (June 22, 2005), 70 FR 37450 (June 29, 2005) (describing a rule designed to bring additional transactions into FICC’s netting system as ‘‘clearly designed to promote the prompt and accurate clearance and settlement of those transactions and to preserve the safety and soundness of the national clearance and settlement system.’’)). 27 Darrell Duffie, Still the World’s Safe Haven Redesigning the U.S. Treasury Market After the COVID–19 Crisis, Hutchins Center Working Paper # 62 (Brookings Inst.) at 15 (June 2020), available at https://www.brookings.edu/wp-content/uploads/ 2020/05/WP62_Duffie_v2.pdf (‘‘Duffie’’). 28 2021 IAWG Report, supra note 4, at 30; Nellie Liang & Patrick Parkinson, Enhancing Liquidity of the U.S. Treasury Market Under Stress, at 9 (Dec. 16, 2020), available at https://www.brookings.edu/ wp-content/uploads/2020/12/WP72_LiangParkinson.pdf (‘‘Liang & Parkinson’’); Duffie, supra note 27, at 16–17. 29 Liang & Parkinson, supra note 28, at 9. 30 G–30 Report, supra note 5, at 13. 31 2021 IAWG Report, supra note 4, at 30; Duffie, supra note 27, at 16; G–30 Report, supra note 5, at 13. All-to-all trading would be characterized by the ability for a bid or offer submitted by one market participant to be accepted by any other market participant, with trades executed at the best bid or PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 potential movement would stem from the fact that increased central clearing of U.S. Treasury securities transactions would, in turn, result in decreased counterparty risk, making all-to-all trading more attractive, that is, a market participant would be more willing to trade with any counterparty if a CCP were to serve as its ultimate counterparty. Finally, the Commission stated that increased central clearing should enhance regulatory visibility in the critically important U.S. Treasury market. Specifically, central clearing increases the transparency of settlement risk to regulators and market participants, and in particular allows a CCP to identify concentrated positions and crowded trades, adjusting margin requirements accordingly, which should help reduce significant risk to the CCP and to the system as a whole.32 In light of the role of U.S. Treasury securities in financing the Federal Government, it is important that regulators improve their visibility into this market. Increased central clearing would also allow for a more aggregated view of market activity in one place. a. Comments Regarding the Requirement To Clear Eligible Secondary Market Transactions Some commenters generally supported the proposal and its approach to requiring additional central clearing of transactions in U.S. Treasury securities.33 However, other commenters generally opposed the proposed requirement to clear eligible offer. See, e.g., Liang & Parkinson, supra note 28, at 9. All-to-all trading could improve the quality of trade execution in normal market conditions and broaden and stabilize the supply of market liquidity under stress. See, e.g., G–30 Report, supra note 5, at 10. 32 Duffie, supra note 27, at 15;2021 IAWG Report, supra note 4, at 30 (centralization of transactions at a CCP ‘‘can simplify data collection and improve visibility into market conditions for the authorities and, to some degree, for market participants’’). 33 See generally Letter from Americans for Financial Reform Education Fund (Dec. 27, 2022) (‘‘AFREF Letter’’); Letter from Stephen W. Hall, Legal Director and Securities Specialist, and Scott Farnin, Legal Counsel, Better Markets, Inc. (Dec. 23, 2022) (‘‘Better Markets Letter’’); Letter from Murray Pozmanter, Managing Director, President of DTCC Clearing Agency Services, Head of Global Business Operations, and Laura Klimpel, General Manager of FICC, Head of SIFMU Business Development, Depository Trust and Clearing Corporation and Fixed Income Clearing Corporation (Dec. 27, 2022) (‘‘DTCC/FICC Letter’’); Letter from Robin Vince, President and Chief Executive Officer, The Bank of New York Mellon Corporation (Dec. 22, 2022) (‘‘BNY Mellon Letter’’); Letter from Rachel Goldberg, Head of Government Relations and Regulatory Strategy, Americas, London Stock Exchange Group (Dec. 27, 2022) (‘‘LSEG Letter’’); Letter from Chris Edmonds, Chief Development Officer, Intercontinental Exchange, Inc. (Jan. 12, 2023) (‘‘ICE Letter’’). E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 secondary market transactions, arguing that there was not sufficient information on the costs and benefits of such a requirement, that the Commission should do further study, and/or that the Commission should incentivize additional clearing instead of requiring it.34 One commenter also referenced the need to assess the potential impact of an increased volume of cleared repo transactions on the Secured Overnight Financing Rate (‘‘SOFR’’), given its importance as a reference rate replacing LIBOR and because SOFR is calculated largely based on implied financing rates of repo transactions cleared at FICC.35 SOFR is calculated as a volumeweighted median, which is the rate associated with transactions at the 50th percentile of transaction volume.36 Specifically, the volume-weighted median rate is calculated by ordering the transactions from lowest to highest rate, taking the cumulative sum of volumes of these transactions, and identifying the rate associated with the trades at the 50th percentile of dollar volume. Such volume weighting should allow preparation of the rate to take into account any increased transaction volume arising from additional central clearing in response to a requirement to clear eligible secondary market transactions, thereby making further study unnecessary. With respect to costs and benefits, one commenter stated that the increased costs of centrally clearing U.S. Treasury security transactions may reduce liquidity and diversity in the Treasury market if firms reduce activity, leave the market, or if barriers to entry are too high, given the significant costs of clearing for market participants.37 The commenter identified several types of costs, including initial margin requirements, clearing fees, obligations with respect to FICC’s Capped Contingent Liquidity Facility (‘‘CCLF’’), the operational build necessary to 34 The Commission discusses the comments on incentives in its discussion of alternative approaches to a clearing requirement in part II.A.5 infra. 35 Letter from William C. Thum, Managing Director and Assistant General Counsel, Securities Industry and Financial Markets Association (‘‘SIFMA’’) Asset Management Group, at 7 (Dec. 23, 2022) (‘‘SIFMA AMG Letter’’). 36 Additional Information about Reference Rates Administered by the New York Fed, available at https://www.newyorkfed.org/markets/referencerates/additional-information-about-referencerates#tgcr_bgcr_sofr_calculation_methodology. 37 Letter from Robert Toomey, Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association, and Michelle Meertens, Deputy General Counsel, Institute of International Bankers, at 8 (Dec. 22, 2022) (‘‘SIFMA/IIB Letter’’). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 access central clearing either as a direct or indirect participant, and legal costs and time associated with onboarding customers for indirect central clearing, including, e.g., the need for Sponsoring Members to file UCC financing statements with respect to Sponsored Members under the Sponsored Member program. The commenter stated that the impact of these costs would be disproportionately felt by small and mid-sized participants in the U.S. Treasury market, and that these costs would reduce diversity in the market and further increase concentration among market participants (which may increase systemic risk) if such participants leave the market.38 As discussed in more detail in part IV.C.2, increased transaction costs will generally reduce the expected return of a particular investment. If the amendments regarding eligible secondary market transactions resulted only in such increased costs, then the potential risk/return tradeoff would worsen, resulting in decreased transaction volumes and decreased liquidity. However, central clearing provides other benefits, including those described in part IV.C.1, many of which could accrue to small and mid-sized market participants. Moreover, increased cost does not necessarily mean that firms will reduce activity or leave the market. The commenter also stated that these costs may incentivize non-direct participants of a U.S. Treasury securities CCA to look for ways to trade away from direct participants in order to not have to centrally clear U.S. Treasury transactions, undermining the policy goals of the proposal.39 The Commission acknowledges that the proposed requirement for U.S. Treasury securities CCAs to require their members to submit eligible secondary market transactions for clearing and settlement does not limit the ability of market participants to transact in U.S. Treasury securities transactions away from CCAs. This requirement is not a mandate to clear all transactions in U.S. Treasury securities, regardless of who executes the transaction, and differs from the swaps mandate imposed by Congress in the Dodd-Frank Act in 2010.40 However, given current market structure and requirements applicable to certain market participants, it would be challenging for market participants to simply shift all their activity to transact away from CCAs. For example, primary dealers, which serve as trading 38 SIFMA/IIB Letter, supra note 37, at 8. Letter, supra note 37, at 8. 40 Dodd-Frank Act section 723; 15 U.S.C. 3C(a). 39 SIFMA/IIB PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 2719 counterparties of the New York Fed in its implementation of monetary policy, are required to maintain a substantial presence as a market maker that provides two-way liquidity in U.S. government securities, particularly Treasury cash and repo operations.41 These primary dealers must be participants in FICC, as the CCP for the government securities market, to support clearing of primary market transactions.42 Therefore, if a market participant wants to transact with a primary dealer which is required to be a direct participant of FICC, it would have to determine an appropriate way to submit such transactions for clearing and settlement. Primary dealers are responsible for a significant portion of market activity in the U.S. Treasury market (see part IV.B infra), and therefore, market participants likely would continue to transact with such primary dealers. In addition, the commenter stated that central clearing can have procyclical effects in times of market stress due to the margin requirements of clearing agencies, further reducing liquidity when it is most needed.43 The commenter stated that, depending on the applicable margin models, clearing can be procyclical in times of market turmoil, as increased margin requirements (including intraday and ad hoc calls) drive demand for liquid assets, which, in turn, increases the scarcity of those assets and further drives market stress. The commenter described FICC’s rules as allowing FICC to demand, at any time in its discretion, additional margin from its members in times of market volatility, including through intraday calls, to safeguard the clearing infrastructure.44 The commenter suggested that the Commission should engage in additional study on the procyclical effects of central clearing before implementing a central clearing requirement, focusing on the appropriate balance from a systemic risk perspective of rigorously managing the risk of positions cleared through a CCP as compared to minimizing liquidity strains on the U.S. Treasury market.45 The Commission acknowledges that, in times of market stress, margin calls 41 See Primary Dealers, available at https:// www.newyorkfed.org/markets/primarydealers (‘‘In order to be eligible as a primary dealer, a firm must . . . Be a participant in the central counterparty service for the government securities market— DTCC’s FICC–GSD—to support clearing of primary market transactions.’’). 42 Id. 43 SIFMA/IIB Letter, supra note 37, at 9. 44 SIFMA/IIB Letter, supra note 37, at 9. 45 SIFMA/IIB Letter, supra note 37, at 9. E:\FR\FM\16JAR2.SGM 16JAR2 2720 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations may increase to address the ongoing market volatility. This is by design, as margin models are built to be responsive to current market conditions. The Commission has specifically required that CCAs have the authority and operational capacity to make intraday margin calls in defined circumstances.46 This ability is important to the CCA’s ability to manage the risk and cover the credit exposures that its participants may bring to the CCA. When considering a CCA’s authority with respect to intraday margin, the Commission may consider its potential procyclicality.47 In addition, the Commission may consider the transparency of the margin model, such that market participants can understand when the CCA may make margin calls.48 In addition to the FICC rules cited by the commenter, FICC has provided additional transparency regarding how it determines the need for intraday margin calls, including the specific criteria that it uses to assess the need.49 46 17 CFR 240.17ad–22(e)(6)(ii). e.g., Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Approving a Proposed Rule Change to Modify the Calculation of the MBSD VaR Floor to Incorporate a Minimum Margin Amount, Exchange Act Release No. 92303, at 32 (June 30, 2021) (discussing commenter’s concern regarding potential procyclical nature of a margin methodology change); Self-Regulatory Organizations; The Options Clearing Corporation; Order Granting Approval of Proposed Rule Change Concerning The Options Clearing Corporation’s Margin Methodology for Incorporating Variations in Implied Volatility, Exchange Act Release No. 95319, at 3 (July 19, 2022) (referencing the impact of a change to margin methodology on procyclicality of margin). 48 See, e.g., Self-Regulatory Organizations; National Securities Clearing Corporation; Order Approving a Proposed Rule Change to Enhance National Securities Clearing Corporation’s HaircutBased Volatility Charge Applicable to Illiquid Securities and UITs and Make Certain Other Changes to Procedure XV, Exchange Act Release No. 34–90502, at 56–59 (Nov. 24, 2020) (discussing commenter’s concerns regarding transparency of change to margin methodology). 49 See Self-Regulatory Organizations; Fixed Income Clearing Corporation; Notice of Filing of Proposed Rule Changes to the Required Fund Deposit Calculation in the Government Securities Division Rulebook, Exchange Act Release No. 82588 (Jan. 26, 2018) (identifying the following specific parameter breaks: (i) a dollar threshold that evaluates whether a Netting Member’s Intraday VaR Charge equals or exceeds a set dollar amount (then set at $1,000,000) when compared to the VaR Charge that was included in the most recently collected Required Fund Deposit including, any subsequently collected Intraday Supplemental Fund Deposit; (ii) a percentage threshold, that evaluates whether the Intraday VaR Charge equals or exceeds a percentage increase (then set at 100%) of the VaR Charge that was included in the most recently collected Required Fund Deposit including, if applicable, any subsequently collected Intraday Supplemental Fund Deposit; (iii) the coverage target, that evaluates whether a Netting Member is experiencing backtesting results below the 99% confidence level). FICC has updated this information via Important Notices to its ddrumheller on DSK120RN23PROD with RULES2 47 See, VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 FICC is also subject to Rule 17ad– 22(e)(23), which requires certain levels of public disclosure regarding FICC’s margin methodology and the costs of participating in FICC, as discussed further in part II.B.2 infra. The Commission’s ongoing consideration of the role and function of intraday margin calls, as well as market participants’ ability to understand such calls, obviates the need for separate study in connection with this proposal.50 b. Comments Regarding the Concentration of Risk in One Covered Clearing Agency Commenters also mentioned the potential concentration risk that would arise as a result of the requirement to clear eligible secondary market transactions, specifically because only one covered clearing agency currently provides such services. One commenter stated that concentrating such significant levels of settlement, operational, liquidity and credit risk in one institution means that were there operational or liquidity stress at FICC, widespread dysfunction in the Treasury markets could result.51 Another commenter which analyzed market views of the proposal identified increased concentration risk as a primary concern for market participants, who cited potential technical issues at FICC that would result in a ‘‘pause [of] counterparty trade transactions and lead to substantial losses for market participants.’’ However, the commenter also acknowledged that a smaller group of market participants explained that they were not opposed to a single clearinghouse model through FICC, stating that FICC has adequate risk models and that the concentration in one CCP is not of concern in the futures or derivatives markets, which, like FICC, also only have one CCP to serve their respective markets.52 In addition, one commenter stated that the Commission should only participants. See, e.g., Important Notice GOV1244– 22, GSD Intraday Supplemental Fund Deposit Parameter Change (Apr. 11, 2022), available at https://www.dtcc.com/-/media/Files/pdf/2022/4/ 11/GOV1244-22.pdf (raising the coverage target). 50 See also Proposed Rule, Covered Clearing Agency Resilience and Recovery and Wind-Down Plans, Exchange Act Release No. 97516 (May 17, 2023), 88 FR 34708 (May 30, 2023) (proposing additional requirements with respect to intraday margin that CCAs require intraday monitoring of their exposures and specifying particular circumstances in which the CCA should make intraday margin calls). 51 SIFMA/IIB Letter, supra note 37, at 10. 52 Comment Submission from SIA Partners, entitled CENTRAL CLEARING OF U.S. TREASURIES & REPO, A Study on the Impact to the Market and Market Participants, at 79–80 (Mar. 2023) (‘‘SIA Partners Comment’’); see also id. at 8. PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 impose a clearing mandate once FICC and at least a second covered clearing agency are able to offer access to clearing solutions that will fulfill the enhanced rule requirements and meet the needs of market participants.53 The commenter noted that the existence of one covered clearing agency serving the U.S. Treasury market is highly problematic as it creates enormous concentration risk for market participants, and highlighted that, given the importance of the U.S. Treasury market to the overall global economy, there needs to be a compelling reason for increasing the concentration of cleared trading activity in a single clearing house that is member owned and operated on a for-profit basis, particularly when there is no alternative or fallback venue should the clearing house experience a disruption to its operations or more significantly were it to fail.54 The Commission acknowledges that, currently, there is only one U.S. Treasury securities CCA, FICC, and that this does create concentration risk for the clearing of U.S. Treasury securities transactions. However, this concentration risk is mitigated by the existence of a supervisory framework for the existing U.S. Treasury securities CCA, and it is not uncommon for one CCA to serve a particular market.55 The Commission therefore disagrees with the commenter that the existence of two CCAs is necessary for this requirement to be implemented. Moreover, the Commission is not requiring that the additional central clearing of U.S. Treasury securities transactions be concentrated in one clearing house. But, if that remains the case going forward, the benefits expected to arise from this additional clearing, as discussed further in part IV.C.1 infra, constitute a sufficient compelling reason to adopt the final rule, even if such concentration is present, which, as discussed, is subject to the appropriate mitigation of risk arising from the regulatory framework applicable to CCAs as discussed in this section. FICC has been designated by the Financial Stability Oversight Council as systemically important under Title VIII of the Dodd-Frank Act. This designation means that FICC is subject to heightened supervision and examination by the Commission, in consultation with the Board of Governors of the Federal Reserve System (‘‘Board of Governors’’. 53 SIFMA/AMG Letter, supra note 37, at 3, 9. Letter, supra note 37, at 9. 55 For example, there is only one CCA in the U.S. equities market and in the U.S. listed derivatives market. 54 SIFMA/AMG E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations FICC is subject to the Covered Clearing Agency Standards, which address the various types of risk that FICC faces as a CCP, including settlement, operational, liquidity, and credit risk. A CCA must be able to meet the requirements of the Covered Clearing Agency Standards regardless of the presence or absence of other CCAs. The Covered Clearing Agency Standards specifically address a CCA’s obligations in 23 specific areas, many of which directly relate to the CCA’s ability to manage the risks presented to it as a CCA. For example, a CCA must have policies and procedures in place to effectively identify, measure, monitor, and manage its credit exposures to participants and those arising from its payment, clearing, and settlement processes, including by, among other things, maintaining sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence and maintain additional financial resources to enable it to cover a wide range of foreseeable stress scenarios, including the default of the largest or two largest participant families (depending on the nature of the CCA’s activities). A CCA also must have policies and procedures in place to effectively measure, monitor, and manage the liquidity risk that arises in or is borne by the CCA, including measuring, monitoring, and managing its settlement and funding flows on an ongoing and timely basis, and its use of intraday liquidity, by, among other things, holding qualifying liquid resources in an amount sufficient to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under a wide range of foreseeable stress scenarios that includes, but is not limited to, the default of the largest participant family in extreme but plausible market conditions. With respect to both its credit and liquidity resources, the CCA is required to, among other things, test the sufficiency of such resources at least once each day using standard and predetermined parameters and assumptions, conduct a comprehensive analysis on at least a monthly basis of the existing scenarios, models, and underlying parameters and assumptions used to ensure that they are appropriate for determining the CCA’s needs and resources in light of current and evolving market conditions, and to perform a model validation of the models used for such testing at least annually.56 56 17 CFR 240.17ad–22(e)(4)(vi) and (vii) and (e)(7)(vi) and (vii). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 In addition, a CCA is required 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 and among other things, 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, and is monitored by management on an ongoing basis and is regularly reviewed, tested, and verified by conducting backtests of its margin model at least once each day using standard predetermined parameters and assumptions and conducting a sensitivity analysis of its margin model and a review of its parameters and assumptions for backtesting on at least a monthly basis, among other things.57 A CCA also is required to have policies and procedures reasonably designed to establish objective, risk-based, and publicly disclosed criteria for participation, which permit fair and open access by direct and, where relevant, indirect participants and other financial market utilities, require participants to have sufficient financial resources and robust operational capacity to meet obligations arising from participation in the clearing agency, and monitor compliance with such participation requirements on an ongoing basis; and identify, monitor, and manage the material risks to the CCA arising from arrangements in which firms that are indirect participants in the CCA rely on the services provided by direct participants to access the CCA’s payment, clearing, or settlement facilities.58 These requirements should ensure that a CCA is able to accommodate the market needs for its clearance and settlement activity and that a CCA can appropriately risk manage the activity that its participants submit for clearing and settlement, which should, in turn, mitigate the potential concentration risk arising from the existence of only one CCA for a particular asset class. Further, regarding the comments raising concerns about potential operational or technical issues at a single CCA, the Covered Clearing Agency Standards include Rule 17ad– 22(e)(17), which requires written policies and procedures reasonably designed to manage the covered clearing agency’s operational risks by (i) identifying the plausible sources of operational risk, both internal and 57 17 58 17 PO 00000 CFR 240.17ad–22(e)(6). CFR 240.17ad–22(e)(18) and (19). Frm 00009 Fmt 4701 Sfmt 4700 2721 external, and mitigating their impact through the use of appropriate systems, policies, procedures, and controls; (ii) ensuring that systems have a high degree of security, resiliency, operational reliability, and adequate, scalable capacity; and (iii) establishing and maintaining a business continuity plan that addresses events posing a significant risk of disrupting operations.59 In addition, CCAs, as registered clearing agencies, are subject to the requirements of Regulation Systems Compliance Integrity (‘‘Regulation SCI’’). Regulation SCI is designed to strengthen the infrastructure of the U.S. securities markets, reduce the occurrence of systems issues in those markets, improve their resiliency when technological issues arise, and implement an updated and formalized regulatory framework, thereby helping to ensure more effective Commission oversight of such systems.60 As entities subject to Regulation SCI, CCAs are required to have written policies and procedures reasonably designed to ensure that their key automated systems have levels of capacity, integrity, resiliency, availability, and security adequate to maintain their operational capability and promote the maintenance of fair and orderly markets, and that such systems operate in accordance with the Exchange Act and the rules and regulations thereunder and the entities’ rules and governing documents, as applicable.61 These requirements should work to mitigate the possibility that a CCA would experience an interruption to its operations. In the event that a CCA were to fail, it is required to have policies and procedures to establish a recovery and wind-down plan to address that situation.62 FICC also must meet its obligations under both Section 19(b) of the Exchange Act, as a self-regulatory organization, and Title VIII of the DoddFrank Act. This means that the Commission has the opportunity to review any proposed rule changes and imposes specific additional filing obligations for an entity designated as systemically important under Title VIII 59 17 CFR 240.17ad–22(e)(17). Exchange Act Release No. 73639 (Nov. 19, 2014), 79 FR 72252, 72253, 72256 (Dec. 5, 2014). 61 See 17 CFR 242.1001. 62 17 CFR 240.17ad–22(e)(3)(ii). In the event of a wind-down in which the result is that the U.S. Treasury securities CCA no longer exists, Rule 17ad–22(e)(18)(iv) would not apply, as there would be no CCA to impose such membership requirements. The requirement to clear eligible secondary market transactions arises under the CCA’s rules and is not a mandate to clear based on the nature of the security. 60 Securities E:\FR\FM\16JAR2.SGM 16JAR2 2722 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations of the Dodd-Frank Act to provide advance notice to the Commission, which must consult with the Board of Governors, of any change to the entity’s procedures that may materially alter the nature or level of risk presented.63 This overall supervisory framework, including the Covered Clearing Agency Standards, should help ensure that FICC continues to be subject to robust supervision and oversight and to be able to manage the risks presented to it, even those arising from increased Treasury clearing. In light of the robust regulatory framework applicable to CCAs, the fact that only one CCA serves the market should not preclude the imposition of a requirement to clear eligible secondary market transactions. Further, the Commission is not persuaded that the ownership or organizational structure of the present U.S. Treasury securities CCA has an effect on its ability to serve the market. The Commission has not imposed particular requirements for the ownership or corporate structure of CCAs, and CCAs currently exhibit a variety of ownership and corporate structures. For example, FICC is wholly owned by the Depository Trust & Clearing Corporation (‘‘DTCC’’), which is, in turn, owned by the members of the clearing agencies owned by the DTCC.64 FICC operates on a cost plus low-margin model, meaning that its fees are costbased plus a markup as approved by the Board or management and that this markup or ‘‘low margin’’ is applied to recover development costs and operating expenses and to accumulate capital sufficient to meet regulatory and economic requirements.65 Nevertheless, a CCA’s status as a for-profit organization does not preclude its ability to meet its requirements under the Covered Clearing Agency Standards. An additional commenter stated its belief that relinquishing control of 63 12 U.S.C. 5465(e); 17 CFR 240.19b–4. members of such clearing agencies are required to purchase common shares under DTCC’s Shareholders Agreement as a condition to use the clearing agencies’ services and facilities. See, e.g., FICC Rule 49, section 2, supra note 19. This differs from other clearing agencies or clearing organizations in which the shareholders are not limited to the participants of the clearing agency and the clearing agency may be owned by a publicly traded company. 65 See, e.g., Self-Regulatory Organizations; Fixed Income Clearing Corporation; Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Amend Certain MBSD Fees, Exchange Act Release No. 96575 (Dec. 22, 2022). In addition, because FICC is member-owned, members may receive rebates when FICC collects excess net income, which is defined as either income of FICC or one business line of FICC after application of expenses, capitalization costs, and applicable regulatory requirements. See FICC Rules, Fee Structure, Section XII, supra note 19. ddrumheller on DSK120RN23PROD with RULES2 64 The VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 credit approval to a single entity poses a significant problem, particularly, with all transactions going through FICC and where margin requirements can be changed at any time. The commenter stated that every firm has a different risk appetite and quantitative and qualitative perspectives as it relates to credit analysis, which are part of the professional services and expertise that well-run firms offer, and that by inserting FICC into the center of the credit approval process, firms lose their ability to apply their deeply informed market views and differentiate themselves from competitors.66 The Commission disagrees that the requirement to clear eligible secondary market transactions, which currently can be done only at FICC, will remove firms’ ability to differentiate themselves from their competitors. FICC has no role in the relationship between a direct participant and the direct participant’s customers, and, indeed, the Exchange Act provides that its rules cannot impose any schedule of prices, or fix rates or other fees, for its participants’ services.67 FICC’s direct participants will remain free to determine what services they will offer to their customers, and at what price, thereby providing the ability for the direct participants to differentiate themselves from their competitors. The Commission also disagrees that margin requirements at FICC can change at any time. FICC’s margin methodology is part of its rules that have been approved by the Commission, and changes to that methodology must be filed with and reviewed by the Commission because of FICC’s status as a self-regulatory organization. The margin methodology, which is part of FICC’s approved rules, does provide some flexibility to FICC to manage risk, and potentially increase margin requirements, in times of market volatility and to guard against exposure to the CCP, but this flexibility is not equivalent to FICC being able to alter its margin requirements at any time. Pursuant to the Commission’s rules, FICC would be obligated to file for Commission review any proposed change to its margin methodology and to file an advance notice of any proposed change to its rules in the event that the change would materially alter the nature or level of risk presented by the CCA, with both of these processes 66 Letter from the Independent Dealer & Trader Association, at 9 (Dec. 27, 2022) (‘‘IDTA Letter’’). 67 15 U.S.C. 78q–1(b)(3)(E). PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 involving notice and the opportunity for public comment.68 Finally, one commenter also stated that any final rule should expressly acknowledge the potential for multiple U.S. Treasury securities CCAs and prohibit a clearing agency’s rules from restricting or impeding in any way their members’ ability to clear U.S. Treasury securities cash or repo transactions at another CCA.69 Such clarification is unnecessary. The requirements being adopted apply to any U.S. Treasury securities CCA and do not rely on the existence of only one U.S. Treasury securities CCA. The Commission acknowledges that there is the potential for multiple clearing agencies serving the U.S. Treasury market under its regulatory framework, and that the existence of additional U.S. Treasury securities CCAs would lower the concentration risk that currently exists due to having a single CCA for that market. Moreover, a rule prohibiting a clearing agency from restricting or impeding in any way its member’s ability to clear at another CCA is also unnecessary because to be registered under Section 17A of the Exchange Act, a clearing agency’s rules must not impose any burden on competition not necessary or appropriate in furtherance of the purposes of Section 17A.70 c. Final Rule For the reasons discussed in parts II.A.1.a and b supra, the Commission is adopting Rule 17ad–22(e)(18)(iv) as proposed.71 This requirement applies to all types of transactions that are of a type currently accepted for clearing at a U.S. Treasury securities CCA; it does not impose a requirement on a U.S. Treasury securities CCA to offer additional products for clearing. 2. Definition of Eligible Secondary Market Transactions As part of Rule 17ad–22(a), the Proposing Release set forth a definition of an eligible secondary market 68 15 U.S.C. 78s(b); Dodd-Frank Act Section 806(e); 17 CFR 240.19b–4. 69 ICE Letter, supra note 33, at 2–3. 70 15 U.S.C. 78q–1(b)(3)(I). 71 The Commission also amends the CFR designation of Rule 17Ad–22 in order to ensure the regulatory text conforms more consistently with section 2.13 of the Document Drafting Handbook. See Office of the Federal Register, Document Drafting Handbook (Aug. 2018 Edition, Revision 2.1, dated Oct. 2023), available at https:// www.archives.gov/files/federal-register/write/ handbook/ddh.pdf. In particular, the Commission amends the CFR section designation for 17 CFR 240.17Ad–22 (Rule 17Ad–22) to replace the uppercase letter with the corresponding lowercase letter, such that the rule is redesignated as 17 CFR 240.17ad–22 (Rule 17ad–22). E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 transaction in U.S. Treasury securities 72 subject to the requirement to submit for clearance and settlement discussed in part II.A.1 above. Specifically, the definition of an eligible secondary market transaction 73 would include: • Repurchase agreements and reverse repurchase agreements in which one of the counterparties is a direct participant; • Any purchases and sales entered into by a direct participant if the direct participant (A) brings together multiple buyers and sellers using a trading facility (such as a limit order book) and (B) is a counterparty to both the buyer and seller in two separate transactions; and • Any purchases and sales of U.S. Treasury securities between a direct participant and a counterparty that is a registered broker-dealer, government securities dealer, or government securities broker, a hedge fund, or an account at a registered broker-dealer, government securities dealer, or government securities broker where such account may borrow an amount in excess of one-half of the value of the account or may have gross notional exposure of the transactions in the account that is more than twice the value of the account. The Commission is adopting this rule, with modifications related to repos by other clearing organizations (see part II.A.2.a.iii), inter-affiliate repo transactions (see part II.A.2.a.vi), and state and local government repo transactions (see part II.A.2.a.vii) and related to cash transactions by hedge funds and leveraged accounts (see part II.A.2.b.iii). The Commission discusses the proposed definitions and the 72 The Commission did not receive any comments on its proposed definition of ‘‘U.S. Treasury security’’ and is adopting that definition as proposed. 73 As the Commission stated in the Proposing Release, the amendment does not apply to the primary market, i.e., the issuance and sale of a U.S. Treasury security to a primary dealer or other bidder in a U.S. Treasury auction. Proposing Release, supra note 14, 87 FR 64621. Further, as the Commission also stated in the Proposing Release, because trading in when-issued securities occurring the day after the auction shares similar characteristics to secondary market transactions and because such trading is already reported as a secondary market transaction, the definition of an eligible secondary market transaction would apply to when-issued trades that occur the day after the auction and are considered on-the-run on some IDBs, to the extent that such when-issued trades otherwise meet the definition of an eligible secondary market transaction, as discussed further in part II.A.2.ii infra. Id. However, because whenissued trading occurring before and on the day of the auction does not share these characteristics and is primarily used as a tool for price discovery leading to the auction, such transactions would not be encompassed by the definition. Id. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 comments received thereupon in the following sections. a. Repo Transactions The proposed definition of an eligible secondary market transaction would include, among other things, all U.S. Treasury repurchase and reverse repurchase agreements entered into by a direct participant of a U.S. Treasury securities CCA, subject to the exclusions discussed in part XX infra. As explained in the Proposing Release, in a U.S. Treasury repo transaction, one party sells a U.S. Treasury security to another party (often referred to as the ‘‘start leg’’) and commits to repurchase the security at a specified price on a specified later date (often referred to as the ‘‘end leg’’), and a reverse repo transaction is the same transaction from the buyer’s perspective.74 In the Proposing Release, the Commission stated that the available data indicates that the volume of repo transactions that are bilaterally cleared and settled remains substantial.75 Because of this, FICC lacks visibility 74 Proposing Release, supra note 14, 87 FR 64616. The effect of a repo transaction is similar to a cash loan, using U.S. Treasury securities as collateral. Id. However, standard industry documentation classifies the start and end legs of the repo transaction as purchases and sales of securities. See, e.g., SIFMA, Master Repurchase Agreement (September 1996 Version), available at https:// www.sifma.org/wp-content/uploads/2017/08/MRA_ Agreement.pdf. In this release, the term ‘‘seller’’ refers to the party selling U.S. Treasury securities on the start leg of the transaction and repurchasing them on the end leg of the transaction. The term ‘‘buyer’’ refers to the party purchasing the U.S. Treasury securities on the start leg of the transaction and selling them on the end leg of the transaction. 75 Proposing Release, supra note 14, 87 FR 64616 (citing 2021 IAWG Report, supra note 4, at 29 (stating that non-centrally cleared bilateral repo represents a significant portion of the market, roughly equal in size to centrally cleared repo) (citing a 2015 pilot program by the Treasury Department); TMPG, Clearing and Settlement Practices for Treasury Secured Financing Transactions Working Group Update (‘‘TMPG Repo White Paper’’), at 1 (Nov. 5, 2021), available at https://www.newyorkfed.org/medialibrary/ Microsites/tmpg/files/CSP_SFT_Note.pdf; Katy Burne, ‘‘Future Proofing the Treasury Market,’’ BNY Mellon Aerial View, at 7 (Nov. 2021), available at https://www.bnymellon.com/content/dam/ bnymellon/documents/pdf/aerial-view/futureproofing-the-us-treasurymarket.pdf.coredownload.pdf (noting that 63% of repo transactions remain non-centrally cleared according to Office of Financial Research data as of Sept. 10, 2021); Sebastian Infante et al., Insights from revised Form FR2004 into primary dealer securities financing and MBS activity (Aug. 5, 2022), available at https://www.federalreserve.gov/ econres/notes/feds-notes/insights-from-revisedform-fr2004-into-primary-dealer-securitiesfinancing-and-mbs-activity-20220805.htm (recent research with respect to primary dealers indicates that 38% of their repo and 60% of their reverse repo activity is not centrally cleared, and, overall, that 20% of all their repo and 30% of their reverse repo activity is centrally cleared through FICC)). PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 2723 into its members’ non-centrally cleared repo trades, and the default of one counterparty can have cascading effects on multiple other market participants, including members of FICC, thereby risking contagion to the CCP. The Commission also stated its belief that, particularly with respect to banks and dealers, an important potential benefit of repo central clearing stems from mitigating the constraints on intermediaries’ balance sheets under the existing accounting and regulatory capital rules.76 The Commission further stated that it believes that the benefit of this resulting additional balance sheet capacity could be shared by all market participants through improved market liquidity and smooth market functioning.77 The Commission also referenced that, as with cash markets, risk management practices in the bilateral clearance and settlement of repos are not uniform across market participants and are not transparent.78 Indeed, a recent publication stated that competitive pressures in the bilaterally settled market for repo transactions have exerted downward pressure on haircuts, sometimes to zero.79 The reduction of haircuts, which serve as a counterparty credit risk mitigant in bilateral repos, could result in greater exposure to potential counterparty default risk in non-centrally cleared repos. The Commission stated that by contrast, a U.S. Treasury securities CCA is subject to the Commission’s risk management requirements addressing financial, operational, and legal risk management, which include, among other things, margin requirements commensurate with the risks and particular attributes of each relevant product, portfolio, and market.80 Therefore, repos cleared at a U.S. Treasury securities CCA would be subject to transparent risk management standards that are publicly available and 76 In effect, accounting rules allow purchases and sales of the same security to be netted but do not allow repos of the same security to be netted, unless the repos are with the same counterparty and the trades have been documented under a master netting agreement. See, e.g., Proposing Release, supra note 14, 87 FR 64621 (citing G–30 Report, supra note 5, at 13; Program on International Financial Systems, Mandatory Central Clearing for U.S. Treasuries and U.S. Treasury Repos, at 25–27 (Nov. 2021), available at https:// www.pifsinternational.org/wp-content/uploads/ 2021/11/PIFS-Mandatory-Central-Clearing-for-U.S.Treasury-Markets-11.11.2021.pdf (‘‘PIFS Paper’’)). Thus, if a dealer’s repos are all with a U.S. Treasury securities CCA, greater netting is allowed. 77 See Committee on the Global Financial System, Repo Market Functioning, at 24 (Apr. 2017), available at https://www.bis.org/publ/cgfs59.pdf. 78 TMPG Repo White Paper, supra note 75, at 1. 79 G–30 Report, supra note 5, at 13. 80 17 CFR 240.17ad–22(e)(6). E:\FR\FM\16JAR2.SGM 16JAR2 2724 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 applied uniformly and objectively to all participants in the CCA. Many commenters supported the definition of an eligible secondary market transaction as it relates to repo and reverse repo transactions.81 These commenters encouraged a broad and comprehensive definition to limit market fragmentation and avoidance of central clearing. Several other commenters that did not support a requirement to clear eligible secondary market transactions still acknowledged that repos were the most appropriate scope for such a requirement if one were to be adopted. For example, one commenter agreed that a clearing mandate applied to bilateral repo transactions would be beneficial, pointing to the balance sheet efficiency resulting from repo clearing, but stressing that this requirement be put in place only after the Commission has strengthened the ability for market participants to access central clearing.82 Another commenter stated that while the case for clearing repos is ‘‘marginally stronger’’ than the case for clearing cash transactions, it is ‘‘far from convincing.’’ 83 Other commenters questioned the need for a requirement with respect to repo, noting that the balance sheet 81 See Letter from Jirı ´ Kro´l, Deputy CEO, Global Head of Government Affairs, Alternative Investment Management Association, at 6–7 (Dec. 22, 2022) (‘‘AIMA Letter’’); AFREF Letter, supra note 33, at 3; see generally Better Markets Letter, supra note 33; DTCC/FICC Letter, note 33; Letter from Ryan Sheftel, Global Head of Fixed Income, GTS Securities, LLC (Jan. 6, 2023) (‘‘GTS Securities Letter’’); LSEG Letter, supra note 33; Letter from ARB Trading Group LP, Citadel Securities, DRW Holdings, LLC, Eagle Seven LLC, Geneva Trading USA, LLC, Hard Eight Futures, LLC, Hudson River Trading LLC, IMC Trading, Jump Trading Group, Kore Trading LLC, Optiver, Quantlab Financial, LLC, WH Trading LLC, and XR Trading LLC, at 4 (Dec. 27, 2022) (‘‘ARB et al. Letter’’); Letter from Manfred E. Will, Founder & CEO, MEW Consul (Oct. 24, 2022); Letter from Shiv Rao, Chairman, Sunthay Holdings LLC, at 2 (Dec. 27, 2022); and Letter from Elisabeth Kirby, Head of U.S. Market Structure, Tradeweb Markets Inc. (Dec. 27, 2022). One commenter, while broadly supporting the definition of an eligible secondary market repo and reverse repo transaction, recommended excluding Derivatives Clearing Organizations (‘‘DCO’’) registered with the CFTC. See Letter from Jonathan Marcus, Senior Managing Director and General Counsel, CME Group Inc., at 6–7 (Dec. 27, 2022) (‘‘CME Letter’’) and part II.A.2.iii infra. Other commenters, while broadly supporting the definition, recommended excluding transactions executed on the triparty repo platform. See Letter from Stephen John Berger, Managing Director, Global Head of Government & Regulatory Policy, Citadel and Citadel Securities (Dec. 27, 2022) (‘‘Citadel Letter’’), Letter from Jennifer W. Han, Executive Vice President, Chief Counsel & Head of Global Regulatory Affairs, Managed Funds Association at 6, 14 (Dec. 21, 2022) (‘‘MFA Letter’’), and part II.A.2.i infra. 82 MFA Letter, supra note 81, at 13 (supporting inclusion of bilateral repo and reverse repo). 83 SIFMA AMG Letter, supra note 35, at 11. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 netting efficiencies already exist, providing a natural incentive to centrally clear such transactions.84 The Commission agrees that centrally cleared repo already benefits from favorable treatment on balance sheet, but also recognizes that, by definition, a requirement to clear repo transactions should result in more transactions being centrally cleared. Thus, there would still be benefits from the requirement, despite the currently existing balance sheet treatment, as discussed further in part IV.C.1.a.ii. In addition, some commenters supported excluding particular types of repos from the definition, and other commenters supported excluding particular types of market participants engaging in repos from the definition. The Commission discusses these comments in the following parts. i. Triparty Repo Several commenters supported excluding triparty repos from the definition of an eligible secondary market transaction.85 One commenter suggested that the cost of including triparty repos would outweigh the benefits, and other commenters raised similar concerns.86 The discussion of additional costs and benefits arising from the inclusion of triparty repos within the definition of an eligible secondary market transaction is provided in part IV.C.2 infra. Several commenters argued that including triparty repos would not significantly reduce the risks that the proposal seeks to address because the current triparty market infrastructure inherently mitigates the associated risks.87 Specifically, these commenters argue that credit risk in the triparty market is mitigated by the triparty agent’s 84 See, e.g., SIFMA AMG Letter, supra note 35, at 4; SIFMA–IIB Letter, supra note 37, at 4. 85 See MFA Letter, supra note 81, at 6, 14; SIFMA–IIB Letter, supra note 37, at 20–21; SIFMA AMG Letter, supra note 35, at 6, 11; Letter from Sarah A. Bessin, Deputy General Counsel, and Nhan Nguyen, Assistant General Counsel, Investment Company Institute at 22–23 (Dec. 23, 2022) (‘‘ICI Letter’’); Citadel Letter, supra note 81, at 6; Letter from Deborah A. Cunningham, Executive Vice President, Chief Investment Officer of Global Liquidity Markets, and Senior Portfolio Manager, Susan R. Hill, Senior Vice President, Senior Portfolio Manager and Head of Government Liquidity, and David R. McCandless, Corporate Counsel, Federated Hermes at 5 (Dec. 28, 2022) (‘‘Federated Letter’’); Letter from Sebastian Crapanzano, Managing Director, Morgan Stanley, at 2 (Nov. 15, 2023) (‘‘Morgan Stanley Letter’’). 86 See MFA Letter, supra note 81, at 6, 14; see also SIFMA/IIB Letter, supra note 37, at 20; ICI Letter, supra note 85, at 11; Federated Letter, supra note 85, at 5. 87 See MFA Letter, supra note 81, at 14; SIFMA/ AMG Letter, supra note 35, at 11; ICI Letter, supra note 85, at 12, 22; Citadel Letter, supra note 81, at 6; Federated Letter, supra note 85, at 5. PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 provision of custodial, collateral management, and settlement services.88 Moreover, one commenter stated that the infrastructure underlying the triparty repo market is robust and provides credit protections, operational safeguards, and strict internal controls akin to central clearing.89 One commenter stated that the triparty agent’s ability to handle the settlement of triparty repos through its collateral allocation system has resulted in a wellfunctioning process that operates under severe time constraints.90 One commenter added that the triparty market is relatively safe from credit risk because the triparty agent is subject to prudential regulation.91 One commenter added that settlement risk in the triparty market is nearly eliminated because collateral posted to the triparty platform cannot generally be repledged outside the platform.92 The commenter stated, therefore, that the only significant source of settlement risk is the rare occurrence of a counterparty’s nonpayment of the repurchase price, which is generally attributable to operational risk as opposed to credit risk.93 Another commenter stated that these types of triparty repos, described as secured funding transactions where the funding counterparty has no rehypothecation rights, do not appear to raise concerns discussed in the proposal regarding the use of transactions to generate leverage that would warrant imposition of the requirement to clear eligible secondary market transactions.94 Despite supporting the exclusion of triparty repos from the definition of an eligible secondary market transaction, one commenter acknowledged that the triparty agent ‘‘does not fulfill a CCP role—it does not guarantee either counterparty’s performance through novation or otherwise and does not assume counterparty risk.’’ 95 For this reason, triparty repos will not be excluded from the definition of an eligible secondary market transaction. The Commission recognizes that the current triparty market infrastructure incorporates credit protections, operational safeguards, and strict internal controls. The Commission also recognizes that the triparty agent’s current processes for handling the settlement of triparty repos generally 88 See id. ICI Letter, supra note 85, at 22. 90 See Federated Letter, supra note 85, at 3. 91 See MFA Letter, supra note 81, at 14. 92 See Federated Letter, supra note 85, at 5. 93 See Federated Letter, supra note 85, at 5. 94 Morgan Stanley Letter, supra note 85, at 2. 95 ICI Letter, supra note 85, at 33. 89 See E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 function well. However, the triparty agent does not serve as a central counterparty, meaning that it does not guarantee either counterparty’s performance through novation or assume counterparty risk, and therefore, the Commission disagrees with the contention that the current market infrastructure incorporates controls equivalent to those available through central clearing. The Commission recognizes that the triparty agent is subject to heightened prudential regulation.96 However, the triparty agent is not subject to regulatory supervision as a CCP, which entails additional protections against the risk of many market participants acting to liquidate similar collateral in the event of a default in a non-centrally cleared environment. A U.S. Treasury securities CCA is subject to the Commission’s risk management requirements addressing financial, operational, and legal risk management, which include, among other things, margin requirements commensurate with the risks and particular attributes of each relevant product, portfolio, and market and also include certain requirements applicable only to covered clearing agencies that are serving as central counterparties.97 In contrast, a triparty agent is not equipped with a mechanism to manage the risk of collateral fire-sale in the aftermath of a counterparty default.98 As a result, a U.S. Treasury securities CCA is better positioned to handle a large, unexpected default than a triparty agent. The possibility that a direct participant in a U.S. Treasury securities CCA with large, unsettled trading volumes (bilateral or triparty) could fail creates contagion risk to the CCA, as well as to the market as a whole. This rulemaking is designed to ameliorate that contagion risk, at least in part. Accordingly, the Commission does not believe that the current triparty market infrastructure alone mitigates the aforementioned contagion risk sufficiently to warrant excluding triparty repos from the definition of an eligible secondary market transaction. In response to the commenter who stated that most risks 96 The triparty agent is supervised and/or regulated by, among others, New York State Department of Financial Services, and the Federal Reserve Bank of New York. See https:// www.bnymellon.com/us/en/disclaimers/businessdisclaimers. Additionally, the triparty agent is designated as a Global Systemically Important Bank by the Financial Stability Board. See https:// www.fsb.org/wp-content/uploads/P211122.pdf. 97 17 CFR 240.17ad-22(e)(6). 98 See, e.g, Brian Begalle et al., The Risk of Fire Sales in the Tri-Party Repo Market, N.Y. Fed Staff Report No. 616 (‘‘Begalle et al.’’), at 9–14, available at, https://www.newyorkfed.org/medialibrary/ media/research/staff_reports/sr616.pdf. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 are eliminated because collateral cannot be posted outside the triparty platform, the Commission disagrees. Significant risks exist if concerns emerge regarding the financial condition of sellers in the triparty market.99 In such scenarios, even though collateral stays within the triparty platform, the buyer could still experience distress following a sudden default of a triparty repo counterparty.100 For example, a triparty repo default may leave a money market fund holding long-dated Treasury securities collateral, which may cause the money market fund to no longer meet requirements under rule 2a–7 relating to the weighted average life to maturity of the fund’s portfolio.101 A spike in market volatility accompanying an event of default and potential collateral liquidation activity by buyers could cause liquidity stress for the financial system leading to decline in collateral value even for the most creditworthy assets such as U.S. Treasury securities. A U.S. Treasury securities CCA is better positioned to manage a repo counterparty default by employing a range of available prefunded resources without reliance on repo collateral liquidation.102 In contrast, the triparty platform is not designed to manage risks associated with a repo counterparty default and a potential collateral liquidation following the default. In a triparty repo transaction, the triparty custodian bank holds the collateral on behalf of the buyer. However, the buyer is responsible for initiating and managing the collateral liquidation process, 99 See 2013 Annual Report of the Financial Stability Oversight Council, at 4, 12–13, 133–134, available at https://home.treasury.gov/system/files/ 261/FSOC-2013-Annual-Report.pdf (‘‘FSOC 2013 Annual Report’’); Begalle et al., supra note 98 (discussing concern that stress caused by a potential default of a triparty repo counterparty can lead to either pre-default fire sales of assets by the counterparty or post-default fire sales of collateral by the triparty repo investor and the related financial stability concerns). See also 2019 Annual Report of the Financial Stability Oversight Council, at 11, available at https://home.treasury.gov/ system/files/261/FSOC2019AnnualReport.pdf (highlighting that the possibility of fire sales of collateral by creditors of a defaulted counterparty in the triparty repo market remains a financial system vulnerability despite the triparty repo infrastructure reform). 100 See FSOC 2013 Annual Report, supra note 99, at 12–13 (recognizing that a major broker-dealer’s default could threaten financial stability as the broker-dealers’ creditors liquidate the collateral pledged against their tri-party repo lending, with the fire sales of this collateral potentially destabilizing financial markets and amplifying the negative consequences of such a default). 101 See 17 CFR 270.2a–7(d)(1). In addition, the money market fund holding the collateral may cause liquidity concerns under rule 2a–7. See 17 CFR 270.2a–7(d)(4). 102 17 CFR 240.17ad–22(e)(13). PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 2725 including Treasury securities, if the liquidation is necessary.103 One commenter argued that including triparty repos in the definition of an eligible secondary market transaction would likely impair the cash and collateral management processes of hedge funds and alternative asset managers.104 Specifically, the commenter suggested that such firms currently conduct same-day bilateral transactions that they would not be able to conduct with a direct participant of a U.S. Treasury securities CCA required to centrally clear its repo transactions.105 Similarly, another commenter argued that including triparty repos would prevent participants, such as money market funds, from conducting transactions on a short term (i.e., overnight) basis when U.S. Treasury securities CCAs are at full capacity.106 The Commission disagrees with these commenters. In its supervisory capacity, the Commission is aware that registered funds, hedge funds, and alternative asset managers currently conduct centrally cleared triparty repo transactions. For example, the Commission is aware that numerous hedge funds conduct such same-day transactions as sponsored members of FICC. Therefore, the existing operational infrastructure supports centrally cleared triparty repo transactions. The FICC novation window for all deliveryversus-payment trades, including the sponsored repo service, remains open until 8 p.m. (ET) and therefore is available for a later-day trading.107 Additionally, the Commission disagrees that there is a finite ‘‘full capacity’’ at a U.S. Treasury securities CCA. The Commission understands that increased demand for a CCA service may lead to a higher volume of trading activity by existing members and, in certain circumstances, reduce members’ ability or willingness to facilitate their clients’ access to central clearing, if such members do not wish to grow this line of business. However, higher demand for access to central clearing could also present an opportunity for dealers that 103 Baklanova, et al., Reference Guide to U.S. Repo and Securities Lending Markets, OFR Working Paper No15–17 (Sept. 2015), available at: https:// www.financialresearch.gov/working-papers/files/ OFRwp-2015-17_Reference-Guide-to-U.S.-Repoand-Securities-Lending-Markets.pdf. 104 See MFA Letter, supra note 81, at 17. 105 See id. 106 See ICI Letter, supra note 85, at 12, 22. 107 See DTCC, Looking to the Horizon: Assessing a Potential Expansion of U.S. Treasury Central Clearing, Sept. 2023 (‘‘DTCC 2023 White Paper’’), available at https://www.dtcc.com/-/media/Files/ Downloads/WhitePapers/Accessing-PotentialExpansion-US-Treasury-Clearing-White-Paper.pdf. E:\FR\FM\16JAR2.SGM 16JAR2 2726 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations do not currently offer such services to enter the market, resulting in growing CCA capacity, more competition among its members, and a wider range of available repo counterparties. The Commission also understands that the existing U.S. Treasury securities CCA may consider, as appropriate, additional changes to their operational infrastructure and trading capacity, including revisions to the eligibility criteria for sponsored membership and an extension of the trade submission and novation windows later in the day,108 to enhance their ability to accommodate any increase in the volume of centrally cleared triparty repo transactions resulting from this rulemaking. One commenter expressed concern that the centrally cleared triparty repo market has only been available since 2021 and is therefore, relatively untested.109 Therefore, the commenter suggested that the Commission should delay its decision whether to include triparty repos in the definition of an eligible secondary market transaction until after the Commission has had an opportunity to evaluate the effectiveness of the centrally cleared triparty repo infrastructure.110 The Commission disagrees. While FICC expanded its Sponsored Service in 2021 to enable sponsored members (e.g., registered funds) to conduct centrally cleared triparty repo transactions,111 FICC has been facilitating such transactions for its direct participants via the General Collateral Finance (‘‘GCF’’) Repo Service since 1998.112 Additionally, although the expanded Sponsored Service is relatively new, the infrastructure is operational, and its usage appears to be increasing. Data provided by the Federal Reserve show a significant increase in the gross value of Treasury securities traded in GCF Repo since March 2020.113 Additionally, as stated above, the Commission understands that the U.S. Treasury securities CCA is consulting with 108 Id. 109 See MFA Letter, supra note 81, at 12, 14. id. 111 Securities Exchange Act Release No. 92799 (Aug. 27, 2021), 86 FR 49387 (Sept. 2, 2021) (SR– FICC–2021–801); Securities Exchange Act Release No. 92014 (May 25, 2021), 86 FR 29334 (June 1, 2021) (SR–FICC–2021–003). 112 Securities Exchange Act Release No. 40623 (Oct. 30, 1998), 63 FR 59831 (Nov. 5, 1998) (SR– GSCC–98–02). 113 Federal Reserve, GCF Repo (showing that the daily snapshot of the Treasury securities value traded in the GCF repo segment was under $120 billion on Mar. 10, 2020. The value reported on June 9, 2023 was over $320 billion, which includes sponsored activity), available at https:// www.newyorkfed.org/data-and-statistics/datavisualization/tri-party-repo#interactive/tripartygcf. ddrumheller on DSK120RN23PROD with RULES2 110 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 market participants and is considering steps to further enhance its operational infrastructure to support any increase in the volume of centrally cleared triparty repo transactions resulting from this rulemaking.114 Finally, commenters argued for the exclusion from the definition of an eligible secondary market transaction of triparty repos involving purchased securities that include both Treasury CUSIPs and securities with other CUSIPs or where permitted substitution may be made in CUSIPs other than Treasury CUSIPs. According to the commenters, the fact that some CUSIPs in a mixed triparty repo are U.S. Treasury security CUSIPs should not bring that transaction into the definition of an eligible secondary market transaction if it were of a type that is entered into in the ordinary course of business or otherwise in connection with a legitimate business purpose. The commenters stated that without such an exemption, the definition of an eligible secondary market transaction could scope in transactions of which U.S. Treasury securities only represent a small component, which would exceed the regulatory objective behind the proposal, and stated that such transactions do have margin collected.115 The Commission understands that market participants may use U.S. Treasury securities as permissible substitutions for other types of collateral and generally should not consider mixed CUSIP triparty repos resulting from such a permissible substitution as within the scope of part (i) of the definition of an eligible secondary market transaction. Collateral substitution allows a repo seller to complete trade settlement even if the type of collateral securities agreed upon at the time of trade initiation is no longer available. Typically, Treasury securities or cash can be permissible substitution.116 However, to the extent that a mixed CUSIP triparty repo contains U.S. Treasury CUSIPs from the outset of the transaction, such a transaction would be included in the scope of part (i) of the definition of an 114 See DTCC 2023 White Paper, supra note 107. SIFMA/IIB Letter, supra note 37, at 20–21; Letter from Jiri Krol, Deputy CEO, Global Head of Government Affairs, Alternative Investment Management Association (Oct. 20, 2023) at 3 (‘‘AIMA Letter II’’); see also Citadel Letter, supra note 81, at 6 (supporting that the Commission exclude triparty repos at this stage, noting that they may include both Treasury and non-Treasury securities as collateral). 116 For example, money market fund filings of portfolio data show that, on average, Treasury securities account for around 3% of collateral backing investments in non-government repos. 115 See PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 eligible secondary market transaction. An exclusion for such transactions is not necessary because the counterparties specifically structured the transaction to include U.S. Treasury securities; therefore, such a transaction is within the scope of the definition. Data submitted by money market funds on Form N–MFP shows that the holdings reported as U.S. Government Agency Repurchase Agreements are typically collateralized by U.S. government agency securities and are also partially collateralized by Treasury securities.117 Collateral management practices may evolve to better delineate collateral types in light of the definition of an eligible secondary market transaction. ii. Repos by Registered Funds Registered investment companies, or registered funds, that is, those entities that are registered under the Investment Company Act of 1940 (‘‘1940 Act’’), including money market funds and exchange-traded funds, are important participants in the U.S. Treasury repo market. Filings of Form N–MFP by money market funds show that, as of September 30, 2023, these funds invested approximately $2.2 trillion in Treasury repos.118 In addition, mutual funds invested $37 billion in repurchase agreements, including those backed by Treasury securities.119 Generally, commenters acknowledged that central clearing of Treasury repos and reverse repos through the FICC Sponsored Service, which has been available to registered funds since 2005, provides additional collateral supply.120 FICC data shows that at the end of November 2023, the daily volume of sponsored ‘‘delivery-versus-payment’’ Treasury repo activity was approximately $820 billion, while the daily volume of sponsored activity in the triparty GCF repo was close to $130 billion.121 117 Money market fund filings of portfolio data show that, on average, Treasury securities account for around 20% of collateral backing investments in U.S. government agency repos. 118 Of this amount, approximately $1.5 trillion was invested in the Federal Reserve’s overnight reverse repo facility. See U.S. Securities and Exchange Commission, Money Market Fund Statistics (Sept. 2023), available at https:// www.sec.gov/divisions/investment/mmf-statistics. Repo transactions with the central bank are excluded from the scope of Eligible Secondary Market Transactions. 119 Federal Reserve, Financial Accounts of the United States, Table L.207 Federal Funds and Security Repurchase Agreements (2023 Q2). 120 ICI Letter, supra note 85, at 13; Federated Letter, supra note 85, at 2; DTCC/FICC Letter, supra note 33, at 17. 121 See DTCC, Sponsored DVP and Sponsored GC Activity, available at https://www.dtcc.com/charts/ membership, which also shows data over a longer timeframe for reference. E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations Several commenters stated that they did not support including repo transactions with registered funds as a counterparty in the definition of an eligible secondary market transaction, which, as proposed, would include repo transactions with all counterparties.122 One commenter stated that the Commission should not, at this time, require that repos between a fund and a direct participant of a U.S. Treasury securities CCA be subject to a clearing requirement because the current clearing framework is not sufficiently developed to support such a mandate.123 The commenter identified several issues to be addressed prior to adopting such a requirement, which are discussed in the following paragraphs. First, the commenter stated that the Commission should encourage FICC to enhance its Sponsored Service in several ways, to address regulatory, structural, and operational issues raised by the proposal. The commenter stated that the Commission should encourage FICC to further develop a ‘‘give up’’ structure to facilitate best execution. The commenter described this as a ‘‘critically important step’’ to incentivize voluntary clearing, because it would generate increased competition among market participants, which may result in more efficient pricing. The commenter also stated that a ‘‘give up’’ structure would be essential under a requirement to centrally clear eligible secondary market transactions because the Sponsored Service may not be able to meet the increased capacity requirements due to the limited number of sponsoring members and the increased demand for sponsored clearing under such a requirement. The commenter suggested that the infrastructure currently used by FICC for prime brokerage clearing could be leveraged to develop a give up model, stating that any such model will need to provide for standardized documentation that facilitates additions and deletions of approved brokers, agreed-upon terms for rejection of trades by a sponsoring member, and centralized storage of delegation.124 The commenter requested that the SEC encourage FICC to establish a feature allowing (but not requiring) registered fund sponsored members to support their obligations by having margin posted with FICC (‘‘FICC registered fund margin arrangement’’) rather than by paying fees to the 122 ICI Letter, supra note 85, at 12–28; Federated Letter, supra note 85, at 2–6. 123 ICI Letter, supra note 85, at 12. 124 ICI Letter, supra note 85, at 13–14. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 sponsoring member.125 FICC’s rules currently provide that each sponsoring member must make a deposit to FICC’s Clearing Fund based on the activity of its sponsored members.126 The contributions of all Netting Members, including those that are sponsoring members, are commingled in the Clearing Fund and are available to FICC for, among other things, securing members’ obligations and providing liquidity to meet its settlement obligations.127 While the commenter stated that the Sponsored Service under current FICC rules does not raise custody issues for registered funds under the 1940 Act because registered funds are not required to post margin to FICC, if a fund’s margin were permitted to be posted with FICC, that could raise custody issues for funds unless such funds receive relief from certain provisions of the 1940 Act.128 The commenter stated that permitting registered funds’ margin to be posted with FICC could reduce costs for registered funds and facilitate their use of cleared reverse repos and term 125 ICI Letter, supra note 85, at 14; Letter from Jennifer W. Han, Executive Vice President, Chief Counsel & Head of Global Regulatory Affairs, Managed Funds Association (Dec. 4, 2023), at 4 (‘‘MFA Letter II’’). See also MFA Letter, supra note 81, at 7 (noting that ‘‘an indirect participant should have the ability (although not the obligation) to fund the margin obligations of the direct participant clearing on its behalf which are attributable to the indirect participant. In such case, the margin posted by the indirect participant should be segregated from the direct participant’s house margin, and it should not be subject to loss mutualization vis-a`vis other direct participants. Given that many indirect participants have fiduciary obligations to their own clients, it is crucial that indirect participants are able to post margin on a segregated basis such that their clients are not subject to the credit risk of others (and, likewise, that their funds are not subject to loss mutualization).’’); SIFMA/IIB Letter, supra note 37, at 12–13 (noting that ‘‘it will be difficult to support expanding cleared trading in U.S. Treasury securities until we have a framework which ensures customers can access clearing solutions where their margin and collateral will be adequately protected, including from loss mutualization by the clearing agency’’). 126 FICC Rule 3A, section 10, supra note 19. 127 FICC Rule 4, supra note 19. 128 Section 17(f) of the 1940 Act (providing that ‘‘[e]very registered management company shall place and maintain its securities and similar investments in the custody of (A) a bank or banks having the qualifications prescribed in paragraph (1) of section 26(a) of this title for the trustees of unit investment trusts; or (B) a company which is a member of a national securities exchange as defined in the Securities Exchange Act of 1934, subject to such rules and regulations as the Commission may from time to time prescribe for the protection of investors; or (C) such registered company, but only in accordance with such rules and regulations or orders as the Commission may from time to time prescribe for the protection of investors.’’). See also rule 17f–1 under the 1940 Act (permitting registered funds to custody assets with a member of a national securities exchange as defined in the 1934 Act pursuant to certain conditions). PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 2727 repos.129 The commenter also stated that the final rule should require FICC to establish margin rules that ensure that margin is held in a segregated manner, not commingled with any direct participant’s house margin, and not be subject to loss mutualization associated with other direct participants.130 Finally, the commenter stated that in order to address concerns regarding the security of registered fund assets under a Treasury repo clearing mandate, FICC rules addressing margin posting would need to be amended to provide for enhanced recordkeeping, internal controls, and transparency around the positions and related margin.131 In order to support a clearing requirement for eligible secondary market transactions, the Commission is taking the position that, for a period of five years, registered funds utilizing such an arrangement in a manner consistent with the circumstances described below would not provide a basis for enforcement action under Section 17(f) of the 1940 Act. The Commission takes this position to recognize the unique circumstances facing registered funds in the context of entering into eligible secondary market transactions using FICC’s Sponsored Program. Our staff has previously stated that it would not recommend enforcement action under the custody provisions of the 1940 Act in the context of certain registered fund trading activities.132 For example, the staff issued the Delta Letter in connection with Delta’s options clearing service, which provided assurances that the staff would not recommend enforcement action under 129 ICI Letter, supra note 85, at 14. 130 Id. 131 See id. (‘‘Enhanced recordkeeping and related controls are critical to appropriately identifying ownership of assets during a Treasury repo or reverse repo transaction particularly since, unlike a typical derivates or cash transaction, ownership of the Treasury securities underlying a repo or reverse repo change owners during the transaction.’’). 132 See e.g., Delta Government Options Corp. NoAction Letter (pub. avail. Sept. 27, 1990) (‘‘Delta Letter’’); cf. CME Group, Inc. No-Action Letter (pub. avail. Dec. 19, 2017); FICC No-Action Letter (pub. avail. Mar. 13, 2003) (‘‘FICC 2003 Letter’’). In the FICC Letter, the staff observed certain operational features of FICC’s Mortgage-Backed Securities Division (‘‘MBSD’’), which differ from the current circumstances of FICC’s Government Securities Division, such as registered funds being direct participants in MBSD’s clearing scheme and participant trades not being novated to MBSD. Any staff statements cited represent the views of the staff. They are not a rule, regulation, or statement of the Commission. Furthermore, the Commission has neither approved nor disapproved their content. These staff statements, like all staff statements, have no legal force or effect: they do not alter or amend applicable law; and they create no new or additional obligations for any person. E:\FR\FM\16JAR2.SGM 16JAR2 2728 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations Section 17(f) of the 1940 Act if registered investment companies deposited margin with Delta.133 One representation in the Delta Letter was that Delta was permitted to withdraw the margin provided ‘‘only upon the investment company’s default on the option contract.’’ 134 Other previous staff no-action positions have been provided in different contexts. In one such noaction position, FICC represented that a registered fund’s margin would not be used to cover another client’s default and segregating fund assets from the custodian’s proprietary assets and other customers’ assets.135 These types of features would help protect fund client assets consistent with the 1940 Act under the FICC registered fund margin arrangement, and we have included similar types of features for purposes of our position that follows below. While the final rules do not require registered funds’ margin to be posted with FICC, and no current U.S. Treasury securities CCA has rules imposing such a requirement, as discussed above, a commenter requested that the Commission encourage FICC to establish a FICC registered fund margin arrangement.136 The Commission agrees that facilitating the ability for a registered fund’s margin to be posted at FICC as an alternative to the sponsoring member posting the margin and passing the cost of doing so through to the registered fund may lower the cost of trading for the fund, and the Commission position below will help facilitate the posting of registered fund margin 137 to satisfy a U.S. Treasury securities CCA’s margin deposit requirements. Specifically, the Commission takes the position that, for a period of five years beginning on the effective date of this adopting release, if a registered investment fund’s cash and/or securities are placed and maintained in the custody of FICC for purposes of meeting FICC’s margin deposit requirements that may be imposed for eligible secondary market transactions in connection with the fund’s participation in the Sponsored Program, it would not provide a basis for enforcement action ddrumheller on DSK120RN23PROD with RULES2 133 Delta Letter. 134 Id. 135 See FICC 2003 Letter. ICI Letter, supra note 85, at 14. 137 The Commission position is intended to address certain considerations under the 1940 Act specific to registered funds. Other types of buy-side participants may have different considerations to address in connection with their participation in the Sponsored Program beyond the scope of the 1940 Act. 136 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 under Section 17(f) of the 1940 Act so long as: 138 • FICC withdraws the margin provided by a sponsored member registered fund only upon that registered fund’s default; 139 • The margin provided by a registered fund is not commingled with, and is kept separate from, FICC’s assets; 140 • FICC segregates on its books and records the margin provided by a registered fund (or series thereof, as applicable), and identifies a value of margin in its books and records as being attributable to the registered fund; • The entity that FICC uses to custody such margin is an eligible fund custodian under the 1940 Act and the applicable rules thereunder; 141 • The margin provided by a registered fund is not subject to loss mutualization 142 or allocation; 143 • The margin provided by a registered fund is not used by FICC for any purpose other than in connection with that registered fund’s default as a sponsored member; 144 • Registered funds receive quarterly statements of accounts concerning the margin provided in connection with eligible secondary market transactions showing, at a minimum, the name of the account, asset movements during the quarter, and quarter-end positions; and • The account into which a registered fund’s margin is deposited is governed by a contract by and among the registered fund, its sponsoring member, and FICC providing for an arrangement consistent with this Commission position, (together, the ‘‘FICC registered fund margin framework’’).145 138 To the extent a registered fund becomes aware that its custodial arrangement is no longer consistent with the FICC registered fund margin framework, the registered fund may not utilize the FICC registered fund margin framework to enter into eligible secondary market transactions. 139 For the avoidance of doubt, FICC may only withdraw margin provided by a registered fund in the event that the registered fund defaults on a transaction that has been novated to FICC. 140 See FICC Letter; see also Institutional Equity Fund No-Action Letter (pub. avail. Feb. 27, 1984) (stating that the staff would not recommend enforcement action under Section 17(f) of the 1940 Act if, among other things, the assets of a registered fund participating in the Options Clearing Corporation’s program were held in a ‘‘nonproprietary account at OCC which does not include any assets held by the Clearing Member agent other than as a fiduciary, custodian or otherwise for customers’’). 141 See Section 17(f) of the 1940 Act and the rules thereunder. 142 See FICC 2003 Letter at n. 18. 143 See e.g., FICC Rule 4, supra note 19. 144 For purposes of this Commission position, FICC is not permitted to use registered fund margin for default liquidity purposes. 145 The Commission notes that this position only applies with respect to the custody of registered fund margin, and does not apply to cash or PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 In general, Section 17(f) of the 1940 Act and the rules thereunder govern the safekeeping of investment company assets.146 The FICC registered fund margin framework is designed to protect fund investor assets, consistent with the principles of the 1940 Act.147 The framework would seek to adequately protect registered fund assets by isolating them from FICC’s proprietary assets and segregating them on FICC’s books and records from the sponsoring member’s other customers, preventing registered fund assets from being used to cover any obligation other than an obligation of that registered fund, limiting FICC’s ability to use registered fund margin for any purpose other than an obligation of the registered fund as a sponsored member, and prohibiting registered fund assets from being subject to loss mutualization or allocation.148 Five years is intended to provide sufficient time for FICC to develop and file any proposed rule changes under Section 19(b) of the Exchange Act that may be relevant to facilitate a registered fund’s ability to have its margin posted at FICC consistent with the FICC registered fund margin framework. The Commission will consider any proposed rule changes consistent with its obligations under Section 19(b) of the Exchange Act in the event that FICC submits any proposal to facilitate a registered fund’s ability to have its margin posted at FICC consistent with the FICC registered fund margin framework in the future, and providing this position for five years will also provide sufficient time for the Commission to determine if extending or revising this position is appropriate. Five years is intended to provide sufficient time for market participants to consider other potential frameworks for the posting of registered fund margin to satisfy FICC’s margin deposit requirements and to gain insight into the merits of such frameworks.149 collateral received under a sponsored repo or reverse repo trade. Further, this position does not impact any other obligation that a registered fund has in connection with its participation in the Sponsored Program or under the 1940 Act and rules thereunder. 146 The legislative history of section 17(f) indicates that Congress intended the assets of investment companies to be kept by a financially secure entity that has sufficient safeguards against misappropriation. See Investment Trusts and Investment Companies: Hearings on S. 3580 Before a Subcomm. of the Senate Comm. on Banking and Currency, 76th Cong., 3d Sess. 264 (1940). 147 See e.g., ICI Letter, supra note 85, at 14. 148 Cf. infra part II.C.2. 149 We note that a U.S. Treasury securities CCA could develop a different mechanism for a registered fund to post margin. For example, the Options Clearing Corporation has a ‘‘deposits in lieu of margin’’ framework whereby a customer of E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 A registered fund may wish to use a member of a national securities exchange as a sponsoring member. Such a sponsoring member that receives and posts margin to a U.S. Treasury securities CCA on behalf of registered funds may be deemed to have custody of fund assets and implicate Rule 17f– 1 under the 1940 Act. Therefore, the Commission takes the position, for a period of five years from the effective date of this adopting release, that if a registered fund’s cash and/or securities are placed and maintained with a sponsoring member that is a member of a national securities exchange, solely in connection with facilitating the posting of margin to FICC on behalf of a registered fund in connection with the registered fund’s participation in the Sponsored Program, it would not provide the basis for an enforcement action against a registered fund under Section 17(f) of the 1940 Act so long as: (i) the fund complies with Rule 17f–1(a), (b)(5), and (d), and (ii) the contract between the registered fund and the member of the national securities exchange provides for the following: • The margin provided by a registered fund is not commingled with, and is kept separate from, the sponsoring member’s assets; 150 • The sponsoring member segregates on its books and records the margin provided by a registered fund (or series thereof, as applicable), and identifies a value of margin in its books and records as being attributable to the registered fund; • The registered fund’s provision of margin is consistent with the FICC registered fund margin framework; and • The sponsoring member does not hold registered fund assets that exceed the amount that is required to be deposited as margin to FICC with respect to the registered fund’s outstanding eligible secondary market transactions.151 a clearing member makes a deposit in lieu of margin through OCC’s escrow deposit program, and the relevant positions are excluded from the clearing member’s margin requirement to OCC. See OCC Rules 610, 610A, 610B, and 610C; see also SelfRegulatory Organization: The Options Clearing Corporation: Notice of Filing of Advance Notice Concerning the Options Clearing Corporation’s Escrow Deposit Program, Securities Exchange Act Rel. No. 34–78334 (Sept. 14, 2016), 81 FR 64537– 38 (Sept. 20, 2016). Although there are fundamental differences in the purpose and use of margin in the OCC’s deposit in lieu of margin framework, a U.S. Treasury securities CCA could use the principles underlying the OCC’s program by analogy in developing its own margin posting framework. 150 See note 140 supra. 151 This Commission position would not apply to the extent that the sponsoring member holds an amount of registered fund assets that exceeds the registered fund’s margin obligations. If a sponsoring member were to hold registered fund assets in an VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 2729 As above, such an approach is intended to accomplish a similar purpose as the FICC registered fund margin framework and additionally limit the amount of assets held in custody at a sponsoring member that is a member of a national securities exchange to an amount of margin that is required by FICC. More generally, the Commission understands that the commenter which raised issues regarding the ability of registered funds to post margin to the CCA is referring to clearing models whereby an indirect participant in a U.S. Treasury securities CCA executes a transaction with a counterparty and then ‘‘gives up’’ the transaction to another party to submit for clearance and settlement. The Commission agrees with the commenter that the use of a ‘‘give up’’ model could be helpful in further facilitating the increased demand for central clearing under a potential clearing requirement. The Commission understands that FICC currently has certain models that facilitate ‘‘give up’’ style clearing, and, consistent with the requirement discussed in part II.B.2 infra, encourages U.S. Treasury securities CCAs to consider how best to facilitate ‘‘give up’’ clearing. The Commission’s ability to ‘‘encourage’’ FICC, a covered clearing agency, must be considered in context of the relevant regulatory framework. Covered clearing agencies are SROs for purposes of the Exchange Act,152 meaning that, as an SRO, a covered clearing agency is required to file with the Commission any proposed rule or proposed change in its rules, including additions or deletions from its rules.153 The Commission publishes all proposed rule changes for comment.154 When considering whether to approve or disapprove a proposed rule change, the Commission shall approve the proposed rule change if it finds that such proposed rule change is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to the particular type of SRO.155 In addition, clearing agencies registered with the Commission are financial market utilities, as defined in section 803(6) of the Dodd-Frank Act.156 A clearing agency that has been designated by the Financial Stability Oversight Council as systemically important or likely to become systemically important, and for which the Commission is the Supervisory Authority (‘‘designated clearing agency’’), is required to file 60-days advance notice with the Commission of changes to rules, procedures, and operations that could materially affect the nature or level of risk presented by the designated clearing agency (‘‘advance notice’’).157 Such an advance notice also requires consultation with the Board of Governors.158 The Clearing Supervision Act authorizes the Commission to object to changes proposed in such an advance notice, which would prevent the clearing agency from implementing its proposed change(s).159 These statutory requirements applicable to covered clearing agencies mean that the Commission must consider proposed rule changes as they are filed. The Commission does not dictate particular proposed rule changes that a CCA should adopt, although a CCA may determine that it should propose certain rule changes in response to a new or amended Commission rule. In response to this amount that exceeds the registered fund’s margin obligations, then the sponsoring member would need to return such excess to the registered fund as promptly as possible or promptly comply with all requirements of Rule 17f–1 under the 1940 Act. 152 17 CFR 240.17ad–22(a)(5) (defining a covered clearing agency); 15 U.S.C. 78c(a)(26) (defining an SRO to include a registered clearing agency). 153 An SRO must submit proposed rule changes to the Commission for review and approval pursuant to Rule 19b–4 under the Exchange Act. A stated policy, practice, or interpretation of an SRO, such as its written policies and procedures, would generally be deemed to be a proposed rule change. See 15 U.S.C. 78s(b)(1); 17 CFR 240.19b–4. See 15 U.S.C. 78s(b)(3)(A) (setting forth the types of proposed rule changes that take effect upon filing with the Commission). The Commission may temporarily suspend those rule changes within 60 days of filing and institute proceedings to determine whether to approve or disapprove the rule changes. 15 U.S.C. 78s(b)(3)(C). 154 See 15 U.S.C. 78s(b)(1). Proposed rule changes are generally required to be approved by the Commission prior to going into effect; however, certain types of proposed rule changes take effect upon filing with the Commission. 155 15 U.S.C. 78s(b)(1)(C)(i). On the other hand, the Commission shall disapprove a proposed rule change if it cannot make such a finding. 15 U.S.C. 78s(b)(1)(C)(ii). 156 See 12 U.S.C. 5462(6). 157 The Dodd-Frank Act defines a ‘‘designated clearing entity’’ as a designated financial market utility that is either a derivatives clearing organization registered under section 5b of the Commodity Exchange Act (7 U.S.C. 7a–1) or a clearing agency registered with the Securities and Exchange Commission under section 17A of the Securities Exchange Act of 1934 (15 U.S.C. 78q–1). See 12 U.S.C. 5462(3). The Commission is the Supervisory Agency, as defined in 12 U.S.C. 5462(8), for four designated clearing agencies (the Depository Trust Company, the National Securities Clearing Corporation, the Fixed Income Clearing Corporation, and the Options Clearing Corporation). See 12 U.S.C. 5465(e)(1)(A). The Commission published a final rule concerning the filing of advance notices for designated clearing agencies in 2012. See 17 CFR 240.19b–4(n); Exchange Act Release No. 34–67286 (June 28, 2012), 77 FR 41602 (July 13, 2012). 158 See 12 U.S.C. 5465(e)(1)(B). 159 See 12 U.S.C. 5465(e)(1)(E) and (F). PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 E:\FR\FM\16JAR2.SGM 16JAR2 2730 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 commenter, and as discussed in part II.B.2 infra, the Commission will consider any proposed rule changes filed by FICC, or any other U.S. Treasury securities CCA, in due course, consistent with its obligations under Section 19(b) of the Exchange Act. The Commission does not have the ability to revise particular aspects of the rules of an SRO that is a registered clearing agency, like a CCA.160 Second, the commenter discussed potential custody issues for registered funds under Section 17(f) of the 1940 Act and Rule 17f–4 thereunder. Section 17(f) requires that a registered fund maintain its securities and similar investments in a bank, a company which is a member of a national securities exchange, or its own custody.161 The commenter stated that substantially all funds use a bank custodian, and that a bank custodian is particularly beneficial to funds in the context of repo and reverse repo transactions with respect to custodying both securities and cash.162 The Commission has adopted rules that specify required qualifications for entities other than those named in Section 17(f) to act as custodians of fund assets, including Rule 17f–4 which permits a registered fund to deposit the securities it owns in a securities depository, under certain conditions.163 A ‘‘securities depository’’ is defined to include a clearing corporation that is registered with the Commission under Section 17A of the Exchange Act.164 The commenter observed that FICC is registered as a clearing agency, but that FICC has stated that it is not a securities depository and does not provide securities depository services.165 The commenter asserted that, because FICC is not deemed to be a securities depository eligible to custody fund assets, expanding the Sponsored Service for funds would require addressing Section 17(f) ‘‘if the offering would require margin posting by funds,’’ and stated that one way to do this would be for FICC to obtain Commission relief to hold fund margin as an eligible securities depository within the meaning of Rule 17f–4.166 The Commission is not opining on whether FICC’s Government Securities Division could currently be considered 160 15 U.S.C. 78s(c) (establishing the Commission’s authority to, by rule, abrogate, add to, and delete from the rules of an SRO other than a registered clearing agency). 161 15 U.S.C. 80a–17(f)(1). 162 ICI Letter, supra note 85, at 15. 163 17 CFR 270.17f–4. 164 17 CFR 270.17f–4. 165 ICI Letter, supra note 85, at 15. 166 ICI Letter, supra note 85, at 15–16. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 a ‘‘securities depository’’ for purposes of Rule 17f–4.167 However, the amendments to Rule 17ad–22(e) do not require that registered funds post margin directly to a U.S. Treasury securities CCA, meaning that this issue is not implicated at this time. Therefore, the Commission does not believe that such concerns are ripe for consideration, as no U.S. Treasury securities CCA has proposed particular rules that would require the posting of registered funds’ securities at the CCA and such an arrangement is not specifically required by the requirement to clear eligible secondary market transactions. Moreover, as discussed in this part above, the Commission has taken the position regarding the FICC registered fund margin framework in light of the commenter’s concern. The Commission’s definition of an eligible secondary market transaction and the requirement to clear such transactions does not, on its own, mandate particular changes to FICC’s membership models, including the Sponsored Service. FICC has not proposed any rule changes with respect to the Sponsored Service in this regard at this time. The Commission will consider any proposed rule changes consistent with its obligations under Section 19(b) of the Exchange Act in the event that FICC submits any such proposal in the future. Third, the commenter stated that FICC’s rules addressing margin posting will need to be amended to provide for enhanced recordkeeping, internal controls, and transparency around the positions and related margin, to address fund concerns regarding the security of fund assets under a requirement to clear certain transactions. The commenter stated that enhanced recordkeeping and 167 The commenter’s assertion that FICC has stated that it is not a securities depository and does not provide securities depository services comes from a statement in FICC’s Disclosure Framework concerning a different regulatory regime. Specifically, the statement concerns whether FICC is a ‘‘central securities depository’’ or provides ‘‘central securities depository’’ services, for purposes of discussing FICC’s obligation to comply with Rule 17ad–22(e)(10), which applies to CCAs that provide central securities depository services. ‘‘Central securities depository’’ is a defined term in the Covered Clearing Agency Standards, meaning a clearing agency that is a securities depository as described in Section 3(a)(23)(A) of the Act (15 U.S.C. 78c(a)(23)(A). Section 3(a)(23)(A) defines a securities depository, in turn, as who (i) acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned, or pledged by bookkeeping entry without physical delivery of securities certificates, or (ii) otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates. PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 related controls are critical to appropriately identifying ownership of assets during a repo transaction particularly since, unlike a typical derivatives or cash transaction, ownership of the U.S. Treasury securities underlying a repo transaction changes during the transaction. The commenter asserted that FICC currently relies on its broker-dealer members and, in certain cases, designated agency banks to maintain records regarding margin positions, and that FICC has indicated that it is not able to identify positions or possess the assets of its members’ customers. The commenter states that notwithstanding FICC’s current lack of infrastructure, ‘‘the Proposal relies heavily on FICC to intermediate transactions under a clearing mandate and contemplates that this approach will provide a higher level of safety to the market than the current bilateral market, which relies on a well-diversified group of creditworthy banks to hold collateral, including through robust tri-party arrangements, and utilizes an industry standard agreement that is well understood by market participants.’’ 168 However, no U.S. Treasury securities CCA has proposed particular rules that would require the posting of registered funds’ securities at the CCA. The Commission’s definition of an eligible secondary market transaction and the requirement to clear such transactions does not, on its own, mandate particular changes to FICC’s membership models, including the Sponsored Service. The Commission will consider any proposed rule changes consistent with its obligations under Section 19(b) of the Exchange Act in the event that FICC submits any such proposal in the future. The Commission disagrees with the commenter’s assertion that FICC has indicated that it is not able to identify positions or possess the assets of its members’ customers. FICC currently is able to maintain position data for customer positions in all its indirect access models.169 In addition, under the amendments being adopted in this release, FICC will, as discussed in section II.B.1 infra, be required to separately calculate and hold customer margin (which it currently does for the Sponsored Service), which addresses 168 ICI Letter, supra note 85, at 16–17. Buyside FAQ at 4, available at https:// www.dtcc.com/ustclearing/-/media/Files/ Downloads/Microsites/Treasury-Clearing/FICCGSD-FAQ.pdf (‘‘FICC records positions of Sponsored Members and positions of Executing Firms of a Prime Broker as long as the Prime Broker submits the trades to FICC using a unique client identifier called the ‘‘Executing Firm symbol.’’) (‘‘FICC Buyside FAQ’’). 169 FICC E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations the commenter’s concern that FICC calculate and hold customer margin separately. Fourth, the commenter highlighted its support for strong protections for fund assets, including ‘‘legally segregated, operationally commingled’’ (‘‘LSOC’’) protections. In addition, another commenter asserted that, without an exclusion from the definition of an eligible secondary market transaction for repos with registered funds, such funds could be subject to greater counterparty credit risk because the existing Sponsored Member clearing model at FICC has no requirement to segregate customer assets, while at present most registered funds use thirdparty custodians to hold securities and cash.170 The Commission addresses these comments in more detail in part II.B.1 below. Fifth, the commenter stated that the Commission and FICC must address the bankruptcy treatment of certain fund assets. Specifically, the commenter stated that FICC’s rules should confirm that agreements entered into by repo counterparties will be enforceable against both parties, notwithstanding that the transactions are cleared, and provide a clear process for closeout of transactions by FICC, including both the start and end legs of the transaction. The commenter also stated that FICC’s rules need to address what happens upon the insolvency of a sponsoring member in a variety of factual circumstances, including providing for prompt replacement of the sponsoring member by its sponsored members and handling of other functions typically performed by the sponsoring member to ensure that transactions by the sponsored member are maintained and allowing the sponsored member the authority to receive certain reports directly and to post to the clearing fund to preserve pending trades. The commenter also stated that FICC’s rules should provide clarity regarding how non-defaulting parties, such as funds, can exercise closeout rights, including those available under Sections 555, 559, 561, and similar sections of the U.S. Bankruptcy Code. The commenter stated that if, in the future, FICC decides to expand the Sponsored Service to permit (but not require) sponsored members to post margin, then the Commission and FICC should clarify that the margin posted by a sponsored member with its sponsoring member for on-posting with FICC would be eligible for customer treatment under the Securities Investor Protection Act (‘‘SIPA’’). The commenter also argues 170 SIFMA AMG Letter, supra note 35, at 5. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 that clarification of FICC’s rules regarding closeout rights—particularly in respect to ‘‘done away’’ trades—is important to clarify a repo counterparty’s rights under different insolvency regimes applicable to cleared transactions.171 Regarding these bankruptcy-related comments, FICC’s rules already address the issues raised by the commenter. For example, with respect to the enforceability of the agreements entered into by repo counterparties, FICC requires applicants for membership to execute a Membership Agreement, in which the applicant agrees to be bound by FICC’s Rules, and FICC further requires applicants for membership to provide a legal opinion regarding the membership agreement, which incorporates FICC’s Rules.172 Novation consists of the termination of the deliver, receive, and related payment obligations between the parties to a trade, and their replacement with identical obligations to and from FICC in accordance with the Rules. Once it novates a transaction, FICC contractually replaces the original counterparties’ obligations to each other with two sets of obligations, both of which include FICC and one of the original counterparties.173 FICC is not a party to the pre-novation bilateral agreements between a Sponsoring Member and its Sponsored Members, and therefore, it cannot guarantee performance of those contracts. In addition, with respect to FICC’s need to establish a process for closeout, FICC’s Rules contain these processes. Upon ceasing to act for an insolvent member, FICC may promptly close out and manage the member’s positions, including with respect to the member’s pending transactions with nondefaulting members.174 Specifically, FICC would terminate and net all of the insolvent member’s positions, after which FICC would liquidate the net positions through market action and determine a single net amount owed to or from the insolvent member from or to FICC.175 After closing out the insolvent member’s final net positions, FICC’s Rules provide for the timely settlement of all deliver, receive, and related payment obligations that would have 171 ICI Letter, supra note 85, at 20–21. Rule 2A, Section 7, supra note 19; FICC Disclosure Framework, Principle 1, available at https://www.dtcc.com/-/media/Files/Downloads/ legal/policy-and-compliance/FICC_Disclosure_ Framework.pdf. 173 FICC Rule 5, section 8 (regarding novation generally) and Rule 3A, section 7(a) (regarding novation in the Sponsored Service), supra note 19. 174 FICC Rule 22A, Section 2, supra note 19. 175 See id. 172 FICC PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 2731 arisen had FICC not ceased to act for the insolvent member (i.e., FICC would seek to fulfill its settlement obligations with respect to the insolvent member’s pending transactions with nondefaulting members.) 176 Similarly, in the event that FICC determines to treat a Sponsoring Member as insolvent, FICC would cease to act for the Sponsoring Member.177 FICC would determine whether to close-out the affected Sponsored Member Trades and/or permit the Sponsored Members to complete their settlement.178 In the event that it closes out the Sponsored Member’s transactions, it would follow the same closeout process.179 Moreover, these comments generally relate to particular features of FICC’s Sponsored Service, including how the sponsored member is able to interact with FICC, FICC’s ability to settle the transactions in the event of a Sponsoring Member default, and the operation of certain bankruptcy provisions. For the reasons discussed in more detail in part II.B.2 infra, the Commission cannot change the rules governing the Sponsored Service. Sixth, the commenter identified issues for registered funds that would arise if additional clearing were to require funds to contribute to FICC’s CCLF. The commenter explained that contribution by a registered fund to the CCLF could result in a prohibited joint transaction in violation of: Section 17(d) of the 1940 Act if affiliates of the fund (e.g., other funds managed by the same investment adviser) also contribute to the fund; Section 18 of the 1940 Act, which prohibits a registered fund from issuing ‘‘senior securities;’’ Section 17(f) of the 1940 Act; the fund’s investment purpose, policies, and organization documents; or the fiduciary duties of the fund’s board and its investment adviser. The commenter asserts that the Commission would need to carefully evaluate the ability of a registered fund to become a FICC netting member and contribute to the CCLF, as well as amending its rules to confirm that view, or that, in the alternative, FICC could create a special category of netting member that would not require a fund to contribute to the CCLF.180 In response to this commenter, any requirement for a U.S. Treasury securities CCA to have policies and procedures requiring its direct participants to clear eligible secondary market transactions does not, on its 176 See id. Rule 3A, Section 16(b), supra note 19. 177 FICC 178 Id. 179 Id. 180 ICI E:\FR\FM\16JAR2.SGM Letter, supra note 85, at 22. 16JAR2 2732 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 own, require any particular market participant to become a direct participant of a U.S. Treasury securities CCA, thereby taking on the membership obligations of such participation, including contribution to the CCLF. The Commission acknowledges the commenter’s view that certain regulatory provisions applicable to registered funds could effect a registered fund’s ability to join a U.S. Treasury securities CCA directly, but the Commission does not believe that these concerns should impact its consideration of the proposal as the proposal would not impose such requirements. Consistent with its obligations under Section 19 of the Exchange Act, in its review of any rule filings, the Commission would consider issues related to the ability of market participants, including registered funds, to participate in FICC. Seventh, the commenter stated that bilateral tri-party repo should be exempted from the definition of an eligible secondary market transaction. The Commission has considered this comment in part II.A.2.a.i supra. In addition, certain commenters also provided specific arguments regarding money market funds subject to Rule 2a– 7 under the 1940 Act.181 One commenter stated that the Commission should not include repos with money market funds subject to Rule 2a–7 within the definition of an eligible secondary market transaction, noting that the current ability to transact in Treasury repurchase agreements across a variety of clearance and settlement platforms allows these funds to be invested in a manner that is in the best interest of their shareholders. The commenter also referred to the planning and tools that have been developed that seek to avoid a disorderly default in repurchase agreement markets. The commenter also stated that the likely insolvency regimes for the major repurchase agreement participants that would be facilitated by a receiver (either the Federal Deposit Insurance Corporation or the Securities Investor Protection Corporation) allow the receiver to transfer or wind down repurchase agreements in an orderly manner.182 Two commenters raised questions with respect to regulatory 181 Federated Letter, supra note 85, at 3; ICI Letter, supra note 85, at 5–8. 182 Federated Letter, supra note 85, at 3 (citing SEC. & EXCH. COMM’N, DIV. OF INV. MGMT GUIDANCE UPDATE: COUNTERPARTY RISK MANAGEMENT PRACTICES WITH RESPECT TO TRI-PARTY REPURCHASE AGREEMENTS (July 2013), available at https://www.sec.gov/divisions/ investment/guidance/im-guidance-2013-03.pdf). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 diversification requirements, that is, whether registered funds, including money market funds, will continue to meet the definition of a ‘‘collateralized fully’’ repurchase agreement under Rule 5b–3 under the Investment Company Act of 1940 if Treasury repo investments through the Sponsored Service grow significantly.183 Commenters explained that meeting the definition of a ‘‘collateralized fully’’ repurchase agreement under Rule 5b–3 is necessary for Treasury repurchase agreements to remain permissible investments for a government money market fund and for achieving ‘‘look through’’ treatment for certain diversification requirements imposed under the 1940 Act and Internal Revenue Code.184 One commenter asked that the Commission confirm through rulemaking or guidance that repo clearing offerings made available by FICC to registered funds ‘‘would continue to satisfy’’ the ‘‘collateralized fully’’ standard set forth in Rules 5b–3 and 2a–7 under the 1940 Act and would allow funds to achieve ‘‘look through treatment’’ for diversification purposes.185 One commenter also referenced the need for relief for reverse repo transactions. The commenter stated that, unlike Treasury repo agreements that are ‘‘collateralized fully,’’ Treasury reverse repo transactions entered into by funds (i.e., where a fund is the seller) currently are not eligible for lookthrough treatment. The commenter concludes that this means that, under the proposal, absent additional rulemaking or relief, most money market funds would be limited to investing no more than 5% of their total assets in reverse repo agreements because funds would face FICC as the counterparty, and that diversified nonmoney market funds would be limited to investing either no more than 25% of their total assets in reverse repo agreements or no more than 5%, with respect to 75% of their total assets, in reverse repo agreements. The commenter stated that registered funds may use Treasury reverse repo agreements as a form of short-term financing to facilitate shareholder redemption requests.186 The Commission acknowledges that the final rule could limit the extent to which some registered funds enter into Treasury reverse repo agreements. 183 17 CFR 270.5b–3(c)(1). Federated Letter, supra note 85, at 6; ICI Letter, supra note 85, at 23–24. 184 Federated Letter, supra note 85, at 6; ICI Letter, supra note 85, at 23–24. 185 ICI Letter, supra note 85, at 23–24. 186 ICI Letter, supra note 85, at 25. PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 However, the Commission believes that this effect will be limited because a relatively small number of funds report Treasury reverse repo agreements on Form N–PORT, and funds generally have other available means to generate cash to meet shareholder redemption requests, such as lines of credit, securities lending, interfund lending, or selling portfolio investments, as applicable. The combined effect of the final rule and the diversification requirements in section 5(b) of the 1940 Act could practically limit the amount some funds may invest in Treasury reverse repo.187 The commenter separately suggested that the final rule would affect money market funds’ use of Treasury reverse repo agreements, in light of additional diversification requirements for those funds. However, money market funds are not permitted to rely on rule 18f–4 under the 1940 Act to enter into reverse repo transactions.188 Moreover, money market funds historically have not reported holdings of reverse repo agreements in their portfolio reports filed with the Commission. The Commission’s definition of an eligible secondary market transaction and the requirement to clear such transactions does not mandate particular changes to FICC’s membership models, including the Sponsored Service. FICC has not proposed any rule changes with respect to the Sponsored Service in this regard at this time. The Commission will consider any proposed rule changes consistent with its obligations under Section 19(b) of the Exchange Act in the event that FICC submits any such proposal in the future. In the event that any U.S. Treasury securities CCA proposes a clearing model in which 187 Section 5(b) divides management investment companies into ‘‘diversified companies’’ and ‘‘nondiversified companies.’’ Under this section, (i) a ‘‘diversified company’’ means a management company which meets the following requirements: At least 75 per centum of the value of its total assets is represented by cash and cash items (including receivables), Government securities, securities of other investment companies, and other securities for the purposes of this calculation limited in respect of any one issuer to an amount not greater in value than 5 per centum of the value of the total assets of such management company and to not more than 10 per centum of the outstanding voting securities of such issuer and (ii) a ‘‘non-diversified company’’ means any management company other than a diversified company. See section 5 of the 1940 Act. 188 See Use of Derivatives by Registered Investment Companies and Business Development Companies, Investment Company Act Release No. 34084 (Nov. 2, 2020), 85 FR 83162 (Dec. 21, 2020); 17 CFR 270.18f–4. Rule 18f–4 establishes a framework for funds’ use of derivatives and certain other transactions, including reverse repurchase agreements. Money market funds are not permitted to rely on rule 18f–4 for these transactions. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 registered funds would be required to place and maintain assets to effect eligible secondary market transactions at the CCA, the Commission would consider the applicability of Section 17(f) of the 1940 Act. One commenter explained that registered funds’ access to the Treasury repo market could be restricted by the number or willingness of the FICC netting members to provide sponsoring services with attending negative effect on the market liquidity.189 Although increases in demand for the Sponsored Service may put pressure on existing sponsoring members and reduce their ability or willingness to onboard additional clients, this could also present an opportunity for dealers that currently do not offer the Sponsored Service to enter the market, resulting in more competition and a wider range of counterparties. This is supported by an observation of a growing number of dealers offering the Sponsored Service and the growing volume of sponsored repo indicating increased adoption of this service by a wider range of market participants.190 Several commenters raised concerns about the potential effect of the proposal and a potential resultant high level of exposure to the U.S. Treasury securities CCA on ratings assigned to certain money market funds by Nationally Recognized Statistical Rating Organizations (NRSROs).191 The commentators explained that NRSROs typically establish exposure limits that a rated money market fund may have to any particular CCA and, if these limits are breached, a fund may not be able to maintain the currently assigned rating.192 The Commission does not have the authority to adjust the NRSROs’ rating criteria and methodologies, and it cannot anticipate how NRSROs may adjust their rating criteria and methodologies in response to the U.S. Treasury market infrastructure changes resulting from the adoption of the Membership Definition. iii. Repos by Other Clearing Organizations Several commenters supported a limited exclusion from the definition of an eligible secondary market transaction for U.S. securities transactions entered into by a derivatives clearing 189 ICI Letter, supra note 85, at 30–31. 190 See Sponsored DVP and GC Repo Activity, available at https://www.dtcc.com/charts/ membership. 191 Federated Letter, supra note 85, at 6–7; ICI Letter, supra note 85, at 25–26; SIFMA AMG Letter, supra note 35, at 14. 192 Id. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 organization (‘‘DCO’’). A DCO is an entity that is regulated by the CFTC and is defined as a clearinghouse, clearing association, clearing corporation, or similar entity, facility, system, or organization that, with respect to an agreement, contract, or transaction (i) enables each party to the agreement, contract, or transaction to substitute, through novation or otherwise, the DCO’s credit for the credit of the parties; (ii) arranges or provides, on a multilateral basis, for the settlement or netting of obligations resulting from such agreements, contracts, or transactions executed by the DCO’s participants; or (iii) otherwise provides clearing services or arrangements that mutualize or transfer among the DCO’s participants the credit risk arising from such agreements, contracts, or transactions executed by the participants.193 Generally, DCOs perform similar functions as CCAs, but for commodities as opposed to securities. One commenter recognized that DCOs are not specifically enumerated as an entity type subject to the expanded clearing requirement, but stated that, in practice, it would be impractical for DCOs to avoid entering into repos with direct participants of U.S. Treasury CCAs, which would therefore be included in the definition of an eligible secondary market transaction.194 First, the commenter stated that an exclusion for DCOs was necessary to allow DCOs to retain the flexibility necessary to effectively manage risk when managing the default of a participant of the DCO, with respect both to access to the appropriate counterparties and to pressing time considerations. The commenter stated that requiring the central clearing of repos entered into for default management by a DCO could undermine the effectiveness of the DCO’s default management practices. Second, the commenter asserted that including transactions with a DCO within the definition of an eligible secondary market transaction would threaten DCOs’ effective cash management. The commenter stated that DCOs regularly receive U.S. dollar cash as margin from their clearing members and then enter into reverse repos, as permitted under the applicable CFTC regulations. However, the commenter expressed concern that the permissible counterparties and counterparty concentration limits included in CFTC Rule 1.25 would appear to be in tension with the requirement to clear eligible 193 7 U.S.C. 1a(15) (defining DCO) and 7a–1(a) (establishing DCO registration requirement). 194 CME Letter, supra note 81, at 6. PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 2733 secondary market transactions because a clearing agency, which would become the counterparty to any transaction that is centrally cleared, is not a permissible counterparty. Finally, the commenter stated that allowing transactions with DCOs to be scoped into the definition of an eligible secondary market transaction would be inconsistent with the spirit, and the letter, of Section 5b(f)(1) of the Commodity Exchange Act, which states that ‘‘under no circumstances shall a [DCO] be compelled to accept the counterparty credit risk of another clearing organization.’’ 195 An additional commenter made similar arguments. This commenter stated that the rule as proposed could create contagion risk by increasing linkages between CCPs, stating that this risk would crystallize if a CCP clearing its investment trades contributed to the mutualized financial resources of another CCP via its default fund or was otherwise exposed to loss in the event of a member default of the other CCP. The commenter further stated that existing regulations under both U.S. and European regulatory frameworks recognize the potential financial stability risks of inter-CCP linkages and prohibit them from accepting the counterparty credit risk of another CCP. According to the commenter, one such conflict arises under the Commodity Exchange Act where, to minimize systemic risk, there is a requirement that ‘‘[. . .] under no circumstances shall a derivatives clearing organization be compelled to accept the counterparty credit risk of another clearing organization.’’ Finally, the commenter states that a clearing model tailored to meet CCPs’ bespoke collateral management requirements would need to be developed before they could operationally clear investment trades.196 The Commission understands that reverse repos are used heavily by central counterparties as a means of investing their cash.197 The Commission also agrees that entities that provide central counterparty services, like DCOs and clearing agencies, must be able to effectively manage the default of a participant.198 In the event of a participant default, the need for such entities to be able to react within potentially compressed timeframes, including by engaging in repos of U.S. 195 CME Letter, supra note 81, at 6–7. from Rachel Goldberg, Head of Government Relations and Regulatory Strategy, Americas, London Stock Exchange Group, at 2–3 (June 15, 2023). 197 See BIS, Committee on the Global Financial System, Repo Market Functioning, Apr. 2017. 198 Proposing Release, supra note 14, 87 FR at 64627. 196 Letter E:\FR\FM\16JAR2.SGM 16JAR2 2734 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations Treasury securities held as margin to create liquidity, may be essential to their default management processes. The Commission agrees that including such transactions within the scope of an eligible secondary market transaction might have systemic risk implications and counteract the goals of effective and efficient default management by CCPs in such scenarios. Accordingly, it is appropriate to exclude repos entered into by an entity acting as a central counterparty from the definition of an eligible secondary market transaction.199 To do so, the Commission is modifying the definition of an eligible secondary market transaction in Rule 17ad–22(a) to exclude any repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities in which one counterparty is a covered clearing agency providing central counterparty services, a derivatives clearing organization (see 7 U.S.C. 7a–1 and 17 CFR 39.3), or is regulated as a central counterparty in its home jurisdiction. With respect to a counterparty that is regulated as a central counterparty in its home jurisdiction, this portion of the exclusion encompasses entities that may serve as central counterparties in their home jurisdiction and may transact in repos with direct participants of a U.S. Treasury securities CCA. Although commenters did not specifically suggest this exclusion for a counterparty that is regulated as a CCP in its home jurisdiction, this aspect of the exclusion is appropriate to ensure that entities serving as central counterparties in other jurisdictions are similarly excepted from the definition of an eligible secondary market transaction as repo counterparties. ddrumheller on DSK120RN23PROD with RULES2 iv. Repos by FCMs Two commenters asked the Commission to adopt an exemption that would allow Futures Commission Merchants (‘‘FCMs’’) to continue to engage in eligible secondary market transactions in U.S. Treasury securities outside of central clearing, and another commenter acknowledged the potential interaction between the proposal and the regulatory framework governing FCMs.200 An FCM is an entity engaged 199 The Commission is not opining on the proposal’s consistency with the Commodity Exchange Act or other regulatory regimes, but the commenter’s concern is moot in light of the modification to the definition of an eligible secondary market transaction that the Commission is adopting. 200 See comments from Walt L. Lukken, President and Chief Executive Officer, Futures Industry Association, at 2–7 (Dec. 23, 2022) (‘‘FIA Letter’’). See also SIFMA/IIB Letter, supra note 37, at 30–31 VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 in soliciting or accepting orders for the purchase or sale of commodities, futures, swaps, or other instruments regulated by the CFTC.201 FCMs can also be registered with the Commission as broker-dealers.202 In their role as market intermediaries, FCMs hold customer funds and securities. The commenter explained that as of October 31, 2022, FCMs held an aggregate amount of more than $500 billion in segregated customer accounts, a substantial percentage of which is held in the form of U.S. Treasury securities.203 As the commenter noted, FCMs are required under the Commodity Exchange Act 204 and the regulations promulgated thereunder 205 to assure the protection of customer funds. Specifically, as the commenter explained, FCMs are required to hold customer funds and securities in segregated accounts with a bank or other permitted depository that acknowledges such customer assets ‘‘will be separately accounted for and segregated’’ from the FCM’s own funds and ‘‘must otherwise be treated in accordance with the provisions of the [CEA]’’ and CFTC rules.206 The commenter highlighted that neither the bank/depository nor the FCM may use the FCM’s customer funds to ‘‘secure or guarantee any obligations’’ that the FCM might owe to the bank/ depository or make the funds ‘‘subject to any right of offset or lien for or on account of any indebtedness, obligations, or liabilities’’ the FCM may owe the bank/depository.207 The commenter expressed concern as to whether the account structure provided by FICC would be consistent with these rules. As an initial matter, the requirement for direct participants of a U.S. Treasury securities CCA to clear eligible secondary market transactions does not (recognizing that the absent an exemption for FCMs from the central clearing requirement, FCMs engaging in repo transactions would be placed in the untenable position of violating either the SEC’s proposal or existing CFTC regulations). See also DTCC/FICC Letter, supra note 33, at 25 (recognizing that CFTC regulations currently limit FCM access to central clearing by preventing FCMs from entering into FICC-cleared repo transactions using customer property). 201 See 7 U.S.C. 1a(28)(A). 202 One commenter states that the majority of FCMs are dually registered as FCMs and brokerdealers. See FIA Letter, supra note 200, at 2. 203 See FIA Letter, supra note 200, at 4. 204 7 U.S.C. 1–26. 205 17 CFR 1.1–190.19. 206 See FIA Letter, supra note 200, at 3 (discussing 17 CFR 1.20 (regarding futures traded on U.S. futures exchanges) and 17 CFR 22.4 (regarding cleared swaps)). 207 FIA Letter, supra note 200, at 3–4 (discussing 17 CFR 1.20, 22.2, and 30.7). PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 require that an FCM post customer assets directly to the U.S. Treasury securities CCA. An FCM could access central clearing through a customer model, such as the Sponsored Service or the Prime Broker/Correspondent clearing models, that allows the customer/FCM to hold customer assets elsewhere (such as at the Sponsoring Member) and does not require that the FCM post customer assets to the U.S. Treasury securities CCA. Therefore, the ability of the CCA to provide an account structure consistent with the CFTC Rules should not prevent an FCM’s transactions from being submitted to central clearing. Moreover, in light of the requirements regarding the segregation of house and customer margin, as discussed in part II.B.1 infra, and the amendments to Rule 15c3–3, as discussed in part II.C infra, U.S. Treasury securities CCAs will have to ensure that they have adopted policies and procedures to separate house and customer margin and to establish certain types of segregated accounts. The Commission encourages FCMs seeking the ability to post customer funds directly to the CCP to engage with the CCAs to consider whether such new account structures may be sufficient to comply with the provisions of the CFTC regulations that the commenter has identified or whether such structures could be leveraged to meet the commenter’s needs. For example, the Commission understands that the existing U.S. Treasury securities CCA recently has indicated that it would develop customer clearing account structures in which each customer’s margin would be calculated on a gross basis and held physically segregated from all other FICC margin and would also be legally segregated from FICC member as well as fellow customer exposures.208 One of the commenters also explained that FCMs are permitted to invest customer funds in certain securities determined by the CFTC to be ‘‘consistent with the objectives of preserving capital and maintaining liquidity.’’ 209 The commenter stated that permitted investments include, among other things, U.S. Treasury securities, and investments with U.S. Treasury securities may be made by either direct purchase or sale or by entering into repo transactions.210 The commenter further explained that, for repo transactions, an FCM’s ‘‘permitted 208 DTCC 2023 White Paper, supra note 107, at 22–23. 209 FIA Letter, supra note 200, at 4–5 (discussing 17 CFR 1.25(b)). 210 FIA Letter, supra note 200, at 4–5 (discussing 17 CFR 1.25(a)). E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 counterparties are limited to a bank . . . , securities broker-dealer, or government securities dealer registered with the [Commission],’’ and a clearing agency is not a permitted counterparty.211 The commenter stated that, absent relief, conflict between the CFTC rules and the proposal would effectively prohibit FCMs from entering into U.S. Treasury security transactions pursuant to CFTC Rule 1.25.212 The commenter explained that a U.S. Treasury securities CCA interposes itself between the counterparties to a securities transaction through novation, acting functionally as the buyer to every seller and seller to every buyer.213 Therefore, according to the commenter, if an FCM were to conduct a cleared transaction, the CCA would become the FCM’s counterparty. Since a CCA is not a permitted FCM counterparty under the CFTC rules, the commenter states that FCMs are prohibited from conducting such cleared transactions.214 The commenter contended that if the Commission adopts the requirement to clear eligible secondary transactions as proposed, an FCM would lose its current ability to conduct transactions in U.S. Treasury securities with a direct participant of a U.S. Treasury securities CCA in compliance with CFTC rules.215 The Commission recognizes that if the FCM were to access a U.S. Treasury securities CCA through a model like FICC’s Sponsored Service, the CCA would novate the transaction and become the counterparty to the FCM, which, as the commenter has described it, would not be consistent with Rule 1.25(d)(2) with respect to permitted counterparties. However, the requirement to clear eligible secondary market transactions does not require that the FCM use a particular type of model that would make the FCM a counterparty to a CCA. The FCM could access central clearing through an agent clearing model like FICC’s Prime Broker or Correspondent Clearing models, in which it would essentially ‘‘give up’’ its transaction to a direct participant for submission without becoming a counterparty to the CCA, which should be consistent with the FCM’s obligations under Rule 1.25(d)(2). Therefore, this requirement to clear eligible secondary market transactions does not obligate the FCM to use a model that would 211 FIA Letter, supra note 200, at 5 (discussing 17 CFR 1.25(d)(2)). 212 FIA Letter, supra note 200, at 6. 213 FIA Letter, supra note 200, at 6; see also Proposing Release, supra note 14, 87 FR at 64612. 214 FIA Letter, supra note 200, at 6 (citing 17 CFR 1.25(d)(2)). 215 See FIA Letter, supra note 200, at 6. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 necessarily result in a transaction with a clearing agency as the counterparty to the FCM. The Commission recognizes this apparent tension between the application of Rule 1.25(d)(2), as described by the commenter, and the requirement to clear repos as part of the definition of eligible secondary market transactions.216 However, as discussed in the Proposing Release, when Congress added section 17A to the Exchange Act as part of the Securities Acts Amendments of 1975, it directed the Commission to facilitate the establishment of (i) a national system for the prompt and accurate clearance and settlement of securities transactions (other than exempt securities) and (ii) linked or coordinated facilities for clearance and settlement of securities transactions, and the Government Securities Act of 1986 specifically included government securities within the scope of section 17A.217 The Commission therefore has the ability to make rules governing central clearing in the U.S. Treasury market, which may affect a diverse group of market participants, including FCMs. The Commission encourages interested parties to work with the CCA to identify any modifications to its client clearing models to better allow FCMs to access central clearing in the U.S. Treasury market. In addition, FCMs could enter into repos with market participants that are not direct participants of a U.S. Treasury securities CCA.218 The commenter also notes that CFTC rules require that securities transferred to an FCM’s customer segregated custodial account must be ‘‘made on a delivery versus payment [(DVP)] basis in immediately available funds.’’ 219 Even if a U.S. Treasury securities CCA would be a permitted FCM counterparty under the CFTC rules, the commenter expressed concern that upon the sale or resale of securities in a repo transaction, the FCM’s customer segregated cash account may not receive same-day funds 216 See CFTC Global Market Advisory Committee (‘‘GMAC’’), Global Market Structure Subcommittee, CFTC Rule1.25(d)(2) Recommendation (discussing the impact of Rule 1.25(d)(2) on FCMs’ ability to participate in cleared repo), available at https:// www.cftc.gov/PressRoom/Events/ opaeventgmac110623. The CFTC’s GMAC voted in favor of this recommendation to amend Rule 1.25(d)(2) to include CCAs as permitted counterparties. 217 Proposing Release, supra note 14, 88 FR at 64617. 218 CFTC Rule 1.25(a)(1) also identifies additional types of permitted investments available to an FCM for its customer funds, including municipal bonds, corporate bonds, and interests in money market mutual funds. 219 FIA Letter, supra note 200, at 5 (discussing 17 CFR 1.25(d)(9)). PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 2735 credited simultaneously with the delivery or transfer of securities.220 The Commission does not believe that such concerns are warranted. FICC clears all transactions DVP meaning that payment of cash is made at the same time as delivery of securities. Finally, the commenter also explained that CFTC rules require that the agreement between an FCM and a repo counterparty must ‘‘make[ ] clear that, in the event of the [FCM’s] . . . bankruptcy, any securities purchased with customer funds that are subject to an agreement may be immediately transferred. The agreement [must] also make[ ] clear that, in the event of an [FCM’s] . . . bankruptcy, the counterparty has no right to compel liquidation of securities subject to an agreement or to make a priority claim for the difference between current market value of the securities and the price agreed upon for resale of the securities to the counterparty, if the former exceeds the latter.’’ 221 The commenter also expressed concern that there is no assurance that a U.S. Treasury securities CCA would agree to the bankruptcy provisions in the CFTC rules applicable to FCMs described above.222 However, as stated in the discussion above, the requirement to clear eligible secondary market transactions does not require that the FCM enter into a repo agreement with the CCA. For the reasons discussed above, the Commission does not believe that an exclusion for FCMs is necessary to accommodate the relevant provisions of the CFTC Rules. Moreover, an exclusion for FCMs would be inconsistent with the purpose of the rule which is to help reduce contagion risk to the CCA and bring the benefits of central clearing to more transactions involving U.S. Treasury securities, particularly in light of their significance to the Treasury market. 220 See id. Letter, supra note 200, at 5 (discussing 17 CFR 1.25(d)(13)). 222 See id. The commenter also noted that the CFTC has advised that ‘‘in-house transactions’’ in which an FCM receiving customer collateral that is not acceptable at a Derivatives Clearing Organization (‘‘DCO’’) or foreign board of trade may, independent of CFTC Rule 1.25 requirements, exchange that collateral for acceptable collateral to the extent necessary to meet margin requirements. The commenter requested confirmation from the Commission that such ‘‘in-house transactions’’ would similarly not be subject to the proposed clearing requirement were an FCM to conduct transactions with a participant of a U.S. Treasury securities CCA. If such transactions are with a participant of a U.S. Treasury securities CCA and otherwise meet the definition of an eligible secondary market transaction, then they would be subject to the requirement. 221 FIA E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 2736 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations v. Repos Involving ‘‘End Users’’ One commenter argued that transactions by commercial entities participating in the Treasury repo market solely for investing their extra cash balances should be excluded from the definition of an eligible secondary market transaction. The commenter stated that corporations are often required under their credit agreements to invest cash in specified cash equivalents, which typically include Treasury repos, and that these transactions are likely to be quite limited in size.223 The commenter suggested that the Commission could leverage the definition of commercial end user in the uncleared security-based swap margin rules or non-financial end user in the uncleared swap margin rules (which both similarly contain exemptions for such entities).224 Another commenter requested a similar exclusion, stating that commercial entities that enter into cash or repo transactions do so for various, legitimate purposes, but that these entities’ trading is rarely large in size and the costs of these transactions being cleared would ultimately outweigh the benefits. The commenter also stated that such an exclusion would be consistent with the exemption in the Commission’s uncleared swap margin rules.225 An additional commenter requested the same exclusion for non-financial commercial end users, such as corporations and municipalities. The commenter stated that these types of entities typically transact in U.S. Treasury repos for funding and liquidity management purposes, and that the increased costs of centrally clearing such transactions may outweigh the willingness of these types of entities to continue to use U.S. Treasury securities for funding and liquidity management purposes, thus eliminating an effective corporate management tool without advancing the Commission’s stated policy objectives.226 The Commission understands that in addition to cash assets obtained through credit agreements, other sources of corporate cash exist that do not typically have accompanying investment limitations, such as equity capital, retained earnings, sales of assets, and legal settlements, among others. Investments of the combined surplus cash by corporate treasurers are typically aligned with the firm’s 223 SIFMA/IIB Letter, supra note 37, at 22. (citing 17 CFR 240.18a–3(b)(2), and 23.151; 12 CFR 45.2). 225 AIMA Letter II, supra note 115, at 3. 226 See Morgan Stanley Letter, supra note 85, at 2. 224 Id. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 projected cash needs and may include a range of investment options in addition to Treasury repos.227 As of June 30, 2023, balances of liquid assets held by nonfinancial corporations are estimated at approximately $6.9 trillion.228 While the commenter stated that such an exclusion may be warranted because the Treasury repo investments are likely to be limited in size, commercial end-users could change the size of their Treasury repo investments, including by entering into large Treasury repo investments, or by using alternative options for the short-term investment of cash that share a similar risk profile, such as a money market fund, depending on many firmspecific and market factors. For example, commercial end-users may increase allocations to U.S. Treasury repos for credit diversification, particularly at times of market stress. U.S. Treasury repos may offer higher yields, particularly at times when issuance of Treasury securities increases and dealers seek financing to complete settlement by borrowing more cash in the repo market. The high liquidity of Treasury repos could also be attractive to commercial end-users, especially if a significant amount of liquidity needs to be accumulated to complete a corporate transaction such as a merger or an acquisition. An exemption for end users could permit commercial entities to enter into Treasury repo investments without the risk-reducing benefits of central clearing. In addition, due to the variety of sources of cash available to commercial entities besides those obtained through credit agreements and the size of corporate liquid assets held by commercial entities, excluding commercial entities from the scope of the definition of an eligible secondary market transaction would not be consistent with the intent to reduce risk and enhance efficiency of the U.S. Treasury market.229 The Commission also disagrees with the contention that the increased costs arising from the clearing mandate would impede the willingness of commercial entities to 227 Association of Finance Professionals, 2023 AFP Liquidity Survey, available at https:// www.afponline.org/publications-data-tools/reports/ survey-research-economic-data/Details/liquiditysurvey. 228 Federal Reserve, Financial Accounts of the United States, L.103 Nonfinancial Corporate Business (the broad measure of liquid assets includes cash held in banks’ accounts and deposits, and cash invested in various liquid financial assets), available at https://www.federalreserve.gov/ releases/z1/20230908/html/l103.htm. 229 Association of Finance Professionals, 2023 AFP Liquidity Survey, available at https:// www.afponline.org/publications-data-tools/reports/ survey-research-economic-data/Details/liquiditysurvey. PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 continue to use the Treasury repo market for funding and liquidity management purposes. As discussed in part I supra, central clearing allows market participants to reduce costs and increase operational efficiency, among other benefits, which would, in turn, lead to lower funding costs in the repo market and greater availability of liquidity for all market participants, including commercial end-users. Moreover, the Commission disagrees with the commenter’s suggestion that it could leverage the definitions used in exempting certain end users from swap clearing requirements. The commercial end user in the uncleared security-based swap margin rules is defined as a counterparty to the swap that is (i) is not a financial entity; (ii) is using swaps to hedge or mitigate commercial risk; and (iii) meets certain reporting obligations associated with entering into noncleared swaps.230 The exemption is intended to ensure that certain types of commercial entities are able to continue to use swaps to manage their specific commercial risks and are not unduly burdened by the need to post margin. The end-user exemption from clearing for swaps may not be available to all commercial entities entering swaps. When implementing the exemption, the CFTC specifically required, among other things, that the end user must be using the swap to hedge or mitigate commercial risk, and that the swap that is hedging or mitigating commercial risk cannot be used for a purpose that is in the nature of speculation, investing, or trading.231 In addition, the counterparty that elected the end-user exception must provide reports relating to its ability to meet financial obligations associated with entering into non-cleared swaps.232 In contrast, the commercial end user activity in the U.S. Treasury repo market is unrelated to the commercial activity of these users. Investment of surplus cash is an activity similar to that of institutional asset managers such as registered funds or other managed investments. As discussed above, investing is a type of activity that would not qualify the end-user exemption in the swap market. For the reasons here and above, the Commission does not believe that an exception for commercial end users is appropriate in the Treasury repo market. vi. Interaffiliate Repos One commenter recommended that the Commission exempt transactions in 230 Commodity Exchange Act section 2(h)(7); Exchange Act section 3C(g). 231 17 CFR 50.50(a)(1)(ii) and (c)(2)(i). 232 17 CFR 50.50(b). E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations U.S. Treasury securities between affiliates from any central clearing requirement. The commenter stated that inter-affiliate transactions are important to corporate groups, which may use them to achieve efficient risk and capital allocation and obtain flexibility for addressing customer demands.233 The commenter further stated that requiring inter-affiliate transactions to be centrally cleared would impose additional costs with limited benefits, for two reasons. First, if an inter-affiliate transaction is part of a ‘‘back-to-back arrangement,’’ meaning that the related external transaction between the affiliated counterparty and a nonaffiliated counterparty is not centrally cleared, then subjecting the interaffiliate transaction to a central clearing requirement does nothing to reduce the contagion risk presented by the nonaffiliated counterparty. The commenter further asserted that if that external transaction is already centrally cleared, the contagion risk would already be addressed and requiring the interaffiliate transaction to be cleared would not create additional benefits. Second, a direct participant’s affiliate’s credit risk is already part of the group-wide financial risks to which the Treasury CCP is exposed, and central clearing of inter-affiliate transactions is unlikely to meaningfully impact the risk profile.234 The commenter stated that, for similar reasons, the CFTC has exempted interaffiliate swaps from the swap mandatory clearing rules.235 Additional commenters made similar arguments. For example, one commenter stated that the definition of an eligible secondary market transaction should not apply to transactions between a direct participant of a U.S. Treasury securities CCA and its affiliates. The commenter explained that a CCA’s direct participants provide a range of risk management, collateral management, asset-liability management, and funding and liquidity services to their affiliates, including affiliated U.S. broker-dealers, and that imposing the definition of those direct participants’ transactions with affiliates would be potentially disruptive and unnecessary to advance the Commission’s stated policy objectives.236 Another commenter stated that a requirement to clear transactions between affiliates would create new, 233 SIFMA/IIB Letter, supra note 37, at 21–22. Letter, supra note 37, at 21–22. 235 See id. at 22 n. 66 (citing generally 17 CFR 50.52). 236 See Morgan Stanley Letter, supra note 85, at 1–2. 234 SIFMA/IIB VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 unnecessary costs without any benefits.237 As discussed in more detail in part IV.B, the Commission understands that inter-affiliate transactions represent an important tool to transfer liquidity and risk within an affiliated group. These transactions may serve different purposes, including, but not limited to, providing U.S. Treasury securities for delivery when an affiliate has taken a long or short position in U.S. Treasury securities as a hedge against other exposures, allowing the movement of U.S. Treasury securities to allow them to be posted as margin on an affiliate’s transaction, ensuring that U.S. Treasury securities can serve as a liquidity buffer for an affiliated bank,238 or to meet liquidity composition targets. To get the U.S. Treasury securities to the appropriate entity within an affiliated group, the affiliate often enters into repos or reverse repos with a direct participant of a U.S. Treasury securities CCA. In certain circumstances, the counterparty credit risk posed by interaffiliate transactions may be less than other transactions.239 However, affiliated entities are separate legal entities and, generally, are not legally responsible for each other’s contractual obligations. In the event that one or more affiliated entities becomes insolvent, the affiliates, as separate legal entities, would be managed as separate estates in a bankruptcy, with the trustee having a duty to the creditors of the affiliate, not the affiliated family. Thus, the Commission does not agree that a U.S. Treasury securities CCA is exposed to the group-wide financial risks of a direct participant’s affiliated group. In response to the comments received, the Commission is modifying the definition of an eligible secondary market transaction in Rule 17ad–22(a) to conditionally exclude inter-affiliate repurchase and reverse repurchase transactions. Specifically, the 237 AIMA Letter II, supra note 115, at 3. liquidity buffer generally refers to liquid assets that a banking organization manages to enable it to meet expected and unexpected cash flows and collateral needs without adversely affecting the banking organization’s daily operations. See generally FRB, FDIC, & OCC, Q&As on Statement Regarding the Use of Capital and Liquidity Buffers (Mar. 17, 2020), available at https://www.fdic.gov/news/financial-institutionletters/2020/fil20020a.pdf. 239 See, e.g., Clearing Exemption for Swaps Between Certain Affiliated Entities, 77 FR 50425, 50427 (Mar. 2012) (discussing the internalization of counterparty risk on inter-affiliate swap transactions as wholly owned members of the same corporate group, but also discussing that similar benefits may not accrue for other inter-affiliate swaps when the counterparties are not members of the same group). 238 A PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 2737 Commission is excluding from that definition any repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities entered into between a direct participant and an affiliated counterparty, provided that the affiliated counterparty submits for clearance and settlement all other repurchase or reverse repurchase agreements collateralized by U.S. Treasury securities to which the affiliated counterparty is a party. By referring to all other repos or reverse repos, the exemption clarifies that the requirement does not encompass transactions between the direct participant and the affiliate, i.e., the transactions that are excluded, and also does not encompass the affiliate’s transactions that would otherwise be excluded under sections (iii), (iv), or (v) of the definition of an eligible secondary market transaction. This exclusion is appropriate to ensure that affiliated groups can continue to use inter-affiliate repo transactions to transfer liquidity or risk, while also conditioning that ability on the affiliated counterparty’s submission of its eligible secondary market repo transactions for clearance and settlement.240 Regarding the conditional nature of the exclusion, the Commission agreed with the commenter that if the external transaction of a ‘‘back-to-back’’ arrangement in which the related external transaction between the affiliated counterparty and a nonaffiliated counterparty is centrally cleared, the contagion risk would already be addressed and requiring the inter-affiliate transaction to be cleared would not create additional benefits. To ensure that this is the case, the Commission is conditioning the availability of the exclusion for interaffiliate transactions on an obligation for the affiliated counterparty to submit its repo transactions, other than those with its direct participant counterparty, for clearance and settlement. This condition should also help ensure that a direct participant cannot rely upon an inter-affiliate transaction to avoid the requirement to clear eligible secondary market transactions. If there were no such condition, a direct participant 240 Although the commenter referred generally to inter-affiliate transactions, without specifying cash versus repo, the Commission is limiting the exclusion to repo transactions only for two reasons. First, inter-affiliate cash transactions would only be included in the definition of an eligible secondary market transaction if they met the definition of such transaction, as discussed further in part II.A.2.b. Second, as discussed in this section and in part IV.B.3.b.v, the Commission understands that the inter-affiliate transactions referenced by the commenter typically take the form of repo or reverse repo transactions. E:\FR\FM\16JAR2.SGM 16JAR2 2738 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations could simply use inter-affiliate transactions to move securities and funds to affiliates, and the affiliated counterparty could then enter into external transactions with counterparties which, if entered into as a direct participant of a U.S. Treasury securities CCA, would be eligible secondary market transactions.241 The Commission did not limit this condition to only the ‘‘back-to-back’’ transactions because such transactions may not serve as the only potential means by which inter-affiliate transactions can be used to evade the requirement to clear eligible secondary market transactions, and for that matter, may not serve as the only potential means by which such transactions can transfer risk.242 This condition should lessen the potential for any impacts arising from the default of an inter-affiliate transaction to spread throughout an affiliated group because it would ensure that the external facing transactions of an affiliated counterparty would be centrally cleared, if the direct participant wanted to exclude its interaffiliate transactions.243 This approach to an inter-affiliate exclusion for repos is consistent with the CFTC’s treatment of this issue in the swaps market, as the commenter suggested. As part of its inter-affiliate swap exemption, the CFTC also included a requirement that that the swaps entered into by the affiliated counterparties with unaffiliated counterparties must be cleared.244 This approach to an inter-affiliate exclusion for repos is also similar to the existing rules with respect to inter-affiliate transactions in place at FICC, as the only U.S. Treasury securities CCA. FICC’s rules require that its direct participants submit the transactions of particular affiliated counterparties (referred to as a Covered Affiliate), i.e., those that are not also direct participants, that are not foreign entities, and that are either broker- ddrumheller on DSK120RN23PROD with RULES2 241 The Commission acknowledges that the affiliated counterparty’s transactions may encompass transactions to which the requirement to clear eligible secondary market transactions already applies, either because the affiliated counterparty is transacting with another direct participant of a U.S. Treasury securities CCA or because the affiliated counterparty is itself a direct participant of a U.S. Treasury securities CCA. The condition for the affiliate to clear its repo or reverse repo transactions would also apply, however, even if the affiliate is not a direct participant of a U.S. Treasury securities CCA. 242 See, e.g., Final Rule, Clearing Exemption for Swaps Between Certain Affiliated Entities, 78 FR 21750, 21761–62 (Apr. 11, 2013). 243 Moreover, the condition is consistent with the commenters’ views noting that in the event that the external transaction is centrally cleared, the benefits of central clearing would be realized. See AIMA Letter II, supra note 115, at 3. 244 See 17 CFR 50.52(a)(4)(i)(E). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 dealers, banks, trust companies, and/or FCMs, if that transaction is with another direct participant or another direct participant’s Covered Affiliate. To accommodate this exclusion, the Commission is also adopting in Rule 17ad–22(a) a definition of an affiliated counterparty for purposes of the definition of an eligible secondary market transaction. Specifically, an affiliated counterparty would be defined as any counterparty which meets the following criteria: (i) the counterparty is either a bank (as defined in 15 U.S.C. 78c(6)), broker (as defined in 15 U.S.C. 78c(4)), dealer (as defined in 15 U.S.C. 78c(5)), or futures commission merchant (as defined in 7 U.S.C. 1a(28)), or any entity regulated as a bank, broker, dealer, or futures commission merchant in its home jurisdiction; (ii) the counterparty holds, directly or indirectly, a majority ownership interest in the direct participant, or the direct participant, directly or indirectly, holds a majority ownership interest in the counterparty, or a third party, directly or indirectly, holds a majority ownership interest in both the direct participant and the counterparty; and (iii) the counterparty, direct participant, or third party referenced in (ii) as holding the majority ownership interest would be required to report its financial statements on a consolidated basis under U.S. Generally Accepted Accounting Principles or International Financial Reporting Standards, and such consolidated financial statements include the financial results of the majority-owned party or of both majority-owned parties. With respect to the types of entities that can be considered an affiliated counterparty, this definition is consistent with how the current U.S. Treasury securities CCA defines the terms for purposes of its rule regarding its participants’ obligation to clear transactions with certain affiliates, and this consistency should be helpful to direct participants when considering compliance with this conditional exemption. The reference to entities that are regulated as banks, brokers, dealers, or futures commission merchants in their home jurisdictions encompasses foreign affiliates of direct participants of a U.S. Treasury securities CCA. This aspect of the definition of an affiliated counterparty is meant to ensure that, to take advantage of the conditional interaffiliate exemption, a direct participant of a U.S. Treasury securities CCA would have to ensure that the transactions of both domestic and foreign affiliates are submitted for clearing. Similarly, with respect to what constitutes affiliated, that is, the specific identification of PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 ownership interest to describe the requisite custody or control to be considered affiliated, this definition is consistent with the definition used by the CFTC for purposes of the interaffiliate swap exemption. This consistency, and additional specificity about the requisite custody or control, should be helpful to the direct participants of a U.S. Treasury securities CCA when determining compliance with this conditional exemption.245 This exemption is conditional, and a direct participant of a U.S. Treasury securities CCA may choose not to use the exemption, meaning that its affiliated counterparty would not be required to submit its repo transactions, other than those with its direct participant counterparty, for clearance and settlement. If a direct participant chooses to use the exemption, its affiliated counterparty could submit its transactions in several ways, including through an indirect clearing model (e.g., at FICC, the affiliated counterparty could be a Sponsored Member or use the Prime Broker or Correspondent Clearing models to submit its transactions for clearance and settlement) or by becoming a direct participant of the CCA.246 vii. Repos by State and Local Governments Several commenters argued that regulatory and practical constraints on the state and local government level could limit their ability to centrally clear their Treasury repo and reverse repo transactions.247 The commenters stated that authorizing statutes and local ordinances in several states only permit repo transactions with a bank or a government securities dealer counterparty.248 As such, a centrally cleared repo, which is novated to a CCA may not comply with these statutes or ordinances, because the CCA would be 245 Rule 17ad–22(a) currently contains a definition of a ‘‘participant family’’ for purposes of Rule 17ad–22(b)(3), (d)(14), (e)(4), and (e)(7). 17 CFR 240.17ad–22(a)(12). This term is defined to mean that if a participant directly, or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with, another participant then the affiliated participants shall be collectively deemed to be a single participant family for purposes of the specified portions of Rule 17ad–22. The Commission believes that a more specific and granular definition of an affiliated counterparty would be helpful for the purposes of the inter-affiliate exclusion because it would address any potential uncertainty about whether an entity controls, is controlled by, or is under common control with, another entity. 246 See notes 680 and 681 infra and accompanying text regarding these models. 247 SIFMA AMG Letter, supra note 35, at 14; Federated Letter, supra note 81, at 7; IDTA Letter, supra note 66, at 10. 248 Id. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations the counterparty. One commenter also highlighted specific collateralization requirements (e.g., 102%) by several states to their repo counterparties and raised concerns that varying levels of margining in central clearing of such trades could create a conflict with state laws.249 The commenters argued that amending state and local governments’ authorizing statutes through the legislative actions of an applicable body would take a substantial amount of time and would disrupt investments of public funds in the Treasury repo market with a negative effect on market liquidity.250 Considering these challenges, the commentors suggested exempting state and local governments from the scope of the definition of an eligible secondary market transaction. The Commission agrees with the commenters that it would be appropriate to adopt an exclusion for any repurchase or reverse repurchase transaction collateralized by U.S. Treasury securities between a direct participant and a state or local government, in light of both the potential conflicts with state and local government authorities related to their investments and because of the nature and size of U.S. Treasury market activity by such entities. According to the United States Census Bureau’s 2017 Census of Governments data, there were over 90,000 local governments in the United States, including county, city, municipality, township, and special purpose governments as well as nearly 13,000 independent school district governments.251 Many of these local governments operate only small budgets and access the Treasury repo market infrequently and on a small scale for secured investment of their surplus cash balances. While comprehensive data about investment activity of state and local governments are lacking, the costs of building legal and operational infrastructure to access central clearing by most of these governments may 249 IDTA Letter, supra note 66, at 10. AMG Letter, supra note 35, at 14; Federated Letter, supra note 81, at 7; IDTA Letter, supra note 66, at 10; see also Letter from James Tabacchi, Chairman, Independent Dealer and Trader Association and attached whitepaper at 5 (Sept. 1, 2023) (discussing the fact that most states and municipalities use Master Repo Agreements based on local law and would by statute be unable to sign a New York law-based agreement to clear through a U.S. Treasury securities CCA). 251 United States Census Bureau, ‘‘2017 Census of Governments—Organization,’’ Table 2: Local Governments by Type and States and Table 9: Public School System by Types of Organization and State, available at https://www.census.gov/data/ tables/2017/econ/gus/2017-governments.html. ddrumheller on DSK120RN23PROD with RULES2 250 SIFMA VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 prevent them from accessing the Treasury repo market. The Commission does not believe that such an exclusion should apply to any pension or retirement plan established or maintained by a state, any of its political subdivisions, or any agency or instrumentality of a state or any of its political subdivisions, for the benefit of its employees (or any beneficiaries of its employees). Such state pension and retirement plans generally do not face the same statutory restrictions as state and local governments regarding their investments,252 and indeed, several such plans are currently Sponsored Members of FICC.253 Moreover, state pension and retirement plans manage a substantial amount of assets and are important participants in the Treasury repo market. In contrast to surplus cash balances of state and local governments that are expected to be managed with the principal preservation objective, public pension and retirement plans typically have more sizable assets under management and pursue a long-term return objective employing a variety of return-enhancing strategies, including the use of leverage.254 As of March 31, 2023, total funded assets under management of these plans were approximately $5.3 trillion.255 A survey 252 See, e.g., California Government Code section 20190 (providing that Board of Advisors of Public Employee Retirement System may, in its discretion, invest the assets of the fund through the purchase, holding, or sale thereof of any investment, financial instrument, or financial transaction when the investment, financial instrument, or financial transaction is prudent in the Board’s informed opinion); N.Y. Retire. & Soc. Sec. Law 177 (identifying eligible investments of NY state public pension funds, without limiting the counterparties to a repo); Wis. Stat. 325.17 (identifying eligible investments for Wisconsin state public pension funds to various instruments, without limiting the counterparties to a repo). 253 DTCC, FICC–GSD Member Directories, Sponsored Member Listings, available at https:// www.dtcc.com/client-center/ficc-gov-directories (showing five state and local pension plans as Sponsored Members). 254 See, e.g., California Public Employees’ Retirement System Total Fund Investment Policy, available at https://www.calpers.ca.gov/docs/totalfund-investment-policy.pdf; State of Wisconsin Investment Board, Investment Strategy, available at https://www.swib.state.wi.us/investmentstrategy; Teachers Retirement System of Texas, Investment Strategy, available at https://www.trs.texas.gov/ Pages/investment_strategy.aspx. 255 Federal Reserve, Financial Accounts of the United States, L.120 State and Local Government Employee Retirement Funds (total funded assets are considered), available at https:// www.federalreserve.gov/releases/z1/20230608/ html/l120.htm. This data set consists of retirement systems that are administered by a recognized unit of a state or local government as defined by the Bureau of the Census and whose members are public employees compensated with public funds. It includes the defined benefit (DB) and defined contribution (DC) retirement funds of both state PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 2739 conducted by the National Association of State Retirement Administrators found that the average public pension fund allocates around 2.5% of its assets to cash investments, which would include investments in the Treasury repo market.256 Given the total asset size of the state pension and retirement plans and the variety of investment strategies that they can pursue as well as their ability to participate in central clearing under their governing statutes, excluding these plans from the scope of the definition of an eligible secondary market transaction would be inconsistent with the intent to reduce risk and enhance efficiency of the U.S. Treasury market. The Commission is therefore excluding from the definition of an eligible secondary market transaction any repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities in which one counterparty is a state or local government. In addition, the Commission would add a definition of state and local government to Rule 17ad–22(a) to mean a state or any political subdivision thereof, or an agency or instrumentality of a State or any political subdivision thereof, but not to include any pension or retirement plan established or maintained by a state, any of its political subdivisions, or any agency or instrumentality of a state or any of its political subdivisions, for the benefit of its employees (or any beneficiaries of its employees).257 viii. Other Repo Comments One commenter suggested that the Commission should provide further specificity around the definition of a repurchase or reverse repurchase agreement, suggesting that it may be advisable for the Commission to adopt the definition used by the current U.S. Treasury securities CCA.258 The governments and local government entities such as counties, municipalities, townships, school districts, and special districts. 256 National Association of State Retirement Administrators, Investments, available at https:// www.nasra.org/investment. 257 ‘‘State’’ is defined in Exchange Act section 3(a)(16) as any State of the United States, the District of Columbia, Puerto Rico, the Virgin Islands, or any other possession of the United States. 258 DTCC/FICC Letter, supra note 33, at 11–12 (citing the FICC definition of a Repo Transaction, which covers ‘‘(1) an agreement of a party to transfer Eligible Securities to another party in exchange for the receipt of cash, and the simultaneous agreement of the former party to later take back the same Eligible Securities (or any subsequently substituted Eligible Securities) from the latter party in exchange for the payment of cash, or (2) an agreement of a party to take in Eligible Securities from another party in exchange for the E:\FR\FM\16JAR2.SGM Continued 16JAR2 2740 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 commenter suggested that this definition is indifferent to the method of documentation, making it clear that inclusion in the definition does not depend on the particular documentation the parties elect to use, such as a Master Securities Lending Agreement or Master Securities Loan Agreement.259 The Commission does not believe that further revision of the definition is necessary. The definition of an eligible secondary market transaction, both as proposed and as adopted, applies to all types of transactions that are of a type currently accepted for clearing at a U.S. Treasury securities CCA. It does not impose a requirement on a U.S. Treasury securities CCA to offer additional products for clearing. One commenter specifically agreed that the proposal should apply to the types of transactions that are eligible for clearing at a U.S. Treasury securities CCA, as those eligibility criteria evolve over time. The commenter stated that such an approach would ensure that the requirement would not inadvertently give rise to risk or undue costs by forcing into central clearing transaction types that have not gone through a methodical risk analysis or for which the costs may outweigh the benefits, while at the same time, it would allow the requirement to evolve as U.S. Treasury securities CCAs, their direct participants, and regulators identify transaction types that would benefit from central clearing.260 The Commission agrees that the definition being adopted will allow for this type of approach to the clearing requirement. Several commenters discussed whether securities lending should be included within the scope of this definition.261 Securities lending payment of cash, and the simultaneous agreement of the former party to later transfer back the same Eligible Securities (or any subsequently substituted Eligible Securities) to the latter party in exchange for the receipt of cash’’). 259 DTCC/FICC Letter, supra note 33, at 11–12. 260 DTCC/FICC Letter, supra note 33, at 12–13. 261 See BNY Mellon Letter, supra note 33, at 2 (suggesting additional analysis before requiring the central clearing of securities lending transactions, as well as consideration of a non-cash model for central clearing such transactions); Federated Hermes Letter, supra note 85, at 7–8 (stating that securities lending transactions should not be included in a clearing mandate because they are subject to different market infrastructure than repurchase agreements, which has not been adapted to facilitate cleared securities lending transactions); Letter from Fran Garritt, Director, Securities Lending & Market Risk and Mark Whipple, Chairman, Committee on Securities Lending Risk Management Association (Dec. 23, 2022) (arguing generally that the scope of an eligible secondary market transaction not be expanded to include securities lending transactions because of the negative impact on beneficial owners, the increased VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 transactions do not fall within the scope of the definition of an eligible secondary market transaction and are not currently available for central clearing. One commenter requested clarification that the definition of an eligible secondary market transaction does not apply to final settlement under physical-delivery futures contracts on U.S. Treasury bonds or notes (‘‘Treasury futures’’). The commenter noted that such Treasury futures are already subject to a central clearing requirement and described how the physical delivery process works, that is, if a Treasury future goes to delivery, then the commenter, which centrally clears Treasury futures, would inform long clearing members of the U.S. Treasury securities that will be delivered by the short position holders to whom they have been matched and the invoice amounts that the short clearing members must receive in payment.262 The Commission agrees with the commenter that the physical settlement of Treasury futures does not fall within the definition of an eligible secondary market transaction because it does not fit within the specific categories set forth in the rule. In addition, the Treasury futures are already subject to central clearing, thereby ensuring that the benefits of central clearing are already present in this aspect of the market. Another commenter did not support a requirement to clear repos, but stated that if such a requirement were adopted, it should be limited to repos by interdealer brokers (‘‘IDBs’’) and brokerdealers because (1) the counterparties to such transactions are the most active participants in the Treasury repo markets, thereby allowing the Commission to meaningfully increase central clearing without applying a more categorical requirement, and (2) such transactions are more interconnected with the rest of the market and have a higher possibility to transfer risk to outside parties (including potentially a U.S. Treasury securities CCA).263 The Commission disagrees that the definition of an eligible secondary market transaction should be limited in this manner. As discussed in part II.A.2.a supra, there are substantive benefits that will arise from the broad scope of the repo market, including with respect to balance sheet netting and greater capacity of dealers to intermediate repos. Further, the Commission disagrees that these transactions are ‘‘more interconnected with the rest of the market,’’ because it generally is not possible to quantify interconnectedness in this manner. Even if a repo is between a dealer and its customer neither of which is an IDB or a broker-dealer, the failure of that transaction could have an impact on its counterparties and transmit that risk to the broader market. In addition, several commenters requested exemptions for transactions entered into outside of the operating hours of a U.S. Treasury securities CCA that would settle on or before the next day on which the CCA is open for business. For example, one commenter stated that firms routinely enter into U.S. Treasury securities transactions after the close of business at FICC, for legitimate business or operational reasons, including for treasury management purposes, and that firms will need the ability to enter into transactions at times that a CCA is not open to accept transactions for novation. The commenter compared the situation to the derivatives context in which a swap subject to mandatory clearing is executed after 4 p.m. or not on a business day, it must then be submitted by the next business day when a derivatives clearing organization is open.264 Another commenter stated that market participants may enter into a transaction after the close of a CCA’s operating/business hours, making it unable to accept the transaction for clearing and novation. The commenter stated that the Commission should therefore exempt these transactions from a final rule, unless and until the existing U.S. Treasury securities CCA can change its operating hours to account for such transactions or another CCA becomes available with 24/7 clearing capabilities.265 Such an exemption is not necessary. The existing U.S. Treasury securities CCA accepts all bilateral DVP trades for novation from 7 a.m. until 8 p.m. eastern time.266 This window is available for submission and novation of bilateral repo transactions, which would be novated in real-time upon submission. The Commission understands that market participants may enter Treasury repo transactions outside the normal U.S. business hours when trades are accepted by U.S. Treasury CCA for novation. A review of repo trading data shows that the largest costs, and lack of infrastructure); SIFMA/IIB Letter, supra note 37, at 22; ICI Letter, supra note 85, at 12 n.35. 262 CME Letter, supra note 81, at 7–8. 263 SIFMA/IIB Letter, supra note 37, at 19–20. 264 SIFMA/IIB Letter, supra note 37, at 21 (citing CFTC Rules 50.1 and 50.2). 265 AIMA Letter II, supra note 115, at 2–3. 266 See FICC Rules, Schedule of Timeframes, supra note 19. PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations share of repo trading activity is conducted during the first 1.5 hours of a trading day from 7 a.m. to 8:30 a.m. eastern time.267 This early morning activity may include repo trades that were arranged prior to the U.S. Treasury market opening at 7:00 a.m. The Commission does not anticipate the final rule affecting this established market practice. With respect to triparty repo, any U.S. Treasury securities CCA must interact with the timelines for triparty repo more generally, which rely upon the Fedwire Funds Service to transfer funds, and Fedwire has a deadline for initiating transfers for the benefit of a third party is 6 p.m. eastern time.268 The existing U.S. Treasury securities CCA accepts triparty submissions from 7 a.m. until 5 p.m. and novates the activity upon settlement of the start leg of the triparty repos, provided that settlement occurs by 5:30 p.m.269 The existing timeline accommodates completion of the activity at the CCA before the Fedwire deadline. Finally, one commenter requested clarification that the definition of an eligible secondary market transactions would not include instances in which market participants post U.S. Treasury securities as collateral to secure transactions in a wide range of asset classes, including cleared and uncleared swaps and listed futures.270 This type of transaction does not meet the definition of a repurchase or reverse repurchase agreement adopted in Rule 17ad–22(a); therefore, it would not be within the scope of an eligible secondary market transaction. ddrumheller on DSK120RN23PROD with RULES2 ix. Final Rule For the reasons set forth in part II.A.2.a, the Commission is adopting the definition of an eligible secondary market transaction in Rule 17ad–22(a), specifically as it relates to repurchase and reverse repurchase agreements, as proposed, except that it is adopting exclusions from the scope of that definition for repos by other clearing organizations, repos by state and local governments, and inter-affiliate repos. 267 Clark et al., Intraday Timing of General Collateral Repo Markets, Federal Reserve Bank of New York Liberty Street Economics (July 14, 2021), available at https:// libertystreeteconomics.newyorkfed.org/2021/07/ intraday-timing-of-general-collateral-repo-markets. 268 See Fedwire Funds Services, available at https://www.federalreserve.gov/paymentsystems/ fedfunds_about.htm#:∼:text= The%20Fedwire%20Funds%20 Service%20business,p.m.%20 on%20the%20preceding%20Sunday. 269 See FICC Rules, Schedule of Sponsored GC Trade Timeframes, supra note 19. 270 See Morgan Stanley Letter, supra note 85, at 2–3. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 b. Purchases and Sales of U.S. Treasury Securities With respect to cash transactions (i.e., purchases and sales of U.S. Treasury securities), the proposal defined an eligible secondary market transaction as including: • Any purchases and sales entered into by a direct participant and any counterparty if the direct participant (A) brings together multiple buyers and sellers using a trading facility (such as a limit order book) and (B) is a counterparty to both the buyer and seller in two separate transactions (‘‘IDB transactions’’); and • Any purchases and sales of U.S. Treasury securities between a direct participant and a counterparty that is either (i) a registered broker-dealer, government securities dealer, or government securities broker (‘‘brokerdealer transactions’’), (ii) a hedge fund, that is any private fund (other than a securitized asset fund): (a) with respect to which one or more investment advisers (or related persons of investment advisers) may be paid a performance fee or allocation calculated by taking into account unrealized gains (other than a fee or allocation the calculation of which may take into account unrealized gains solely for the purpose of reducing such fee or allocation to reflect net unrealized losses); (b) that may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (c) that may sell securities or other assets short or enter into similar transactions (other than for the purpose of hedging currency exposure or managing duration) (‘‘hedge fund transactions’’), or (iii) an account at a registered brokerdealer, government securities dealer, or government securities broker where such account may borrow an amount in excess of one-half of the value of the account or may have gross notional exposure of the transactions in the account that is more than twice the value of the account (‘‘leveraged account transactions’’). When describing the categories included within the definition, the Commission stated its belief that including this set of transactions in the eligible secondary market definition and therefore subjecting these transactions to the proposal represents an incremental first step to address potential risks arising to a U.S. Treasury securities CCA.271 The Commission 271 Proposing Release, supra note 14, 87 FR at 64622. PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 2741 referenced recent data indicating that an estimated 68 percent of the overall dollar value of cash market transactions in U.S. Treasury securities are not centrally cleared, and an estimated 19 percent of the overall dollar value of such transactions are subject to socalled hybrid clearing (as described above).272 Regarding IDB transactions, in the Proposing Release, the Commission stated its belief that including these transactions in the definition of an eligible secondary market transaction would specifically address the potential for contagion risk associated with hybrid clearing that a number of commentators have highlighted. Hybrid clearing refers to transactions that are executed on an IDB platform in which one counterparty is a member of a CCA and submits its transaction with the IDB for central clearing, while the other counterparty is not a member of a CCA and bilaterally clears its transaction with the IDB.273 As the Commission explained in the Proposing Release, the configuration of counterparty risk presented by hybrid clearing allows the U.S. Treasury securities CCA to manage the risks arising from the IDB–CCA direct participant transaction, but the U.S. Treasury securities CCA cannot manage the risks arising from the IDB’s offsetting transaction with its nonmember counterparty and the potential counterparty credit risk and settlement risk posed to the IDB from that trade.274 Thus, under the current hybrid clearing model, the U.S. Treasury securities CCA is indirectly exposed to the IDB’s noncentrally cleared transaction, but it lacks the ability to risk manage its indirect exposure to this non-centrally cleared leg of the transaction. Specifically, it does not know who the ultimate counterparty of the transaction is and cannot collect margin on that transaction. This, in turn, results in margin collection at the CCP which is based upon only one transaction and 272 Id. (citing 2021 IAWG Report, supra note 4, at 30; TMPG White Paper, supra note 13, at 12). 273 Proposing Release, supra note 14, 87 FR at 64622 (citing TMPG, supra note 13, at 12). These estimates use FR2004 data, which are reports provided to the Federal Reserve Bank of New York regarding primary dealer market activity in U.S. Government securities, covering the first half of 2017 and are based on various assumptions specified in the TMPG White Paper. See also FR2004, Government Securities Dealer Reports, available at https://www.federalreserve.gov/apps/ reportforms/reportdetail.aspx?sOoYJ+ 5BzDZq2f74T6b1cw. 274 See, e.g., Proposing Release, supra note 14, 87 FR at 64622 (citing TMPG White Paper, supra note 13, at 22 (noting that in a hybrid clearing arrangement, an IDB’s rights and obligations to the CCP are not offset and the IDB is not in a net zero settlement position with respect to the CCP at settlement date)). E:\FR\FM\16JAR2.SGM 16JAR2 2742 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 has been calculated to cover this seemingly directional position, as well as an inability to net these offsetting transactions and provide the benefits of central clearing. In particular, if the IDB’s non-CCP member counterparty fails to settle a transaction that is subject to hybrid clearing, such IDB may not be able to settle the corresponding transaction that has been cleared with the U.S. Treasury securities CCA due to a lack of financial resources at the IDB, which could lead the IDB to default.275 As part of its existing default management procedures, the U.S. Treasury securities CCA could seek to mutualize its losses from the IDB’s default, which could in turn transmit stress to the market as a whole. In the Proposing Release, the Commission reiterated its belief that membership requirements help to guard against defaults of any CCP member, as well as to protect the CCP and the financial system as a whole from the risk that one member’s default could cause others to default, potentially including the CCP itself. Further, contagion stemming from a CCP member default could undermine confidence in the financial system as a whole, even if the health of the CCP is not implicated, causing others to back away from participating in the market. This risk of decreased participation could be particularly problematic if the defaulting participant was an IDB, whose withdrawal from the market could impact other market participants’ ability to access the market for on-therun U.S. Treasury securities, approximately 49.7% of which trade on IDBs.276 Including such transactions as eligible secondary market transactions would therefore help protect against this risk by requiring that a U.S. Treasury securities CCA ensure that direct participants who are IDBs centrally clear both sides of their transactions, thereby eliminating the various aspects of potential contagion risk posed by socalled hybrid clearing. Regarding broker-dealer transactions, in the Proposing Release, the Commission explained that the enumerated types of market participants (i.e., a registered broker-dealer, government securities broker, or government securities dealer) are market intermediaries that are engaged in the 275 See 2021 IAWG Report, supra note 4, at 31; Depository Trust and Clearing Corporation, More Clearing, Less Risk: Increasing Centrally Cleared Activity in the U.S. Treasury Cash Market, at 5 (May 2021), available at https://www.dtcc.com/-/media/ Files/PDFs/DTCC-US-Treasury-Whitepaper.pdf (‘‘DTCC May 2021 White Paper’’). 276 TMPG White Paper, supra note 13, at 32; see part IV.B.3.a.i infra. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 business of effecting transactions in securities for the account of others (in the case of brokers) or for their own accounts (in the case of dealers).277 The Commission relied upon data indicating that a majority of trades in the secondary cash Treasury market now clear bilaterally and estimated that the trading volume of non-FICC members exceeds that of FICC members.278 The Commission stated its belief that their collective trading activity likely is responsible for a not insignificant portion of the volume of transactions involving Treasury securities and could present contagion risk to a U.S. Treasury securities CCA. Regarding hedge fund transactions, the Commission in the Proposing Release described its intent in including transactions with hedge funds in the definition of an eligible market transaction as two-fold. First, hedge funds generally can engage in trading strategies that may pose heightened risks of potential financial distress to their counterparties, including those who are direct participants of a U.S. Treasury securities CCA. There are several characteristics of hedge fund strategies that could raise such issues, including using financial institutions that may have systemic importance to obtain leverage, employing investment strategies that may use leverage, derivatives, complex structured products, and short selling in an effort to generate returns, and relying upon strategies involving high volumes of trading and concentrated investments.279 The Commission stated its belief that significant hedge fund failures, resulting from their investment positions or use of leverage or both, could result in material losses at the financial institutions that lend to them if collateral securing this lending is inadequate, and that these losses could have systemic implications if they require these financial institutions to scale back their lending efforts or other financing activities generally. For these reasons, the Commission stated its belief that that if any of a hedge fund’s activities, even those that are not related 277 Proposing Release, supra note 14, 87 FR at 64623. 278 Id. (citing TMPG White Paper, supra note 13, at 21; 2021 IAWG Report, supra note 4, at 30). 279 Proposing Release, Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Release No. IA–3145 (Jan. 26, 2011), 76 FR 8068, 8073 (Feb. 12, 2011) (‘‘Form PF Proposing Release’’). The Commission adopted the hedge fund definition with some amendments thereafter. Final Rule, Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Release No. IA–3308 (Oct. 31, 2011), 76 FR 71127 (Nov. 16, 2011). PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 to the U.S. Treasury market, cause financial stress to a counterparty that is a direct participant of a U.S. Treasury securities CCA, the inclusion of a hedge fund’s U.S. Treasury securities cash transactions with a direct participant in the definition of an eligible secondary market transaction should help ensure that such financial stress would not transmit to the U.S. Treasury securities CCA and through to the U.S. Treasury market. Second, the Commission relied upon the role of hedge funds in the overall U.S. Treasury market to support its proposal to include hedge fund transactions in the definition of an eligible secondary market transaction.280 The Commission stated its belief that hedge funds transacting in the U.S. Treasury market present a potential contagion risk to a U.S. Treasury securities CCA because, similar to the risks posed to a U.S. Treasury securities CCA by noncentrally cleared trades entered into by an IDB, non-centrally cleared transactions entered into between hedge funds and direct participants of the CCA could cause risks to the CCA in the event that the hedge fund is not able to meet its obligations to the direct participant, which could, in turn, create stress to the direct participant and through to the CCA. Therefore, the Commission stated that including the direct participant’s purchase and sale transactions with hedge funds within the definition of an eligible secondary market transaction should reduce the potential for financial distress arising from the transactions that could affect the direct participant and the U.S. Treasury securities CCA. The proposed definition of a hedge fund was described as consistent with the Commission’s definition of a hedge fund in Form PF.281 The Commission 280 Proposing Release, supra note 14, 87 FR at 64624 (citing Private Funds Statistics for Q4 2021, Table 46 (July 22, 2022), available at https:// www.sec.gov/divisions/investment/private-fundsstatistics/private-funds-statistics-2021-q4.pdf; Ayelen Banegas, Sizing Hedge Funds’ Treasury Market Activities and Holdings (Oct. 6, 2021), available at https://www.federalreserve.gov/ econres/notes/feds-notes/sizing-hedge-fundstreasury-market-activities-and-holdings20211006.htm; see also Daniel Barth & R. Jay Kahn, Hedge Funds and the Treasury Cash-Futures Disconnect (Apr. 1, 2021), available at https:// www.financialresearch.gov/working-papers/2021/ 04/01/hedge-funds-and-the-treasury-cash-futuresdisconnect/; Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID–19 Crisis, available at https://www.federalreserve.gov/ econres/feds/files/2021038pap.pdf; 2021 IAWG Report, supra note 4, at 34; SEC Staff Report on U.S. Credit Markets Interconnectedness and the Effects of the COVID–19 Economic Shock (Oct. 2020), available at https://www.sec.gov/files/US-CreditMarkets_COVID-19_Report.pdf). 281 17 CFR 279.9 (Form PF Glossary of Terms). E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 stated its belief that defining a hedge fund in a manner consistent with Form PF is reasonable, because such definition should encompass those funds that use strategies that the Commission has determined merit additional reporting to allow a better picture of the potential systemic risks posed by such activities.282 Including transactions with such funds within the definition of an eligible secondary market transaction should help to limit the potential contagion risk that could arise from any financial distress experienced at such a fund that could, in turn, be transmitted to a direct participant of a U.S. Treasury securities CCA (and to the CCA) via any noncentrally cleared transactions. The Commission further states its belief that using a definition consistent with that of Form PF to identify transactions with a U.S. Treasury securities CCA’s direct participant as part of the definition of an eligible secondary market transaction should capture transactions with entities whose default would be most likely to cause potential contagion risk to the Treasury securities CCA. For example, hedge funds’ use of leverage can make them more vulnerable to liquidity shocks, which could, in turn, make them unable to deliver in a transaction with a direct participant of a U.S. Treasury securities CCA. Regarding leveraged account transactions, in the Proposing Release, the Commission stated its belief that the inclusion of transactions with such accounts, i.e., those that can take on significant amounts of leverage, within the definition of an eligible secondary market transaction should encompass transactions between direct participants of a U.S. Treasury securities CCA and a prime brokerage account, which, based on the Commission’s supervisory 282 Final Rule, Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Release No. IA–3308 (Oct. 31, 2011), 76 FR 71127 (Nov. 16, 2011). The reporting requirements for Form PF vary based on the amount of private fund assets under management for an investment adviser registered with the Commission. For example, if an investment adviser’s private fund assets under management, including with respect to hedge funds, are less than $150 million on the last day of the most recent fiscal year, then the investment adviser is not required to file Form PF. Separately, additional reporting requirements apply to large hedge fund advisers with at least $1.5 billion in hedge fund assets under management. See Form PF, Instructions 1 and 3. However, the Commission believes that including all hedge funds within paragraph (ii)(C) of the definition of an ‘‘eligible secondary market transaction’’ in Proposed Rule 17ad-22(a) would be consistent with its overall policy goals for central clearing in the U.S. Treasury market and ensuring that hedge fund transactions with direct participants in a U.S. Treasury securities CCA do not adversely impact the direct participant and, potentially, the CCA. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 knowledge, may hold assets of entities, such as, for example, private funds or separately managed accounts, and may use leverage that poses a risk to U.S. Treasury securities CCA and the broader financial system. The Commission further stated that by including the account, and not the entity using the account, this aspect of the proposal is targeted to the activity that could bring the most potential risk to a U.S. Treasury securities CCA and the financial system more generally. The Commission addresses each of these particular types of transactions in parts II.B.2.b.ii through iv infra, after addressing more general comments with respect to cash transactions. i. Comments Regarding Cash Clearing Generally Several commenters supported the Commission’s proposal overall, including the cash clearing requirement.283 By contrast, other commenters opposed cash clearing generally. One commenter did not support a clearing requirement or otherwise see the current imperative for incentivizing the central clearing of cash transactions. The commenter stated that any requirement to clear cash transactions will serve to increase costs, generate operational complexities, and reduce liquidity without producing meaningful benefits to address perceived issues with respect to the cash market.284 The commenter explained that the increased costs would be substantial and would include, among other things, increased margin, default fund contributions, and clearing fees, as well as the costs incurred to put in place the operations, infrastructure, and standard documentation required to support central clearing.285 The commenter also explained that intra-day margin calls will ‘‘simply create operational burdens and costs’’ with no obvious benefit given that many margin calls will be met late in the day only to be returned to the posting party the next day. The commenter stated that to the extent that dealers are required to post collateral to a covered clearing agency without compensation or to incur other costs associated with client clearing, those costs will have to be absorbed either by clients or dealers, which may reduce their capacity and further constrain liquidity.286 The commenter also stated 283 AFREF Letter, supra note 33, at 2; Better Markets Letter, supra note 33, at 2, 6–8. 284 SIFMA AMG Letter, supra note 35, at 3. 285 Id. at 3; see also MFA Letter II, supra note 125, at 5 (regarding increased costs associated with clearing cash transactions). 286 SIFMA AMG Letter, supra note 35, at 7. PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 2743 that additional netting benefits for dealers are unclear as accounting rules already allow dealers to net unsettled cash transactions across all counterparties on their balance sheets.287 Another commenter also opposed the requirement to clear cash transactions, but supported the exclusion of money market funds from the scope of included cash transactions within the definition of an eligible secondary market transaction.288 In response to the commenters opposed to the inclusion of any cash transactions in the definition of an eligible secondary market transaction, the Commission disagrees. As discussed in the Proposing Release, currently, the majority of cash market transactions are not centrally cleared, which is in contrast to the market conditions in the mid-2000s when most cash transactions were centrally cleared. The fact that more than half of market activity occurs outside central clearing could represent a contagion risk to any U.S. Treasury securities CCA serving the market. Therefore, the Commission identified a set of cash transactions to include in the definition of an eligible secondary market transaction that would represent an incremental first step in the cash market, to address risks to the CCA, and identified a specific rationale with respect to each set of categories, as discussed in part II.A.2.b supra. Addressing these risks is a meaningful benefit in that it would ensure that a U.S. Treasury securities CCA is well positioned to understand and manage the risks posed by its participants’ transactions. Further, as discussed in more detail in part IV.C, although, as the commenter states, additional clearing likely would result in increased margin contributions and clearing fees, simply to account for the increased clearing volume, as well as the one-time costs regarding the institution of new contractual arrangements to access central clearing,289 the benefits of central clearing, as discussed in part II.A.1 supra, justify these costs. The commenter’s discussion regarding the operational issues of intraday margin calls does not specify the particular operational complexities that would arise, and it does not take into account the risk management 287 SIFMA AMG Letter, supra note 35, at 3. Letter, supra note 85, at 2. 289 The commenter also references increased default fund contributions. However, the only U.S. Treasury securities CCA serving the U.S. Treasury market does not currently maintain a default fund; therefore, the Commission disagrees that some increase in such contributions would result from the proposal. 288 Federated E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 2744 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations benefit arising from such calls, that is, ensuring that a covered clearing agency can address the risks presented by significant intraday changes to market volatility or a member’s portfolio of net unsettled positions. Without such an ability, a covered clearing agency would face potential exposure in the event of the default of a clearing member; therefore, the additional risk management that a clearing agency can accomplish using intraday margin calls must be considered. Moreover, the Commission disagrees with the commenter’s implication that this proposal needs to address the entirety of the ‘‘perceived issues’’ with respect to the cash market. The Commission stated in the Proposing Release that the requirement to clear eligible secondary market transactions will not, by itself, necessarily prevent future market disruptions, but that it could improve the functioning of the U.S. Treasury market.290 Although it may have other effects beyond the immediate requirement for U.S. Treasury securities CCAs, the requirement being adopted in this release is designed to improve the resilience of such CCAs by expanding their ability to manage the risks arising from direct participants who currently engage in non-centrally cleared transactions away from the CCA 291 and need not solve all the issues that commentators have identified regarding the U.S. Treasury market. By contrast, several commenters suggested that the scope of eligible secondary market transactions in the cash market be broadened. One commenter stated that the Commission should align the scope of the definition with respect to cash transactions with the proposed scope for repos, subject to certain limited exceptions for investors that trade de minimis volumes. The commenter argued that the Commission’s approach with respect to cash transactions will increase costs for a specific subset of market participants (i.e., hedge funds, leveraged accounts, and those using IDBs), thereby putting them at a competitive disadvantage, while failing to deliver the envisaged market-wide benefits associated with central clearing (i.e., it would materially reduce the associated multilateral netting benefits, impair the risk management practices of clearing agencies, and hinder the evolution in trading protocols that can be expected from a market-wide clearing 290 Proposing Release, supra note 14, 87 FR at 64614. 291 Id. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 requirement).292 For similar reasons, another commenter also stated that the benefits of central clearing detailed will only materialize if ‘‘a market-wide mandate is implemented’’ and supported defining the scope of eligible secondary market transactions for cash transactions as broadly as that proposed for repos.293 Another commenter stated that limiting the scope of the cash clearing mandate would result in unwarranted competitive disadvantages and related market distortions for some types of investors, such as hedge funds, or some types of trading platforms, such as anonymous trading facilities.294 An additional commenter stated that the proposed definition leaves out other important market participants’ cash Treasury transactions that also make up a large segment of Treasury market liquidity, and that the Commission should require other market participants’ cash Treasury transactions in which a direct participant is involved to be cleared, so that the benefits of central clearing that the Commission cites will accrue throughout the broader cash Treasury market.295 In addition, another commenter acknowledged the benefits of a comprehensive clearing requirement, but acknowledged the need for a pragmatic approach and supported the Commission’s proposed requirements as a reasonable foundation to begin mandatory central clearing in this market.296 In response to the comments that the scope of the cash transactions that are included in the definition of an eligible secondary market transaction should be broadened, the scope is not being broadened and, in fact, is being further narrowed, as discussed further in part II.A.2.b.iii regarding hedge fund and leveraged account cash transactions (unless captured by another portion of the rule, e.g., as an IDB transaction). As stated in the Proposing Release and discussed in part II.2.b supra, the Commission proposed a deliberate and targeted approach to clearing in the cash market in the Proposing Release, limiting the clearing requirement to specific types of entities transacting 292 Citadel Letter, supra note 81, at 5. et al. Letter, supra note 81, at 4 (stating that the netting benefits associated with transitioning only proprietary trading firm (‘‘PTF’’) transactions into central clearing are much smaller, given the substantial netting that already occurs directly with IDBs; the trading-related benefits of central clearing will only accrue to market participants if their transactions are covered by the proposed mandate; and that clearing agency resiliency will be negatively impacted if only one segment of the market is cleared). 294 MFA Letter, supra note 81, at 2. 295 AIMA Letter, supra note 81, at 7. 296 GTS Letter, supra note 81, at 3–5. 293 ARB PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 with members of a U.S. Treasury securities CCA that pose heightened risks when clearing cash market treasury transactions bilaterally. Specifically, the Commission proposed eligible secondary market transaction to be defined as, with reference to cash market transactions, a purchase or sale between a direct participant of a covered clearing agency and (A) any participant if the direct participant is an IDB; (B) a registered broker-dealer, government securities broker, or government securities dealer that is not a member of a covered clearing agency; (C) a hedge fund; or (D) a leveraged account. In each case, the Commission explained the reasoning for why such counterparties were to be included in the scope of the proposal.297 In response to the comments that the benefits of central clearing would only materialize with a market-wide mandate and that the targeted cash scope would fail to deliver the market-wide benefits associated with central clearing, the Commission disagrees because the increased clearing of cash transactions, targeted to address the differing risk profiles of each market segment, would still bring the benefits of central clearing to some portion of the market, even if not as widely as the scope for repo transactions, while also addressing the risks inherent in these particular market segments. The Commission does not believe that the benefits of central clearing exist only if the entire market is centrally cleared. The increased costs for certain market participants, that is, those whose transactions with direct participants of a U.S. Treasury securities CCA are included in the definition of an eligible secondary market transaction, are justified by the benefit of addressing the risks inherent in those particular transactions, and the Commission addresses each of these categories separately in parts II.A.2.b.ii through iii infra. Moreover, other types of cash transactions do not present the same types of risk to the CCA in terms of potential contagion risk. ii. IDB Transactions The proposed definition of an eligible secondary market transaction would include, among other things, any purchase or sale between a direct participant of a U.S. Treasury securities CCA and any counterparty, if the direct participant of the covered clearing agency (A) brings together multiple buyers and sellers using a trading facility (such as a limit order book) and 297 Proposing Release, supra note 14, 87 FR at 64622–25. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations (B) is a counterparty to both the buyer and seller in two separate transactions. One commenter anticipated that certain other commenters would advocate for a definition of eligible secondary market transaction that would include IDB transactions and would exclude dealer-to-client over-thecounter trades, which is not what the Commission proposed.298 The commenter cautioned against such an ‘‘uneven’’ approach because it would incentivize market participants to trade bilaterally instead of using an IDB to avoid central clearing.299 Thus, the commenter supports the scope of the definition of an eligible secondary market transaction as proposed, that is, including both IDB transactions and the other categories of transactions set forth in the definition.300 The Commission agrees with the commenter that the definition, as proposed, would not incentivize market participants to trade away from IDBs to avoid central clearing because the definition of what constitutes an eligible secondary market transaction is broader than simply IDB transactions, such that avoiding IDBs alone would not be sufficient to avoid the requirement to submit eligible secondary market transactions for clearing. In addition, commenters expressed concerns that including IDB transactions in the definition of an eligible secondary market transaction could draw trading activity away from IDBs, thereby reducing market liquidity and market stability.301 The commenters also noted that IDBs are anonymous platforms that currently support all-toall trading, and that the Commission has recognized that all-to-all trading would improve market structure and stability.302 The commenters argued that including IDB transactions in the definition of an eligible secondary market transaction could, therefore, hinder all-to-all trading.303 One of these commenters further argued that by discouraging market participants from trading on IDBs, the definition of an eligible secondary market transaction could limit the choices of market participants with respect to trading ddrumheller on DSK120RN23PROD with RULES2 298 See CME Letter, supra note 81, at 5. 299 See id. 300 See CME Letter, supra note 81, at 5–6 (stating the commenter’s belief that the proposal appears to have been carefully drafted to avoid encouraging market participants to trade away from IDBs). 301 See ICI Letter, supra note 85, at 3, 11; MFA Letter, supra note 81, at 20; Tradeweb Letter, supra note 81, at 3–4. 302 See ICI Letter, supra note 85, at 3, 11; MFA Letter, supra note 81, at 20–21; Tradeweb Letter, supra note 81, at 3–4. 303 See id. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 venues.304 The inclusion of IDB transactions, along with other types of transactions, would not necessarily lead to decreased liquidity and market stability or negatively impact all-to-all trading in the U.S. Treasury market. The market function provided by IDBs, that is, bringing together buyers and sellers anonymously, will continue to be desirable, even if such transactions are eligible secondary market transactions, meaning that market participants likely still would use IDBs to transact in the U.S. Treasury market. Because market participants likely would continue to transact on IDBs, the commenters’ concerns regarding decreased liquidity and market stability would not materialize. Moreover, even if some of these concerns materialize from the inclusion of IDB transactions, including them is justified as it would allow the U.S. Treasury securities CCA to better risk manage ‘‘hybrid’’ transactions that are currently not being submitted for central clearing.305 Specifically, including IDB transactions in the definition of an eligible secondary market transaction would address the potential for contagion risk associated with hybrid clearing. As explained in the Proposing Release, the configuration of counterparty risk presented by hybrid clearing allows the U.S. Treasury securities CCA to manage the risks arising from the IDB–CCA direct participant transaction, on the one hand, but the U.S. Treasury securities CCA cannot manage the risks arising from the IDB’s offsetting transaction with its non-member counterparty and the potential counterparty credit risk and settlement risk arising to the IDB from that trade.306 Thus, under the current hybrid clearing model, the U.S. Treasury securities CCA is indirectly exposed to the IDB’s non-centrally cleared transaction, but it lacks the ability to risk manage its indirect exposure to this non-centrally cleared leg of the transaction. Specifically, it does not know who the ultimate counterparty of the transaction is and cannot collect margin on that 304 See MFA Letter, supra note 81, at 20. term ‘‘IDB’’ typically refers only to IDBs that are also ATSs. See note 643 infra. 306 See, e.g., Proposing Release, supra note 14, 87 FR at 64622 (citing TMPG White Paper, supra note 13, at 22 (noting that in a hybrid clearing arrangement, an IDB’s rights and obligations to the CCP are not offset and the IDB is not in a net zero settlement position with respect to the CCP at settlement date)). Thus, the IDB is not able to net all of its positions for clearing at a U.S. Treasury securities CCA, and the IDB’s positions appear to the CCA to be directional, which impacts the amount of margin that the CCA collects for the transaction. 305 The PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 2745 transaction. This, in turn, results in margin collection at the CCP which is based upon only one transaction and has been calculated to cover this seemingly directional position, as well as an inability to net these offsetting transactions and provide the benefits of central clearing. In particular, if the IDB’s non-CCP member counterparty fails to settle a transaction that is subject to hybrid clearing, such IDB may not be able to settle the corresponding transaction that has been cleared with the U.S. Treasury securities CCA due to a lack of financial resources at the IDB, which could lead the IDB to default.307 As part of its existing default management procedures, the U.S. Treasury securities CCA could seek to mutualize its losses from the IDB’s default, which could in turn transmit stress to the market as a whole. The Commission has previously stated that membership requirements help to guard against defaults of any CCP member, as well as to protect the CCP and the financial system as a whole from the risk that one member’s default could cause others to default, potentially including the CCP itself.308 Further, contagion stemming from a CCP member default could undermine confidence in the financial system as a whole, even if the health of the CCP is not implicated. This is because the default could cause others to back away from participating in the market. This risk of decreased participation could be particularly problematic if the defaulting participant was an IDB, whose withdrawal from the market could impact other market participants’ ability to access the market for on-therun U.S. Treasury securities, approximately 49.7% of which trade on IDBs.309 Including such transactions within the definition of an eligible secondary market transaction would therefore help protect against this risk by requiring that a U.S. Treasury securities CCA ensure that direct participants who are IDBs centrally clear both sides of their transactions, thereby eliminating the various aspects of potential contagion risk posed by socalled hybrid clearing. One commenter urged the Commission to consider adopting the proposal in increments based on further 307 See 2021 IAWG Report, supra note 4, at 31; Depository Trust and Clearing Corporation, More Clearing, Less Risk: Increasing Centrally Cleared Activity in the U.S. Treasury Cash Market, at 5 (May 2021), available at https://www.dtcc.com/-/media/ Files/PDFs/DTCC-US-Treasury-Whitepaper.pdf (‘‘DTCC May 2021 White Paper’’). 308 See Proposing Release, supra note 14, 87 FR at 64623. 309 TMPG White Paper, supra note 13, at 32; section IV.B.4 (Table 1) infra. E:\FR\FM\16JAR2.SGM 16JAR2 2746 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 study, with IDB transactions as the first market segment to be included in the definition due to the distinct settlement risks associated with the IDBs’ hybrid clearing model.310 In contrast, another commenter supported adopting the proposal as drafted, arguing that to include only IDB transactions would be an uneven approach that would incentivize market participants to execute their transactions bilaterally, damaging liquidity on IDB platforms.311 Commenters identified the inclusion of IDB transactions as a targeted option to include in the definition of an eligible secondary market transaction to address contagion risk.312 One commenter stated that, if the Commission’s concern is the hybrid clearing at IDBs, it would be more effective to focus on the regulation of the platforms.313 The Commission agrees with all of the commenters regarding the appropriateness of Commission action to mitigate the risks associated with IDBs’ hybrid clearing model. The Commission included IDB transactions in the definition of an eligible secondary market transaction in order to eliminate the potential contagion risk posed by hybrid clearing. However, the Commission disagrees with the commenters arguing in favor of limiting the scope of the definition to include IDB transactions only or taking an entirely different approach that would simply regulate IDB platforms. As discussed above, to single out IDBs (whether in the definition of eligible secondary market transaction or through another regulatory approach), without including the other cash transactions included in the definition of an eligible secondary market transaction, could incentivize market participants to trade away from IDBs, creating the potential for negative effects on market liquidity, market stability, all-to-all trading, and participant choice of trading venue. Accordingly, the Commission is adopting the definition as proposed. Two commenters argued that transactions by registered funds that take place on an IDB should be excluded from the definition of an eligible secondary market transaction. Specifically, one commenter urged the Commission to expressly exclude registered funds (e.g., mutual funds, exchange-traded funds, closed-end funds, and unit investment trusts) from the effects of including IDB transactions in the Membership Proposal.314 Similarly, another commenter supported an exclusion for registered money market funds.315 The Commission does not agree with these commenters and is not including any exclusion for registered funds transacting on an IDB. If a fund chooses to transact on an IDB, the same potential hybrid contagion risk to the U.S. Treasury securities CCA arises as when other market participants transact on an IDB. Therefore, the Commission does not believe that such an exclusion is appropriate. iii. Other Cash Transactions The Commission also proposed to include certain additional categories of cash transactions of U.S. Treasury securities by the direct participants of a U.S. Treasury securities CCA in the definition of an eligible secondary market transaction subject to the Membership Proposal. First, the Commission proposed that the definition of an eligible secondary market transaction include those cash purchase and sale transactions in which the counterparty of the direct participant is a registered broker-dealer, government securities broker, or government securities dealer. Each of these entities is a type of market intermediary that is engaged in the business of effecting transactions in securities for the account of others (in the case of brokers) or for their own accounts (in the case of dealers).316 Commenters did not address this aspect of the definition of an eligible secondary market transaction. For the reasons stated in the Proposing Release and as discussed in part II.A.2.b supra, the Commission continues to believe that these portions of the definition are appropriate.317 The Commission is therefore adopting this aspect of the exclusions as proposed. Second, the Commission proposed to include within the definition of an eligible secondary market transaction any purchase and sale transaction between a direct participant of a U.S. Treasury securities CCA and a hedge fund, that is any private fund (other than a securitized asset fund): (a) with 314 See 310 See SIFMA/IIB Letter, supra note 37, at 2–3, 16–18 (limiting the proposal to IDB transactions in the cash market would address the most salient risks that could be addressed through central clearing). 311 See CME Letter, supra note 81, at 5–6. 312 AIMA Letter, supra note 81, at 7; SIFMA/IIB Letter, supra note 37, at 16–18. 313 SIFMA AMG Letter, supra note 35, at 11. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 ICI Letter, supra note 85, at 11. Federated Letter, supra note 85, at 2. 316 See generally TMPG, Automated Trading in Treasury Markets (White Paper, June 2015), available at https://www.newyorkfed.org/TMPG/ medialibrary/microsites/tmpg/files/TPMG-June2015-Automated-Trading-White-Paper.pdf (‘‘TMPG Automated Trading White Paper’’). 317 Proposing Release, supra note 14, 87 FR at 64623. 315 See PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 respect to which one or more investment advisers (or related persons of investment advisers) may be paid a performance fee or allocation calculated by taking into account unrealized gains (other than a fee or allocation the calculation of which may take into account unrealized gains solely for the purpose of reducing such fee or allocation to reflect net unrealized losses); (b) that may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (c) that may sell securities or other assets short or enter into similar transactions (other than for the purpose of hedging currency exposure or managing duration). Third, the Commission proposed to include within the definition of an eligible secondary market transaction any purchase and sale transaction between a direct participant of a U.S. Treasury securities CCA and an account at a registered broker-dealer, government securities dealer, or government securities broker that either may borrow an amount in excess of one-half of the net value of the account or may have gross notional exposure of the transactions in the account that is more than twice the net value of the account. This would apply to accounts that can take on significant leverage, that is, by borrowing an amount that is more than one half of its net value or take on exposures worth more than twice the account’s net value (referred to herein as ‘‘leveraged accounts’’). Some commenters supported the proposed inclusion of transactions with hedge funds within the definition of an eligible secondary market transaction.318 However, other commenters asserted that transactions with a hedge fund or a leveraged account 319 should not be within the definition of an eligible secondary market transaction. One commenter stated that the inclusion of hedge funds within the counterparties to an eligible secondary market transaction would arbitrarily single out hedge funds’ cash Treasury transactions.320 Another commenter 318 See DTCC/FICC Letter, supra note 33, at 12; Better Markets Letter, supra note 33, generally; AFREF Letter, supra note 33, at 2–3. 319 Commenters generally addressed the inclusion of leveraged account transactions in the definition of an eligible secondary market transaction as part of a broader discussion including both hedge fund transactions and leveraged account transactions. Therefore, the Commission is considering both types of transactions together for purposes of discussing the comments. 320 AIMA Letter, supra note 81, at 7. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 stated that there is no data to support imposing a clearing requirement that targets hedge funds and leveraged accounts and expressed concern that a partial mandate may result in some dealers choosing to offer liquidity only in a cleared environment thereby reducing the liquidity available today to accounts in the uncleared cash market.321 Another commenter stated that the inclusion of hedge funds within the counterparties to an eligible secondary market transaction would create an uneven playing field that will subject hedge funds to much higher costs than other market participants.322 In addition, certain commenters also raised concerns with the definition of a hedge fund in the Proposing Release, stating that because of the nature of the definition, eligible secondary market transactions would include those with firms that may (but in practice might not actually) exceed the quantitative thresholds without regard to the risks that these firms actually take on, or their investment models and strategies.323 The Commission is not adopting proposed sections (ii)(C) and (D) of the definition of an eligible secondary market transaction with respect to hedge funds and leveraged accounts in light of questions raised by commenters regarding the inclusion of a hedge fund and a leveraged account as proposed that merit further consideration, and the Commission will continue to evaluate the issues raised to determine if any further action is appropriate with respect to transactions in the cash market. This change from the proposal allows for a more incremental approach to requiring central clearing of transactions in the cash market. However, the requirement to clear eligible secondary market transactions that are repos encompasses repos between a direct participant of a U.S. Treasury securities CCA and a hedge fund or leveraged account, as discussed in part II.A.2.a supra. This requirement should ensure that many of the risks posed by hedge funds, including the repo portion of a basis trade,324 would be addressed by the proposal. Moreover, repo transactions between a direct participant of a U.S. Treasury securities CCA and a hedge fund or leveraged account would be within the 321 SIFMA AMG Letter, supra note 35, at 11; see also MFA Letter II, supra note 125, at 7 (regarding decreased liquidity and potentially shifting transactions away from the requirement to clear eligible secondary market transactions). 322 MFA Letter II, supra note 125, at 7. 323 MFA Letter, supra note 81, at 18–20; AIMA Letter, supra note 81, at 6; SIFMA AMG Letter, supra note 35, at 11. 324 See note 723 infra. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 scope of the definition of an eligible secondary market transaction discussed in part II.A.2.a supra. This inclusion is important because it addresses the risks posed by hedge fund and leveraged account repo activity in the U.S. Treasury market, which is often highly leveraged and subject to low or zero haircut.325 iv. Comments Regarding Cash Transactions for Registered Funds As discussed in part II.A.2.b supra, the definition of eligible secondary market transactions does not include transactions between direct participants of a U.S. Treasury securities CCA and registered funds. However, if a registered fund were transacting on an IDB, that transaction would be an eligible secondary market transaction because it otherwise meets the definition of such a transaction (i.e., it is an IDB transaction) and not because it is a registered fund. Certain commenters addressed cash market transactions specifically with respect to registered funds. One commenter supported an exclusion from the definition of an eligible secondary market transaction for registered funds.326 The commenter stated that applying a cash Treasury clearing mandate to funds would not promote risk reduction or enhancements to market liquidity to a degree that would justify the considerable costs and burdens to funds, which would have to build out an entire new clearing infrastructure, with such costs borne indirectly by fund investors. The commenter stated that the characteristics of typical fund cash Treasury transactions are distinguishable from the types of transactions that the Commission is seeking to capture under the mandate for risk reduction purposes, i.e., those using significant leverage and/or giving rise to potential contagion risk. According to the commenter, registered funds, by contrast, invest in cash Treasury securities for purposes such as obtaining desired exposure, hedging risks associated with investments in other markets, diversifying their portfolios, and protecting capital, among other reasons. The commenter stated that these transactions are generally not linked to other leveraged strategies, and observed that funds are limited in their ability to incur leverage, both by statute 325 See, e.g., Ayelen Banegas and Phillip Monin, Hedge Fund Treasury Exposures, Repo, and Margining (Sept. 8, 2023), available at https:// www.federalreserve.gov/econres/notes/feds-notes/ hedge-fund-treasury-exposures-repo-andmargining-20230908.html. 326 ICI Letter, supra note 85, at 10. PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 2747 (i.e., Section 18 of the 1940 Act) and by SEC rules (e.g., Rule 18f–4 under the 1940 Act). The commenter further asserted that as a matter of investment strategy as well, buy-side market participants such as bond funds generally do not acquire significant leverage, including when investing in Treasury securities. For these reasons, the commenter asserted that including registered fund transactions in the definition of an eligible secondary market transaction would not yield additional risk reduction benefits.327 An additional commenter stated that applying this mandate to money market funds would yield minimal benefits while potentially imposing significant costs on such funds.328 The commenter stated that its money market funds do not normally utilize leverage in the cash purchase of Treasury securities, but instead are generally investing in Treasury securities on a long-term basis or are using them to hedge risks, for capital protection or for diversifying the risk in their investment portfolios. The commenter stated that these strategies are generally not linked to other leveraged strategies and therefore there is minimal contagion risk evident in these transactions. The commenter further stated that the costs of such a mandate would be significant as the commenter currently does not clear cash Treasury transactions and therefore would need to establish the technological, operational and legal frameworks that are necessary to support such a clearing mandate, meaning that any anticipated benefits of money market funds, as well as other registered funds, clearing their cash Treasury purchases would be vastly outweighed by the costs and burdens associated with such a mandate. The commenter also supported a broader exclusion for transactions with registered funds from the definition of an eligible secondary market transaction.329 As stated in the Proposing Release, the Commission identified certain categories of purchases and sales of U.S. Treasury securities that should be part of the definition of an eligible secondary market transaction, and these categories represented an incremental first step to address potential risks arising to a U.S. Treasury securities CCA. The Proposing Release did not include transactions with registered funds as a counterparty within the definition of an eligible secondary market transaction, and the Commission does not believe that a 327 ICI Letter, supra note 85, at 10. Letter, supra note 85, at 5. 328 Federated 329 Id. E:\FR\FM\16JAR2.SGM 16JAR2 2748 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations specific exclusion for registered funds is necessary. Although a transaction with a registered fund may constitute an eligible secondary market transaction if the transaction otherwise meets the definition, it would not be because of the fact of the registered fund as a counterparty, but, rather, because the transaction met some other criteria of the definition. The Commission understands generally that, consistent with the commenters’ statements, registered funds, including money market funds, typically do not use cash transactions in U.S. Treasury securities to take on leverage, both as a matter of strategy and because of applicable regulatory requirements, and that they instead use cash transactions to obtain desired exposure, hedge risks associated with investments in other markets, diversify portfolios, or protect capital. However, in response to the commenters that argued that registered funds’ lack of leverage means that they pose no counterparty risk, the Commission believes that, to the extent that a registered fund chooses to transact on an inter-dealer broker, such transactions would pose the same type of contagion risk as other transactions executed on an inter-dealer broker. For the reasons discussed in part II.A.2.b.ii supra, in such cases, it is appropriate that registered funds’ cash transactions, if on an IDB, would be encompassed within the definition of an eligible secondary market transaction because of the risks such transactions present as an IDB transaction and the potential for a default at the IDB to have a knock-on effect at the CCA. ddrumheller on DSK120RN23PROD with RULES2 v. Final Rule For the reasons set forth in part II.A.2.b, the Commission is adopting the definition of an eligible secondary market transaction in Rule 17ad–22(a), as set forth in sections (ii)(A) and (B) of that definition with respect to IDB transactions and transactions with a registered broker-dealer, but it is not adopting the definition of an eligible secondary market transaction as set forth in sections (ii)(C) and (D) of that definition with respect to hedge fund and leveraged account transactions. 3. Other Exclusions From the Definition of an Eligible Secondary Market Transaction Proposed Rule 17ad–22(a) would exclude transactions between direct participants of a U.S. Treasury securities CCA and certain counterparties from the definition of an eligible secondary market transaction in U.S. Treasury securities. These exclusions would VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 apply to any purchase or sale transaction in U.S. Treasury securities or repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities between a direct participant and a central bank, a sovereign entity, or an international financial institution. A central bank would, in turn, be defined as a reserve bank or monetary authority of a central government (including the Board of Governors or any of the Federal Reserve Banks) and the Bank of International Settlements. A sovereign entity would be defined as a central government (including the U.S. Government), or an agency, department, or ministry of a central government. An international financial institution would be defined by specifying the entities, i.e., (1) African Development Bank; (2) African Development Fund; (3) Asian Development Bank; (4) Banco Centroamericano de Integracio´n Econo´mica; (5) Bank for Economic Cooperation and Development in the Middle East and North Africa; (6) Caribbean Development Bank; (7) Corporacio´n Andina de Fomento; (8) Council of Europe Development Bank; (9) European Bank for Reconstruction and Development; (10) European Investment Bank; (11) European Investment Fund; (12) European Stability Mechanism; (13) InterAmerican Development Bank; (14) InterAmerican Investment Corporation; (15) International Bank for Reconstruction and Development; (16) International Development Association; (17) International Finance Corporation; (18) International Monetary Fund; (19) Islamic Development Bank; (20) Multilateral Investment Guarantee Agency; (21) Nordic Investment Bank; (22) North American Development Bank, and providing that the term would also include any other entity that provides financing for national or regional development in which the United States government is a shareholder or contributing member. In addition, Proposed Rule 17ad–22(a) would also exclude transactions in U.S. Treasury securities between a direct participant of a U.S. Treasury securities CCA and a natural person. Commenters expressed support for these exclusions.330 For the reasons stated in the Proposing Release, the Commission believes that these exclusions are appropriate.331 The 330 SIFMA/IIB Letter, supra note 37, at 20; CME Letter, supra note 81, at 6. 331 Proposing Release, supra note 14, 87 FR at 64625–26. PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 Commission is therefore adopting the exclusions as proposed. In addition, several commenters requested an exclusion for market participants that engage in cash or repo transactions but are unable to access a U.S. Treasury securities CCA. For example, one commenter stated that this inability to access a CCA could be because of the CCA’s existing rules or otherwise.332 Another commenter stated that this inability could result from being ineligible under the CCA’s existing rules, regulatory burdens, or other material impediments that prevent such access. The commenter further stated that that not all market participants will be able to work with a U.S. Treasury securities CCA to determine if there are serious obstacles to access during the proposal’s comment period and that it may take more time for any possible issues to surface.333 It is difficult to determine what entities will be ‘‘unable’’ to access central clearing and for what reasons, given that, for example, the existing rules of a CCA may change during the implementation period, see part III infra, and that different market participants may face different regulatory or other requirements that could have an effect on its access to central clearing. Therefore, such an exclusion would be overly broad and would undermine the policy goals of the requirement to clear eligible secondary market transactions. The Commission has identified a number of exclusions in this release and would consider any additional specific requests for exclusions in the future as market participants work to finalize arrangements to implement the requirements of this release. 4. Policies and Procedures Regarding U.S. Treasury Securities CCA’s Monitoring of Its Direct Participants’ Transactions The proposed amendments to Rule 17ad–22(e)(18)(iv)(B) would require that a U.S. Treasury securities CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, identify and monitor its direct participants’ required submission of transactions for clearing, including, at a minimum, addressing a direct participant’s failure to submit transactions. One commenter supported this aspect of the proposal.334 The commenter 332 See AIMA Letter II, supra note 115, at 4. Letter, supra note 37, at 21. 334 See DTCC/FICC Letter, supra note 33, at 21– 22. 333 SIFMA/IIB E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 noted that this aspect of the proposal uses the phrase ‘‘identify and monitor,’’ which is an understood phrase used elsewhere in the Covered Clearing Agency Standards.335 Accordingly, the commenter anticipated that implementation of this aspect of the proposal would be similar to implementation of other Covered Clearing Agency Standards provisions that use that phrase.336 For example, the commenter stated that it expects a U.S. Treasury securities CCA would require its direct participants to submit information regarding their U.S. Treasury transactions as well as attestations from senior officials that the participant is in compliance with its obligations.337 The commenter stated that it further expects that a U.S. Treasury securities CCA would review publicly available information (e.g., information collected through FINRA’s Trade Reporting and Compliance Engine (‘‘TRACE’’) reporting) as well as information made available to it by regulatory and self-regulatory organizations.338 Additionally, the commenter stated that it expects a U.S. Treasury securities CCA would seek to identify opportunities to coordinate with market participants and selfregulatory organizations to examine collected data and identify possible instances of non-compliance.339 The commenter cautioned, however, that the ability of a U.S. Treasury securities CCA to effectively identify and monitor its direct participants’ required submission of transactions for clearing would depend on the quality and comprehensiveness of available data, and the commenter asked that the Commission continually review and improve the quality of available data.340 The commenter stated that it expects a U.S. Treasury securities CCA would take steps to remediate non-compliance on the part of its direct participants in a manner consistent with the Covered Clearing Agency Standards and breaches of the CCA’s own rules.341 The commenter cautioned, however, that a U.S. Treasury securities CCA’s capacity to monitor participant non-compliance is limited because a CCA does not have authority over non-participants that may seek to evade the requirement to clear eligible secondary market transactions.342 Therefore, the 335 See DTCC/FICC Letter, supra note 33, at 21. id. 337 See id. 338 See id. 339 See id. 340 See DTCC/FICC Letter, supra note 33, at 21– 22. 341 See DTCC/FICC Letter, supra note 33, at 22. 342 See id. 336 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 commenter asked that the Commission utilize its supervisory authority to help support any requirement to clear eligible secondary market transactions.343 Consistent with the commenter, the Commission continues to believe that such a requirement should ensure that a U.S. Treasury securities CCA has a framework in place for oversight of participants’ compliance with the policies that would be adopted as part of the requirement to submit eligible secondary market transactions for clearing. Without such policies and procedures, it would be difficult for the CCA to assess if the direct participants are complying with the amendments to Rule 17ad–22(e)(18)(iv)(A) that would require the submission of eligible secondary market transactions for clearing. The Commission continues to believe that there are a number of possible methods that a U.S. Treasury securities CCA could establish to assess its direct participants’ compliance with the policies and procedures adopted pursuant to the Membership Proposal. For example, the Commission agrees with the commenter that a U.S. Treasury securities CCA could require direct participants to submit to the CCA information regarding their U.S. Treasury securities transactions or to require attestations from senior officials of the CCA’s direct participants as to their submission of the required transactions and compliance with their obligations to submit such transactions. The Commission further agrees that a U.S. Treasury securities CCA also could review publicly available information and information made available to it by regulatory and self-regulatory organizations as part of its assessment of its direct participants’ compliance. The Commission continues to believe that requiring a U.S. Treasury securities CCA to adopt policies and procedures that address a failure of a direct participant to submit transactions that are required to be submitted is consistent with section 17A(b)(3)(G) of the Exchange Act. That section requires that the rules of a registered clearing agency provide that its participants shall be appropriately disciplined for violation of any provision of the rules of the clearing agency by expulsion, suspension, limitation of activities, functions, and operations, fine, censure, or any other fitting sanction. The Commission continues to believe that policies and procedures consistent with this aspect of the proposal should specify how a U.S. Treasury securities 343 See PO 00000 id. Frm 00037 Fmt 4701 Sfmt 4700 2749 CCA would penalize its participants who do not submit the required transactions, whether by a particular fine or other action. For these reasons, the Commission is adopting the requirement in Rule 17ad– 22(e)(18)(iv)(B) as proposed. 5. Alternative Approaches Proposed by Commenters As discussed in part II.A.1.a supra, commenters identified several methods by which the Commission could or should incentivize additional central clearing without adopting a requirement to clear eligible secondary market transactions. The Commission discusses its views on each of these in turn, including whether it has the authority to adopt certain initiatives. However, as a general matter, the Commission is not persuaded that incentivizing central clearing would be sufficient at this point, as those types of changes would not ensure that the current risks to U.S. Treasury securities CCAs are addressed. Therefore, the requirement to clear eligible secondary market transactions is necessary. First, commenters identified the proposed amendments to Rule 15c3–3 discussed in part II.C infra as a method to incentivize additional central clearing.344 One commenter stated that the practical effect of this change would be to allow broker-dealers to use margin collected from customers to satisfy margin requirements associated with such customers’ transactions, rather than using proprietary funds to finance customer margin as is the case today, and expressed its support for this amendment because it will free up broker-dealer resources by reducing the amount of proprietary funds needed to finance customer margin and therefore lower the cost of clearing, while continuing to protect customer funds.345 Another commenter stated that the proposed change to allow a debit under the Rule 15c3–3a customer reserve formula should incentivize central clearing of U.S. Treasury securities transactions by reducing costs.346 One commenter stated that this change would reduce the costs of centrally clearing U.S. Treasury securities transactions and thus incentivize more central clearing of such transactions.347 Second, commenters identified the proposed amendments to require U.S. Treasury securities CCAs to segregate customer positions and margin 344 SIFMA AMG Letter, supra note 35, at 8; SIFMA/IIB Letter, supra note 37, at 12; MFA Letter, supra note 81, at 3, 10. 345 MFA Letter, supra note 81, at 10. 346 SIFMA AMG Letter, supra note 35, at 8. 347 SIFMA/IIB Letter, supra note 37, at 12. E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 2750 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations discussed in part II.C.1 infra as a method to incentivize additional central clearing.348 One commenter stated that this change would ensure that a direct participant’s proprietary positions would be available to net against other proprietary positions, which would incentivize additional central clearing.349 An additional commenter stated that the segregation of customer positions should allow for a dealer’s proprietary positions to be netted against that dealer’s proprietary positions vis-a`-vis other dealers, allowing more central clearing of U.S. Treasury securities transactions.350 Third, commenters identified requiring CCAs to review their access models and/or adopt particular access models or features thereof as a method to incentivize clearing, as discussed in part II.B.2 infra.351 The Commission agrees that the methods identified by the commenters could incentivize and facilitate additional central clearing. The Commission therefore is adopting the amendments to Rule 15c3–3, the requirement to segregate house and customer margin, and the requirement to ensure access to central clearing, as discussed in parts II.C, II.B.1, and II.B.2 infra respectively. However, the Commission disagrees with these commenters that these changes alone, without also requiring that U.S. Treasury securities CCAs obligate their direct participants to submit eligible secondary market transactions for clearing, are enough. Merely incentivizing and facilitating greater central clearing is not sufficient, as those types of changes would not ensure that the current risks to U.S. Treasury securities CCAs are addressed. Therefore, for the reasons discussed in part II.2.a and b, the requirement to clear is also necessary. Fourth, one commenter argued that another way the Commission could incentivize greater central clearing without requiring it was to require FICC to consider amending its clearing fund structure to separate initial margin from default fund requirements that can be subject to loss mutualization, which would result in capital efficiencies for bank or bank-affiliated dealers and also may allow for increased participation from counterparty types that are restricted from participating in loss 348 SIFMA AMG Letter, supra note 35, at 8; SIFMA/IIB Letter, supra note 37, at 12; MFA Letter, supra note 81, at 3. 349 SIFMA/IIB Letter, supra note 37, at 12, 25. 350 SIFMA AMG Letter, supra note 35, at 8. 351 SIFMA/IIB Letter, supra note 37, at 13; SIFMA AMG Letter, supra note 35, at 8; MFA Letter, supra note 81, at 3, 6–10. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 mutualization arrangements (e.g., money market funds).352 Another commenter also stated that changing the sponsored member clearing fund contribution to a pool of margin that is used in the event of a default of the underlying sponsored member would more closely align a sponsored member’s exposure to potential losses in a default scenario with its own creditworthiness (i.e., the defaulter pays first) and be more cost effective for sponsoring members.353 Another commenter stated that FICC must be required to separate initial margin from default fund requirements that can be subject to loss mutualization, prior to the imposition of a clearing requirement.354 The Commission recognizes that the particular clearing fund structure used by FICC may bring some level of capital inefficiency to banks who choose to join a CCA.355 However, the Commission previously has declined a commenter’s suggestion to impose such a requirement.356 As it stated when considering a similar comment when adopting the Covered Clearing Agency Standards, the Commission acknowledges that loss mutualization and other pooling-of-resources arrangements involve tradeoffs that a CCA generally should carefully assess and balance. A CCA may be better able to manage multiple defaults in extreme conditions more efficiently using pooled resources because the pooled resources would be greater than the resources of any single defaulting participant. Further, because the arrangements are prefunded, participants can model and manage the risks they face from the clearing agency while being able to take into account the amount of resources that they have provided to the clearing agency. The pooling of resources, however, can increase interdependencies among, and therefore the potential risks to, participants of the CCA. The use of loss mutualization and other pooling-of-resources arrangements generally should, to minimize systemic 352 SIFMA/IIB Letter, supra note 37, at 3. Letter, supra note 85, at 14. 354 MFA Letter II, supra note 125, at 4. 355 Banking regulations may result in different treatment for collateral posted as margin to a CCP if that collateral is potentially subject to loss mutualization versus collateral that is not subject to loss mutualization. Specifically, a bank has to treat potentially mutualized collateral, like clearing fund posted to FICC or, more generally, the guaranty fund posted to derivatives CCPs, differently from collateral that would be used only in the event of the specific bank member’s default to the CCP. Such banking regulations are outside the scope of this rulemaking or the Commission’s authority in general. 356 CCA Standards Adopting Release, supra note 10, 81 FR at 70813. 353 ICI PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 risk, balance the safety and soundness of the CCA against the potential for increased exposures among participants that may arise from the manner the CCA holds financial resources. For all these reasons, the Commission continues to believe that it should not impose such a requirement on CCAs, notwithstanding the potential capital efficiencies arising from a different clearing fund structure at a CCA. Pursuant to Rule 17ad–22(e)(23), a covered clearing agency must establish, implement, maintain and enforce written policies reasonably designed to disclose, among other things, key aspects of its default rules and procedures and the risks, fees, and other material costs participants incur by participating in the covered clearing agency. The availability of these policies and procedures should allow participants to understand in advance a covered clearing agency’s reliance on such resources and to consider their own ability to meet the CCA’s membership obligations, including with respect to financial resources, prior to becoming members of the covered clearing agency. Fifth, several commenters discussed facilitating cross-margining of indirect participants’ transactions in U.S. Treasury securities with those in U.S. Treasury futures as a method to incentivize additional clearing.357 One commenter stated that the Commission should take steps to allow crossmargining of customer transactions between Treasury securities and U.S. Treasury futures, because the reduced margin requirements obtained through cross-margining serves an important function in increasing market liquidity through balance sheet savings and incentivizing risk reduction through hedging. The commenter also referred to the work of the G–30, which observed that wider use of cross-margining would reduce the risk that increases in initial margin requirements on the futures leg of cash-futures basis trades result in forced sales of Treasury securities, which may have contributed to selling pressures in the market in March 2020.358 Another commenter stated that cross-margining would lower costs for market participants by allowing them to apply margin across positions submitted for clearing through various clearinghouses. The commenter stated that this would ensure that a market participant can post margin adequate to support its positions without having to 357 MFA Letter, supra note 81, at 11; SIFMA/IIB Letter, supra note 37, at 13; SIFMA AMG Letter, supra note 35, at 8. 358 SIFMA/IIB Letter, supra note 37, at 13. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 post margin in excess of regulatory requirements due to an inability to apply margin across platforms.359 Another commenter stated that the Commission should explore developing a framework that would allow cross margining of futures and securities transactions, and an additional commenter added that this type of framework would ensure a level playing field between direct and indirect members and noting that, unlike direct participants, clients are not permitted to cross-margin positions cleared at FICC with futures positions cleared at CME Group under FICC’s current crossmargining framework, which significantly increases clearing costs for clients (depending on the trading strategies involved), discouraging clearing and creating an unlevel playing field between direct members and clients at FICC.360 The current cross-margining agreement between FICC and CME is part of FICC’s rulebook, any changes to which have to be filed with the Commission pursuant to Section 19(b) of the Exchange Act. The Commission historically has supported and approved cross-margining at clearing agencies and recognized the potential benefits of cross-margining systems, which include freeing capital through reduced margin requirements, reducing clearing costs by integrating clearing functions, reducing clearing agency risk by centralizing asset management, and harmonizing liquidation procedures.361 The Commission has stated that crossmargining arrangements may be consistent with Section 17A(b)(3)(F) of the Exchange Act in that they may strengthen the safeguarding of assets through effective risk controls that more broadly take into account offsetting positions of participants in both the cash and futures markets, and promote prompt and accurate clearance and 359 MFA Letter, supra note 81, at 11. The commenter further stated that the Commission should ensure indirect participants also can take into account offsetting positions when calculating margin requirements. MFA Letter II, supra note 125, at 4. 360 SIFMA/AMG Letter, supra note 35, at 8; ARB et al. Letter, supra note 81, at 9. 361 Self-Regulatory Organizations; the Fixed Income Clearing Corporation; Order Granting Approval of Proposed Rule Change To Amend and Restate the Cross-Margining Agreement Between FICC and CME, Exchange Act Release No. 98327 (Sept. 8, 2023), 88 FR 63185, 63187 (Sept. 14, 2023); see also Exchange Act Release No. 90464 (Nov. 19, 2020), 85 FR 75384, 75386 (Nov. 25, 2020) (approving a second amended and restated crossmargining agreement between the Options Clearing Corp. and CME); Exchange Act Release No. 38584 (May 8, 1997), 62 FR 26602, 26604–05 (May 14, 1997) (establishing a cross-margining agreement with the Options Clearing Corp., CME, and the Commodity Clearing Corporation). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 settlement of securities through increased efficiencies.362 For these reasons, the Commission continues to believe that market participants can benefit from cross-margining arrangements and encourages U.S. Treasury securities CCAs to consider the potential of such benefits. Sixth, commenters identified a number of regulations that purportedly could be changed to further incentivize central clearing that are outside the Commission’s jurisdiction. For example, one commenter stated that requiring counterparties to post margin for noncentrally cleared bilateral repos through internationally agreed upon standards could level the playing field for margin requirements in Treasury repos, whether or not centrally cleared, and therefore incentivize market participants to centrally clear repos.363 The Commission alone cannot prescribe standards applicable to all market participants with respect to uncleared repo, and imposing requirements solely upon entities regulated by the Commission could lead to potential regulatory arbitrage. In addition, the commenter stated that FICC should have the ability to access a Federal Reserve standing repurchase facility for FICC as a systemically important financial market utility, which would (i) reduce the need for a participant-funded liquidity resources at a CCA, thereby reducing costs and incentivizing further central clearing, and (ii) mitigate the increased concentration risk of substantially increasing the Treasury transactions cleared at FICC.364 However, the Commission does not have the authority to provide that access. In addition, the commenter stated that exempting a clearing member’s exposure to FICC’s CCLF from the Single Counterparty Credit Limits (‘‘SCCL’’) or increasing the SCCL with respect to exposures to FICC, due to the larger possible CCLF exposure that bank holding companies may end up incurring, would allow market participants to clear additional transactions at FICC without risking exceeding SCCL limits.365 Another commenter suggested that the Commission work with other regulators to advocate for improvements to prudential rules which would have the effect of enhancing liquidity in the U.S. Treasury market (i.e., the Supplementary Leverage Ratio and 362 Id. 363 SIFMA/IIB Letter, supra note 37, at 13. Letter. supra note 37, at 13–14. 365 SIFMA/IIB Letter, supra note 37, at 14. 364 SIFMA/IIB PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 2751 other capital requirements).366 The SCCL and the Supplementary Leverage Ratio, as well as other bank capital requirements, arise from regulations of the Board of Governors.367 Therefore, any changes to the SCCL and banking capital regulations are outside the Commission’s jurisdiction. One commenter suggested promoting alternatives to central clearing that could improve liquidity and strengthen the U.S. Treasury market. The commenter stated that CUSIP aggregation has been applied successfully in the past to agency mortgage-backed securities and may improve liquidity by increasing the size of certain off-the-run U.S. Treasury issuances. The commenter further stated that the U.S. Treasury could also continue to consider engaging in buybacks of existing U.S. Treasury securities as a way of improving liquidity. The commenter also stated that the Commission could further engage with the industry in discussions on how to expand all-to-all trading in secondary market cash transactions as a way to promote liquidity. Finally, the commenter stated that other recent rule proposals and enhancements to the TRACE reporting obligations for U.S. Treasury securities will in time give the Commission greater visibility into this market.368 In response to the comments regarding CUSIP aggregation and buyback of U.S. Treasury securities, those actions would be undertaken by either the Federal Reserve Bank of New York (or other market participants) or the U.S. Department of the Treasury, respectively.369 The Commission does not have the authority to conduct such actions, and these actions would not impact the overall level of central clearing in the market. In response to the comments regarding all-to-all liquidity, the Commission agrees that increased all-to-all trading could improve liquidity in the U.S. Treasury market and, as stated in the Proposing 366 SIFMA AMG Letter, supra note 35, at 8. 12 CFR part 252 subpart H (regulations regarding SCCL); 12 CFR 217.10(c) (SLR regulation) and part 217 generally regarding bank capital requirements); see also Final Rule, SingleCounterparty Credit Limits for Bank Holding Companies and Foreign Banking Organizations, 83 FR 38460 (Aug. 6, 2018). 368 SIFMA AMG Letter, supra note 35, at 8. 369 See FRBNY, Statement Regarding Aggregation of Agency Mortgage-Backed Securities Holdings (Oct. 6, 2022), available at https:// www.newyorkfed.org/markets/opolicy/operating_ policy_221006; 31 CFR part 375, Marketable Treasury Securities Redemption Operations (establishing the terms and conditions by which the U.S. Department of the Treasury may redeem outstanding, unmatured marketable Treasury securities). 367 See E:\FR\FM\16JAR2.SGM 16JAR2 2752 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 Release, believes that increased central clearing could, in fact, increase all-to-all trading.370 However, all-to-all trading does not, on its own, address the risks to CCAs that the proposal was designed to address. The Commission therefore believes that imposing requirements on CCAs to have their members centrally clear eligible secondary market transactions should proceed, regardless of the current status of all-to-all trading, to address these issues. Similarly, in response to the comments regarding TRACE reporting, the Commission does not believe that the increased reporting would address the risks to CCAs arising from current clearing practices in the U.S. Treasury market. Therefore, relying on reporting alone would not be sufficient. Eighth, one commenter stated that the Commission should require enhanced transparency regarding FICC’s margining calculations and default management procedures. The commenter states that the proposal does not set default management standards or require disclosure of such standards. The commenter asserts that while FICC has disclosed ‘‘key aspects’’ of its default rules and procedures, greater transparency into these procedures, including, in particular, with respect to how FICC manages the default risk of indirect participants, would be beneficial. The commenter also stated that the proposal does not set margin requirements or require transparency into how margin requirements are set. The commenter states that with respect to both default management and margin calculations, enhanced transparency would enhance confidence in, and the resilience of, FICC, which will, in turn increase market participants’ confidence in submitting additional transactions for clearing.371 Another commenter also referenced the ‘‘broad opacity’’ of FICC margin models and the challenges that posed for participants, stating that the participants’ inability to replicate FICC’s margin models left the direct and indirect participants as not being able to accurately predict the daily (or more) margin calls to a reasonable degree.372 The Commission’s existing rules address these issues and require 370 Proposing Release, supra note 14, 87 FR at 64628; see also FRBNY Staff Report No. 1036, Allto-All Trading in the U.S. Treasury Market at 12– 13 (Oct. 2022), available at https:// www.newyorkfed.org/medialibrary/media/research/ staff_reports/sr1036.pdf?sc_lang=en (discussing how central clearing could make all-to-all trading more likely to expand in the Treasury market, while also potentially increasing the costs). 371 MFA Letter, supra note 81, at 11–12; see also MFA Letter II, supra note 125, at 5. 372 SIA Partners Comment, supra note 52, at 18; see also id. at 74–75. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 transparency into default management, and margin methodology. On default management, Rule 17ad–22(e)(13) requires that a covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to ensure the covered clearing agency has the authority and operational capacity to take timely action to contain losses and liquidity demands and continue to meet its obligations by, at a minimum, requiring the covered clearing agency’s participants and, when practicable, other stakeholders to participate in the testing and review of its default procedures, including any close-out procedures, at least annually and following material changes thereto.373 When adopting the Covered Clearing Agency Standards, the Commission declined to prohibit or adopt specific loss allocation or default management tools suggested by commenters, relying upon the Commission’s belief that, when determining the content of its policies and procedures with respect to default management, each CCA must have the ability to enhance its policies and procedures to meet the evolving challenges and risks in the securities market that the CCA serves.374 For these reasons, the Commission continues to believe that it should not set particular default management procedures for CCAs. In addition, Rule 17ad–22(e)(6) requires that a CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to cover, if the covered clearing agency provides central counterparty services, its credit exposures to its participants by establishing a risk-based margin system.375 Thus, CCAs are required to develop policies governing how they calculate margin. In addition, under the amendments to Rule 17ad–22(e)(6) being adopted in this release, CCAs will be obligated to have policies and procedures to calculate house margin separately from customer margin. Further, both default management and margin calculation generally constitute material aspects of the operations of a CCA, meaning that they should be considered stated policies, practices, or interpretations under Exchange Act Rule 19b–4.376 As such, they are subject to the filing obligations applicable to SROs under Section 19(b) of the Exchange Act. This means that the 373 17 CFR 240.17ad–22(e)(13). Standards Adopting Release, supra note 10, 81 FR at 70829. 375 17 CFR 240.17ad–22(e)(6). 376 17 CFR 240.19b–4(a)(6)(i). 374 CCA PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 default management processes and margin methodologies are described in SRO rule filings upon which market participants may comment and that the Commission must review and approve. CCAs have adopted rules on these topics pursuant to the SRO rule filing process.377 The filing obligations under Section 19(b) of the Exchange Act provide transparency into the covered clearing agencies’ default management processes and margin methodologies. Second, in addition to the aforementioned obligations under the Covered Clearing Agency Standards specific to default management and margin, Rule 17ad–22(e)(23) also imposes a set of requirements related to transparency and disclosure. Specifically, a CCA is obligated to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for publicly disclosing all relevant rules and material procedures, including key aspects of its default rules and procedures, and providing sufficient information to enable participants to identify and evaluate the risks, fees, and other material costs they incur by participating in the CCA.378 In addition, a CCA must produce a comprehensive public disclosure that describes its material rules, policies, and procedures regarding its legal, governance, risk management, and operating framework, accurate in all material respects at the time of publication, that includes, among other things, a standard-bystandard summary narrative for each applicable standard set forth in 377 Regarding default management, see, e.g., FICC Rule 4, sections 6, 7, 7a, and 7b (addressing application of clearing fund deposits and other Amounts to defaulting members’ obligations, loss allocation waterfall, corporate contribution, and withdrawal from membership in the event of a loss allocation); FICC Rule 3A, sections 12, 15, and 16 (addressing loss allocation in the Sponsored Service and the insolvency of either a sponsoring or sponsored member), supra note 19; Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Approving a Proposed Rule Change, as Modified by Amendment No. 1, to Amend the Loss Allocation Rules and Make Other Changes, Exchange Act Release No. 83970 (Aug. 28, 2018). Regarding margin methodologies, see e.g., FICC Rule 4, section 1b (setting forth the GSD unadjusted margin portfolio amount) and section 2a (describing the intraday supplemental required fund deposit), in conjunction with Rule 1 (defining the various components of the margin methodology, including, among other things, the VaR Charge, the Backtesting Charge, and the Margin Liquidation Adjustment Charge), supra note 19; see also Self-Regulatory Organizations; Fixed Income Clearing Corporation; Notice of Filing of Amendment No. 1 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 1, To Implement Changes to the Required Fund Deposit Calculation in the Government Securities Division Rulebook, Exchange Act Release No. 83362 (June 1, 2018), 83 FR 26514 (June 7, 2018). 378 17 CFR 240.17ad–22(e)(23)(i) and (ii). E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations paragraph (e)(1) through (23) of the Covered Clearing Agency Standards section with sufficient detail and context to enable a reader to understand the CCA’s approach to controlling the risks and addressing the requirements in each standard.379 Thus, each CCA issues a public document designed to address each standard, including those with respect to fees, default management, and margin.380 In addition, CCAs provide a variety of additional tools to assist their participants in understanding their margin obligations, such as descriptions of the components, including their calculations, and margin calculators that can be used to estimate margin requirements based on potential changes to a participant’s portfolio.381 Accordingly, because of the existing framework applicable to transparency, the Commission disagrees that enhanced transparency into margining calculations and default management procedures is necessary or that it would meaningfully incentivize greater clearing. However, the Commission encourages market participants and CCAs to engage regarding the existing tools and potential additional resources that could be provided to better assist market participants at understanding potential margin obligations. Finally, one commenter encouraged the Commission to consider whether proposal should specifically require FICC to establish rules ensuring that fees charged by direct participants are transparent and reasonable.382 Section 17A(b)(3)(E) of the Exchange Act requires that the rules of a clearing agency do not impose any schedule of prices, or fix rates or other fees, for services rendered by its participants. In light of this statutory provision, a rule ddrumheller on DSK120RN23PROD with RULES2 379 17 CFR 240.17ad–22(e)(23)(iii). 380 See, e.g., FICC Disclosure Framework, available at https://www.dtcc.com/-/media/Files/ Downloads/legal/policy-and-compliance/FICC_ Disclosure_Framework.pdf. 381 See, e.g., FICC Government Securities Division, Overview of the Clearing Fund Methodology (Oct. 2023), available at https:// www.dtcc.com/-/media/Files/Downloads/legal/ policy-and-compliance/GSD-Clearing-FundMethodology-Overview-October-2023.pdf; Comment Letter from FICC re: SR–FICC–2020–017 and SR– FICC–2020–804, available at https://www.sec.gov/ comments/sr-ficc-2020-017/srficc2020017-8451684229787.pdf (describing the different capabilities provided at FICC to enable direct participants to determine their margin requirements, including, but not limited to a calculator that provides functionality to direct participants to enter ‘‘what if’’ position data and recalculate their VaR Charge to determine margin impact pre-trade execution and to see the impact to VaR if specific transactions are executed or to anticipate the impact of an increase or decrease to a current clearing position). 382 MFA Letter, supra note 81, at 11. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 such as that suggested by the commenter would not be appropriate. For all these reasons, the Commission disagrees with commenters that would support not requiring the clearance of eligible secondary market transactions. The Commission believes that requiring direct participants of U.S. Treasury securities CCAs to clear their eligible secondary market transactions is essential to improving risk management at U.S. Treasury securities CCAs (including contagion risk) and to obtaining the benefits of central clearing in the U.S. Treasury market, as discussed in part II.A.1.a supra. As discussed in more detail in parts III and IV infra, the Commission does not believe that further study is necessary, but believes that, as discussed in more detail in part III, a phased implementation schedule for the requirements discussed in part II, beginning with some of the items identified as incentives to central clearing, should address commenters’ concerns that the necessary market infrastructure is not in place to support the requirement to clear eligible secondary market transactions. B. Additional Changes to Covered Clearing Agency Standards The Commission also proposed additional changes to the Covered Clearing Agency Standards, designed to address the likely increase in the volume of U.S. Treasury securities transactions submitted for central clearing resulting from the proposed requirement that direct participants of a U.S. Treasury securities CCA submit eligible secondary market transactions for clearance and settlement. The Commission is adopting these additional changes, for the reasons discussed in more detail below. 1. Netting and Margin Practices for House and Customer Accounts The proposed amendments to Rule 17ad–22(e)(6)(i) would require a U.S. Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate, collect, and hold margin amounts from a direct participant for its proprietary U.S. Treasury securities positions separately and independently from margin calculated and collected from that direct participant in connection with U.S. Treasury securities transactions by an indirect participant that relies on the services provided by the direct participant to access the covered clearing agency’s payment, clearing, or settlement facilities. This rule would prohibit a PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 2753 U.S. Treasury securities CCA from netting customer and proprietary positions. In the Proposing Release, the Commission stated it believed that the separation of house and customer positions could reduce the potential risk to the U.S. Treasury securities CCA arising from such transactions. Such changes should allow a U.S. Treasury securities CCA to better understand the source of potential risk arising from the U.S. Treasury securities transactions it clears and potentially further incentivize central clearing.383 Importantly, the amendment to Rule 17ad–22(e)(6)(i) would not require that a CCA’s direct participant collect a specified amount of margin from its customers or determine customer margin in a particular manner, such as on a gross basis; the calculation and collection of margin between a CCA direct participant and its customers would be left to other applicable regulations and, to the extent applicable, bilateral negotiation between the member and its customer. As the Commission stated in the Proposing Release,384 the amendments to Rule 17ad–22(e)(6)(i) would, in this way, require policies and procedures that closely resemble the calculation, collection, and holding of margin for listed options.385 When considering and adopting the Covered Clearing Agency Standards, the Commission noted that customer segregation can be achieved through such an omnibus account structure, where all collateral belonging to all customers of a particular member is commingled and held in a single account segregated from that of the member,386 which is consistent with the practice at the clearing agency for listed options and this amendment to Rule 17ad–22(e)(6)(i). 383 Proposing Release, supra note 14, 87 FR at 64633. 384 Proposing Release, supra note 14, 87 FR at 64634. 385 Currently, the covered clearing agency that clears and settles listed options transactions holds margin for customer trades separately from the proprietary trades of the submitting participant in an omnibus account. See Options Clearing Corp. Rules 601(c) and (d), available at https:// www.theocc.com/getmedia/9d3854cd-b782-450fbcf7-33169b0576ce/occ_rules.pdf (‘‘OCC Rules’’). This approach is also similar to the approach used for futures customers. See 17 CFR 1.22 and Advanced Notice of Proposed Rulemaking, Protection of Cleared Swaps Customers Before and After Commodity Broker Bankruptcies, 75 FR 75162, 75163 (Dec. 2, 2010) (describing the futures model). 386 See Proposing Release, supra note 14, 87 FR at 64634 (discussing CCA Standards Proposing Release, supra note 8, 79 FR at 29547; CCA Standards Adopting Release, supra note 10, 81 FR at 70832–33). E:\FR\FM\16JAR2.SGM 16JAR2 2754 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 Commenters generally supported the proposed amendment to Rule 17ad– 22(e)(6)(i).387 One commenter agreed that this amendment would further the risk management benefits associated with central clearing and help avoid a direct participant’s disorderly default because FICC would have a more holistic view of the market than currently available, and that because a direct participant’s margin would be calculated, collected and held separately and independently than that of its customers, the direct participant’s trades with its customers can be netted against the direct participant’s trades with other direct participants.388 One commenter stated that the proposed changes with respect to risk management requirements would facilitate the proposal’s goals of increased central clearing, and that it would also appropriately assign the risk of centrally cleared customer U.S. Treasury securities transactions to the customer.389 However, commenters also raised several additional issues with respect to the separation of house and customer margin that the Commission will address below. First, several commenters argued that this rule should also prohibit the use of separate customer margin for any other purpose, including loss mutualization (i.e., when a clearing agency uses nondefaulting customers’ funds in the event of a default, thereby ‘‘mutualizing’’ the loss).390 Another commenter stated that prohibiting the use of customer margin 387 ICE Letter, supra note 33, at 3; DTCC/FICC Letter, supra note 33, at 25; ICI Letter, supra note 85, at 25–26; SIFMA/IIB Letter, supra note 37, at 25–26; Tradeweb Letter, supra note 81, at 3; AIMA Letter, supra note 81, at 8; AFREF Letter, supra note 33, at 5; SIFMA AMG Letter, supra note 35, at 8. 388 AIMA Letter, supra note 81, at 8. 389 SIFMA/IIB Letter, supra note 37, at 25. 390 SIFMA/IIB Letter, supra note 37, at 26–27; ICI Letter, supra note 85, at 19 (supporting strong protections for funds in whatever models FICC chooses to adopt, including LSOC protections, and stating that customer funds must be identified as fund assets and have the benefit of customer treatment); AIMA Letter, supra note 81, at 8 (stating that the Commission should specify that client initial margin should not be included as part of a clearing agency’s default waterfall and subject to loss mutualization); ARB et al. Letter, supra note 81, at 8 (‘‘in no event should margin posted for client positions be available for use as part of a clearing agency’s default waterfall’’); MFA Letter, supra note 81, at 7 (‘‘it is crucial that indirect participants are able to post margin on a segregated basis such that their clients are not subject to the credit risk of others (and, likewise, that their funds are not subject to loss mutualization’’); see also SIFMA AMG Letter, supra note 35, at 12–13 (‘‘it will be difficult to support expanding cleared trading in U.S. Treasury securities until we have a framework which ensures customers can access clearing solutions where their margin and collateral will be adequately protected, including from loss mutualization by the clearing agency’’). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 for loss mutualization would mitigate higher risk-weighted assets under certain bank capital rules and may also facilitate clearing for market participants that are subject to restrictions regarding exposure to loss mutualization.391 What the commenters seek is akin to the requirements applicable to derivatives clearing organizations clearing swaps, that is, the ‘‘legally segregated, operationally commingled’’ (‘‘LSOC’’) model, which, as the Commission stated in the Proposing Release, differs from the requirements proposed in Rule 17ad–22(e)(6)(i).392 Under such an approach, customer collateral may be held in one combined account and commingled, but in the event of a customer default, the collateral of non-defaulting customers would not be available to cover any losses attributable to the defaulting customer (i.e., they would be legally separated from the collateral of the defaulting customer and not available for loss mutualization).393 As discussed in the Proposing Release, the Commission previously has declined to require such an approach for covered clearing agencies, preferring to allow each covered clearing agency to determine the method that works best for the products it clears and markets it serves.394 When discussing that conclusion, the Commission also noted that this type of segregation does not occur at the CCP level under the current market structure for cash securities and listed options, and that customer positions and funds in the cash securities and listed options markets are eligible for protection under SIPA, which is not the case for futures and cleared swaps.395 The Commission continues to believe that it would not be appropriate to require an LSOC model for U.S. Treasury security CCAs, because customer positions and funds in the market for cash securities and listed options would be eligible for protection under SIPA, unlike in other markets which use an LSOC model. However, a 391 Letter from Ann Battle, Senior Counsel, Market Transitions, International Swaps and Derivatives Association, Inc., at 2 (Dec. 27, 2022) (‘‘ISDA Letter’’). 392 Proposing Release, supra note 14, 87 FR at 64634 (discussing 17 CFR 22.15). 393 See, e.g., Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions, 77 FR 6336, 6339 (Feb. 7, 2012) (describing the LSOC approach and adopting final rules for this approach). 394 See Proposing Release, supra note 14, 87 FR at 64634 (discussing CCA Standards Adopting Release, supra note 10, 81 FR at 70832). 395 Id. PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 U.S. Treasury securities CCA may choose to offer such a model, based upon what works best for both direct and indirect participants or to satisfy other regulatory obligations. In practice, U.S. Treasury securities CCAs seeking to provide services that would allow broker-dealers to rehypothecate customer margin to the CCA, as discussed further in part II.C.2 infra, would, consistent with that flexibility, choose to adopt practices that would ensure that customer funds can be used only for a loss arising from customer activity and could not be used for loss mutualization. Thus, adopting the changes described in section II.C.2 below should also result in U.S. Treasury securities CCAs incorporating access models that provide for the type of segregation requested by the commenters. Another commenter argued that the Commission should consider additional changes that would compel FICC to require that all margin requirements related to customer positions be satisfied by those customers, to appropriately allocate risk to those customers and lower barriers to participation in central clearing for customers by direct participants who otherwise may not be able to submit margin on behalf of their customers.396 The requirement to collect, calculate, and hold customer margin separate from proprietary margin should ensure that, at the CCA level, the risks arising from customer clearing are sufficiently margined to protect the CCA from the exposure arising from customer clearing. In the event that a direct participant of the CCA is not able to submit margin on behalf of its customers, such participants could elect to take advantage of the amendments to Rule 15c3–3, as discussed in part II.C.2 infra, regarding Rule 15c3–3, which would require the participant to collect 100% customer margin in order to be able to onward post the margin. An additional commenter described the proposed rule as requiring customers to be margined individually and requiring FICC to collect margin even where a member’s overall customer position is netted, which would ‘‘exponentially’’ increase the margin requirement on all those involved in the U.S. Treasury market.397 The Commission disagrees that the proposed amendments to Rule 17ad– 22(e)(6)(i) would require customers to 396 SIFMA/IIB Letter, supra note 37, at 26 (analogizing to the CFTC requirement that DCOs collect at least 100% of margin to cover customer positions, see 17 CFR 39.13(g)(8)). 397 IDTA Letter, supra note 66, at 4. E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations be margined individually or that FICC would be required to collect margin even where a participant’s overall position is netted. As discussed in the Proposing Release, the proposed changes would require that a U.S. Treasury securities CCA calculate, collect, and hold margin for positions in U.S. Treasury securities transactions of a direct participant in a U.S. Treasury securities CCA separately from those of customers or other indirect participants that rely on the direct participant to access the covered clearing agency’s payment, clearing, or settlement facilities, but this does not mandate the calculation of margin for individual customers, that is, on a gross basis for each customer.398 A U.S. Treasury securities CCA would have the discretion to collect a single netted amount for each clearing member’s customer account as a whole, that is, netting each customer’s margin against that of other customers within the overall customer account.399 The commenter also discusses the impact of this purported gross margining on small and mid-size brokerdealers who are disproportionately affected by FICC’s Excess Capital Premium (‘‘ECP’’) charge, which is a margin add-on that collects a premium when a member’s VaR charge exceeds the member’s Net Capital, net assets or equity capital (as applicable to that member based on its type of regulation).400 The commenter explained the potential impact of the ECP charge in conjunction with FICC’s Sponsored Service, stating that ‘‘the combination of gross margining and ECP currently in use under the Sponsored Model, and what is prescribed in the Proposed Rule, effectively prevents smaller and middle market broker dealers from materially participating in the Treasury market.’’ 401 The commenter states that the potential effect of the ECP charge would be exacerbated when customer/ institutional counterparty margin is included in the calculation, and the surcharge prevents smaller independent broker-dealers from sponsoring institutional counterparties/ customers.402 The commenter states that the proposal must be changed to ensure that the combined effect of gross margining and the ECP does not excessively burden smaller, middle398 Proposing Release, supra note 14, 87 FR at 64634. 399 Id. 400 IDTA Letter, supra note 66, at 4; see also FICC Rule 4, section 14, supra note 19. 401 IDTA Letter, supra note 66, at 5. 402 IDTA Letter, supra note 66, at 5. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 market broker dealers and their institutional investor customers.403 The commenter’s concerns regarding the interplay between purported required gross margining and the ECP charge rests on the assumption that gross margin is required under the proposal, which, as discussed in the prior paragraph, is not the case. In addition, FICC recently has indicated that it intends to make available client clearing models that do not require gross margin, consistent with its current offerings.404 Therefore, the Commission does not believe that the proposal needs to be changed to address this issue. With respect to the ECP charge on its own, the Commission is not taking any action with respect to the ECP charge as part of adopting these new requirements. The ECP charge is part of FICC’s existing rulebook, and any change to that rulebook would be made pursuant to the proposed SRO rule change process under Section 19(b).405 Another commenter stated that the Commission should encourage FICC to hear and consider input from indirect participants regarding potential changes to fee and governance models.406 The Commission has adopted a requirement that registered clearing agencies must establish, implement, maintain and enforce written policies and procedures reasonably designed to solicit, consider, and document its consideration of the views of participants and other relevant stakeholders of the registered clearing agency regarding material developments in its governance and operations on a recurring basis.407 Requiring these policies and procedures should ensure that FICC considers input from indirect participants regarding potential changes to fee and governance models. For the reasons discussed above, the Commission is therefore adopting the amendments to Rule 17ad–22(e)(6)(i) as proposed. 2. Facilitating Access to U.S. Treasury Securities CCAs Proposed Rule 17ad–22(e)(18)(iv)(C) would require that a U.S. Treasury 403 IDTA Letter, supra note 66, at 6. DTCC 2023 White Paper, supra note 107, at 6 (discussing that the proposal would allow the option to calculate and collect margin associated with customer activity on a gross or net basis depending on the client clearing model selected by the member and stating that FICC would offer options via different access models that would allow those parties to balance the benefits of netting and segregation in different ways). 405 15 U.S.C. 78s(b); see also 15 U.S.C. 78s(c). 406 AIMA Letter, supra note 81, at 8. 407 Adopting Release, Clearing Agency Governance and Conflicts of Interest, Exchange Act Release No. 98959 (Nov. 16, 2023), 88 FR 84454 (Dec. 5, 2023) (adopting Rule 17ad–25(j)). 404 See PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 2755 securities CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the U.S. Treasury securities CCA’s board of directors reviews annually. In the Proposing Release, the Commission explained that this provision does not prescribe specific methods for market participants to obtain indirect access to a U.S. Treasury securities CCA.408 In the Proposing Release, the Commission stated its understanding that indirect participants may have significantly different preferences with respect to how they access and obtain clearing services from direct participants of U.S. Treasury securities CCAs. The Commission explained that this proposed requirement is intended to help ensure that all U.S. Treasury security CCAs review their indirect access models and ensure that they facilitate access to clearance and settlement services in a manner suited to the needs and regulatory requirements of market participants throughout the U.S. Treasury securities market, including indirect participants.409 a. Comments Supporting the Commission’s Proposed Rule Commenters generally supported the Commission’s attention to the need for appropriate access to the U.S. Treasury securities CCA,410 and several commenters specifically agreed that the Commission should not prescribe any particular model. One commenter cautioned that dictating a single model of clearing would close off clearing to many market participants, force indirect participants to bear additional clearing costs, increase concentration, reduce competition, and negatively impact market liquidity.411 In addition, another commenter stated that clearing agencies should have flexibility to innovate in this area.412 Another commenter stated that it supported the proposal’s approach of allowing clearing agencies to engage on potential reforms directly with affected market participants via the clearing agencies’ existing rulemaking processes, particularly given the many 408 Proposing Release, supra note 14, 87 FR at 64635. 409 Id. 410 MFA Letter, supra note 81, at 5. 411 DTCC/FICC Letter, supra note 33, at 14, 18. 412 ICE Letter, supra note 33, at 3. E:\FR\FM\16JAR2.SGM 16JAR2 2756 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 risks involved and given that various models may be appropriate for different firms and different situations.413 Another commenter asked the Commission to retain optionality in access models for U.S. Treasury securities CCAs, because all access models have costs and benefits and different access models may be appropriate for different market participants or commercial arrangements. The commenter agreed with the Commission that neither the Commission nor the rulebook of a U.S. Treasury securities CCA should mandate a single approach to access or require that direct participants that clear for indirect participants offer all possible access models. The commenter stated that a U.S. Treasury securities CCA should provide the flexibility necessary to allow market participants to match access models with optimal use cases, which would encourage maximum market participation from a diverse group.414 The Commission agrees with these commenters regarding the need for flexibility in a U.S. Treasury securities CCA’s access models. These CCAs should be able to develop models that meet the needs of different market participants, and they should not mandate a single approach to access or require that direct participants that clear for indirect participants offer all possible access models. When considering whether its models meet the needs of different market participants, a U.S. Treasury securities CCA generally should consider certain topics related to its access models, such as their sustainability, the need for additional models or revisions, and potential applicability of models used in other markets, as part of the CCA’s consideration of its compliance with this proposed rule. Many commenters also expressed that the Commission should impose additional requirements regarding access to a U.S. Treasury securities CCA. These comments are discussed in the following parts II.B.2.b and c. b. Comments Regarding the Commission’s Authority To Require a CCA To Accept Done Away Transactions Several commenters stated that the Commission should require that a U.S. Treasury securities CCA obligate its members to accept done-away transactions and/or that the Commission should prohibit anticompetitive practices at CCPs, including prohibiting 413 ISDA Letter, supra note 391, at 3. Letter, supra note 37, at 23. 414 SIFMA/IIB VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 clearing members from requiring clients to bundle execution and clearing.415 The commenters argued that the Commission had the statutory authority to implement such a requirement. First, the commenters stated that ‘‘since a clearing requirement cannot be implemented in the Treasury market unless the Commission ensures that both direct and indirect participant have a way to access a clearing agency, the two topics are inseparable and the Commission can rely on the statutory authority underlying the clearing requirement in order to address related access issues, including promoting the prompt and accurate clearance and settlement of Treasury securities.’’ 416 Second, the commenters stated that Section 17A of the Exchange Act grants the Commission broad authority to improve access and competitive practices at a clearing agency. The commenters identified the Commission’s authority to adopt rules for clearing agencies that are necessary or appropriate in the public interest or otherwise in furtherance of the purposes of this chapter, noting that the purposes of Section 17A include maintaining fair competition among brokers and dealers and scrutinizing clearing agency rules to ensure they do not permit unfair discrimination among participants in the use of the clearing agency and do not impose any burden on competition not necessary or appropriate.417 Another commenter stated that the Commission has the authority in Section 17A to prohibit anticompetitive practices at all CCAs.418 Similarly, one commenter asserted that requiring a direct participant that offers clearing services to indirect participants to accept those indirect participants’ done away transactions would be consistent with Exchange Act Section 17A, including, in particular, requirements relating to addressing unnecessary costs, maintaining fair competition, removing impediments to a national market system, and promoting the public interest and protection of investors. The commenter also suggested, at a minimum, that the Commission should require that if a clearing agency permits its direct participants to condition an indirect participant’s access to clearing on the indirect participant also executing transactions with the direct participant 415 See, e.g., ARB et al. Letter, supra note 81, at 7; MFA Letter II, supra note 125, at 3–4; see also Citadel Letter, supra note 81, at 7. 416 ARB et al. Letter, supra note 81, at 7; see also Citadel Letter, supra note 81, at 7. 417 See Citadel Letter, supra note 81, at 7; ARB et al. Letter, supra note 81, at 6. 418 AIMA Letter, supra note 81, at 6. PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 or its affiliate, the clearing agency must specify in its rules when such conditional access is permitted, which should be limited to circumstances where the clearing agency can show such conditional access is consistent with the Exchange Act. The commenters cited several provisions of Section 17A in support of their views. First, several commenters referenced language in Section 17A(a)(1), which sets forth the Congressional findings underpinning Section 17A. Specifically, Congress found that, inefficient procedures for clearance and settlement impose unnecessary costs on investors and persons facilitating transactions by and acting on behalf of investors, and that the linking of all clearance and settlement facilities and the development of uniform standards and procedures for clearance and settlement will reduce unnecessary costs and increase the protection of investors and persons facilitating transactions by and acting on behalf of investors. These findings, including the reference to ‘‘unnecessary costs,’’ do not provide the Commission with authority to adopt rules requiring CCAs to impose particular requirements on their direct participants regarding the direct participants’ business models. Instead, they represent Congress’ findings about the consequences of the situation at the time Section 17A was adopted in 1975. Second, the commenters relied upon language in Section 17A(a)(2) setting forth the Congressional direction to the Commission regarding a national system for clearance and settlement. This direction instructs the Commission to take into account, among other things, the maintenance of fair competition among brokers and dealers when facilitating the establishing of a national system for the prompt and accurate clearance and settlement of securities transactions. Third, commenters relied upon language in Section 17A(b)(3)(F) and (I). These provisions set forth certain requirements for a clearing agency’s rules that must be met in order for the Commission to register the clearing agency. In the portions cited by commenters, Section 17A(b)(3)(F) states that the clearing agency’s rules should be, among other things, designed to remove impediments to and perfect the mechanism of a national system for the prompt and accurate clearance and settlement of securities transactions, and, in general, to protect investors and the public interest, and that they should not be designed to permit unfair discrimination among participants in the use of the clearing agency. Section E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations 17A(b)(3)(I) states that the clearing agency’s rules should not impose any burden on competition not necessary or appropriate in furtherance of the purposes of this chapter. The type of requirement sought by commenters differs from the requirement to clear eligible secondary market transactions, in that the requirement to clear eligible secondary market transactions relates to transactions that the direct participant already has determined to enter into, based on its own business model.419 It is not requiring the direct participant to engage in particular transactions or to offer particular business models. By contrast, the commenters’ support for a prohibition on anti-competitive practices or a requirement to accept done-away transactions would require clearing agencies to, in turn, require their direct participants to transact with their customers in specific ways and limit their ability to offer certain types of pricing services. As discussed in the Proposing Release, the current client clearing models in place at FICC allow for the submission of done-away transactions and allows non-FICC entities to access the CCA through multiple direct participants, but do not require any direct participant to submit done-away transactions on behalf of other market participants.420 Therefore, the Commission disagrees that the failure to require the submission of done-away transactions necessarily constitutes ‘‘unfair discrimination,’’ as discussed in Section 17A(b)(3)(F). Moreover, in order to encourage market participants to provide services to enable indirect access to central clearing, the Commission believes it is best not to remove the ability of a direct participant of a U.S. Treasury securities CCA to determine what risk it will take with respect to guaranteeing transactions to the CCA. In addition, the Commission would not agree with the commenter that, at this time, the current access models offered by the existing U.S. Treasury securities CCA constitute a burden on competition that is not necessary or appropriate, as discussed in Section 17A(b)(3)(I). More generally, the Commission disagrees that it should impose a particular access model at this time. The Commission is adopting a number of changes with regard to the method by which CCAs will provide services to the U.S. Treasury market, including the 419 Specifically, the definition of an eligible secondary market transaction would simply identify various types of transactions but would not favor or require one over another. 420 Proposing Release, supra note 14, 88 FR at 64635. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 segregation of house and customer margin and the potential ability to use Rule 15c3–3 to rehypothecate customer margin to the CCA to meet margin requirements, and regarding the CCA’s obligations with respect to ensuring access. These changes will present both new obligations, but also potentially new business opportunities, for existing direct participants of the U.S. Treasury securities CCA. It is appropriate to allow the U.S. Treasury market to take these new requirements into account, before determining that additional access models are needed. Currently, FICC’s models do allow for done-away transactions, and the Commission therefore disagrees that an additional model is a prerequisite to the requirement to clear eligible secondary market transactions.421 Finally, a commenter also stated that in order to satisfy the proposal’s principles-based access requirement, a clearing agency should have to demonstrate that, for each clearing model it considers necessary to offer to satisfy that access standard, the clearing agency is clearing a material volume of transactions through that model (i.e., if permitting done away clearing is necessary for the clearing agency to satisfy the proposal, then the clearing agency must demonstrate that material volume of done away clearing is actually taking place).422 The Commission agrees with the commenter that the CCA generally should consider the volumes and proportion of the market that are being centrally cleared through different access models as part of the CCA’s consideration of whether its access models are meeting the needs of the market. c. Other Comments Regarding Access Other commenters supported additional Commission requirements regarding customer clearing models, particularly with respect to done-away transactions. One commenter stated that the Commission needs to be more prescriptive in directing covered clearing agencies on how they design their access models, disagreeing with the amount of discretion left to the clearing agency and its board. The commenter stated that a successful clearing model must also facilitate and incentivize the clearing of ‘‘done away’’ transactions, which will require changes to incentives so that clearing brokers are 421 In addition, the Commission notes that any additional model would have to be consistent with Section 17A(b)(3)(E), which requires that the rules of a registered clearing agency not impose any schedule of prices, or fix rates or other fees, for services rendered by its participants. 422 MFA Letter, supra note 81, at 9. PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 2757 compensated for facilitating this activity. The commenter identified ‘‘the only viable path’’ to a clearing requirement as the Commission’s issuing a detailed rulemaking establishing a common clearing model and standards which must be met by any U.S. Treasury securities CCA, including FICC.423 The Commission addressed similar comments in the discussion in part II.B.2.b supra. As discussed there, the Commission is not prescribing particular access models. The Commission agrees with commenters that a workable done-away model will be critical to this market, to accommodate the increased central clearing that would result from implementation of this rule, and encourages FICC and other market participants to consider how to offer and price the currently available models to ensure that indirect participants can access central clearing. One commenter stated that the Commission should adopt more robust and direct measures to ensure fair and open access, specifically to make sure that market participants have sufficient access to clearing.424 This commenter identified three overarching principles or concerns with respect to FICC’s current clearing access models ‘‘that must be addressed in any final rule.’’ First, the commenter stated that FICC’s rules must ensure that an indirect participant can consolidate the clearing of its portfolio in one or a small number of direct participants by requiring a direct participant offering customer clearing to accept transactions executed by the customer with third-party executing firms (that is, to accept ‘‘doneaway’’ transactions). The commenter stated that under the current FICC rules, indirect participants may be prevented by their clearing firms from clearing these ‘‘done-away’’ transactions, which means that the indirect participant often needs to establish a clearing relationship with each executing counterparty, which divides portfolios, increases margin costs and operational complexity, and potentially reduces netting efficiencies.425 In response to this comment, for the reasons explained above, the Commission is not prescribing particular access models. Second, the commenter stated that indirect participants should be able to access central clearing models providing for FICC to guarantee settlement of their 423 SIFMA AMG Letter, supra note 35, at 9–10. Letter, supra note 81, at 5; MFA Letter II, supra note 125, at 3–4. 425 MFA Letter, supra note 81, at 7; MFA Letter II, supra note 125, at 3–4. 424 MFA E:\FR\FM\16JAR2.SGM 16JAR2 2758 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 transactions, which the commenter asserts is not the case with certain models today including FICC’s correspondent and prime broker models. The commenter states that these models do not afford indirect participants the benefits of central clearing because settlement of the transactions they clear through those models remains dependent upon the direct participant because the indirect participant does not face FICC directly. The commenter states that because a clearing mandate would, in practice, force many market participants to contract with FICC direct participants to access clearing (and would disallow various bilateral settlement models), it is critical that the Commission ensure that settlement of such market participants’ transactions is not contingent upon circumstances outside the indirect participants’ control, including, for example, the solvency of a direct participant.426 The Commission recognizes that certain access models offered by FICC may not result in a contractual relationship or direct obligation between FICC and the indirect participant, meaning that FICC itself cannot guarantee settlement of such transactions. The Commission observes that this generally would be the case in any agent clearing relationship in which an indirect participant relies upon a direct participant to submit transactions for clearing on its behalf. For example, customers who access DCOs through an FCM that is a direct participant in the DCO may face exposure if the FCM fails. DCO rules generally require that it take steps to port the customer transactions (i.e., to transfer the customer positions to a new direct participant if the customer’s original direct participant defaults), but ultimately retain the ability to close out the transactions if needed, leaving the customer to seek redress from its direct participant.427 However, this structure still provides the benefits of central clearing to the market as a whole, as described in part II.A.1 supra, despite the fact that an indirect participant may face continued exposure to its agent direct participant. Third, the commenter states that an indirect participant should have the ability (although not the obligation) to fund the margin obligations of the direct 426 MFA Letter, supra note 81, at 7; see also MFA Letter II, supra note 125, at 4. 427 See, e.g., ICE Clear Credit Rule 20A–02(a) (describing what happens in the event that FICC determines to effect the closing-out Process for client-related positions of a defaulting participant); CME Group Exchange Rule 802.G(1) (describing the DCO’s ability to terminate transactions in a customer futures account). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 participant clearing on its behalf which are attributable to the indirect participant. The commenter states that given that many indirect participants have fiduciary obligations to their own clients, it is crucial that indirect participants are able to post margin on a segregated basis such that their clients are not subject to the credit risk of others (and, likewise, that their funds are not subject to loss mutualization), which would promote systemic risk mitigation by facilitating a defaulterpays model for clearing by indirect participants.428 The Commission addressed this issue in its discussion of a similar comment in part II.A.2.a.ii supra. One commenter stated that the Commission should undertake a study of possible models to access U.S. Treasury securities CCAs, including models used in other markets. The commenter stated that current access models may not be suited for all participants or commercial arrangements, for various reasons including FICC membership requirements, operational constraints, and resource costs associated with legal documentation. The commenter stated that implementing a central clearing requirement without a comprehensive analysis regarding the suitability of current models to access U.S. Treasury securities CCAs and whether there is a need for additional models or revisions to current models could drive market participants away from transacting with direct participants or from the Treasury market entirely, if such participants do not believe there is a reasonable means of accessing a CCA. The commenter stated that such study should take place prior to the adoption of any rule requiring additional central clearing.429 Another commenter suggested that the Commission conduct a holistic review of FICC rules to ensure fair access for all market participants (both direct participants and indirect participants), prior to imposing any requirements.430 The Commission does not agree that a formal study or holistic review of access models must occur before adoption of the proposal. As discussed in part II.C.2 supra, a U.S. Treasury securities CCA generally should consider these topics, such as the sustainability of current models and the need for additional models or revisions, as well as the potential applicability of models used in other markets, as part of the CCA’s consideration of its compliance with this proposed rule. The Commission will have the opportunity to consider these issues as well, in its review of any changes to access models filed pursuant to Section 19(b) of the Exchange Act. Finally, one commenter stated that the Commission’s goal of ensuring access for indirect participants to U.S. Treasury securities CCAs should be balanced against sufficiently robust membership criteria to ensure risk is appropriately managed.431 The commenter cautioned that any expansion of access to U.S. Treasury securities CCA services should not relax membership requirements essential for appropriate risk management.432 The commenter stated that less stringent membership requirements in the name of increasing access to central clearing would increase the risk of a participant default, increasing risk to FICC.433 The Commission agrees with the commenter that membership requirements are essential to a covered clearing agency’s risk management. As the Commission stated in the Proposing Release, membership requirements help to guard against defaults of any CCP member, as well as to protect the CCP and the financial system as a whole from the risk that one member’s default could cause others.434 Membership requirements will remain essential even with the requirement to clear eligible secondary market transactions, and U.S. Treasury securities CCAs generally should not relax membership requirements to accommodate such a requirement. A U.S. Treasury securities CCA is subject to Rule 17ad–22(e)(18)(i), (ii), and (iii), which requires that a CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to establish objective, risk-based, and publicly disclosed criteria for participation, which permit fair and open access by direct and, where relevant, indirect participants and other financial market utilities, require participants to have sufficient financial resources and robust operational capacity to meet obligations arising from participation in the clearing agency, and monitor compliance with such participation requirements on an ongoing basis. These requirements should help ensure that CCAs are not able to use less stringent membership requirements to comply with the requirement to clear eligible secondary market transactions. Moreover, any changes to FICC’s membership 431 SIFMA/IIB 432 SIFMA/IIB 428 MFA 433 Id. 429 SIFMA/IIB Letter, supra note 81, at 7. Letter, supra note 37, at 24. 430 MFA Letter II, supra note 125, at 5. 434 Proposing PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 at 25. 64623. E:\FR\FM\16JAR2.SGM Letter, supra note 37, at 23. Letter, supra note 37, at 24. 16JAR2 Release, supra note 14, 87 FR at ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations requirements would necessarily encompass a change to FICC’s Rules, which would be subject to Commission review and consideration pursuant to Section 19(b) of the Exchange Act. One commenter stated that the Commission must address other aspects of the Sponsored Service to better promote the objectives of central clearing, with such issues including the treatment of the start leg of the transaction, FICC’s obligations to complete settlement of a Sponsored Member’s positions in the event of a Sponsoring Member’s default, and a Sponsored Member’s ability to engage with FICC to address issues arising from repo transactions that have been submitted through sponsored clearing.435 With respect to the start leg of the transaction, the commenter stated that, within the Sponsored Service, FICC does not novate the settlement of the start leg of a repo transaction that is submitted for clearing between a Sponsoring Member and a Sponsored Member, although it does novate the end leg of the transaction, meaning that the counterparties continue to be responsible for settlement outside of FICC and bear the risk of a settlement fail vis a` vis one another. The commenter also states that the lack of central clearing for the start leg of repo transactions in the Sponsored Service means that a requirement to clear eligible secondary market transactions may not eliminate counterparty credit risk issues to the extent the Commission anticipates, which, in turn, means that the proposal may not increase competition or reduce spreads as the Commission predicted in the Proposing Release. A U.S. Treasury repo transaction generally encompasses both the start leg and the end leg of a U.S. Treasury repo. The Commission understands that, currently, the only U.S. Treasury securities CCA novates the start legs of many types of repo transactions cleared by the CCA, but does not provide central clearing for the start legs of repo transactions cleared through a particular client clearing access model. The Commission understands that, contrary to transactions cleared at FICC outside the Sponsored Service, FICC currently does not novate the start legs of same-day settling Sponsored DVP Repos where the Sponsored Member’s pre-novation counterparty is its Sponsoring Member (i.e., ‘‘done-with’’ Sponsored DVP Repo) or of Repos. The Commission acknowledges that this transaction occurring outside central 435 ICI Letter, supra note 85, at 26–28. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 clearing could somewhat reduce the benefits of central clearing in this limited instance, but the counterparty credit risk arising from the start legs of such transactions are largely addressed by the fact that they usually settle on a delivery-versus-payment basis between the counterparties, meaning that the securities and funds are exchanged simultaneously and resulting in less counterparty credit risk to address. The Commission does not believe that the lack of clearing for the start leg undermines the overall benefits of the requirement to clear eligible secondary market transactions. However, the Commission further understands that FICC has stated that it is able to clear the start leg of any repo transaction and currently does clear the start leg of all repos between two direct participants, the start leg of any Sponsored DVP repo where the Sponsored Member’s prenovation counterparty is a third-party member of FICC (i.e., ‘‘done-away’’ from the Sponsoring Member), and any Sponsored DVP Repo where the start leg of such repo is scheduled to settle on some business day in the future (i.e., forward-settling repos).436 The Commission would consider any proposal to provide additional clearing of repo start legs in particular access models in due course, consistent with its obligations under Section 19(b) of the Exchange Act. With respect to the completion of settlement of a Sponsored Member’s transactions if the Sponsoring Member defaults, the commenter states that neither the Sponsored Bilateral DVP Service nor the Sponsored GC Repo Service compel FICC to complete the settlement of a sponsored member’s transactions in the event of a sponsoring member’s default, and that this approach is not consistent with the Commission’s assumption that central clearing increases the likelihood of settlement.437 The Commission agrees that in most cases of a Sponsoring Member’s default, the ability for the CCA to settle its sponsored transactions likely would tend to minimize market disruption. However, the Commission understands that the current structure of the Sponsored Service, as set forth in FICC’s rules, would allow FICC the ability to, potentially, terminate the Sponsored Member’s transaction in such circumstances, and that this structure arises from the fact that, by design, the Sponsoring Member serves as the processing agent for all movement of funds and securities for its Sponsored 436 See FICC Rule 11, section 2, supra note 19; FICC Buyside FAQ, supra note 169, at 2–3. 437 ICI Letter, supra note 85, at 27. PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 2759 Members. FICC is not able to guarantee that an insolvent Sponsoring Member, which may be subject to the control of another legal entity, such as a bankruptcy trustee, would be able to continue processing such transactions, thereby allowing settlement to occur. This aspect of FICC’s rules is consistent with how other central counterparties have addressed the potential termination of customer transactions in the event of their agent’s default.438 The Commission does not believe that the potential for FICC to terminate these transactions, in the unlikely event of a Sponsoring Member default in which it is unable to work with the controlling legal entity, means that the benefits in the Proposing Release would not be, to a great extent, realized. Based on its supervisory knowledge, the Commission is not aware of any instance in which FICC was unable to work with the controlling legal entity for a defaulting member (i.e., a member for which FICC has ceased to act). Therefore, this is an extremely infrequent event and would depend on the facts and circumstances of a particular insolvency. With respect to the overall structure of the Sponsored Service, one commenter stated that market participants have raised concerns about the ability, as sponsored members, to engage with FICC to address issues arising from repo transactions that have been submitted through sponsored clearing, which, if not addressed, may prove to be a further impediment to the expansion of sponsored repo clearing. The commenter also states that market participants have cited challenges with seeking recourse from FICC in cases where the sponsoring member is in default.439 As discussed in the prior paragraph, the Commission understands that this is inherent to the design of the Sponsored Service, in that the Sponsoring Member serves as a processing agent for all the Sponsored Member’s cleared transactions. FICC’s rules address how it would proceed in the event of a Sponsoring Member default, including in the event that it closes out a Sponsored Member’s transactions.440 In the event that FICC chooses to revisit this structure to provide some additional ability for the Sponsored Member to directly access FICC, without relying on its Sponsoring Member, the Commission would consider such a proposal in due course, 438 See note 427 supra. Letter, supra note 85, at 27–28. 440 See FICC Rule 3A, section 14(c) (stating that FICC would rely upon Rule 22, section 3 to close out Sponsored Member transactions and to determine the amount owed to or due from a Sponsoring Member), supra note 19. 439 ICI E:\FR\FM\16JAR2.SGM 16JAR2 2760 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 consistent with its obligations under Section 19(b) of the Exchange Act. d. Final Rule For the reasons discussed in parts II.B.2.a through c, the Commission is adopting Rule 17ad–22(e)(18)(iv)(C) as proposed. To facilitate compliance with this requirement, a U.S. Treasury securities CCA generally should conduct and document an initial review of its access models and related policies and procedures. As it conducts this review, in view of the critical services it provides, the U.S. Treasury securities CCA generally should seek to provide access in as flexible a means as possible, consistent with its responsibility to provide sound risk management and comply with other provisions of the Exchange Act, the Covered Clearing Agency Standards, and other applicable regulatory requirements. A U.S. Treasury securities CCA generally should consider a wide variety of appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants. To ensure that it considers a sufficiently broad set of perspectives, the U.S. Treasury securities CCA generally should consult with a wide-range of stakeholders, including indirect participants, as it seeks to comply with proposed rule 17ad–22(e)(18)(iv)(C). A U.S. Treasury securities CCA generally should review and document any instance in which its policies and procedures treat transactions differently based on the identity of the participant submitting the transaction, the fact that an indirect participant is a party to the transaction, or the method of execution, or in any other way, and confirm that any variation in the treatment of such transactions is necessary and appropriate to meet the minimum standards regarding, among other things, operations, governance, and risk management identified in the Covered Clearing Agency Standards. The review by a U.S. Treasury securities CCA’s board of directors under proposed Rule 17ad–22(e)(18)(iv)(C) generally should include consideration of whether to establish policies and procedures that enable direct members to submit to the U.S. Treasury securities CCA eligible transactions for clearance and settlement that have been executed by two indirect participants of the U.S. Treasury securities CCA, which could potentially help address some of the concerns potential participants raised about the inability to present ‘‘done away’’ trades for clearance and settlement described above. Finally, as VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 part of its consideration, a U.S. Treasury securities CCA generally should consider the volumes and proportion of the market that are being centrally cleared through different access models as part of the CCA’s consideration of whether its access models are meeting the needs of the market. To the extent that a U.S. Treasury securities CCA’s initial (or any subsequent) review occasions a change to its rules, such U.S. Treasury securities CCA would need to file such changes for Commission review and approval, as appropriate, under section 19(b) of the Exchange Act and Title VIII of the Dodd-Frank Act.441 The review by a U.S. Treasury securities CCA’s board of directors under proposed Rule 17ad– 22(e)(18)(iv)(C) generally should include consideration whether the U.S. Treasury securities CCA’s written policies and procedures are reasonably designed to ensure appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants. C. Amendments to Rule 15c3–3a 1. Introduction The rules adopted above could cause a substantial increase in the margin broker-dealers must post to a U.S. Treasury securities CCA resulting from their customers’ cleared U.S. Treasury positions.442 Currently, Rules 15c3–3 and 15c3–3a do not permit brokerdealers to include a debit in the customer reserve formula equal to the amount of margin required and on deposit at a U.S. Treasury securities CCA. This is because no U.S. Treasury securities CCA has implemented rules and practices designed to segregate the margin and limit it to being used solely to cover obligations of the brokerdealer’s customers. Therefore, increases in the amount of margin required to be deposited at a U.S. Treasury securities CCA as a result of the adoption of the Membership Proposal would result in corresponding increases in the need to use broker-dealers’ cash and securities to meet these new requirements.443 To facilitate implementation of the Membership Proposal, the Commission proposed to amend Rule 15c3–3a to permit margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula, subject to the 441 See 15 U.S.C. 78s(b); 17 CFR 240.19b–4; 12 U.S.C. 5465(e). 442 See Proposing Release, supra note 14, 87 FR at 63637. 443 Proposing Release, supra note 14, 87 FR at 64637. PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 conditions discussed below. This new debit item would offset credit items in the Rule 15c3–3a formula and, thereby, free up resources that could be used to meet the margin requirements of a U.S. Treasury securities CCA. The debit item would be reported on a newly created Item 15 of the Rule 15c3–3a reserve formula. The proposed amendments also set forth a number of conditions that would need to be met to include the debit in the reserve formula. As discussed below, these proposed conditions were designed to permit the inclusion of the debit under conditions that would provide maximum protection to the broker-dealer’s customers. The goal of the proposed amendments was to facilitate implementation of the Membership Proposal in a way that does not diminish the customer-protection objective of Rules 15c3–3 and 15c3– 3a.444 The proposed conditions would be set forth in a new Note H to the reserve formula similar to how the conditions for including a debit in the reserve formula with respect to margin required and on deposit at a securities futures clearing agency or DCO are set forth in Note G. The proposed amendments were based, in part, on the conditions in Note G and the requirements in Rules 15c3–3 and 15c3–3b for including a debit with respect to margin required and on deposit at security-based swap clearing agency. The Note G conditions and requirements of Rules 15c3–3 and 15c3–3b similarly were designed to permit the debit under circumstances that provide protection to customers.445 Overall, commenters supported the proposal to permit this debit item.446 Commenters stated that the proposed amendments would make clearing more efficient and free up resources that could be used to meet the CCA’s margin requirements, while continuing to protect customer funds.447 Commenters also stated that the proposal would incentivize central clearing.448 A commenter stated that the proposal would extend to margin held at a U.S. Treasury securities CCA the same 444 Proposing Release, supra note 14, 87 FR at 64637. 445 Proposing Release, supra note 14, 87 FR at 64637. 446 See AIMA Letter, supra note 81, at 8; CME Letter, supra note 81, at 4; DTCC/FICC Letter, supra note 33, at 28–29; ICE Letter, supra note 33, at 3; MFA Letter, supra note 81, at 10; ISDA Letter, supra note 391, at 2; SIFMA AMG Letter, supra note 35, at 8. 447 See AIMA Letter, supra note 81, at 8; MFA Letter, supra note 81, at 10; SIFMA/IIB Letter, supra note 37, at 27–28. 448 See CME Letter, supra note 81, at 4; SIFMA AMG Letter, supra note 35, at 8. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations treatment as margin posted to other clearing organizations.449 As a result, this commenter stated that the proposal would facilitate greater access to clearing and eliminate an undue burden on competition. Another commenter— in supporting this aspect of the proposal—stated that it does not make sense that margin cannot be freely rehypothecated from a customer through a broker-dealer to a U.S. Treasury securities CCA without the broker-dealer receiving a beneficial adjustment as part of its customer reserve formula calculation.450 For greater and more efficient client clearing, another commenter encouraged the Commission to adopt this proposal irrespective of whether the Membership Proposal is adopted.451 Commenters did suggest certain modifications to the proposal. The Commission’s responses to comments, modifications to the proposed rule text made in response to comments, and the final amendments are discussed below. ddrumheller on DSK120RN23PROD with RULES2 2. Credit Items Cash delivered by a customer to the broker-dealer to be posted by the brokerdealer to a U.S. Treasury securities CCA would be a free credit balance or other credit balance in the customer’s securities account. Thus, this cash will need to be included in Item 1 to the Rule 15c3–3a formula. Further, when a broker-dealer uses customer margin securities to borrow funds or execute a securities loan transaction, the firm must put a credit in the formula.452 The credit items are designed to require the broker-dealer to reserve sufficient funds to be able to retrieve securities that collateralize the borrowed funds or have been loaned. There is not a specific Item in the Rule 15c3–3a formula to include the credit arising from the brokerdealer’s use of customers’ securities to meet a margin requirement imposed on the broker-dealer by a U.S. Treasury securities CCA. Consequently, the Commission proposed to amend Note B to Item 2 of the Rule 15c3–3a formula to instruct broker-dealers to include as a credit in Item 2 the market value of customers’ U.S. Treasury securities on deposit at a U.S. Treasury securities CCA that meets the definition of a ‘‘qualified clearing agency’’ in Note H.453 The Commission did not receive any comments on this aspect of the 449 See DTCC/FICC Letter, supra note 33, at 28. SIFMA AMG Letter, supra note 35, at 8. 451 See ISDA Letter, supra note 391, at 2. 452 See Items 2 and 3 to Rule 15c3–3a. 453 See Proposing Release, supra note 14, 87 FR at 64638, n. 232. 450 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 proposal and is adopting it substantially as proposed.454 3. New Debit Item On the debit side of the formula, the Commission proposed renumbering current Item 15 of the Rule 15c3–3a formula as Item 16.455 As proposed, new Item 15 would identify as a debit in the Rule 15c3–3a formula margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Exchange Act resulting from the following types of transactions in U.S. Treasury securities in customer accounts that have been cleared, settled, and novated by the clearing agency: (1) purchases and sales of U.S. Treasury securities; and (2) U.S. Treasury securities repurchase and reverse repurchase agreements (together ‘‘customer position margin’’).456 As proposed, this debit item was limited to customer position margin required and on deposit at a clearing agency that clears, settles, and novates transactions in U.S. Treasury securities. Except for the debits identified in current Items 13 and 14 of the Rule 15c3–3a formula, margin required and on deposit at other types of clearing agencies or for other types of securities transactions would not qualify as a debit item under the proposal. Further, this debit item would be limited to customer position margin required and on deposit at the U.S. Treasury securities CCA resulting from U.S. Treasury positions in customer accounts. Margin required and on deposit at the U.S. Treasury securities CCA as result of the broker-dealer’s proprietary U.S. Treasury positions could not be included in this debit item. This proposed limitation would effectuate a fundamental aspect of Rule 15c3–3: that customer cash and securities not be used by the brokerdealer to finance its proprietary business activities. Finally, the debit would be limited to customer position margin required and 454 See Note B to Item 2 of Rule 15c3–3a, as adopted. The phrase ‘‘customers’ U.S. Treasury securities’’ in the note—as proposed—has been replaced with the more generic phrase ‘‘customers’ securities’’ in the note, as adopted. Id. This modification conforms the note to modifications discussed below that expand the type of customer collateral that can be posted to the U.S. Treasury securities CCA. As proposed, the broker-dealer was limited to posting customer cash or U.S. Treasury securities. See Proposing Release, supra note 14, 87 FR at 64638. This provision is being modified to include any securities accepted as margin by the U.S. Treasury securities CCA, subject to certain conditions. See Note H(a)(1) to Item 15, as adopted. 455 Current Item 15 is where the broker-dealer reflects the amount, if any, that total credits exceed total debits. 456 See Proposing Release, supra note 14, 87 FR at 64637. PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 2761 on deposit at the U.S. Treasury securities CCA. This would mean that the broker-dealer could not include in this debit item amounts on deposit at the U.S. Treasury securities CCA that exceed the broker-dealer’s margin requirement resulting from its customers’ cleared U.S. Treasury securities positions. This limitation is designed to prevent the broker-dealer from artificially increasing the amount of the debit item by depositing cash and securities at the U.S. Treasury securities CCA that are not needed to meet a margin requirement resulting from its customers’ U.S. Treasury securities positions. The Commission did not receive any comments on these aspects of the proposal and is adopting them as proposed.457 4. Note to New Debit Item As proposed, Item 15 of the Rule 15c3–3a formula would have a Note H (‘‘Note H’’) that sets forth conditions that would need to be met to include the amount of customer position margin required and on deposit at the U.S. Treasury securities CCA as a debit.458 Each of the conditions in Note H to Item 15 would need to be met for a brokerdealer to include a debit equal to the amount of customer position margin required and on deposit at the U.S. Treasury securities CCA. As discussed below, the Commission is adopting the conditions largely as proposed, with some modifications in response to comments.459 a. First Condition—Permitted Collateral The first condition—set forth in paragraph (a) of Note H—provided that the debit item could be included in the Rule 15c3–3a formula to the extent that the customer position margin is in the form of cash or U.S. Treasury securities and is being used to margin U.S. Treasury securities positions of the customers of the broker-dealer that are cleared, settled, and novated at the U.S. Treasury securities CCA.460 The objective was to limit the assets underlying the debit item to the safest and most liquid instruments, given that the debit item would offset credit items (cash owed to customers).461 As 457 See Item 15 of the Rule 15c3–3a formula, as adopted. 458 Proposing Release, supra note 14, 87 FR at 64638–40. 459 See Note H to Rule 15c3–3a, as adopted. 460 Proposing Release, supra note 14, 87 FR at 64638. 461 See, e.g., 17 CFR 240.15c3–3(e) (limiting the assets that can be deposited into the customer reserve account to cash and qualified securities); 17 CFR 240.15c3–3(a)(6) (defining the term ‘‘qualified security’’ to mean a security issued by the United E:\FR\FM\16JAR2.SGM Continued 16JAR2 2762 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 discussed above, the liquidity of the debit items protects the customers whose cash or securities are used to finance or facilitate customer transactions. In response to the proposed first condition, commenters stated that the Commission should expand the types of securities that could be used to meet the customer position margin requirement.462 Specifically, one commenter stated that the use of the debit should not be limited to margin in the form of cash or Treasury securities.463 This commenter stated that FICC accepts additional securities for clearing fund deposits, including eligible obligations of U.S. agencies or government sponsored entities and eligible mortgage-backed securities.464 The commenter also stated that the Commission found—in the context of approving a FICC rule change—that the expanded scope of acceptable forms of clearing fund collateral deposits would ‘‘better enable FICC to assure the safeguarding of securities and funds in its custody or control or for which it is responsible,’’ and therefore was consistent with the requirements of the Exchange Act and other governing regulations.465 In response to comments, the Commission is modifying paragraph (a) of Note H to permit ‘‘qualified customer securities’’ to be used to meet the customer position margin requirement in addition to cash and U.S. Treasury securities.466 The term ‘‘qualified customer securities’’ is defined to mean securities of a customer of the brokerdealer (other than U.S. Treasury securities) that are held in custody by the broker-dealer for the customer and that under the rules of the U.S. Treasury States or a security in respect of which the principal and interest are guaranteed by the United States). 462 See ISDA Letter, supra note 391; SIFMA/IIB Letter, supra note 37, at 29. 463 See SIFMA/IIB Letter, supra note 37, at 29. 464 See SIFMA/IIB Letter, supra note 37, at 29. 465 See SIFMA/IIB Letter, supra note 37, at 29 (citing Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Approving Proposed Rule Change to Modify its Rules to Diversify and Standardize Clearing Fund Collateral Requirements Across the Divisions to Improve Liquidity and Minimize Risk for its Members, Exchange Act Release No. 54969 (Dec. 26, 2006), 71 FR 77837, 77838 (Dec. 27, 2006)). 466 See Rule 15c3–3a, Note H(a)(1), as adopted. To implement this modification, paragraph (a) of Note H is being divided into subparagraphs (a)(1) and (2). Subparagraph (a)(1) identifies the types of collateral that can be used to meet the customer position margin requirement (i.e., cash, U.S. Treasury securities, and qualified customer securities), and subparagraph (a)(2) contains the text that provides that the collateral must be used to margin U.S. Treasury securities positions of the customers of the broker-dealer that are cleared, settled, and novated by the qualified clearing agency, as was proposed. See Rule 15c3–3a, Note H(a)(1) and (2), as adopted. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 securities CCA are eligible to be used to margin U.S. Treasury securities positions of the customer that are cleared, settled, and novated by the CCA.467 Therefore, a broker-dealer may post cash, U.S. Treasury securities, and qualified customer securities (i.e., securities other than U.S. Treasury securities that are accepted by the U.S. Treasury securities CCA) to meet a customer position margin requirement. As proposed, paragraph (b) of Note H set forth the second, third, and fourth conditions that would need to be met to include the amount of customer position margin required and on deposit at the U.S. Treasury securities CCA as a debit item.468 b. Second Condition—Customer Position Margin The second condition—set forth in paragraph (b)(1) of Note H—provided that the customer position margin must consist of cash owed to the customer of the broker-dealer or U.S. Treasury securities held in custody by the brokerdealer for the customer that was delivered by the broker-dealer to meet to meet a margin requirement resulting from that customer’s U.S. Treasury securities positions cleared, settled, and novated at the U.S. Treasury securities CCA and not for any other customer’s or the broker-dealer’s U.S. Treasury securities positions cleared, settled, and novated at the U.S. Treasury securities CCA.469 In sum, to meet this condition, the broker-dealer would need to: (1) use customer assets exclusively to meet the customer position margin requirement; (2) use a particular customer’s assets exclusively to meet the amount of the customer position margin requirement resulting from that customer’s cleared U.S. Treasury securities positions; and (3) have delivered the customer’s assets to the U.S. Treasury securities CCA. The objective of the first component of the second condition—the need to use customer assets exclusively—was to segregate the customer assets being used to meet the customer position margin requirement from the broker-dealer’s proprietary assets.470 Additional conditions—under the proposal— provided that the U.S. Treasury securities CCA must hold the assets being used to meet the customer position margin requirement in an account of the broker-dealer that is segregated from any other account of the 467 See Rule 15c3–3a, Note H(c), as adopted. Note H(b)(1) through (3) of Rule 15c3–3a, as proposed. 469 Proposing Release, supra note 14, 87 FR at 64638. 470 Proposing Release, supra note 14, 87 FR at 64638. 468 See PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 broker-dealer and is identified as being held for the exclusive benefit of the broker-dealer’s customers.471 The first prong of the condition was designed to ensure that only customer assets are held in the account. The objective of the second component of the second condition— the need to use a particular customer’s assets exclusively to meet the amount of the customer position margin requirement resulting from that customer’s cleared U.S. Treasury securities positions—was to avoid the use of one customer’s assets to meet another customer’s margin requirement.472 For example, FICC’s Sponsored Member program allows its members to sponsor a person’s (i.e., a Sponsored Member’s) U.S. Treasury securities transactions for clearance and settlement. FICC interacts solely with the sponsoring member as processing agent for purposes of the day-to-day satisfaction of the Sponsored Member’s obligation to or from FICC, including the Sponsored Member’s cash and securities settlement obligations. However, FICC calculates a separate margin requirement for each Sponsored Member’s trading activity and the sum of each sponsored member’s margin calculation is the aggregate margin requirement that must be met by the sponsoring member. Further, this margin is held in an omnibus account that is separate from the account that holds the Sponsoring Member’s net margin obligation for non-sponsored securities transactions. In this scenario, the U.S. Treasury securities CCA’s margin calculations and resulting requirements can be traced to a specific customer’s cleared U.S. Treasury securities positions. Consequently, the broker-dealer would be able to allocate the amount of the U.S. Treasury securities CCA’s daily customer position margin requirement attributable to a specific customer. Under this component of the second condition, the broker-dealer would need to deliver cash or U.S. Treasury securities belonging to that specific customer to meet the amount of the U.S. Treasury securities CCA’s customer position margin requirement resulting from that customer’s cleared U.S. Treasury securities positions. This would mitigate the risk to all the brokerdealer’s customers by limiting when their assets can be used to meet the U.S. 471 See Proposing Release, supra note 14, 87 FR at 64639–40 (discussing these additional conditions). As discussed below, the Commission is adopting these additional conditions, substantially as proposed. 472 Proposing Release, supra note 14, 87 FR at 64638. E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations Treasury securities CCA’s customer position margin requirement. The objective of the third component of the second condition—that the broker-dealer had delivered the customer’s assets to the U.S. Treasury securities CCA—was to address the potential that a customer may use more than one broker-dealer to engage in U.S. Treasury securities transactions.473 In this case, two or more broker-dealers may be subject to customer position margin requirements of the U.S. Treasury securities CCA resulting from the customer’s cleared U.S. Treasury securities positions. The intent was to prevent a broker-dealer from including as a debit the amount of customer position margin that another brokerdealer delivered to the U.S. Treasury securities CCA with respect to U.S. Treasury securities positions of a customer of both the broker-dealers. The amount that a given broker-dealer’s debit items can offset its credit items should be limited to the amount of customer position margin it delivered to the U.S. Treasury securities CCA. Otherwise, the customers of the brokerdealer would be put at risk for transactions effected by another brokerdealer. Two commenters stated that brokerdealers should not be limited to posting the same assets received from its customer to a U.S. Treasury securities CCA.474 One stated that in many instances, broker-dealers post proprietary assets to a clearing agency on behalf of a customer given timing and operational constraints.475 The other commenter stated that FICC collects clearing fund margin on a faster timeline than broker-dealers are able to collect margin from their customers.476 More specifically, this commenter stated that FICC collects margin from direct participants on an overnight and intraday basis, while most brokerdealers generally provide their customers with a full business day to post margin. As a result, this commenter stated that most broker-dealers generally post clearing fund margin to FICC and then subsequently collect that clearing fund margin from their customers. One of these commenters stated that posting proprietary collateral is permissible in the context of margin posted to the other clearing agencies and should also be permissible with respect to margin posted to a U.S. Treasury Securities 473 Proposing Release, supra note 14, 87 FR at 64638–39. 474 See DTCC/FICC Letter, supra note 33, at 32; SIFMA/IIB Letter, supra note 37, at 30. 475 See SIFMA/IIB Letter, supra note 37, at 30. 476 See DTCC/FICC Letter, supra note 33, at 32. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 CCA.477 Finally, one of these commenters stated that not allowing the use of proprietary assets would significantly undercut the benefits to the Rule 15c3–3a proposal.478 In response to comments, the Commission is modifying Note H under the final rule to permit broker-dealers to elect to deliver proprietary U.S. Treasury securities to meet a margin requirement of a customer resulting from that customer’s U.S. Treasury securities positions cleared, settled, and novated at the qualified clearing agency.479 This will address the concern raised by commenters that the U.S. Treasury securities CCA may call for margin from a broker-dealer arising from a customer’s cleared U.S. Treasury security transaction before the customer is able to deliver the requisite margin to the broker-dealer. However, the final rule places strict limits on this requirement. First, the broker-dealer must use proprietary U.S. Treasury securities for this purpose and, therefore, it cannot use other types of securities collateral acceptable to the U.S. Treasury securities CCA.480 For example, as discussed above, a brokerdealer can post qualified customer securities (which are securities other than U.S. Treasury securities acceptable to the U.S. Treasury securities CCA), provided the customer has delivered them to the broker-dealer. However, the broker-dealer could not post these types of securities if they belong to the brokerdealer. This is designed to ensure that the safest most liquid securities of the broker-dealer are commingled with the customer cash and securities in the account.481 It also will prevent the 477 See SIFMA/IIB Letter, supra note 37, at 30. DTCC/FICC Letter, supra note 33, at 32. 479 See Note H(b)(1)(iii) of Rule 15c3–3a, as adopted. To implement this modification, paragraph (b)(1) is being divided into subparagraphs (b)(1)(i) through (iii). Subparagraphs (b)(1)(i) and (ii) contain the proposed components of the second condition that the broker-dealer can use cash owed to a customer or U.S. Treasury securities held in custody by the broker-dealer for the customer to meet a margin requirement of the U.S. Treasury securities CCA resulting from that customer’s U.S. Treasury securities transactions cleared at the CCA, with the modifications that cash and securities are now addressed in a separate subparagraphs (subparagraphs (b)(1)(i) and (ii), respectively) and qualified customer securities held in custody by the broker-dealer for the customer also can be used for this purpose. See Note H(b)(1)(i) and (ii) of Rule 15c3–3a, as adopted. Subparagraph (b)(1)(iii) contains the new provision—discussed below—permitting the use of the broker-dealer’s proprietary securities, subject to certain conditions. See Note H(b)(1)(iii) of Rule 15c3–3a, as adopted. 480 See prefatory text of Note H(b)(1)(iii) of Rule 15c3–3a, as adopted. 481 See supra note 461; see also Section I. Introduction (describing the critical and unique role that U.S. Treasury securities play a critical in the 478 See PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 2763 broker-dealer from using customer cash deposited with the broker-dealer to purchase less liquid securities and post them to the U.S. Treasury securities CCA to meet a customer position margin requirement. Second, the broker-dealer’s ability to post proprietary U.S. Treasury securities is limited to circumstances where the broker-dealer did not owe the customer or hold in custody for the customer sufficient cash, U.S. Treasury securities, and/or qualified customer securities to meet a margin requirement resulting from that customer’s U.S. Treasury securities positions cleared, settled, and novated at the qualified clearing agency at the time the margin requirement arose.482 Thus, the broker-dealer is limited to using proprietary U.S. Treasury securities to address the specific concern raised by commenters: a timing mismatch between when margin must be delivered to the U.S. Treasury securities CCA and when the broker-dealer receives the margin from the customer. Third, the broker-dealer must call for the customer to deliver a sufficient amount of cash, U.S. Treasury securities, and/or qualified customer securities to meet the margin requirement on the day the margin requirement arose and must receive a sufficient amount of cash, U.S. Treasury securities, and/or qualified customer securities to meet the margin requirement by the close of the next business day after the margin requirement arose.483 Thus, the brokerdealer can deliver proprietary U.S. Treasury securities to meet a margin call related to its customers’ transactions as an interim step before receiving the associated margin from its customer no later than the close of the next business day. The objective is to narrowly confine the ability to use proprietary U.S. Treasury securities and thereby promote the final rule’s objective of using a specific customer’s collateral to meet a customer position margin requirement generated by that customer’s cleared U.S. Treasury securities transactions. U.S. and global economy) and Section IV.B. Economic Analysis—Baseline (describing U.S. Treasury securities and repos, and clearance and settlement of these positions); see also 17 CFR 240.15c3–1(c)(2)(vi)(A)(1) (prescribing haircuts under the broker-dealer net capital rule for a security issued or guaranteed as to principal or interest by the United States or any agency thereof ranging from 0 to 6%). 482 See Note H(b)(1)(iii)(A) of Rule 15c3–3a, as adopted. 483 See Note H(b)(1)(iii)(B) and (C) of Rule 15c3– 3a, as adopted. E:\FR\FM\16JAR2.SGM 16JAR2 2764 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 c. Third Condition—Rules of U.S. Treasury Securities CCA The third condition for including customer position margin as a debit in the Rule 15c3–3a formula was set forth in proposed paragraph (b)(2) of Note H.484 Under this condition, the customer position margin needed to be treated in accordance with rules of the U.S. Treasury securities CCA designed to protect and segregate the customer position margin, and the U.S. Treasury securities CCA and broker-dealer would need to be in compliance with those rules (as applicable). As proposed, paragraph (b)(2) of Note H identified five sets of rules that would need to be implemented by the U.S. Treasury securities CCA.485 The first rule set—identified in paragraph (b)(2)(i) of Note H—provided that the customer position margin must be treated in accordance with rules requiring the qualified U.S. Treasury securities CCA to calculate a separate margin amount for each customer of the broker-dealer and the broker-dealer to deliver that amount of margin for each customer on a gross basis.486 As discussed above, a component of the second condition—set forth in paragraph (b)(1) of Note H, as proposed—was that the broker-dealer use a particular customer’s assets exclusively to meet the amount of the customer position margin requirement resulting from that customer’s cleared U.S. Treasury securities positions.487 The proposal that the U.S. Treasury securities CCA implement these margin calculation rules was designed to facilitate that condition. This would allow the broker-dealer to allocate the amount of the customer position margin requirement attributable to each of its customers. In addition, the rules needed to require the broker-dealer to deliver the margin amount calculated for each customer on a gross basis. This would mean that the risk of one customer’s positions could not be offset by the risk of another customer’s positions in determining the amount of customer position margin the broker-dealer would need to have on deposit at the U.S. Treasury securities CCA. As a result, the broker-dealer would not be able to deliver assets belonging to one customer to meet the margin requirement of another customer. 484 Proposing Release, supra note 14, 87 FR at 64639. 485 Proposing Release, supra note 14, 87 FR at 64639–40. 486 Proposing Release, supra note 14, 87 FR at 64639. 487 Proposing Release, supra note 14, 87 FR at 64638–39. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 In response to this aspect of the proposal, a commenter suggested that the Commission modify the requirement to be consistent with the requirements of Item 13 and Note F to the reserve formula which covers margin required and on deposit with the Options Clearing Corporation (‘‘OCC’’) for all option contracts written or purchased in customer accounts.488 In particular, the permitted debit under Item 13 and Note F is based on a margin amount posted to OCC that is calculated on a net basis across all the broker-dealer’s customers with listed options positions. This is different than the proposal to permit a debit with respect to margin posted to a U.S. Treasury securities CCA in that the margin amount needed to be calculated for each customer on a gross basis and that gross amount to be delivered to the CCA. For the reasons discussed below, the Commission is retaining the requirement that the U.S. Treasury securities CCA implement rules requiring that the margin be calculated and delivered on a gross basis for each customer.489 Listed options cleared at the OCC are subject to customer margin requirements of the broker-dealer SROs.490 Under Rule 15c3–3, a brokerdealer can use customer cash or securities that are serving as margin for listed options positions under SRO margin rules, subject to certain limitations.491 If the margin is in the form of cash, the broker-dealer needs to treat it as an ‘‘other credit balance’’ in the customer’s securities account and include it in Item 1 in the Rule 15c3– 3a reserve formula.492 The broker-dealer can use this cash to finance a margin loan to another customer, to borrow securities to effect a short sale of another customer, or to deliver it to the OCC to meet a margin requirement for other customers’ listed options positions 488 See 489 See DTCC/FICC Letter, supra note 33, at 31. Note H(b)(2)(i) of Rule 15c3–3a, as adopted. 490 See, e.g., FINRA Rule 4210(f)(2); Cboe Rules 10.1 et seq.; see also 12 CFR 220.12(f). Generally, buyers of options (i.e., long options) that expire in nine months or less must pay for these positions in full. Margin requirements for option writers (i.e., short options) are complex and are not the same for every type of underlying security or component value. SRO rules generally require an option writer to post 100% of the options proceeds to the margin account, plus a specific percentage of the market value of the underlying securities or component value as options margin (e.g., 20% for an option on a single equity security). SRO rules also recognize certain spread positions. Finally, equity-based options also are eligible positions under SRO securities portfolio margin rules. See, e.g., FINRA Rule 4210(f)(2) and (g); Cboe Rules 10.3 and 10.4. 491 See 17 CFR 240.15c3–3. 492 See 17 CFR 240.15c3–3a, Item 1. PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 cleared at the OCC.493 In each case, the ‘‘other credit balance’’ on the credit side of the Rule 15c3–3a reserve formula is offset by a corresponding debit balance on the debit side of the formula. If the margin is in the form of securities, the broker-dealer can rehypothecate them to obtain a bank loan, to deliver on a securities loan, or to meet a margin requirement of the OCC.494 The brokerdealer’s use of the customer’s margin securities generates a credit in the Rule 15c3–3a reserve formula that generally is offset by debits in the formula stemming from the broker-dealer’s financing of the customer’s margin loan, facilitating the customer’s short sale, or delivering margin to the OCC to meet margin requirements arising from customer options positions.495 SRO options margin requirements help to protect the broker-dealer from the consequences of a customer default, because the required equity in a customer’s account (because of the SRO option margin requirements) serves to over-collateralize an option customer’s obligations to the broker-dealer. This buffer also protects the customers whose cash was used to facilitate the brokerdealer’s financing of securities transactions of other customers (i.e., margin loans, short sales, or to meet a margin requirement for other customers’ listed options positions cleared at the OCC). For example, if the broker-dealer fails, the customer debits, because they generally are over-collateralized, should be attractive assets for another brokerdealer to purchase or, if not purchased by another broker-dealer, they should be able to be liquidated to a net positive 493 See 17 CFR 240.15c3–3(e)(2) (providing, in pertinent part, that a broker-dealer must not accept or use any of the amounts under items comprising Total Credits under the Rule 15c3–3a reserve formula except for the specified purposes indicated under items comprising Total Debits under the formula); 17 CFR 240.15c3–3a, Items 10, 11, and 13. 494 See 17 CFR 240.15c3–3(a)(3), (4), and (5) (defining, respectively, the terms ‘‘fully paid securities,’’ ‘‘margin securities,’’ and ‘‘excess margin securities’’); 17 CFR 240.15c3–3(b)(1) (providing, in pertinent part, that a broker-dealer shall promptly obtain and shall thereafter maintain the physical possession or control of all fully-paid securities and excess margin securities carried by a broker-dealer for the account of customers but not applying this requirement to margin securities). 495 See 17 CFR 240.15c3–3a, Items 2 and 3 (requiring, respectively, credits to be added to the Rule 15c3–3a reserve formula for: (1) monies borrowed collateralized by securities carried for the accounts of customers; and (2) monies payable against customers’ securities loaned); 17 CFR 240.15c3–3a, Items 10, 11, and 13 (requiring, respectively, debits to be added to the reserve formula for: (1) debit balances in customers’ cash and margin accounts; (2) securities borrowed to effectuate short sales by customers; and (3) margin required and on deposit with the Options Clearing Corporation for all option contracts written or purchased in customer account). E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 equity.496 The proceeds of the debits sale or liquidation can be used to repay the customer cash used to finance the customer obligations. This cash plus the funds and/or U.S. government securities held in the customer reserve account should equal or exceed the total amount of customer credit items (i.e., the total amount owed by the broker-dealer to its customers).497 In contrast, although SRO margin rules require the collection of margin for certain transactions in U.S. Treasury securities, transactions between dealers and institutional customers generally are subject to a variable ‘‘good-faith’’ margin standard, which the Commission understands—based on its supervisory experience—can often result in a brokerdealer collecting less (or no) margin collateral from a customer with respect to transactions in U.S. Treasury securities.498 Consequently, the SRO margin requirements for U.S. Treasury securities transactions do not result in the same levels of over-collateralization that the SRO margin requirements for listed options impose and, therefore, would not provide the same level protection to the broker-dealer’s customers. Accordingly, modifying the proposal to align it with how margin posted to the OCC is treated would diminish an important protection that the proposal is designed to achieve in terms of protecting the broker-dealer’s customers: preventing one customer’s 496 The attractiveness of the over-collateralized debits facilitates the bulk transfer of customer accounts from a failing or failed broker-dealer to another broker-dealer. 497 See Net Capital Requirements for BrokerDealers; Amended Rules, Exchange Act Release No. 18417 (Jan. 13, 1982), 47 FR 3512, 3513 (Jan. 25, 1982) (‘‘The alternative approach is founded on the concept that, if the debit items in the Reserve Formula can be liquidated at or near their contract value, these assets along with any cash required to be on deposit under the [customer protection] rule, will be sufficient to satisfy all liabilities to customers (which are represented as credit items in the Reserve Formula).’’). 498 SRO rules provide for the collection of margin for cash U.S. Treasury transactions. See, e.g., FINRA Rule 4210(e)(2)(A) (setting forth margin requirements for U.S. Treasury securities and certain other bonds). However, these rules do not necessarily apply to exempt accounts. See FINRA Rule 4210(e)(2)(F) (permitting FINRA-member broker-dealers to not collect margin for certain good faith securities held in exempt accounts and providing for a capital charge for any uncollected mark-to-market loss); FINRA Rule 4210(a)(13) (defining exempt account). Although SRO rules also require a broker-dealer to establish procedures to review limits and types of credit extended to all customers, formulate their own ‘‘house’’’ margin requirements, and review the need for instituting higher margin requirements than are required for individual securities or customer accounts, based on the Commission’s supervisory experience, the resulting customer margin collection is often less than that required pursuant to FICC’s margin model. See Proposing Release, supra note 14, 87 FR at 64627 n.171. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 cash or securities to be used to meet a margin requirement of the U.S. Treasury securities CCA resulting from another customer’s cleared U.S. Treasury securities transactions. This protection is achieved through the proposed requirements that the U.S. Treasury securities CCA calculate a gross margin amount for each of the broker-dealer’s customers and that the broker-dealer must meet that gross margin amount with cash or securities owned by the customer whose U.S. Treasury securities transactions generated the margin requirement.499 Moreover, cash delivered by a customer to the broker-dealer to be posted by the broker-dealer to a U.S. Treasury securities CCA generally would be a free credit balance, given the minimal margin requirements of the SROs with respect to the types of U.S. Treasury securities transactions that would be cleared (i.e., the cash would not have the same status as cash serving as margin for a listed options position under the SRO margin rules). For the same reason, securities delivered by a customer to the broker-dealer to be posted by the broker-dealer to a U.S. Treasury securities CCA generally would be fully paid securities (i.e., they would not have the same status as margin securities serving as margin for listed options under the SRO margin rules). The proposal—consequently—set forth strict limitations on the brokerdealer’s ability to use the cash or securities to meet a margin requirement the U.S. Treasury securities CCA imposed on the broker-dealer. These limitations were designed to restrict the broker-dealer’s ability to use the customer cash and securities—and thereby protect them—given that these customer assets generally otherwise would need to be treated as a free credit balance or fully paid securities in the customer’s securities account. For these reasons, the Commission is retaining the requirement that the U.S. Treasury securities CCA implement rules requiring that the margin be calculated and delivered on a gross basis for each customer.500 Therefore, the Commission is adopting the gross margining requirement, as proposed. The second rule set—identified in paragraph (b)(2)(ii) of Note H—provided that the customer position margin be 499 As discussed above, under the final rule, the broker-dealer can use proprietary U.S. Treasury securities in limited circumstances and under strict conditions to meet a margin requirement of the U.S. Treasury securities CCA resulting from a particular customer’s cleared U.S. Treasury securities transactions. See Note H(b)(1)(iii) of Rule 15c3–3a. 500 See Note H(b)(2)(i) of Rule 15c3–3a, as adopted. PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 2765 treated in accordance with rules requiring that the U.S. Treasury securities CCA be limited to investing it in U.S. Treasury securities with a maturity of one year or less.501 The objective was to limit the assets underlying the debit item to the safest and most liquid instruments. The Commission did not receive comments on this aspect of the proposal and is adopting it as proposed.502 However, one commenter sought clarification that the conditions of Rule 15c3–3 would not preclude a U.S. Treasury securities CCA from entering into a repurchase transaction using customer cash margin, so long as the purchased securities under such repurchase transaction consist of U.S. Treasury securities held in a segregated account for the benefit of customers and satisfy certain other requirements.503 The commenter stated that the proposal was not clear whether the conditions related to Rule 15c3–3 would preclude a U.S. Treasury securities CCA from using customer margin for liquidity purposes, and that there are ways to use customer margin for liquidity purposes that ensure that cash or Treasury securities having a value equal to or exceeding the posted customer margin remain in a segregated account for the benefit of customers.504 The commenter further explained that if a U.S. Treasury securities CCA could not use customer margin as a qualifying liquid resource, for purposes of its obligations under Rule 17ad–22(e)(7), it might need to obtain liquidity resources from other sources, which could mean increasing certain requirements applicable to direct participants or increasing the cash margin requirements applicable to direct participants and/or other indirect participants.505 Finally, the commenter suggested adding language to Note H that a CCA’s use of cash margin for liquidity purposes would not cause item 15 to cease to apply, so long as (i) the CCA only uses the cash margin after it determines that it does not have the 501 See Proposing Release, supra note 14, 87 FR at 64639. 502 See Note H(b)(2)(ii) of Rule 15c3–3a, as adopted. 503 Letter from Brian Steele, Managing Director, President of DTCC Clearing Agency Services, Head of Global Business Operations, and Laura Klimpel, General Manager of FICC, Head of SIFMU Business Development, at 1–2 (Nov. 10, 2023) (‘‘DTCC/FICC Letter II’’). 504 Id. at 2. The commenter stated that a U.S. Treasury securities CCA could enter into a repurchase transaction with a broker-dealer, as agent for its customers, pursuant to which the broker-dealer purchases U.S. Treasury securities using customer cash margin and holds such securities in a segregated account of the brokerdealer. Id. 505 Id. at 5. E:\FR\FM\16JAR2.SGM 16JAR2 2766 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 ability to obtain liquidity from other resources in order to satisfy the cash payment obligations that were originally due to be paid by a defaulting member, (ii) in connection with such usage, the CCA deposits into and maintains an account of the broker-dealer that generally satisfies the requirements for a special reserve account U.S. Treasury securities or cash that at all relevant times have a value of no less than the value amount of used cash, and (iii) the CCA replenishes the cash margin promptly after the liquidity need is satisfied.506 The objective of the conditions for including the debit in the customer reserve formula is to provide maximum protection to the cash or securities delivered to the U.S. Treasury securities CCA. The commenter provides a summary of potential protections that could be put in place to ensure that— if a U.S. Treasury securities CCA uses cash in the broker-dealer’s segregated account for liquidity purposes—the cash will be protected through collateral comprising U.S. Treasury securities deposited into the account and other measures. The Commission would need to review a more detailed plan for how the cash will be used and customers protected before taking any action on any formal request. In this regard, were FICC to file proposed rule changes that provide specific details regarding the protections and how cash will be used, the Commission will consider those proposed rule changes at that time consistent with the statutory standard for approval under Section 19(b). The third rule set—identified in paragraph (b)(2)(iii) of Note H— provided that the customer position margin be treated in accordance with rules designed to address the segregation of the broker-dealer’s account at the U.S. Treasury securities CCA that holds the customer position margin and set strict limitations on the U.S. Treasury securities CCA’s ability to use the margin.507 The required rules were modeled on the requirements for a broker-dealer to include a debit with respect to margin delivered to a security-based swap clearing agency.508 In particular, the note provided that the customer position margin needed to be treated in accordance with rules 506 Id. at 7–8. 507 Proposing Release, supra note 14, 87 FR at 64639. 508 See 17 CFR 240.15c3–3(p)(1)(iii) (defining the term ‘‘qualified clearing agency account’’); 17 CFR 240.15c3–3b, Item 15 (permitting a broker-dealer to include a debit in the security-based swap reserve formula equal to the margin required and on deposit in a qualified clearing agency account at a clearing agency). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 requiring that it must be held in an account of the broker-dealer at the U.S. Treasury securities CCA that is segregated from any other account of the broker-dealer at the U.S. Treasury securities CCA and that is: • Used exclusively to clear, settle, novate, and margin U.S. Treasury securities transactions of the customers of the broker-dealer; • Designated ‘‘Special Clearing Account for the Exclusive Benefit of the Customers of [name of broker-dealer]’’; • Subject to a written notice of the U.S. Treasury securities CCA provided to and retained by the broker-dealer that the cash and U.S. Treasury securities in the account are being held by the U.S. Treasury securities CCA for the exclusive benefit of the customers of the broker-dealer in accordance with the regulations of the Commission and are being kept separate from any other accounts maintained by the brokerdealer or any other clearing member at the U.S. Treasury securities CCA; and • Subject to a written contract between the broker-dealer and the U.S. Treasury securities CCA which provides that the cash and U.S. Treasury securities in the account are not available to cover claims arising from the broker-dealer or any other clearing member defaulting on an obligation to the U.S. Treasury securities CCA or subject to any other right, charge, security interest, lien, or claim of any kind in favor of the U.S. Treasury securities CCA or any person claiming through the U.S. Treasury securities CCA, except a right, charge, security interest, lien, or claim resulting from a cleared U.S. Treasury transaction of a customer of the broker-dealer effected in the account. The objective was to protect the customer position margin that the broker-dealer deposits with the U.S. Treasury securities CCA to margin its customers’ U.S. Treasury security positions by isolating it from any other assets of the broker-dealer at the U.S. Treasury securities CCA and to prevent it from being used to cover any obligation other than an obligation of the broker-dealer’s customer resulting from a U.S. Treasury transaction cleared, settled, and novated in the account.509 Further, the account designation and written notice requirements were designed to alert creditors of the broker-dealer and U.S. Treasury securities CCA that the assets in this account are not available to satisfy any claims they may have against the broker-dealer or the U.S. Treasury 509 Proposing Release, supra note 14, 87 FR at 64639. PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 securities CCA. The written contract requirement was designed to limit the U.S. Treasury securities CCA’s rights to use the customer position margin for any purpose other than an obligation of the broker-dealer’s customers. For example, the assets in the account could not be used to cover an obligation of the broker-dealer to the U.S. Treasury securities CCA if the broker-dealer defaults on the obligation. Similarly, the assets in the account could not be used to mutualize the loss across the U.S. Treasury securities CCA’s members if a member defaulted and its clearing funds were insufficient to cover the loss. The Commission did not receive comments on this aspect of the proposal and is adopting it substantially as proposed.510 The fourth rule set—identified in paragraph (b)(2)(iv) of Note H— provided that the customer position margin be treated in accordance with rules designed to address how the U.S. Treasury securities CCA holds the customer position margin.511 The objective was to isolate the customer position margin and prevent it from being used to satisfy the claims any creditors may have against the U.S. Treasury securities CCA. In particular, the note provided that the customer position margin needed to be treated in accordance with rules of the U.S. Treasury securities CCA requiring that the U.S. Treasury securities CCA hold the customer position margin itself or at either a U.S. Federal Reserve Bank or a ‘‘bank’’ (as defined in section 3(a)(6) of the Exchange Act (15 U.S.C. 78c(a)(6)) that is insured by the Federal Deposit Insurance Corporation. The objective was to have the U.S. Treasury securities CCA hold the customer position margin at a safe financial institution. In addition, the rules would need to provide that the U.S. Treasury securities CCA’s account at the U.S. Federal Reserve Bank or bank be: • Segregated from any other account of the U.S. Treasury securities CCA or any other person at the U.S. Federal Reserve Bank or bank and used exclusively to hold cash and U.S. Treasury securities to meet current margin requirements of the U.S. Treasury securities CCA resulting from positions in U.S. Treasury securities of the customers of the broker-dealer 510 See Note H(b)(2)(iii) of Rule 15c3–3a, as adopted. The rule text of this paragraph has been modified to add the phrase ‘‘and qualified customer securities’’ after the phrase ‘‘U.S. Treasury securities’’ wherever the latter appears in the paragraph to conform the rule text to the modification discussed above relating to the brokerdealer’s ability to post qualified customer securities. 511 Proposing Release, supra note 14, 87 FR at 64640. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 members of the qualified U.S. Treasury securities CCA; • Subject to a written notice of the U.S. Federal Reserve Bank or bank provided to and retained by the U.S. Treasury securities CCA that the cash and U.S. Treasury securities in the account are being held by the U.S. Federal Reserve Bank or bank pursuant to Rule 15c3–3 and are being kept separate from any other accounts maintained by the U.S. Treasury securities CCA or any other person at the U.S. Federal Reserve Bank or bank; and • Subject to a written contract between the U.S. Treasury securities CCA and the U.S. Federal Reserve Bank or bank which provides that the cash and U.S. Treasury securities in the account are subject to no right, charge, security interest, lien, or claim of any kind in favor of the U.S. Federal Reserve Bank or bank or any person claiming through the U.S. Federal Reserve Bank or bank. These conditions with respect to the account designation, written notice, and written contract would be designed to achieve the same objectives as the analogous conditions discussed above with respect to the broker-dealer’s account at the U.S. Treasury securities CCA. The Commission did not receive comments on this aspect of the proposal and is adopting it substantially as proposed.512 The fifth rule set—identified in paragraph (b)(2)(v) of Note H—provided that the customer position margin be treated in accordance with rules of the clearing agency requiring systems, controls, policies, and procedures to return customer position margin to the broker-dealer that is no longer needed to meet a current margin requirement resulting from positions in U.S. Treasury securities of the customers of the broker-dealer no later than the close of the next business day after the day the customer position margin is no longer needed for this purpose.513 As discussed above, the debit would be limited to customer position margin required and on deposit at the U.S. Treasury securities CCA. This would mean that the broker-dealer could not include in this debit item the amount of customer position margin on deposit at 512 See Note H(b)(2)(iv) of Rule 15c3–3a, as adopted. The rule text of this paragraph has been modified to add the phrase ‘‘and qualified customer securities’’ after the phrase ‘‘U.S. Treasury securities’’ wherever the latter appears in the paragraph to conform the rule text to the modification discussed above relating to the brokerdealer’s ability to post qualified customer securities. 513 Proposing Release, supra note 14, 87 FR at 64640. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 the U.S. Treasury securities CCA that exceeds the broker-dealer’s margin requirement resulting from its customers’ cleared U.S. Treasury securities positions. The objective of this condition was to effectuate the prompt return of customer position margin to the broker-dealer. Several commenters opposed the proposed requirement to return excess collateral within one business day.514 A commenter stated that this requirement does not apply to margin posted to other clearing agencies or DCOs and does not seem to serve any customer protection benefit.515 The commenter stated further that FICC does not have a mechanism to push excess margin to direct participants and direct participants do not have the capability of accepting unsolicited excess margin. Rather, similar to other clearing organizations, this commenter stated that FICC regularly notifies direct participants of excess margin every time margin is calculated and then allows such direct participants to demand a return of such margin. Furthermore, this commenter stated that some direct participants prefer to leave excess margin with FICC to serve as a buffer for future margin calls. Another commenter stated that the proposed requirement was inconsistent with other cleared products and unnecessary for customer protection.516 Finally, a commenter stated that a required automatic return would add significant operational burdens, as broker-dealer participants would need to update their systems to accept an automatic return of excess margin without a request and ensure that any such amounts are appropriately treated as customer assets.517 The Commission agrees with commenters that the proposed requirement may add significant operational burdens to broker-dealers if a U.S. Treasury securities CCA is required to return excess collateral to a broker-dealer no later than the close of the next business day after the day the collateral is no longer needed to meet a current margin requirement resulting from positions in U.S. Treasury securities of the customers of the brokerdealer. Moreover, because the debit is limited to margin required and on deposit at the U.S. Treasury securities CCA, the broker-dealer has an incentive to obtain the prompt return of excess margin collateral held by the CCA that 514 See, e.g., DTCC/FICC Letter, supra note 33, at 31–32; ICE Letter, supra note 33, at 3; SIFMA/IIB Letter, supra note 37, at 30. 515 See DTCC/FICC Letter, supra note 33, at 31. 516 See ICE Letter, supra note 33, at 3–4. 517 See SIFMA/IIB Letter, supra note 37, at 30. PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 2767 is in the form of securities. Specifically, the amount of the excess margin would remain a credit in the Rule 15c3–3a formula with no offsetting debit because the excess margin amount is no longer required by the U.S. Treasury securities CCA. Consequently, maintaining the excess margin collateral at the U.S. Treasury CCA could increase the amount that the broker-dealer must deposit into the customer reserve account.518 For these reasons, the Commission is removing this aspect of the requirement from the final rule. However, the final rule retains the provision that the customer position margin is treated in accordance with rules of the clearing agency requiring systems, controls, policies, and procedures to return customer position margin to the brokerdealer that is no longer needed to meet a current margin requirement resulting from positions in U.S. Treasury securities of the customers of the brokerdealer.519 Thus, it retains the overall objective of the proposal to effectuate the prompt return of customer position margin to the broker-dealer that is no longer needed to meet a margin requirement but leaves it to the brokerdealer and the U.S. Treasury securities CCA arrange when that amount will be returned. d. Fourth Condition—Commission Approval of Rules of U.S. Treasury Securities CCA The fourth condition for including customer position margin as a debit in the Rule 15c3–3a formula was set forth in paragraph (b)(3) of Note H.520 Under 518 See Item 15 of the Rule 15c3–3a formula, as adopted (requiring that the debit in Item 15 of the Rule 15c3–3a formula equal the margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Exchange Act resulting from the following types of transactions in U.S. Treasury securities in customer accounts that have been cleared, settled, and novated by the clearing agency: (1) purchases and sales of U.S. Treasury securities; and (2) U.S. Treasury securities repurchase and reverse repurchase agreements); see also Item 13 of the Rule 15c3–3a formula (requiring that the debit in Item 13 of the 15c3–3a reserve formula equal the margin required and on deposit with the OCC for all option contracts written or purchased in customer accounts). 519 See Note H(b)(2)(v) to Rule 15c3–3a, as adopted. To implement the modification discussed above, the phrase ‘‘no later than the close of the next business day after the day the cash and U.S. Treasury securities are no longer needed for this purpose’’ was deleted from the rule text. In addition, the rule text of this paragraph has been modified to add the phrase ‘‘and qualified customer securities’’ after the phrase ‘‘U.S. Treasury securities’’ to conform the rule text to the modification discussed above relating to the brokerdealer’s ability to post qualified customer securities. 520 Proposing Release, supra note 14, 87 FR at 64640. E:\FR\FM\16JAR2.SGM 16JAR2 2768 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations this condition, the Commission would need to have approved rules of the U.S. Treasury securities CCA that meet the conditions of proposed Note H and the Commission would had to have published (and not subsequently withdrawn) a notice that brokers-dealers may include a debit in the customer reserve formula when depositing customer position margin to meet a margin requirement of the U.S. Treasury securities CCA resulting from positions in U.S. Treasury securities of the customers of the broker-dealer. The Commission staff would analyze the U.S. Treasury securities CCA’s approved rules and practices regarding the treatment of customer position margin and make a recommendation as to whether they adequately implement the customer protection objectives of the conditions set forth in proposed Note H. If satisfied with the staff’s recommendation, the Commission would publish a positive notice. The objective was to permit the debit only after the Commission has approved the U.S. Treasury securities CCA’s rules pursuant to section 19(b) of the Exchange and published the notice.521 Any changes to those rules and practices that would undermine these customer protection objectives could result in the Commission withdrawing the notice, at which point the Commission would no longer permit the debit. The Commission did not receive comments on this aspect of the proposal and is adopting it substantially as proposed.522 5. PAB Reserve Computation Finally, broker-dealers are required to perform a separate reserve computation for PAB accounts and maintain a separate reserve account with respect to that computation.523 The Rule 15c3–3a computation provides that this separate PAB reserve computation must be performed in accordance with the Rule 15c3–3a computation for the brokerdealer’s non-PAB customers, except as provided in Notes to the PAB 521 See 15 U.S.C. 78s. Note H(b)(3) to Rule 15c3–3a, as adopted. The rule text of this paragraph has been modified to add the phrase ‘‘and qualified customer securities’’ after the phrase ‘‘U.S. Treasury securities’’ to conform the rule text to the modification discussed above relating to the brokerdealer’s ability to post qualified customer securities. 523 See 17 CFR 240.15c3–3(a)(16) (defining the term ‘‘PAB account’’ to mean a proprietary securities account of a broker-dealer (which includes a foreign broker-dealer, or a foreign bank acting as a broker-dealer) other than a deliveryversus-payment account or a receipt-versuspayment account); 17 CFR 240.15c3–3(e) (requiring separate reserve accounts and reserve account computations for PAB accounts). ddrumheller on DSK120RN23PROD with RULES2 522 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 Computation.524 Therefore, the amendments discussed above adding a new debit in Item 15 would apply to the PAB reserve computation. Further, the Commission proposed to amend Note 9 Regarding the PAB Reserve Bank Account Computation—which permits a debit in the PAB reserve computation for clearing deposits required to be maintained at registered clearing agencies—to clarify that the conditions set forth in new Note H with respect to including a debit in the non-PAB customer reserve computation would apply to the PAB reserve computation as well.525 The Commission did not receive comments on this aspect of the proposal and is adopting it as proposed.526 III. Compliance Dates In the Proposing Release, the Commission sought input from commenters on the appropriate compliance date or implementation schedule for the proposed amendments.527 Commenters generally supported a staged approach to implementation and compliance. Specifically, commenters stated that as a first step, the proposed requirements related to the segregation of house and customer margin (discussed in part II.B.1), access to central clearing (discussed in part II.B.2), and Rule 15c3–3 (discussed in part II.C) should become effective, and that as a second step, the proposed requirements related to clearing eligible secondary market transactions (discussed in part II.A) should become effective thereafter. Commenters also generally supported a lengthy or substantial timeframe for implementation. These comments are discussed in detail in this part. For example, one commenter which currently is a U.S. Treasury securities CCA stated that it would take the commenter and the U.S. securities industry as a whole substantial time to make the documentation, operational, organizational, and systems changes needed to comply with the proposal, and that the commenter would need to amend its rules, which amendments the Commission would need to approve.528 524 See 17 CFR 240.15c3–3a, Notes 1 through 10 Regarding the PAB Reserve Bank Account Computation. 525 Proposing Release, supra note 14, 87 FR at 64640. 526 See Rule 15c3–3a, Note 9 Regarding the PAB Reserve Bank Account Computation. 527 Proposing Release, supra note 14, 87 FR at 64641. 528 FICC/DTCC Letter, supra note 33, at v. The commenter elaborated that it will take market participants substantial time to scope the transactions subject to the requirement, execute the PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 The commenter stated that it would be advisable to adopt a phased implementation schedule, under which different requirements of the proposal become effective, beginning with the customer segregation requirement. The commenter stated that, depending on when any final rule is adopted, FICC and market participants may be able to implement the segregation requirement by 2025, giving market participants a full year after the expected implementation of T+1 to focus on these changes.529 Another commenter stated that a phased approach to implementation is necessary to ensure that the market can support a clearing mandate without undue costs to market participants and market liquidity or stability.530 The commenter stated that the Commission should first adopt rules to ensure that market participants have sufficient access to clearing, including changes to the access models, the segregation of house and customer margin, and changes to Rule 15c3–3. The commenter then recommended that subsequent to the Commission’s adoption of such rules and FICC’s implementation of the necessary corresponding changes to its access models, which would require at a minimum two years, the Commission should provide 18 months for the implementation of a tailored clearing mandate that applies to bilateral repo transactions.531 The commenter stated that the Commission and market participants could then observe the effects of the clearing mandate in the bilateral repo market and consider whether and how to apply the mandate to triparty repo transactions.532 Another commenter stated, in considering an appropriate compliance timeframe, the Commission must build in the time necessary for: (i) FICC to work with the Commission to identify changes to its rules necessary to address the issues we have identified above with respect to the Sponsored Program; (ii) FICC to propose and adopt additional rules or amendments, subject to public notice and comment, that may be documentation necessary to submit such transactions for central clearing, implement internal procedures and systems to monitor and ensure compliance, and establish the relevant accounts and operational integrations with a Treasury CCA. It also stated that, concurrently, the commenter will need to develop and test the systems, operations, and documentation needed to accommodate a far greater volume of transactions, create a strategy and framework to identify and monitor compliance, and establish margin segregation arrangements. Id. at 27–28. 529 FICC/DTCC Letter, supra note 33, at v, 28. 530 MFA Letter, supra note 81, at 21. 531 Id. at 21; MFA Letter II, supra note 125, at 8. 532 MFA Letter, supra note 81, at 21; see also MFA Letter II, supra note 125, at 5. E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations needed to address these issues; (iii) the Commission to propose and adopt amendments to its rules, subject to public notice and comment, and provide regulatory relief as needed to address the issues for funds that we have highlighted above; and (iv) FICC and industry participants to implement the extensive changes to policies and procedures, documentation, and operations (as detailed above for funds) that will be needed to comply with final rules.533 The commenter stated that these steps will require a significant amount of time and recommended that the Commission propose a multi-year, staged, compliance schedule, including, at a minimum, that a requirement to comply with a clearing requirement should go into effect no earlier than three years after the Commission and FICC have adopted final rules and amendments, as described in (ii) and (iii).534 Another commenter stated that the Commission should implement any central clearing requirement in stages and at a measured pace commensurate with the size, scope and scale of the implementation program required.535 The commenter stated that the Commission should work to determine an implementation that will be the least disruptive to the market and that accounts for the practical challenges that different industry participants may face as they prepare for a central clearing requirement, which may not be clear until participants are able to review any proposals from FICC regarding implementation. The commenter stated that staging implementation would allow the Commission to appropriately calibrate the costs and benefits of any requirement to clear eligible secondary market transactions and referenced that similarly significant changes to market structure (i.e., triparty market reform and swaps clearing) were successfully phased-in over five or more years to allow adequate time for market readiness while mitigating the potential for disruption.536 Another commenter stated that, if adopting a clearing requirement, a measured approach to implementation is required. The commenter specified that any new requirement to clear should be introduced only after enhancements to the clearing infrastructure are achieved, FICC’s readiness is assured, and at least one other covered clearing agency registered 533 ICI Letter, supra note 85, at 31. Letter, supra note 85, at 31. 535 SIFMA/IIB Letter, supra note 37, at 33. 536 ICI Letter, supra note 85, at 33. 534 ICI VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 with the Commission is ready to support the market in clearing eligible secondary market transactions.537 The commenter further stated that industry participants should have at least 18 months to engage with each CCA on the design of an appropriate clearing model thar provides the minimum level of protection it described in its comment letter. The commenter also stated a timetable for clearing requirements should only be set only once sufficient consensus has emerged around the appropriate clearing model and appropriate regulatory requirements are developed. The commenter recommended that the clearing requirement should be phased in over several years based on the volume of U.S. Treasury securities transaction activity in which a market participant engages (like the phase-in approach which was followed for regulatory initial margin requirements for uncleared OTC derivatives which took more than five years following the publication of final rules to be fully implemented). The commenter stressed the importance of phasing in the new requirements in a manner that avoids too many market participants looking to finalize documentation and go-live with clearing all on the same day.538 The commenter also stated that a long phase-in period is essential, as there will be a significant implementation effort needed to comply with any new requirements.539 The commenter stated that it is difficult to estimate the potential scope of this work and the effort involved until the access models are more developed. The commenter stated that given the breadth of participation in the U.S. Treasury markets, the potential scale of the effort 537 SIFMA AMG Letter, supra note 35, at 15. AMG Letter, supra note 35, at 15. 539 SIFMA AMG Letter, supra note 35, at 15. For direct participants, these efforts would include obtaining information to classify their counterparties to determine who qualifies as an IDM, a hedge fund, or a leveraged account and negotiating clearing agreements with each hedge fund and leveraged account. For asset managers, these efforts would include implementation of documentation such as clearing agreements, give-up agreements, and related infrastructure. For managed funds, these efforts would include revisiting existing formation and distribution documentation, such as investment management agreements and investment guidelines, as they do not permit clearing activity or contemplate the clearing of U.S. Treasury securities. Buy-side firms will have to undertake a significant operational build to be able to settle and margin cleared transactions. The commenter, a trade association, stated that many of its members trade in blocks on behalf of multiple underlying accounts, and that the industry will have to consider and address how a mandatory requirement to clear would impact an asset manager’s transaction allocation process where some accounts are required to clear and others are not. Id. at 15–16. 538 SIFMA PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 2769 and time required to complete this work, implementation will take many years to complete after a final rule.540 An additional trade association commenter stated that its members would incur incredible costs as they establish numerous costly clearing relationships to ensure that all its transactions can be cleared as required, which will take a significant amount of time.541 The commenter therefore recommended a compliance date of at least 30 months after the publication of any final rule in the Federal Register.542 An additional commenter recognized that clearing requirements can have unintended and disruptive consequences and therefore recommended that the Commission implement the changes with respect to the segregation of house and customer margin, access models, and Rule 15c3– 3 before moving forward with any expanded clearing requirements.543 Finally, an additional commenter supported an extensive implementation timeframe that is appropriately prioritized and sequenced due to the breadth of the proposal, the time and resources necessary for a covered clearing agency to revise its policies and procedures, and the changes necessary for market participants’ compliance. The commenter referred to tri-party market reform as a successful example of the time and sequencing involved in such a significant change.544 The Commission agrees with commenters that a phased approach to implementation and compliance would be appropriate for these amendments. As discussed in the Proposing Release, the Commission understands that the amendments to Rule 17ad– 22(e)(18)(iv)(A) will likely result in a significant increase in the volume of U.S. Treasury securities transactions submitted for central clearing, including transactions of market participants that currently may not submit such transactions for central clearing.545 The Commission therefore stated its belief that additional changes with respect to the segregation of house and customer margin and access, as proposed in Rule 17ad–22(e)(6)(i) and (e)(18)(iv)(C), respectively, may be warranted. These changes were designed to improve risk management by and access to the U.S. Treasury securities CCA and would also serve to help manage the risks and 540 SIFMA AMG Letter, supra note 35, at 16. Letter, supra note 81, at 9. 542 AIMA Letter, supra note 81, at 9. 543 CME Letter, supra note 81, at 8. 544 BNY Mellon Letter, supra note 33, at 3. 545 Proposing Release, supra note 14, 87 FR at 64632, 64637. 541 AIMA E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 2770 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations facilitate access that would likely result from the requirement to clear eligible secondary market transactions.546 In addition, the Commission proposed changes to Rule 15c3–3 to facilitate implementation of the requirement to clear eligible secondary market transactions, by reducing the amount of broker-dealers cash and securities that would be needed to meet the requirements of Rule 15c3–3.547 The Commission continues to believe that the changes with respect to the segregation of house and customer margin, ensuring access to central clearing, and Rule 15c3–3 would help facilitate the central clearing of additional U.S. Treasury securities transactions, as will likely result when a requirement to clear eligible secondary market transactions goes into place. The Commission also agrees with the commenters, that it would be appropriate to implement those changes prior to the imposition of any clearing requirement. This would allow for the development of additional infrastructure that would support the eventual increased amount of central clearing that would occur upon the applicability of a requirement to clear eligible secondary market transactions. To do so, the Commission is adopting a different compliance date for the amendments to Rule 17ad–22(e)(6)(i) (regarding separation of house and customer margin), 17ad–22(e)(18)(iv)(C) (regarding access), and 15c3–3 (regarding the broker-dealer customer protection rule), from the compliance date for the amendments to Rule 17ad– 22(e)(18)(iv)(A) and (B) (regarding the requirements to clear eligible secondary market transactions and monitoring of the submission of such transactions). This staging would allow market participants, including U.S. Treasury securities CCAs, the opportunity to incorporate changes to their rules, systems, practices, contractual arrangements, and other documentation, prior to the applicability of a clearing requirement. It also would provide time between the implementation of structural changes to accommodate the separation of house and customer margin, the potential ability to rehypothecate margin pursuant to Rule 15c3–3, as amended, and additional access by new types of market participants, on the one hand, and the requirement for a U.S. Treasury securities CCA to require its direct participants to clear eligible secondary market transactions, on the other hand. 546 Id. 547 Id. at 64632–33. at 64637. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 On the latter point, the Commission is incorporating two stages of compliance for the requirement to clear eligible secondary market transactions: the first would apply to the cash market transactions described in section (i) of the definition of an eligible secondary market transaction, and the second would apply to the repo market transactions described in section (ii) of the definition of an eligible secondary market transaction. Providing additional time for repo transactions to be centrally cleared should allow time for many market participants who are active in the repo market but do not centrally clear this volume of their transactions to plan for and implement necessary contractual arrangements and processes to manage the increase in volume of central clearing. With respect to the changes to Rule 17ad–22(e)(6)(i) (regarding separation of house and customer margin), 17ad– 22(e)(18)(iv)(C) (regarding access), and 15c3–3 (regarding the broker-dealer customer protection rule), (1) each covered clearing agency will be required to file with the Commission any proposed rule changes regarding those amendments required under Section 19(b) and/or advance notices required under Title VIII of the Dodd-Frank Act no later than 60 days following January 16, 2024, and (2) the proposed rule changes must be effective by March 31, 2025. With respect to the proposed changes to Rule 17ad–22(e)(18)(iv)(A) and (B) (regarding the requirements to clear eligible secondary market transactions and monitoring of the submission of such transactions), (1) each covered clearing agency will be required to file with the Commission any proposed rule changes regarding those amendments required under Section 19(b) and/or advance notices required under Title VIII of the DoddFrank Act no later than 150 days following January 16, 2024, and (2) the proposed rule changes must be effective by December 31, 2025, for cash market transactions encompassed by section (ii) of the definition of an eligible secondary market transaction, and by June 30, 2026, for repo transactions encompassed by section (i) of the definition of an eligible secondary market transactions. Compliance by the direct participants of a U.S. Treasury securities CCA with the requirement to clear eligible secondary market transactions would not be required until December 31, 2025, and June 30, 2026, respectively, for cash and repo transactions. This staged implementation timeframe will encompass two and a half years from the time of the action set forth in this release. This amount of PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 time is consistent with commenters who sought a staged, multi-year approach to implementation for this proposal, which, as adopted, is less extensive than what was proposed.548 It is also consistent with the comment of the existing U.S. Treasury securities CCA that stated that it and market participants would need until at least 2025 to implement any final rule, as it allows for that timeframe. Although some commenters referred to potentially longer timeframes for implementation, whether expressly (e.g., by referring to some particular length of time, such as 18 months or three years after the U.S. Treasury securities CCA has updated its rules 549) or more generally (e.g., by referring to the need for a lengthy timeline or several years to impose clearing requirements 550), the Commission believes that this timeframe would allow the benefits of greater central clearing to be achieved sooner and therefore is adopting the staged implementation timeframe discussed in this part.551 In addition, one commenter also stated its belief that, given the complexity and extent of changes that will be necessary to implement the proposal, it would be advisable to engage in a consultative process regarding the implementation timeline, with that process occurring after any adoption of the proposal because it is difficult for market participants to assess how long it will take to implement a requirement when they do not yet know with clarity the scope of the final requirement.552 The commenter specifically stated that, after any adoption of the proposal, the Commission should require U.S. Treasury CCAs to submit to the Commission a proposed rule change, pursuant to Section 19 of the Exchange Act, containing an implementation schedule by no later than 180 days after 548 See AIMA Letter, supra note 81, at 9 (seeking 30 months after publication of any final rule in the Federal Register). 549 See MFA Letter, supra note 81, at 21; ICI Letter, supra note 85, at 33. 550 See SIFMA/IIB Letter, supra note 37, at 33; BNY Mellon Letter, supra note 33, at 3; SIFMA AMG Letter, supra note 35, at 16. 551 In addition, with respect to the compliance date, several commenters requested the Commission to consider interactions between the proposed rule and other recent Commission rules. In determining compliance dates, the Commission considers the benefits of the rules as well as the costs of delayed compliance dates and potential overlapping compliance dates. For the reasons discussed throughout the release, to the extent that there are costs from overlapping compliance dates, the benefits of the rule justify such costs. See infra parts IV.A and IV.C.2.e for a discussion of the interactions of the final rule with certain other Commission rules. 552 FICC/DTCC Letter, supra note 33, at v. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 the publication of the final rule in the Federal Register. The commenter stated that this would provide market participants with the ability to comment on the timing and requirements set forth in the proposed rule change with the benefit of knowing the requirements’ scope, and that the Commission and the commenter could then consider those comments in adopting a final implementation schedule. The commenter stated that this kind of deliberative and consultative approach would facilitate the adoption of a realistic timeline and thereby avoid the need for successive extensions and the attendant uncertainty and disruption such shifting timelines present.553 However, the Commission’s phased compliance timeline allows for the type of deliberation and consultation that the commenter recommends. A U.S. Treasury securities CCA will be required to submit proposed rule changes to comply with the requirements being adopted in this release, and there will be opportunity for comment on those proposals by market participants, thereby allowing for consultation about the potential impact of any such proposed rule changes. IV. Economic Analysis The Commission is mindful of the economic effects that may result from these amendments, including the benefits, costs, and the effects on efficiency, competition, and capital formation. Exchange Act section 3(f) requires the Commission, when it is engaged in rulemaking pursuant to the Exchange Act and is required to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.554 In addition, Exchange Act section 23(a)(2) requires the Commission, when making rules pursuant to the Exchange Act, to consider among other matters the impact that any such rule would have on competition and not to adopt any rule that would impose a burden on competition that is not necessary or appropriate in furtherance of the purposes of the Exchange Act.555 The Commission is adopting amendments to its rules that impose additional requirements for any U.S. Treasury securities CCA.556 First, the amendments require that U.S. Treasury 553 FICC/DTCC Letter, supra note 33, at v. 15 U.S.C. 78c(f). 555 See 15 U.S.C. 78w(a)(2). 556 See part II supra. 554 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 securities CCAs establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, establish objective, riskbased, and publicly disclosed criteria for participation, which require that the direct participants of such covered clearing agency submit for clearance and settlement all of the eligible secondary market transactions to which they are a counterparty.557 In addition, the amendments require that such CCAs establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, identify and monitor its direct participants’ required submission of transactions for clearing, including, at a minimum, policies and procedures that address any failures to submit transactions.558 Strengthening the membership standards will help reduce contagion risk to U.S. Treasury securities CCAs and bring the benefits of central clearing to more transactions involving U.S. Treasury securities, thereby lowering the risk of disruptions to the U.S. Treasury securities market.559 Second, the Commission is adopting additional requirements on how U.S. Treasury securities CCAs calculate, collect, and hold margin posted on behalf of indirect participants (i.e., customers) who rely on the services of a direct participant (i.e., the member of the U.S. Treasury securities CCA) to access the CCA’s services.560 As discussed in more detail below, such requirements also will improve the risk management practices at U.S. Treasury securities CCAs and incentivize and facilitate additional central clearing in the U.S. Treasury securities market. Third, the Commission is adopting amendments that will require that a U.S. Treasury securities CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, and that its board of directors reviews these policies and procedures annually.561 Although these requirements do not prescribe specific methods for market participants to 557 See part II.A.1 and part II.A.2 supra for a description of the requirement to clear eligible secondary market transactions including the definition of ‘‘eligible secondary market transaction.’’ 558 See part II.A.4 supra. 559 See part IV.A infra. 560 See part II.C supra. 561 See part II.B.2 supra. PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 2771 obtain indirect access to a U.S. Treasury securities CCA, they are intended to help ensure that all U.S. Treasury security CCAs review their indirect access models and ensure that they facilitate access to clearance and settlement services in a manner suited to the needs and regulatory requirements of market participants throughout the U.S. Treasury securities market, including indirect participants. Lastly, the Commission is amending its rules to permit margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula, subject to certain conditions.562 As discussed further below, these amendments to its rules, in conjunction with the amendments requiring the separation of house and customer margin, should incentivize and facilitate additional central clearing in the U.S. Treasury securities market. The discussion of the economic effects of the rule amendments begins with a discussion of the risks inherent in the clearance and settlement process and how the use of a CCP can mitigate those risks. This is followed by a baseline of current U.S. Treasury securities market practices. The economic analysis then discusses the likely economic effects of the rule amendments, as well as their effects on efficiency, competition, and capital formation. The Commission has, where practicable, attempted to quantify the economic effects expected to result from these rule amendments. In some cases, however, data needed to quantify these economic effects is not currently available. For example, prior to the proposal the reporting of data for bilaterally cleared repo transactions was not a regulatory requirement, so counterparty-specific statistics were not available and any aggregate statistics on this market segment may not have been comprehensive.563 In the intervening period, and as discussed further below, the Department of the Treasury’s Office of Financial Research (OFR) has reported the results of a pilot data collection of non-centrally cleared bilateral repo.564 Likewise, the reporting 562 See part II.C supra. J. Hempel, R. Jay Kahn, Vy Nguyen, and Sharon Y. Ross, Non-Centrally Cleared Bilateral Repo, The OFR Blog (Aug. 24, 2022) (‘‘Hempel et al. (2022)’’), available at https:// www.financialresearch.gov/the-ofr-blog/2022/08/ 24/non-centrally-cleared-bilateral-repo/. 564 See part IV.B.3.b.ii infra. See also Samuel J. Hempel, R. Jay Kahn, Robert Mann, and Mark Paddrik, Why Is So Much Repo Not Centrally Cleared?, OFR Brief (May 12, 2023) (‘‘Hempel et al. (2023)’’), available at https:// www.financialresearch.gov/briefs/2023/05/12/why563 Samuel E:\FR\FM\16JAR2.SGM Continued 16JAR2 2772 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 of U.S. Treasury securities transactions to TRACE has been until recently 565 limited to cash transactions in which at least one of the counterparties is a FINRA member, so analyses based on that data will necessarily be incomplete. In many cases, and as noted below, the Commission is unable to quantify the economic effects of the rule amendments and in the proposal solicited comment, including estimates and data from interested parties, to help inform the estimates of the economic effects of the proposal. As discussed further below, several commenters stated the importance of further research and to better understand the potential intended and unintended impacts of the rule. Although many of the commenters calling for additional research did not provide additional data or propose how any remaining uncertainty might be resolved, as discussed below, some commenters did provide limited data on quantifiable costs.566 Costs and benefits will depend in part on how market participants access central clearing in order to clear eligible secondary market transactions. As some commenters have highlighted, the current clearing framework may need to be changed and extended to support the requirement to clear eligible secondary market transactions. The Commission agrees that changes to the current clearing framework are necessary and therefore is adopting as proposed Rule 17ad–22(e)(18)(iv)(C) that requires that a U.S. Treasury securities CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure that it has appropriate means to facilitate access to clearance and is-so-much-repo-not-centrally-cleared/. The OFR has also proposed rulemaking mandating the collection of daily transaction level data from certain financial companies on their non-centrally cleared bilateral repurchase agreement trades. See Office of Financial Research, Office of Financial Research Releases Proposal to Collect Data on Certain Repo Transactions (Jan. 5, 2023), available at https://www.financialresearch.gov/pressreleases/2023/01/05/office-of-financial-researchreleases-proposal-to-collect-data-on-certain-repotransactions/. 565 Reporting of additional cash transactions to TRACE, by certain U.S. and foreign banks, began on Sept. 1, 2022, but the recent nature of that change makes it difficult to draw conclusions from the limited data available. See generally Federal Reserve System, Agency Information Collection Activities: Announcement of Board Approval Under Delegated Authority and Submission to OMB, 86 FR 59716 (Oct. 28, 2021); see also Bd. Governors Fed. Rsrv. Sys., Supporting Statement for the Treasury Securities and Agency Debt and Mortgage-Backed Securities Reporting Requirements, Federalreserve.gov, available at https:// www.federalreserve.gov/reportforms/formsreview/ FR%202956%20OMB%20SS.pdf (last visited Dec. 11, 2023). 566 See part IV.C.2 infra. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the U.S. Treasury securities CCA’s board of directors reviews annually. A. Broad Economic Considerations Clearance and settlement risk is the risk that a counterparty fails to deliver a security or cash as agreed upon at the time when the security was traded. One method of reducing such risk is to require one or both counterparties to the trade to post collateral.567 The purpose of posting collateral in financial transactions is to alleviate frictions caused by adverse selection and moral hazard.568 The amount of collateral needed to support a set of unsettled trades, however, can depend on whether trades are cleared bilaterally or through a CCP. In cases where market participants have several outstanding buy and sell orders, central clearing reduces the total collateral required to support a given set of trades due to multilateral netting.569 A simple example illustrates the effect. Suppose there are 3 firms trying to complete three bilateral trades among themselves. Firm A is buying $90 million in U.S. Treasury securities from Firm B, Firm B is buying $80 million in the same U.S. Treasury securities from Firm C, and Firm C is buying $100 million in the same U.S. Treasury securities from Firm A. This means that over the settlement cycle, the firms in this example would need to post collateral to cover a total of $270 million in gross obligations to 567 An alternative method of reducing counterparty credit risk is delivery versus payment (‘‘DVP’’). Under DVP, counterparties aim to deliver securities and payment simultaneously, so that the transfer of securities happens if and only if payment has also been made. 568 For example, if the fulfillment of a contract depends on a counterparty exerting unobservable and costly effort, collateral can be used as a commitment device by putting more of the counterparty’s resources at stake in the case of nonfulfillment. See Bengt Holmstrom & Jean Tirole, Financial Intermediation, Loanable Funds, and the Real Sector, 112 Q. J. Econ. 663 (Aug. 1997); Albert J. Menkveld & Guillaume Vuillemey, The Economics of Central Clearing, 13 Ann. Rev. Fin. Econ. 153, 158 (2021). 569 Darrell Duffie & Haoxiang Zhu, Does a Central Clearing Counterparty Reduce Counterparty Risk? 1 Rev. Asset Pricing Stud. 74 (2011), available at https://academic.oup.com/raps/article-abstract/1/ 1/74/1528254. The authors note that this benefit scales with the square root of the number of participants when the trading positions are statistically independent and identically distributed. The authors also note certain conditions that can impact netting efficiencies, e.g., when cross asset netting is allowed in non-centrally cleared markets, asset specific CCPs can negatively impact netting efficiency. We also note, as discussed below, that certain aspects of client clearing models can impact netting efficiency. PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 complete these three trades. If these trades were centrally cleared, however, then the net obligations would be substantially smaller. In this example, the collateral required would no longer be that required to support $270 million in outstanding obligations, but instead would reduce to $40 million: $20 million for Firm C, and $10 million each for Firms A and B.570 Central clearing can, in part, replace a trading network made up of a web of bilateral relationships with a simpler hub and spoke model. As each connection is a potential source of failure, a simpler system can imply less risk. Clearance and settlement through a CCP can also make trades less ‘‘informationally sensitive’’ in the sense that the value of the trade does not depend on information about the creditworthiness of the counterparties, thereby reducing adverse selection.571 This occurs when the trade is novated to the CCP, and the CCP becomes the buyer to every seller and the seller to every buyer. This reduces the need for investors to acquire private information about the credit risk of their counterparty. By mitigating adverse selection through the substitution of the CCP’s counterparty credit risk evaluation for a market participant’s own, central clearing through a CCP lowers the cost of trading by market participants and should increase their willingness to trade, thereby improving market liquidity. Reducing the information sensitivity of trades also increases the uniformity of the asset that is traded. In the absence of novation, the U.S. Treasury security is essentially bundled together with counterparty risk. That is, when buying or selling a security, if there is counterparty risk, the pricing depends not only on the security itself but also on the reliability of the counterparty to the trade. It is as if, from an economic perspective, one is ‘‘buying’’ both the security and the characteristics of the counterparty. Besides the reduction in adverse selection, reducing counterparty credit risk makes the security a more standard product. Standardization itself increases liquidity.572 Financial networks that incorporate a CCP can further improve the resilience 570 This example is from Duffie, supra note 27. Gary Gorton & George Pennacchi, Financial Intermediaries and Liquidity Creation, 45 J. Fin. 49 (1990); see also Francesca Carapella & David Mills, Information Insensitive Securities: the Benefits of Central Counterparties (N.Y. Fed, working paper Oct. 17, 2012), available at https:// www.newyorkfed.org/medialibrary/media/research/ conference/2012/MP_Workshop/Carapella_Mills_ information_insensitive_securities.pdf. 572 See Ben Bernanke, Clearing and Settlement During the Crash, 3 Rev. Fin. Stud. 133 (1990). 571 See E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 of financial markets. The Bank for International Settlements stated in 2015 that the shift to central clearing had helped to mitigate the risks that emerged in non-centrally cleared markets before and during the 2007– 2009 financial crisis. Further, it had reduced financial institutions’ exposure to counterparty credit risk shocks through netting, margining and collateralization.573 Another potential benefit of central clearing is it should reduce the magnitude of, or even prevent, fire sales of assets. This mitigation of fire sale risk is achieved when a member defaults and the CCP manages the liquidation of assets. Central management of asset liquidation may mitigate suboptimal outcomes in the face of capital or margin constraints. For example, if investors believe the counterparty will sell in the case of a missed margin call, other investors may join the selloff, leading to further declines in asset prices. If market participants can pledge to not sell, then a more efficient equilibrium in which there is no fire sale could be achieved. In this way, the CCP acts as a way to select into the more efficient equilibrium by allowing members to credibly pre-commit to the coordinated liquidation of assets in the case of a missed margin call.574 Finally, broadening central clearing could lead to a wider group of liquidity providers, which likely would increase the reliability of access to funding during periods of market stress.575 The reason is that novation of the trade to a central counterparty reduces one of the major reasons for not doing business with a particular counterparty: the risk that that counterparty may fail to deliver on its obligations. It also reduces one of the reasons for failing to provide liquidity, namely concerns over the credit risk of counterparties. Therefore, as a result of increased levels of central clearing and the resulting increased centralization of counterparty credit risk evaluation by a CCP and the CCP’s application of consistent and transparent risk management,576 more 573 Dietrich Domanski, Leonardo Gambacorta, and Cristina Picillo, Central clearing: trends and current issues, BIS Q. Rev. (Dec. 2015), available at https:// www.bis.org/publ/qtrpdf/r_qt1512g.pdf. 574 John Chi-Fong Kuong, Self-Fulfilling Fire Sales: Fragility of Collateralized Short-Term Debt Markets, 34 Rev. Fin. Stud. 2910 (2021), available at https://academic.oup.com/rfs/article/34/6/2910/ 5918033?login=true. 575 G–30 Report, supra note 5, at 13. 576 See TMPG White Paper, supra note 13 (‘‘[b]ilateral clearing involves varying risk management practices that are less uniform and less transparent to the broader market . . .’’). In addition, FICC has been designated by FSOC as a systemically important financial market utility, VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 counterparties—who would also be potential liquidity providers—would be willing to compete to provide liquidity to buy-side investors and to each other. In addition, several academic studies following the 2008 financial crisis emphasize the role of intermediary balance sheet constraints as a cause of financial crises.577 Moreover, losses experienced by market participants can lead to an increase in risk aversion leading those market participants to exit, creating a need for new market participants to replace them in order to provide liquidity.578 Therefore, either because of increased risk aversion or because some friction implies that the liquidity providers who find themselves warehousing the asset can no longer do so due to trading losses, outside liquidity providers may play an important role in stabilizing the market. In addition, central clearing facilitates anonymized all-to-all trading that would enable the provision of market liquidity by investors.579 580 Several commenters were generally supportive of benefits of central clearing. One commenter stated that it, ‘‘ . . . supports central clearing because, when calibrated appropriately, it has increased resiliency, liquidity and transparency in financial markets.’’ 581 Another commenter stated that ‘‘[i]f implemented thoughtfully, increased central clearing of Treasury cash and repurchase (‘‘repo’’) transactions will reduce systemic risk and meaningfully which brings heightened risk management requirements and additional regulatory supervision by both its primary regulator and the Board of Governors. See also U.S. Dept. of the Treasury, Fin. Stability Oversight Council, 2012 Annual Report, App. A, available at https://home.treasury.gov/ system/files/261/2012-Annual-Report.pdf (‘‘FSOC 2012 Annual Report’’). 577 See e.g., Markus K. Brunnermeier & Yuliy Sannikov, A Macroeconomic Model with a Financial Sector, 104 a.m. Econ. Rev. 379 (Feb. 2014); see also Zhiguo He & Arvind Krishnamurthy, Intermediary Asset Pricing, 103 a.m. Eco. Rev. 732 (Apr. 2013). Balance sheet constraints and the impact of losses on risk aversion both affect the ability and willingness of market participants to provide liquidity. A CCP is not similarly affected as it does not supply liquidity. 578 See, e.g., John Y. Campbell & John H. Cochrane, By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior, 107 J. Pol. Econ. 205 (Apr. 1999). 579 G–30 Report, supra note 5, at 13. See also Duffie, supra note 27, at 4 (‘‘Further, given broad access to a CCP, some Treasury transactions could flow directly from ultimate sellers to ultimate buyers without necessarily impinging on dealer balance sheet space.’’). 580 The market responded to the stress of 2020 through some increase in all-to-all trading. See MarketAxess, FIMSAC Slides, at 6 (Oct. 5, 2020), available at https://www.sec.gov/spotlight/fixedincome-advisory-committee/mcvey-fimsac-slides100120.pdf Additional central clearing may have enabled a greater increase. 581 AIMA Letter, supra note 81, at 2. PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 2773 improve counterparty risk management, market liquidity, and resiliency.’’ 582 Several additional commenters made similar statements.583 Several commenters, including some who were generally supportive of the benefits of central clearing, referenced the need to do additional study before imposing any requirement on U.S. Treasury securities CCAs for their participants to clear and settle eligible secondary market transactions. One commenter stated that the Commission should conduct detailed analysis on the costs and benefits of central clearing across market segments and participant types, as well as analyze the overall impact on Treasury market liquidity. The commenter stated that it is widely recognized within existing literature on Treasury market structure reform that further detailed study is needed in this area. The commenter also stated that increased central clearing resulting from incentives to centrally clear U.S. Treasury securities transactions would provide additional data for this analysis.584 In support of its claim that it is widely recognized within existing literature on Treasury market structure reform that further study is needed, the commenter cites two working papers.585 The first citation includes a quote stating that it would be difficult to estimate the amount of liquidity savings associated with central clearing without further study.586 However, the cited work is generally supportive of central clearing, stating that ‘‘Without a broad central clearing mandate, the size of the Treasury market will outstrip the capacity of dealers to safely intermediate the market on their own balance sheets, raising doubts over the safe-haven status of U.S. Treasuries and concerns over the cost to taxpayers of financing growing federal deficits.’’ 587 The second citation provided by the commenter also focuses on the potential benefit of improved liquidity.588 The working paper states that a potential mandate for wider use of central 582 Citadel Letter, supra note 81, at 1. AIMA Letter, supra note 81, at 2; CME Group, supra note 81, at 2; DTCC/FICC Letter, supra note 33, at 1; GTS Letter, supra note 81, at 3; ISDA Letter, supra note 391, at 2; LSEG Letter, supra note 33, at 2; MFA Letter, supra note 81, at 2; ARB Trading et al. Letter, supra note 81, at 1; SIFMA/ IIB Letter, supra note 37, at 1; Sunthay Letter, supra note 33, at 4; Tradeweb Letter, supra note 81, at 2; Better Markets Letter, supra note 33, at 8; ICE Letter, supra note 33, at 1. 584 SIFMA/IIB Letter, supra note 37, at 2. 585 SIFMA/IIB Letter, supra note 37, at 2 (citing working papers by Duffie, supra note 27, and Liang and Parkinson, supra note 28). 586 Id. at 2. 587 Duffie, supra note 27, at 1. 588 Liang and Parkinson, supra note 28. 583 See E:\FR\FM\16JAR2.SGM 16JAR2 2774 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations clearing for Treasury securities is the second of four complementary measures for enhancing the liquidity of U.S. Treasury markets when under stress.589 The cited work also does not address the potential benefits of increased central clearing other than the potential for improved liquidity. Immediately following the authors’ statement in favor of further study, they state that ‘‘If such a study were to conclude that expanded clearing is not appropriate for Treasury securities, it should explain what distinguishes Treasury markets from the many other markets, such as equities and Treasury futures, for which there is a clearing mandate.’’ 590 Another commenter stated that the Commission should substantiate the benefits and potential costs of clearing through additional studies and data. The commenter stated that the Commission’s proposal should be considered after the Commission has had an opportunity to gather additional data and further assess whether increased clearing is the best way to mitigate the risks confronting the U.S. Treasury market, including a more indepth understanding of how these changes will affect the costs of transactions for institutional investors who depend on access to these markets for active portfolio management and, as a result, represent a significant source of market liquidity.591 In addition, one commenter, which surveyed market participants as the basis of its comment, conveyed a ‘‘strong belief that insufficient review and examination has been given to the proposal by the official sector and that such work needs to be detailed and focused to properly vet a mixture of economic, operational, legal and market challenges before the proposal is enacted.’’ 592 The Commission has reviewed the academic literature on central clearing as well as the reports published by the G–30, the TMPG, the OFR, and others 593 and does not agree with 589 Id. 590 Id. at 3. 591 SIFMA AMG Letter, supra note 37, at 2–3. Partners Comment, supra note 52, at 8. 593 See, e.g., Duffie, supra note 27; Duffie and Zhu, supra note 569; Duffie, infra note 718; Duffie et al., infra note 718; G–30 Report, supra note 5; TMPG White Paper, supra note 13; TMPG Repo White Paper, supra note 75; Hempel et al. (2022), supra note 563; Hempel et al. (2023), supra note 564; Kahn & Olson, supra note 628; 2017 OFR Report, infra note 797; 2021 IAWG Report, supra note 4; Staffs of the U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission, Enhancing the Resilience of the U.S. Treasury Market: 2022 Staff Progress Report (Nov. (2023), supra note 564; Kahn & Olson, supra note 628; 2017 ddrumheller on DSK120RN23PROD with RULES2 592 SIA VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 commenters that suggest that additional study should precede adoption of a requirement for U.S. Treasury securities CCAs to obligate direct participants to clear eligible secondary market transactions. Although the Commission recognizes that some of the benefits of additional central clearing of eligible secondary market transactions may be mitigated for certain transactions,594 the Commission has consulted with other regulators regarding this proposal and believes it has performed sufficient analysis in both the Proposing Release and in this release to consider the costs and benefits arising from its proposal. As discussed in more detail throughout this release, and especially in part IV.C infra, the Commission understands that the costs associated with the requirement to clear eligible secondary market transactions will vary depending on how a market participant is able to and/or chooses to access central clearing. The degree to which market participants have increased costs will depend largely on whether and how they currently access central clearing, and therefore, costs likely will vary greatly across different types of market participants. For example, for certain indirect participants whose transactions with direct participants of a U.S. Treasury securities CCA are not submitted for central clearing currently, the costs of establishing some indirect participant relationship, whether through FICC’s Sponsored Service or some other client clearing model, may be high. In addition, following the initial costs, the ongoing costs of submitting transactions for central clearing, such as posting margin and paying fees to a direct participant which facilitates access, may also be high.595 However, benefits will accrue from the requirement to submit for clearing and settlement eligible secondary market transactions. As discussed OFR Report, infra note 797; 2021 IAWG Report, supra note 4; Staffs of the U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission, Enhancing the Resilience of the U.S. Treasury Market: 2022 Staff Progress Report (Nov. 2022), available at https://home.treasury.gov/system/files/ 136/2022-IAWG-Treasury-Report.pdf (‘‘2022 IAWG Report’’); Staffs of the U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, U.S. Securities and Exchange Commission, and U.S. Commodity Futures Trading Commission, Enhancing the Resilience of the U.S. Treasury Market: 2023 Staff Progress Report (Nov. 2023), available at https://home.treasury.gov/system/files/ 136/20231106_IAWG_report.pdf (‘‘2023 IAWG Report’’); 2017 Treasury Report, infra note 736; Joint Staff Report, supra note 4. 594 See, e.g., part IV.B.5 infra. 595 See part IV.C.2.a.ii infra. PO 00000 Frm 00062 Fmt 4701 Sfmt 4700 earlier in this section and in part IV.C.1 supra, one of the several cited benefits of additional central clearing is the increased resiliency of centrally cleared markets. The economic costs of market disruptions can be high so market changes that decrease the probability of such events by even a small amount can result in a large expected economic benefit. Discussion of disruptions in the U.S. Treasury Securities Market over the last decade typically discuss the size of the market and interconnectedness of the U.S. Treasuries markets with other financial markets as evidence of their importance; estimates of the cost to the U.S. economy as a result of these disruptions are less common.596 However, there is evidence that the costs of extreme financial crises can be high.597 In addition, the requirement for direct participants to clear such transactions will reduce risk to the U.S. Treasury securities CCA, by reducing counterparty risk and enabling additional multilateral netting and centralized default management, as discussed in part II.A.1 supra. Further, to the extent that implementation costs arise from changes to the CCA’s rules, the CCA’s implementation of the requirement will provide further opportunity to consider the costs and benefits of particular methods of implementation. Because CCAs are selfregulatory organizations, any rule changes to implement the requirement will need to be reviewed by the Commission,598 and commenters will be able to comment on the particular 596 See part IV.B.6 infra, for a discussion of the Mar. 2020, Sept. 2019, and Oct. 2014 market disruptions. See SEC Staff Report on U.S. Credit Markets Interconnectedness and the Effects of the COVID–19 Economic Shock (Oct. 2020), supra note 280, for discussion of the interconnectedness of financial crisis and market disruptions. 597 Barnichon et al., estimate that ‘‘the 2007–08 financial crisis persistently lowered output by roughly 7 percentage points. This is a large number: In dollar terms, it represents a lifetime income loss in present-discounted value terms of about $70,000 for every American.’’ Regis Barnichon, Christian Matthes, and Alexander Ziegenbein, The Financial Crisis at 10: Will We Ever Recover?, FRBSF Econ. Letter 2018–19 (Aug. 13, 2018), available at https:// www.frbsf.org/economic-research/publications/ economic-letter/2018/august/financial-crisis-at-10years-will-we-ever-recover/?utm_source=frbsfhome-economic-letter-title&utm_ medium=frbsf&utm_campaign=economic-letter. Romer and Romer (2017) study a panel of countries in the Organization for Economic Co-operation and Development and find that gross domestic product is typically about 9 percentage points lower five years after an extreme financial crisis. Christina Romer and David Romer, New Evidence on the Aftermath of Financial Crises in Advanced Countries, 107 a.m. Econ. Rev. 3,072 (Oct. 2017). 598 See Exchange Act section 19(b) and Rule 19b– 4. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations changes and issues raised by such changes, including costs and benefits. ddrumheller on DSK120RN23PROD with RULES2 B. Baseline The baseline against which the costs, benefits, and the effects on efficiency, competition, and capital formation of the final rule are measured consists of the current state of the market for U.S. Treasury securities, including the repo market, current practice as it relates to the purchase and sale of U.S. Treasury securities, and the current regulatory framework. The economic analysis considers existing regulatory requirements, including recently adopted rules, as part of its economic baseline against which the costs and benefits of the final rule are measured.599 Certain commenters requested the Commission to consider interactions between the economic effects of the proposed rule and other recent Commission proposals.600 The Commission recently adopted six of the proposed rules mentioned by commenters as potentially impacting the economic effects of the final rule,601 599 See, e.g., Nasdaq v. SEC, 34 F.4th 1105, 1111– 15 (D.C. Cir. 2022). This approach also follows SEC staff guidance on economic analysis for rulemaking. See SEC Staff, Current Guidance on Economic Analysis in SEC Rulemaking (Mar. 16, 2012), available at https://www.sec.gov/divisions/riskfin/ rsfi_guidance_econ_analy_secrulemaking.pdf (‘‘The economic consequences of proposed rules (potential costs and benefits including effects on efficiency, competition, and capital formation) should be measured against a baseline, which is the best assessment of how the world would look in the absence of the proposed action.’’); id. at 7 (‘‘The baseline includes both the economic attributes of the relevant market and the existing regulatory structure.’’). The best assessment of how the world would look in the absence of the proposed or final action typically does not include recently proposed actions, because that would improperly assume the adoption of those proposed actions. 600 Letter from Eric Pan, Pres. & CEO, and Susan Olsen, General Counsel, Investment Company Institute at 1 (Aug. 17, 2023) (‘‘ICI Letter 2’’) (‘‘The Commission has issued a wide range of interconnected rule proposals . . . [that] in the aggregate warrant further analysis by the Commission.’’); Letter from Jennifer W. Han, Executive Vice President, Chief Counsel & Head of Global Regulatory Affairs, Managed Funds Association at 6 (July 21, 2023) (‘‘MFA Letter 2’’) (‘‘the Commission should holistically examine all of the pending Proposals, consider the potential overlap between them, and . . . evaluat[e] the costs and benefits of the Proposals in light of one another.’’); see also ARB et al. Letter, supra note 81, at 9 (‘‘the Commission has simultaneously put forward multiple proposals designed to achieve [ ] objectives without considering how these various proposals interact with each other.’’); cf. AIMA Letter II, supra note 115, at 4 (‘‘Together, the Treasury Clearing Proposal and ATS Proposal render the [then-proposed amendments to the definition of dealer] unnecessary.’’). 601 Those six proposals are: Amendments to Form PF to Require Current Reporting and Amend Reporting Requirements for Large Private Equity Advisers and large Liquidity Fund Advisers, Release No. IA–5950 (Jan. 26, 2022) 87 FR 9106 (Feb 17, VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 namely the May 2023 SEC Form PF Amending Release,602 Private Fund Advisers Adopting Release,603 Beneficial Ownership Amending Release,604 the Rule 10c–1a Adopting Release,605 the Short Position Reporting 2022) (see MFA Letter 2, supra note 600, at 10–12); Modernization of Beneficial Ownership Reporting, Release Nos. 33–11030, 34–94211 (Feb. 10, 2022), 87 FR 13846 (Mar. 10, 2022) (see MFA Letter 2, supra note 600, at 14–15); Short Position and Short Activity Reporting by Institutional Investment Managers, Release No. 34–94313 (Feb. 25, 2022), 87 FR 14950 (Mar. 16, 2022) (see MFA Letter 2, supra note 600, at 15–16); Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews, Release No. IA–5955 (Feb. 9, 2022), 87 FR 16886 (Mar. 24, 2022) (see MFA Letter 2, supra note 600, passim); Prohibition Against Conflicts of Interest in Certain Securitizations, Release No. 33–11151 (Jan. 25, 2023), 88 FR 9678 (Feb. 14, 2023) (see MFA Letter 2, supra note 600, at 21–22); Outsourcing by Investment Advisers, Release No. IA–6176 (Oct. 26, 2022), 87 FR 68816 (Nov. 16, 2022) (see MFA Letter 2, supra note 600, at 17–18). 602 Form PF; Event Reporting for Large Hedge Fund Advisers and Private Equity Fund Advisers; Requirements for Large Private Equity Fund Adviser Reporting, Release No. IA–6297 (May 3, 2023) 88 FR 38146 (June 12, 2023) (‘‘May 2023 SEC Form PF Amending Release’’). The Form PF amendments require large hedge fund advisers and all private equity fund advisers to file reports upon the occurrence of certain reporting events. The compliance dates are Dec. 11, 2023, for the event reports in Form PF sections 5 and 6, and June 11, 2024, for the remainder of the Form PF amendments. 603 Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews, Release No. IA–6383 (Aug. 23, 2023), 88 FR 63206 (Sept. 14, 2023) (‘‘Private Fund Advisers Adopting Release’’). The Private Fund Advisers Adopting Release includes new rules designed to protect investors who directly or indirectly invest in private funds by increasing visibility into certain practices and restricting other practices, along with amendments to the Advisers Act books and records rule and compliance rule. The amended Advisers Act compliance provision for registered investment advisers has a Nov. 13, 2023, compliance date. The compliance date is Mar. 14, 2025, for the rule’s quarterly statement and audit requirements for registered investment advisers with private fund clients. For the rule’s adviser-led secondaries, restricted activity, and preferential treatment requirements, the compliance date is Sept. 14, 2024, for larger advisers and Mar. 14, 2025, for smaller advisers. See Private Fund Advisers Adopting Release, sections IV, VI.C.1. 604 Modernization of Beneficial Ownership Reporting, Release No. 33–11253 (Oct. 10, 2023), 88 FR 76896 (Nov. 7, 2023) (‘‘Beneficial Ownership Amending Release’’). Among other things, the amendments shorten the filing deadlines for beneficial ownership reports filed on Schedule 13D and Schedule 13G. The compliance dates are 90 days after publication in the Federal Register, for Schedule 13D amended filing deadlines; Sept. 30, 2024, for the Schedule 13G amended filing deadlines; and Dec. 18, 2024, for the structured data requirement. 605 Reporting of Securities Loans, Release No. 34– 98737 (Oct. 13, 2023), 88 FR 75644 (Nov. 3, 2023) (‘‘Rule 10c–1a Adopting Release’’). The securities loan reporting rule requires any person who loans a security on behalf of itself or another person to report information about securities loans to a registered national securities association (namely, FINRA) and requires FINRA to make certain information it receives available to the public. The PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 2775 Adopting Release,606 and the Securitizations Conflicts Adopting Release.607 These rules were not included as part of the baseline in the Proposing Release because they had not been adopted at that time. In response to commenters, this economic analysis considers potential economic effects arising from any overlap between the compliance period for the final amendments and these recently adopted rules.608 1. U.S. Treasury Securities U.S. Treasury securities are direct obligations of the U.S. Government issued by the U.S. Department of the Treasury. After issuance in the primary market U.S. Treasury securities trade in covered persons will include market intermediaries, securities lenders, broker-dealers, and reporting agents. The final rule’s compliance dates require that FINRA propose its rules within four months of the effective date of final Rule 10c–1a, or approximately May 2024, and finalize them no later than 12 months after the effective date of final Rule 10c–1a, or approximately Jan. 2025; that FINRA implement data retention and availability requirements for reporting 24 months after the effective date of final Rule 10c–1a, or approximately Jan. 2026; that covered persons report Rule 10c–1a information to FINRA starting on the first business day thereafter; and that FINRA publicly report Rule 10c–1a information within 90 calendar days thereafter, or approximately Apr. 2026. See Rule 10c–1a Adopting Release, section VIII, at 75691. 606 Short Position and Short Activity Reporting by Institutional Investment Managers, Release No. 34– 98738 (Oct. 13, 2023), 88 FR 75100 (Nov. 1, 2023) (‘‘Short Position Reporting Adopting Release’’). The new rule and related form are designed to provide greater transparency through the publication of short sale-related data to investors and other market participants. Under the new rule, institutional investment managers that meet or exceed certain specified reporting thresholds are required to report, on a monthly basis using the related form, specified short position data and short activity data for equity securities. The compliance date for the rule is 12 months after the effective date of the release, which will be approximately Jan. 2025. In addition, the Short Position Reporting Adopting Release amends the national market system plan governing CAT to require the reporting of reliance on the bona fide market making exception in the Commission’s short sale rules. The compliance date for the CAT amendments is 18 months after the effective date, or approximately July 2025. 607 Prohibition Against Conflicts of Interest in Certain Securitizations, Release No. 33–11254 (Nov. 27, 2023), 88 FR 85396 (Dec. 7, 2023) (‘‘Securitizations Conflicts Adopting Release’’). The new rule prohibits an underwriter, placement agent, initial purchaser, or sponsor of an asset-backed security (ABS) (including a synthetic ABS), or certain affiliates or subsidiaries of any such entity, from engaging in any transaction that would involve or result in certain material conflicts of interest. The compliance date is 18 months after publication in the Federal Register, or June 9, 2025. 608 In addition, commenters indicated there could also be overlapping compliance costs between the final amendments and proposals that have not been adopted. See, e.g., ICI Letter 2, supra note 600, at 8 n.13. To the extent those proposals are adopted, the baseline in those subsequent rulemakings will reflect the existing regulatory requirements at that time. E:\FR\FM\16JAR2.SGM 16JAR2 2776 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations an active secondary market.609 A number of types of market participants intermediate between investors in U.S. Treasury securities. These investors hold U.S. Treasury securities as a relatively riskless way of saving, as a way of placing a directional bet on interest rates, or as a means of hedging against deflation. U.S. Treasury securities can also function directly as U.S. Treasury securities have consistently made up approximately 3% of the total value of all marketable U.S. Treasury securities during the 2012– 2022 period, but, as Figure 3 shows, account for a disproportionate share of trading volume. Thus, an on-the-run security is generally far more liquid than a similar off-the-run security. a medium of exchange in some instances, and, as described in more detail below, as collateral for loans. Market participants refer to the most recently issued U.S. Treasury securities as ‘‘on-the-run,’’ with earlier issues referred to as ‘‘off-the-run’’.610 Figure 1 shows the outstanding value of on-therun (Panel A) and off-the-run (Panel B) U.S. Treasury securities. On-the-run Figure 1: On-the-run and off-the-run U.S. Treasury securities (trillions? Panel 8: Off-the-run ll'easury Securities Panel A-. On-the-run ll'easury Securities 1- I ,. . l year or less I 2-lOyears 20 <lOyears I 0.6 !l!GIII l year or less 2-lOyears l o.s - <lOyears I 1- lo.4 15 i 1: 10 5 o.i 0.0 I 1- 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2012 2013 2014 2015 2016 2017 2018 2019 2020 20212022 Source: Calculated from U.S. Treasury Monthly Statement of the Public Debt (MSPD). See Dep't of the Treas., MSPD (2023), available at https://fiscaldata.treasury.gov/datasets/monthly-statement-publicdebt/detail-of-marketable-treasury-securities-outstanding. As of November 2023, the total market value outstanding of marketable U.S. Treasury securities held by the public was $26.3 trillion.611 As shown in Figure 2, the value of marketable U.S. Treasury securities outstanding has increased by approximately $19 trillion since 2000. The total amount of marketable U.S. Treasury securities issued during 2022 was $17.4 trillion.612 609 There is also an active market for U.S. Treasury securities that trade on a ‘‘when-issued’’ (WI) basis. ‘‘Based on Treasury TRACE transactions data, WI trading volume averaged $80 billion per day between July 1, 2019, and June 30, 2020, accounting for 12% of the $651 billion traded daily across all Treasury securities.’’ See Michael Fleming, Or Shachar, and Peter Van Tassel, Treasury Market When-Issued Trading Activity, Liberty Street Economics Blog (Nov. 30, 2020), available at https:// libertystreeteconomics.newyorkfed.org/2020/11/ treasury-market-when-issued-trading-activity/. As discussed in the Proposing Release, supra note 14, 87 FR at 64615, for purposes of this rulemaking only the WI market after the auction but before issuance (WI on-the-run issues) is considered part of the secondary market for U.S. Treasury securities. Most of the WI trading in the Fleming, Shachar, and Van Tassel analysis occurred in onthe-run issues. (‘‘WI trading that occurs up to and including the auction day (account[s] for about onethird of WI trading) and WI trading that occurs after the auction day (account[s] for about two-thirds of WI trading’’).) For a discussion of how WI trading functions in the context of central clearing, see Kenneth D. Garbade & Jeffrey F. Ingber, The Treasury Auction Process: Objectives, Structure, and Recent Adaptations, 11 Current Issues Econ. & Fin. 1 (2005), available at https:// www.newyorkfed.org/medialibrary/media/research/ current_issues/ci11-2.html. 610 On-the-run U.S. Treasury securities are the most recently auctioned nominal coupon securities. These securities are referred to as ‘‘on-the-run’’ starting the day after they are auctioned. Nominal coupon securities pay a fixed semi-annual coupon and are currently issued at original maturities of 2, 3, 5, 7, 10, 20, and 30 years. These standard maturities are commonly referred to as ‘‘benchmark’’ securities because the yields for these securities are used as references to price a number of private market transactions. 611 See SIFMA US Treasury Securities Statistics, available at https://www.sifma.org/resources/ research/us-treasury-securities-statistics/. 612 U.S. Treasury, Debt Position and Activity Report (July 31, 2023), available at https:// www.treasurydirect.gov/government/public-debtreports/debt-position-and-activity-report/. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 E:\FR\FM\16JAR2.SGM 16JAR2 ER16JA24.000</GPH> ddrumheller on DSK120RN23PROD with RULES2 a Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations 2777 Figure 2: Market Value of Marketable U.S. Treasury Securities Outstanding Over Timea -g "c::' 15 -t----------------------,"""'------ l:'.! 10 .!!! +-------------,______________ ·;:: t:. o0 0 .... 9 0 0 0 N m ....90 0 N Ll'l 9 N 0 0 N ..... O'I 9 9 (Yl 0 0 N <:t 0 0 N .... .... (Yl Ll'l ..... '7 9 9 9 9 ..... Ll'l 00 O'I 0 .... 0 0 N 0 0 N 0 0 N 0 0 N 0 N ........ .... m ..... ........ .... ........0' ....N ....~ 0....' ....9ID 9......... ....900 ....' ....9 0 0 0 0 0 0 0 0 0 Ll'l O'I O'I LI') N N N N O'I N N N N (Yl 9 N Ll'l 9 m N N N N N N 0 0 • Source: Federal Reserve Bank of Dallas, Market Value of Marketable Treasury Debt In the primary market, the Treasury Department auctions securities (i.e., debt) to the public through a competitive bidding process and subsequently issues awarded securities to finance the Federal Government.613 Financial institutions designated by the Federal Reserve Bank of New York as ‘‘primary dealers’’ are expected to submit competitive bids on a pro-rata basis and participate meaningfully in all U.S. Treasury auctions at reasonably competitive rates or yields.614 The Treasury Department typically issues U.S. Treasury securities a few days after the auction and trade on the secondary market.615 The subsequent trading of U.S. Treasury securities is defined as the secondary market. Figure 3 reports weekly trading values in the secondary market for U.S. Treasury securities. According to industry reports, 67% of the $913.2 billion in average daily trading volume of U.S. fixed income securities in 2022 was in U.S. Treasury securities.616 As shown in Figure 3, average weekly trading volume was approximately $3 trillion in 2022, with notable peaks in March 2020 and early 2021.617 613 TMPG White Paper, supra note 13, at 6. The Federal Reserve Bank of New York serves as fiscal agent for the U.S. Treasury in conducting auctions of marketable U.S. Treasury debt. See 12 U.S.C. 391. 614 See Federal Reserve Bank of New York, Administration of Relationships with Primary Dealers, available at https://www.newyorkfed.org/ markets/primarydealers.html. Specifically, primary dealers are required to be either (1) a registered broker-dealer or government securities brokerdealer, which is approved as a member of the Financial Industry Regulatory Authority, Inc. and has net regulatory capital of at least $50 million, or (2) a state or federally chartered bank or savings association (or a state or federally licensed branch or agency of a foreign bank) that is subject to bank supervision and maintains at least $1 billion in Tier 1 capital. Id. Thus, for those primary dealers that fall into the former category, they are a subset of the broader set of registered broker-dealers or government securities broker-dealers. 615 The Treasury Department typically announces a new security that it intends to sell several days before the auction at which it is first sold to the public. These securities begin trading after announcement before the auction and through issuance, which occurs a few days after the auction. Such trading is known generally as ‘‘when-issued’’ trading; however, in the timeframe between the announcement and the auction, such trading is known as when-issued and referred to as such by market participants, but after the auction and before issuance, the securities are typically referred to simply as on-the-run, consistent with market practice. See Fleming et. al. supra note 609. 616 Another 26% was Agency MBS, 4% corporate debt, with the remainder in municipal, non-agency mortgage-backed, Federal agency debt and assetbacked securities. SIFMA, US Fixed Income Securities Statistics (last updated Aug. 7, 2023), available at https://www.sifma.org/resources/ research/us-fixed-income-securities-statistics/. 617 Id. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 PO 00000 Frm 00065 Fmt 4701 Sfmt 4700 E:\FR\FM\16JAR2.SGM 16JAR2 ER16JA24.001</GPH> ddrumheller on DSK120RN23PROD with RULES2 [MVMTD027MNFRBDAL], retrieved from FRED, Federal Reserve Bank of St. Louis, available at https://fred.stlouisfed.org/series/MVMTD027MNFRBDAL (retrieved on Aug. 7, 2023). 2778 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations Figure 3: Weekly trading volume in U.S. Treasury securities cash marketa ■ Bills and FRNs Off•the-run !II! On-the-run 6000 ■ 5000 ~ 4000 ~ e 3000 ~ 11:1 ~ 2000 0 1000 • Source: TRACE Weekly Aggregate Statistics, available at https://www.finra.org/finra-data/browse-catalog/abouttreasury/weekly-data. Floating Rate Notes ("FRNs") are U.S. Treasury Securities with a maturity of two years at issuance, pay interest four times each year and have an interest rate that may change over time. Treasury bills are 2. U.S. Treasury Repurchase Transactions A U.S. Treasury repurchase transaction generally refers to a transaction in which one market participant sells a U.S. Treasury security to another market participant and commits to repurchase the security at a specified price on a specified later date.618 Because one side of the transaction receives cash, and the other side receives securities, to be returned at a later date, the transaction is a sale and purchase of securities that is economically similar to borrowing cash against securities as collateral. The amount the lender pays for the security in the initial leg may be less than the market price. The difference between the market price and the price paid divided by the market price of the collateral is known as the ‘‘haircut.’’ A positive haircut implies that the loan is over-collateralized: the collateral is worth more than the cash that is loaned. A related term is ‘‘initial margin’’—the ratio of the purchase price to the market value of the collateral. General collateral repurchases are an important variation on the above type of transaction, where one participant 618 See supra note 74. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 purchases from a class, not a specific issue, of U.S. Treasury securities.619 U.S. Treasury repo for a specific asset is generally a bilaterally settled arrangement, whereas general collateral repurchases are usually settled with a third agent, known as a triparty agent. In bilaterally settled repo arrangements (bilateral repo), the repo buyer has the title to the specific asset in question and can sell or re-hypothecate it. In repo that is settled through a triparty agent (triparty repo), which is discussed below, the repo buyer has more limited use of the collateral. However, this collateral is often re-hypothecated within the same triparty system; 619 More specifically, general collateral is a set of security issues which trade in the repo market at the same or a very similar repo rate. These security issues can therefore be substituted for one another without changing the repo rate. In other words, the buyer in a general collateral repo is indifferent to which of the general collateral securities she will receive. The basket of security issues that form a particular general collateral repo market belong to the same class (e.g., government bonds) or sub-class (e.g., government bonds with no more than five years remaining to maturity). See International Capital Market Association, [FAQ] 8. What is General Collateral (GC)?, ICMA ERCC Publications (Jan. 2019), available at https:// www.icmagroup.org/market-practice-andregulatory-policy/repo-and-collateral-markets/ icma-ercc-publications/frequently-asked-questionson-repo/8-what-is-general-collateral-gc. PO 00000 Frm 00066 Fmt 4701 Sfmt 4700 namely, a buyer may use the securities purchased from the seller for its own reverse repo transaction. As described in the Proposing Release, repurchase agreements are generally classified by the term over which they take place, either ‘‘overnight’’ or ‘‘term.’’ 620 In overnight repurchase agreements, the repurchase of the security takes place the day after the initial purchase, meaning that these agreements serve, essentially, as overnight loans collateralized by U.S. Treasury securities. Term repurchase agreements, conversely, take place over a longer horizon.621 U.S. Treasury repo has various economic uses. First, it is analogous to secured borrowing and lending, allowing some market participants to, in effect, turn their U.S. Treasury securities 620 See Proposing Release, supra note 14, 87 FR at 64616. 621 Overnight repurchase agreements account for 87.5% of daily transaction volume. See Figure 5 and the associated discussion for more details. In addition to term repo agreements with fixed maturity dates, there exist term repurchase agreements with embedded options that lead to an uncertain maturity date. For example, ‘‘callable’’ repos include an option for the lender to call back debt (i.e., resell securities) at its discretion. ‘‘Open’’ repos have no defined term but rather allow either party to close out at the contract at any date after initiation of the agreement. E:\FR\FM\16JAR2.SGM 16JAR2 ER16JA24.002</GPH> ddrumheller on DSK120RN23PROD with RULES2 short-dated debt with a maturity of one year or less, sold at a discount to face value, and that pay interest at maturity. Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations into cash positions, and others to temporarily invest cash that is not in use in a way that mitigates exposure to, for example, the counterparty risk of a depository institution. Bilateral repo can allow market participants to effectively price interest rate expectations into bonds, and to arbitrage differences in the market prices of closely related U.S. Treasury securities, because it provides financing for U.S. Treasury security purchases and facilitates short sales. Repos also play a role in monetary policy. The Federal Reserve operates a reverse repurchase facility in which it receives cash from eligible market participants in exchange for collateral consisting of U.S. Treasury securities. The interest rate on these repurchase agreements is the overnight reverse repurchase offer rate set by the Federal Reserve to aid implementation of monetary policy by firming up the floor for the effective Federal funds rate.622 There is some evidence of dealer concentration in repo markets. In a December 2019 report, the BIS reported that as repo rates rose above the interest rate on excess reserves in mid-2018, the four largest U.S. banks appeared to have turned into the marginal lender in repo markets.623 However, in 2021 the ddrumheller on DSK120RN23PROD with RULES2 622 See Federal Reserve Bank of New York, Monetary Policy Implementation, available at https://www.newyorkfed.org/markets/domesticmarket-operations/monetary-policyimplementation. 623 See Fernando Avalos, Torsten Ehlers and Egemen Eren, September stress in dollar repo markets: passing or structural?, BIS Q. Rev. (Dec. 2019), available at https://www.bis.org/publ/qtrpdf/ r_qt1912v.htm. Up to July 28, 2021, interest was paid at an IORR (interest on required reserves) rate and at an IOER (interest on excess reserves) rate. The IORR rate was paid on balances maintained to satisfy reserve balance requirements, and the IOER rate was paid on excess balances. Effective Mar. 24, 2020, the Board amended Regulation D to set all reserve requirement ratios for transaction accounts to 0%, eliminating all reserve requirements. To account for those changes, the Board approved a final rule amending Regulation D to replace references to an IORR rate and to an IOER rate with references to a single IORB (interest rate on required balance) rate. See Board of Governors of the Federal Reserve, Interest on Reserve Balances (IORB) Frequently Asked Questions (July 29, 2021), available at https://www.federalreserve.gov/ monetarypolicy/iorb-faqs.htm. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 Federal Reserve Bank of New York economists reported that the secured funding portion of the repo market is competitive.624 Using data on centrally cleared U.S Treasury repo transactions and all triparty settled transactions, the New York Fed economists filtered the data using the same filters used in the construction of SOFR in order to eliminate transactions likely driven by considerations other than secured funding and then reported measures of dealer concentration.625 The authors report that the top 5 (10) dealers comprise 44.2 (63.6) percent of repo selling (cash-lending) activity and 40.2 (56.7) percent of repo purchasing (cashborrowing) activity and conclude that the centrally cleared and triparty portion of the repo market is less concentrated than might appear from the BIS study.626 The market for repos is dominated by large, sophisticated institutions, at least as compared to the cash market. The institutions that participate in the market for repos are also those for whom access to central clearing may be the least costly economically. Relatedly, 624 Adam Copeland, R. Jay Kahn, Antoine Martin, Matthew McCormick, William Riordan, Kevin Clark, and Tim Wessel, How Competitive are U.S. Treasury Repo Markets?, Federal Reserve Bank of New York Liberty Street Economics (Feb. 18, 2021), available at https://libertystreeteconomics .newyorkfed.org/2021/02/how-competitive-are-ustreasury-repo-markets/#:∼:text=In%20 contrast%2C%20the%20GCF%20 Repo,both%20sides%20of%20the%20market. 625 Among other filters, transactions to which the Federal Reserve is a counterparty are excluded. See Additional Information about Reference Rates Administered by the New York Fed, Federal Reserve Bank of New York (Jan. 24, 2022), available at https://www.newyorkfed.org/markets/referencerates/additional-information-about-referencerates#treasury_repo_data_exclusions. 626 See supra note 623. The New York Fed makes available data on top 3 dealer concentration (see Tri-Party/GCF Repo, Federal Reserve Bank of New York, available at https://www.newyorkfed.org/ data-and-statistics/data-visualization/tri-partyrepo#interactive/concentration (last visited Dec. 12, 2023)) in the tri-party/GCF repo segment; however, the New York Fed’s statistics treat its own Overnight Reverse Repo Facility as a dealer. Since the use of this facility has grown from zero to $2.2 trillion since 2021 Q1, the New York Fed’s data on the concentration of the top 3 ‘‘dealers’’ is difficult to interpret and is not included here. PO 00000 Frm 00067 Fmt 4701 Sfmt 4700 2779 although difficult to quantify precisely, the number of participants is one or more orders of magnitude greater in the cash market as compared with the repo market: e.g., tens of thousands as opposed to thousands. As Figure 4 shows, the U.S. Treasury securities repurchase market is large; throughout 2020 and through May of 2021, daily transaction volume of repo that was either centrally cleared or settled on the triparty platform ranged between $1.4 and $2.1 trillion per day. Since May 2021, the daily volume has increased considerably—as high as $4.6 trillion per day—coinciding with the growth in the Federal Reserve’s overnight reverse repurchase operations. Figure 4 further splits these totals into three categories based on 3 of the 4 repo market components discussed in part IV.B.3.b supra: non-centrally cleared triparty, FICC DVP Service, and FICC GCF Repo Service.627 Despite steadily increasing volumes of centrally cleared repurchase transactions, due in part to the development of services to enable acceptance of more types of repurchase transactions at the covered clearing agency, the Commission understands that the volume of bilateral repurchase transactions that are cleared and settled directly between the two counterparties remains substantial, representing approximately half of all bilateral repurchase transactions in 2021.628 627 Figure 4 does not include bilateral repo transactions—including most inter-affiliate transactions—that are not settled on the tri-party platform or centrally cleared through FICC for which comprehensive data is not currently available. Trades resulting from the Federal Reserve Bank of New York’s standing repo facility and reverse repo facility are cleared and settled on the tri-party platform and are included in Figure 4. See Federal Reserve Bank of New York, FAQs: Standing Repo Facility (July 26, 2023), available at https:// www.newyorkfed.org/markets/repo-agreement-opsfaq and Federal Reserve Bank of New York, FAQs: Reverse Repurchase Agreement Operations (July 26, 2023), available at https://www.newyorkfed.org/ markets/rrp_faq. 628 See R. Jay Kahn & Luke M. Olson, Who Participates in Cleared Repo?, OFR Brief Series (July 8, 2021), available at https:// www.financialresearch.gov/briefs/files/OFRBr_2101_Repo.pdf. E:\FR\FM\16JAR2.SGM 16JAR2 2780 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations Figure 4: Daily U.S. Treasury Repurchase Transaction Volumea 5 Tri-party ■ GCF 4 fZI DVP vi" C: .2 3 ~ !:::.. "',._ ~ 0 2 0 1 ddrumheller on DSK120RN23PROD with RULES2 The triparty segment of the U.S. Treasury securities repurchase agreement market is large, with an average of approximately $575 billion of daily trading volume in 2020, and has taken on a substantially larger role since the beginning of 2021, peaking at approximately $3.1 trillion in transaction volume in the March of 629 See 630 See Figure 4. Figure 5. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 2023.629 Of this, overnight repos is the largest segment, making up 92% on average of daily transaction volume since 2020, as shown in Figure 5. Although different types of securities are used as collateral in triparty repos, over 70% of daily volume of triparty repo since 2020 are transactions with U.S. Treasury securities as collateral.630 The remainder are agency securities, referring to mortgage-backed securities issued by U.S government agencies and government sponsored enterprises, and various other securities including corporate bonds, non-U.S. sovereign debt, equity, municipal debt, and commercial paper.631 631 See Mark E. Paddrik, Carlos A. Ram(rez, & Matthew J. McCormick, The Dynamics of the U.S. Overnight Triparty Repo Market (FEDS Notes, Aug. 2, 2021), available at https:// www.federalreserve.gov/econres/notes/feds-notes/ the-dynamics-of-the-us-overnight-tripartyrepomarket-20210802.htm. PO 00000 Frm 00068 Fmt 4701 Sfmt 4700 E:\FR\FM\16JAR2.SGM 16JAR2 ER16JA24.003</GPH> • Figure 4 includes only transactions that are settled on the triparty platform or bilateral repo that is centrally cleared. Source: Office of Financial Research Short-term Funding Monitor - Data Sets, U.S. Repo Markets Data Release, refreshed daily, available at https://www.financialresearch.gov/short-term-funding-monitor/datasets/repo/. See also IAWG Report, supra note 4, at 29. Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations 2781 Figure 5: Triparty Repurchase Agreement Trading Volume, Splitsa Panel B: Collateral Type Panel A: Overnight vs. Term 4000 ~ 3500 ii:i 3000 2000 - II Corporate Debt 1----------➔nnl ■ OtherCollateral 1 - - - - - - - ~ ■ Agency Debt 1500 - - - - - - - - 1000 1000 500 500 0 0 Office of Financial Research Short-term Funding Monitor - Data Sets, U.S. Repo Markets Data Release, refreshed daily, available at https://www.fmancialresearch.gov/short-term-funding-monitor/datasets/repo/. 3. Clearance and Settlement of U.S. Treasury Security Transactions The secondary market includes the ‘‘cash market,’’ for outright purchases and sales of securities, and the repo market, where one participant sells a U.S. Treasury security to another participant and commits to repurchase the security at a specified price on a specified later date.632 These rule amendments and new rules apply to the secondary market for U.S. Treasury securities. a. Cash Market The cash market has two main components: the interdealer market and the dealer-to-customer market. In the interdealer market, dealers primarily trade with each other and with principal trading firms (‘‘PTFs’’), which trade as principals for their own accounts. In the dealer-to-customer market, dealers trade with their customers. 632 See 2021 IAWG Report, supra note 4, at 3. The secondary market also includes the market for U.S. Treasury futures, which trade electronically on the Chicago Board of Trade, a designated contract market operated by the Chicago Mercantile Exchange (‘‘CME’’) Group, and centrally cleared by CME Clearing. U.S. Treasury futures are generally regulated by the U.S. Commodity Futures Trading Commission. ddrumheller on DSK120RN23PROD with RULES2 ii:i 3000 2000 1500 VerDate Sep<11>2014 r;::::====:::;-------------- 2500 2500 a "' 4000 c: ~ 3500 C: 20:19 Jan 12, 2024 Jkt 262001 i. Interdealer The majority of trading in the interdealer market in on-the-run U.S. Treasury securities occurs on trading platforms operated by IDBs, as described in part II.A.2.b.ii, supra.633 These IDBs are generally direct participants of a U.S. Treasury securities CCA and stand as counterparties to both sides of each trade on their platforms.634 The majority of trades in the interdealer markets are trades in ‘‘onthe-run’’ issues. The majority of interdealer trading for off-the-run U.S. Treasury securities occurs via bilateral transactions through traditional voiceassisted brokers and electronic trading platforms offering various protocols to bring together buyers and sellers, although some interdealer trading in offthe-run U.S. Treasury securities does occur on IDBs that anonymously bring together buyers and sellers.635 Most IDBs are FICC direct participants, and the trades between an IDB, which is a FICC direct participant, and another FICC direct participant are submitted for central clearing to FICC, which, as discussed below, is currently the only U.S. Treasury securities CCA. Direct participants of FICC are generally 633 Joint Staff Report, supra note 4, at 11, 35–36. IAWG Report, supra note 4, at 21. 635 Joint Staff Report, supra note 4, at 35. 634 2021 PO 00000 Frm 00069 Fmt 4701 Sfmt 4700 either dealers (both bank-affiliated and independent) or banks. FICC’s current rules generally require that FICC direct participants submit for clearing all trades with other FICC direct participants.636 However, FICC’s rules do not require that a trade between a FICC direct participant and a party that is not a FICC direct participant be submitted for clearing. Therefore, for trades on IDBs between a party that is not a FICC direct participant (which, on an IDB, is generally a PTF) and a dealer that is a FICC direct participant—which results in two separate transactions, between the IDB and the dealer, on the one hand, and between the IDB and the PTF, on the other hand—the transaction between the dealer and the IDB would be centrally cleared. But the transaction between a PTF which is not a FICC member and the IDB, on the other side, would not be centrally cleared and instead would be settled bilaterally with the IDB, often through a clearing agent acting on behalf of the non-FICC direct participant.637 636 FICC Rule 2A section 7(e) (requirement that FICC Netting Members submit to FICC all of its eligible trades with other Netting Members); FICC Rule 18 section 2 (similar requirement with regard to Repo transactions), supra note 19. 637 See TMPG White Paper, supra note 13, at Figures 5A and 5B (providing graphical description of this type of clearing). E:\FR\FM\16JAR2.SGM 16JAR2 ER16JA24.004</GPH> II) 2782 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations Estimates from the first half of 2017 further suggest that only 13 percent of the cash transactions in the U.S. Treasury securities market are centrally cleared. These estimates suggest that another 19 percent of transactions in this market are subject to so-called hybrid clearing in which one leg of a transaction facilitated by an IDB platform is centrally cleared and the other leg of the transaction is cleared bilaterally.638 Until the mid-2000s, most inter-dealer trading occurred between primary dealers who were FICC members and thus was centrally cleared.639 Today, PTFs actively buy and sell large volumes of U.S. Treasury securities on an intraday basis using high-speed and other algorithmic trading strategies.640 PTFs are not generally FICC members and, as such, their trades are often not centrally cleared. Moreover, PTFs compose a substantial portion of trading volume, averaging about 20% of overall U.S. Treasury cash market volume and accounting for around 50–60% of IDB volume in outright purchases and sales of U.S. Treasury securities.641 Primary dealers, who are FICC members and who transact the 40–50% of IDB volume not accounted for by PTFs, are required by Federal Reserve Bank of New York policy to centrally clear their U.S. Treasury securities primary market cash activity.642 As Tables 1 and 2 below show, during the 6-month period ending in June 2023 trading volume of on-the-run U.S. Treasury securities was approximately two and half times that of off-the-run U.S. Treasury securities. Over half (57.9%) of on-the-run U.S. Treasury security trading volume and approximately one quarter (22.9%) of off-the-run U.S. Treasury security trading volume occurred on ATSs (which are also IDBs) and non-ATS IDBs.643 Of the on-the-run U.S. Treasury security trading volume that occurred on ATS IDBs and non-ATS IDBs, 34.0% were dealer trades, 18.4% were PTF trades, and the remainder were customer trades. For off-the-run trading in U.S. Treasury securities, the comparable figures are 19.0% dealer trades, 1.2% PTF trades, and the remainder are customer trades. In contrast to trades that take place on an ATS or a non-ATS IDB, 42.0% of onthe-run U.S. Treasury security transactions and 77.1% of off-the-run U.S. Treasury security transactions are traded bilaterally. The majority of these (78.5% of on-the-run and 84.3% of offthe-run) are dealer-to-customer trades. Bilaterally cleared trades make up 87% of total trading in the secondary U.S. Treasury securities market, making them the most prevalent trade type in the market.644 These trades include at least one party that is not a netting member of the single U.S. Treasury securities CCA. The bilateral clearing process comes with risks. After the trade is executed, the principals to the trade face counterparty credit risk, in the event that either party fails to deliver on its obligations.645 TABLE 1—ON-THE-RUN U.S. TREASURY SECURITIES TRADING VOLUME Number of venues ddrumheller on DSK120RN23PROD with RULES2 ATSs ........................................................................................................................................ Customer trades ............................................................................................................... Dealer trades .................................................................................................................... PTF trades ........................................................................................................................ Non-ATS Interdealer Brokers .................................................................................................. Customer trades ............................................................................................................... Dealer trades .................................................................................................................... Bilateral dealer-to-dealer trades .............................................................................................. Bilateral dealer-to-customer trades ......................................................................................... 638 See 2021 IAWG Report, supra note 4, at 30; see also TMPG White Paper, supra note 13, at 12. The figures are estimated using FR 2004 data covering the first half of 2017 and are based on various assumptions: (a) primary dealers account for all dealer activity, (b) 5% of dealers’ trading not through an IDB is with another dealer, (c) the shares of dealer and non-dealer activity in the IDB market for coupon securities equal the weighted averages of the shares reported in the Oct. 15 report (that is, 41.5% and 58.5%, respectively), (d) only dealers trade bills, FRNs, and TIPS in the IDB market, and (e) the likelihood of dealer and non-dealers trading with one another in the IDB market solely reflects their shares of overall volume. Commission staff understands that these assumptions may be less appropriate for more recent time periods (e.g., PTFs are responsible for a growing share of IDB activity). 639 See G–30 Report, supra note 5; 2021 IAWG Report, supra note 4, at 5–6; TMPG White Paper, supra note 13, at 6. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 640 See Joint Staff Report, supra note 4, at 1, 8, 32, 35–36, 39. 641 See James Collin Harkrader & Michael Puglia, Principal Trading Firm Activity in Treasury Cash Markets (FEDS Notes, Aug. 2020) (‘‘Harkrader and Puglia FEDS Notes’’), available at https:// www.federalreserve.gov/econres/notes/feds-notes/ principal-trading-firm-activity-in-treasury-cashmarkets-20200804.htm. 642 See Federal Reserve Bank of New York, Administration of Relationships with Primary Dealers, available at https://www.newyorkfed.org/ markets/primarydealers.html. 643 The term ‘‘IDB’’ typically refers only to IDBs that are also ATSs. The entities referred to as IDBs here are encompassed in the ATSs category in the tables set forth in this section because of the way that such IDBs are categorized in TRACE. Specifically, the ‘‘ATS’’ category in TRACE encompasses these IDBs. By contrast, the non-ATS IDBs category in TRACE encompasses the voicebased or other non-anonymous methods of bringing PO 00000 Frm 00070 Fmt 4701 Sfmt 4700 Average weekly volume ($M) 16 12 16 7 24 22 23 283 521 874,284 38,338 510,296 325,649 151,353 59,639 91,714 159,760 584,832 Volume share (%) 49.4 2.2 28.8 18.4 8.5 3.4 5.2 9.0 33.0 together buyers and sellers, which are also sometimes referred to as interdealer brokers by market participants. 644 TMPG White Paper, supra note 13, at 12. This figure is estimated from 2017H1 data and includes approximately 19% hybrid clearing. As reported by TMPG, the estimates are based on various assumptions: (a) primary dealers account for all dealer activity, (b) 5% of dealers’ trading not through an IDB is with another dealer, (c) the shares of dealer and non-dealer activity in the IDB market for coupon securities equal the weighted averages of the shares reported in the Oct. 15 report (that is, 41.5% and 58.5%, respectively), (d) only dealers trade bills, FRNs, and TIPS in the IDB market, and (e) the likelihood of dealer and non-dealers trading with one another in the IDB market solely reflects their shares of overall volume. Commission staff understands that these assumptions may be less appropriate for more recent time periods (e.g., PTFs are responsible for a growing share of IDB activity). 645 TMPG White Paper, supra note 13, at 13. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations 2783 TABLE 1—ON-THE-RUN U.S. TREASURY SECURITIES TRADING VOLUME—Continued Number of venues Total ........................................................................................................................... Average weekly volume ($M) ........................ 1,770,229 Volume share (%) 100.0 This table reports trading volume and volume share for ATSs,a Non-ATS interdealer brokers, bilateral dealer-to-dealer transactions, bilateral dealer-to-customer, and bilateral dealer-to-PTF transactions for on-the-run U.S. Treasury Securities. On-the-run U.S. Treasury Securities are the most recently issued nominal coupon securities and Treasury Inflation Protected Securities (TIPS). Nominal coupon securities pay a fixed semiannual coupon and are currently issued at original maturities of 2, 3, 5, 7, 10, 20, and 30 years. Treasury Bills and Floating Rate Notes are excluded. Volume is the average weekly dollar volume in par value (in millions of dollars) over the six-month period, from Jan. 1, 2023, to June 30, 2023.b Number of Venues is the number of different trading venues in each category and the number of distinct MPIDs for bilateral transactions.c Volume Share (%) is the measure of the dollar volume as a percent of total dollar volume.d The volumes of ATSs and non-ATS interdealer brokers are broken out by Customer trades, Dealer trades, and PTF trades within each group.e Data is based on the regulatory version of TRACE for U.S. Treasury Securities from Jan. 1, 2023, to June 30, 2023. Bilateral trades are a catchall classification that may include trades conducted via bilateral negotiation, as well as trades conducted electronically via platforms not registered with FINRA as an ATS. a This analysis is necessarily limited to transactions reported to TRACE, which may not be all transactions in U.S. Treasury securities. Transactions that take place on non-FINRA member ATSs or between two non-FINRA members are not reported to TRACE. Entities in the ATS TRACE category encompass the IDBs described in the preamble of this release. By contrast, the non-ATS IDB category in TRACE encompasses the voice-based or other non-anonymous methods of bringing together buyers and sellers. PTFs that are FINRA members are included as dealers while PTFs refer to PTFs that are not FINRA members. See Proposing Release note 43 and referencing text. b FINRA reports volume as par volume, where par volume is the volume measured by the face value of the bond, in dollars. See relevant weekly volume files, available at https://www.finra.org/filing-reporting/trace/data/trace-treasury-aggregates. c Dealers are counted using the number of distinct MPIDs. d Total dollar volume (in par value) is calculated as the sum of dollar volume for ATSs, non-ATS interdealer brokers, bilateral dealer-to-dealer transactions, and bilateral dealer-to-customer transactions. e We identify ATS trades and non-ATS interdealer broker trades using MPID. The regulatory version of TRACE for U.S. Treasury securities includes an identifier for customer and interdealer trades. Furthermore, we use MPID for non-FINRA member subscriber counterparties in the regulatory version of TRACE for U.S. Treasury securities to identify PTF trades on ATSs. TABLE 2—OFF-THE-RUN U.S. TREASURY SECURITIES TRADING VOLUME Number of venues Average weekly volume ($M) Volume share (%) ATSs ........................................................................................................................................ Customer trades ............................................................................................................... Dealer trades .................................................................................................................... PTF trades ........................................................................................................................ Non-ATS Interdealer Brokers .................................................................................................. Customer trades ............................................................................................................... Dealer trades .................................................................................................................... Bilateral dealer-to-dealer trades .............................................................................................. Bilateral dealer-to-customer trades ......................................................................................... 13 9 13 5 24 19 22 568 732 126,489 10,713 107,304 8,472 34,796 7,967 26,829 85,178 458,070 18.0 1.5 15.2 1.2 4.9 1.1 3.8 12.1 65.0 Total ........................................................................................................................... ........................ 704,533 100.0 ddrumheller on DSK120RN23PROD with RULES2 This table reports trading volume and volume share for ATSs,a non-ATS interdealer brokers, bilateral dealer-to-dealer transactions, bilateral dealer-to-customer, and bilateral dealer-to-PTF transactions for off-the-run U.S. Treasury Securities. Off-the-run or ‘‘seasoned’’ U.S. Treasury Securities include TIPS, STRIPS, and nominal coupon securities issues that preceded the current on-the-run nominal coupon securities. Number of Venues is the number of different trading venues in each category and the number of distinct MPIDs for bilateral transactions. Volume is the average weekly dollar volume in par value (in millions of dollars) over the six-month period, from Jan. 1, 2023, to June 30, 2023. Volume Share (%) is the measure of the dollar volume as a percent of the total dollar volume. The volumes of ATSs and non-ATS interdealer brokers are broken out by Customer trades, Dealer trades, and PTF trades within each group.b Data is based on the regulatory version of TRACE for U.S. Treasury Securities from Jan. 1, 2023, to June 30, 2023. Bilateral trades are a catchall classification that may include trades conducted via bilateral negotiation, as well as trades conducted electronically via platforms not registered with FINRA as an ATS. a The analysis based on TRACE is necessarily limited to transactions reported to TRACE, which may not be all transactions in government securities. Transactions that take place on non-FINRA member ATSs or between two non-FINRA members are not reported to TRACE. The analysis based on TRACE is necessarily limited to transactions reported to TRACE, which may not be all transactions in government securities. Transactions that take place on non-FINRA member ATSs or between two non-FINRA members are not reported to TRACE. Entities in the ATS TRACE category encompass the IDBs described in the preamble of this release. By contrast, the non-ATS IDB category in TRACE encompasses the voice-based or other non-anonymous methods of bringing together buyers and sellers. PTFs that are FINRA members are included as dealers while PTFs refer to PTFs that are not FINRA members. See Proposing Release note 43 and referencing text. b We identify ATS trades and non-ATS interdealer broker trades using MPID in the regulatory version of TRACE for U.S. Treasury securities. The regulatory version of TRACE for U.S. Treasury securities includes an identifier for customer and interdealer trades. Furthermore, we use MPID for non-FINRA member subscriber counterparties in the regulatory version of TRACE for U.S. Treasury Securities to identify PTF trades on ATSs. ii. Dealer-to-Customer Dealer-to-customer trading generally involves ‘‘off-the-run’’ issues more often than the interdealer market and typically is conducted via voice or electronically (i.e., electronic ‘‘request for quote’’ systems referred to in Tables VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 1 and 2, supra as non-ATS IDBs).646 Trading in the dealer-to-customer cash market is generally—and has historically been—conducted through bilateral transactions. Customers have not traditionally traded directly with other end users.647 Rather, non-dealers primarily trade with dealers, and dealers use the interdealer market as a source of orders and trading interest to 646 G–30 Report, supra note 5, at 1; TMPG White Paper, supra note 13, at 1–2. 647 See Exchange Act Release No. 90019 (Sept. 28, 2020), 85 FR 87106, 87108 (Dec. 30, 2020). PO 00000 Frm 00071 Fmt 4701 Sfmt 4700 E:\FR\FM\16JAR2.SGM 16JAR2 2784 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations help facilitate their trading with customers in the dealer-to-customer market. Generally, trades in the dealerto-customer market are not centrally cleared.648 In cash U.S. Treasury security transactions that are bilaterally cleared, the process generally begins with participants initiating the trade by an electronic or voice trading platform, and both parties booking the details of the trade in their internal systems and confirming the details of the trade with one another. Once the details are confirmed, each party then sends messages to its clearing or settlement agents to initiate the clearing process. Different types of institutions use different clearing and settlement agents, with buy-side firms typically using custodial banks, dealers using clearing banks, and hedge funds and PTFs using prime brokers. b. U.S. Treasury Repo Market Depending on clearing and settlement practices, the U.S. Treasury repo market consists of four main components: (1) non-centrally cleared, settled bilaterally, (2) centrally cleared, settled bilaterally, (3) non-centrally cleared, settled on a triparty platform, and (4) centrally cleared, settled on a triparty platform. The Office of Financial Research has collected transaction level data for centrally cleared repo transactions since October 2019, and the New York Fed collects data on triparty repo transactions through its supervisory role. However, as discussed in part II.A.2.a supra, the lack of reporting of non-centrally cleared bilateral repo makes estimating the size of this segment of the repo market difficult. ddrumheller on DSK120RN23PROD with RULES2 i. Non-Centrally Cleared Bilateral Repo For non-centrally cleared bilateral U.S. Treasury repos, the parties agree to the terms and settle the trades between themselves, without involving a CCP or other third-party. As mentioned above, FICC’s rules require its direct participants to submit for central clearing all eligible trades with other direct participants. Therefore, noncentrally cleared bilateral U.S. Treasury repos may involve at least one party that is not a FICC direct participant (e.g., a hedge fund or PTF); alternatively, or additionally, such repos may also involve a transaction type that FICC does not accept for clearing. In January of 2022, the Federal Reserve Bank of New York updated its primary dealer statistics to capture the 648 G–30 Report, supra note 5, at 1; 2021 IAWG Report, supra note 4, at 3; TMPG White Paper, supra note 13, at 6. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 segments of the repo market used by primary dealers. On average during the first three quarters of 2022, the noncentrally cleared bilateral market made up $1.19 trillion of primary dealer reverse repo (60% of the total) and $0.94 trillion of primary dealer repo (37% of the total).649 At more than $2 trillion in total exposure, this would make noncentrally cleared bilateral repo the largest segment of the repo market in gross exposure by primary dealers. The Office of Financial Research (OFR) conducted a pilot collection of data on non-centrally cleared bilateral repurchase agreement trades spanning nine dealers over three reporting dates in June 2022.650 Using that pilot data collection, the OFR finds that with regard to rates, counterparty types, and collateral, pilot participants’ activity in the non-centrally cleared bilateral repo segment roughly mirrors their activity in the centrally cleared bilateral segment.651 However, as discussed in part IV.B.5 infra, haircuts in this segment differ from those in the centrally cleared segments.652 ii. Centrally Cleared Bilateral Repo For centrally cleared bilateral U.S. Treasury repos, for parties that are FICC direct participants, each party submits agreed-upon trade details to FICC for central clearing, and those trades are settled delivery versus payment using the members’ clearing banks and/or Fedwire Securities Service. Market participants that are not direct participants of FICC may access central clearing through a customer model, such as the Sponsored Service or the Prime Broker/Correspondent clearing models.653 Although a U.S. Treasury repo transaction generally encompasses both the start leg and the end leg of a U.S. Treasury repo, currently the only U.S. Treasury securities CCA does not provide central clearing for the start leg of certain transactions.654 Central clearing of U.S. Treasury repo is further discussed below. Data on the extent of central clearing in the U.S. Treasury securities market is limited. As discussed previously, the Commission believes that 649 See Hempel et al. (2022), supra note 563. 650 The OFR has a proposed rulemaking that mandates the collection of daily transaction level data from certain financial companies on their noncentrally cleared bilateral repurchase agreement trades. See supra note 564. 651 See Hempel et al. (2023), supra note 564, at 1. 652 Id. at 3. 653 See Proposing Release, supra note 14, 87 FR at 64616. 654 FICC Rule 11, section 2, supra note 19. PO 00000 Frm 00072 Fmt 4701 Sfmt 4700 approximately half of bilateral repo trades are centrally cleared.655 iii. Non-Centrally Cleared Repo Settled on a Triparty Platform For non-centrally cleared triparty U.S. Treasury repos, repo buyers (cash lenders (e.g., money market funds)) provide financing to repo sellers (cash borrowers (e.g., dealers)). The parties agree to the terms of a trade and arrange for a clearing bank to facilitate settlement. Like non-centrally cleared bilateral repos, at least one party to the transaction is not a FICC member. While the clearing bank provides a triparty platform to help facilitate the movement of cash and securities among accounts of counterparties to the transaction, it does not itself become a counterparty to the transactions and does not guarantee either counterparty’s performance of its obligations. Collateral posted to the triparty platform generally cannot be repledged outside the platform, thereby protecting against settlement fails.656 iv. Centrally Cleared Repo Settled on a Triparty Platform For centrally cleared U.S. Treasury triparty repos, the parties are FICC members that submit agreed-upon trade details to FICC for central clearing through FICC’s General Collateral Finance (‘‘GCF’’) Repo Service. Unlike centrally cleared bilateral repos, these triparty repos are settled on the clearing bank’s triparty platform. Like centrally cleared bilateral repos, centrally cleared triparty repos are novated to FICC, and FICC acts as a CCP for these transactions, including by collecting margin pursuant to its margin methodology for such transactions. Until recently, centrally cleared triparty repos were only conducted through the GCF Repo Service between two direct members of FICC. However, in September 2021, FICC introduced its Sponsored General Collateral Service (‘‘Sponsored GC Service’’), which enables centrally cleared triparty repos between a sponsored member and its sponsoring member.657 The Sponsored GC Service accepts general collateral in a number of generic CUSIPs, and though U.S. Treasury securities are among the 655 See part IV.B.3.b.i, supra. See also note 75, supra. 656 See generally Reference Guide to U.S. Repo and Securities Lending Markets (Nov. 9, 2015), available at https://www.financialresearch.gov/ working-papers/files/OFRwp-2015-17_ReferenceGuide-to-U.S.-Repo-and-Securities-LendingMarkets.pdf. 657 Exchange Act Release No. 92808 (Aug. 30, 2021), 86 FR 49580 (Sept. 3, 2021). Currently, the Bank of New York Mellon operates the triparty platform that facilitates trades conducted via the GCF Repo Service and Sponsored GC Service. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations general collateral types acceptable in the Sponsored GC Service, other types of collateral including agency and mortgage backed securities are acceptable for use as collateral as well.658 Each type of eligible collateral for the Sponsored GC Service is assigned its own generic CUSIP number, and security types are not mixed.659 ddrumheller on DSK120RN23PROD with RULES2 v. Inter-Affiliate Repo Current FICC rules require the submission of transactions of a netting member’s ‘‘Covered Affiliate’’ with another FICC netting member where a Covered Affiliate is defined as an affiliate of a netting member that: (1) is not itself a netting member; (2) is not a foreign person; and (3) is a brokerdealer, bank, trust company, and/or FCM, if that transaction is with another netting member or a Covered Affiliate of another netting member.660 FICC rules do not require the submission of transactions between (1) a netting member and an affiliate or (2) between a netting member’s affiliates. The Commission understands that inter-affiliate repo transactions represent an important tool to transfer liquidity and risk within an affiliated group. These transactions may serve different purposes, including, but not limited to, providing U.S. Treasury securities for delivery when an affiliate has taken a long or short position in U.S. Treasury securities as a hedge against other exposures, allowing the movement of U.S. Treasury securities to allow them to be posted as margin on an affiliate’s transaction, ensuring that U.S. Treasury securities can serve as a liquidity buffer for an affiliated bank,661 or to meet liquidity composition targets. To get the U.S. Treasury securities to the appropriate entity with an affiliated group, the affiliate often enters into repos or reverse repos with a direct participant of a U.S. Treasury securities CCA. Using assets and liabilities data reported by the five largest U.S. brokerdealers in their 2022 annual audited 658 See generally DTCC Sponsored General Collateral Service (‘‘DTCC SGCS’’), available at https://www.dtcc.com/-/media/Files/Downloads/ Clearing-Services/FICC/GOV/SponsoredGC-FSINTL.pdf (last visited Dec. 11, 2023). 659 Id. 660 GSD Rule 11, Section 3 (along with Rule 1 for the definition of a Covered Affiliate), supra note 19. 661 A liquidity buffer generally refers to liquid assets that a banking organization manages to enable it to meet expected and unexpected cash flows and collateral needs without adversely affecting the banking organization’s daily operations. See generally FRB, FDIC, & OCC, Q&As on Statement Regarding the Use of Capital and Liquidity Buffers (Mar. 17, 2020), available at https://www.fdic.gov/news/financial-institutionletters/2020/fil20020a.pdf. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 financial statements, the Commission observed that the value of repo and reverse repo from inter-affiliate transactions ranges from 25–75% of total repo and reverse repo reported at the end of year. 4. Central Clearing in the U.S. Treasury Securities Market Currently, FICC is the sole provider of clearance and settlement services for U.S. Treasury securities.662 On July 18, 2012, FSOC designated the FICC as a systemically important financial market utility under Title VIII of the U.S. DoddFrank Act. FSOC assigned this designation on the basis that a failure or a disruption to FICC could increase the risk of significant liquidity problems spreading among financial institutions or markets and thereby threaten the stability of the financial system in the United States. Should a trade be centrally cleared, the CCP receives a notice of the executed trade from both parties, and after comparison (i.e., matching of the trade details), the CCP guarantees and novates the contract, where novation refers to the process by which the CCP becomes the counterparty to both the buyer and seller in the original trade. Once the trading day ends and all trades have been reported to the CCP (i.e., end of T+0), the CCP determines its net obligations to each CCP participant for each security and communicates the resulting settlement obligations to the counterparties. The participants then have the obligation to settle their portion of the trade on T+1. Once this information is communicated, the participants send instructions to their settlement agents. In contrast to the bilateral case, central clearing reduces the credit risk that both parties are exposed to throughout the trade. While at execution both CCP members hold the usual counterparty credit risk to one another, this risk is transformed, generally within minutes of trade execution, when the trade details are sent to the CCP and the CCP guarantees and novates the trade. Consequently, both parties to the trade now hold centrally cleared credit risk, and the CCP has counterparty risk to both members. Direct membership in FICC typically consists of banks and registered dealers, who must meet specified membership criteria.663 In other markets such as U.S. 662 See part I, supra. Commission believes that not all market participants likely would satisfy a covered clearing agency’s stringent membership criteria. See 17 CFR 17ad–22(e)(18); FICC Rule 2A, supra note 19. Even among those that do, legal operational or other considerations may preclude many market 663 The PO 00000 Frm 00073 Fmt 4701 Sfmt 4700 2785 equity markets, not all active participants are direct members of the clearing agency. For this reason, it is likely that under the requirement to clear eligible secondary market transactions, some market participants will access clearing indirectly. At FICC, the indirect clearing models are its Sponsored Program and a prime broker/ correspondent clearing program.664 As of August 14, 2023, FICC has 208 direct members.665 Centrally cleared institutional triparty (‘‘CCIT’’) membership is a limited direct membership for entities who buy repo using FICC’s GCF Repo Service that settles using triparty settlement.666 In 2017, FICC developed the CCIT Service to allow repo cash providers to access central clearing as limited-purpose members without the sponsorship or intermediation of a direct participant.667 These entities pledge to FICC the purchased securities under their repos in order to secure their obligation to perform under the transaction. As of July 27, 2023, there were 7 CCIT members, all of which were affiliated with a single investment firm.668 FICC interacts solely with the Sponsoring Member/direct participant as agent for purposes of the Sponsoring Member’s clients/Sponsored Members’ obligations to and from FICC. Sponsoring Members also guarantee to FICC the payment and performance obligations of their Sponsored Members.669 Sponsoring Members can participants from becoming direct members of a CCP that clears and settles government securities transactions. 664 See, e.g., FICC Rules, 8, 18, 3A (providing for prime brokerage and correspondent clearing, as well as sponsored membership), supra note 19. 665 See FICC Member Directories, available at https://www.dtcc.com/client-center/ficc-govdirectories (last visited Dec. 12, 2023) (This includes all members who make use of Netting, Repurchase Netting, and/or GCF services.). 666 DTCC, CCIT Service, available at https:// www.dtcc.com/clearing-services/ficc-gov/centrallycleared-institutional-triparty. 667 The Commission has not yet approved registered investment companies to participate in CCIT. See Order Granting Approval of Proposed Rule Change to Establish the Centrally Cleared Institutional Triparty Service and Make Other Changes, Exchange Act Release No. 80574, File No. SR–FICC–2017–005, 82 FR 21439, 21440 n.11 (May 2, 2017). 668 DTCC, FICC-Gov Member Directory (July 27, 2023), available at https://www.dtcc.com/clientcenter/-/media/Files/Downloads/client-center/ FICC/FICC-GSD-Member-Directory-CCIT.xlsx. 669 See Exchange Act Release No. 51896 (June 21, 2005), 70 FR 36981 (June 27, 2005); see also FICC Rule 3A, supra note 19. For general information and statistics regarding the Sponsored Service, see DTCC, Sponsored Service, available at https:// www.dtcc.com/clearing-services/ficc-gov/ sponsored-membership, as well as part IV.B.7.d.i infra. The Sponsored Service also allows the submission of cash transactions; however, at this E:\FR\FM\16JAR2.SGM Continued 16JAR2 2786 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 be either bank direct participants of FICC that meet certain capital and other requirements or any other FICC direct participant that meets what FICC determines to be the appropriate financial resource requirements; in practice, Sponsoring Members include both banks and broker-dealers.670 Sponsored Members have to be ‘‘qualified institutional buyers’’ as defined by Rule 144A under the Securities Act of 1933, as amended, or otherwise meet the financial standards necessary to be a ‘‘qualified institutional buyer,’’ and currently, Sponsored Members generally consist of hedge funds, money market funds, other asset managers, and smaller banks.671 The Sponsored Service allows eligible direct participants (Sponsoring Members) to (i) sponsor their clients into a limited form of FICC membership (Sponsored Members) and then (ii) submit certain eligible client securities transactions for central clearing. The requirement to clear eligible secondary market transactions could affect Sponsored Members. FICC interacts solely with the Sponsoring Member/ direct participant as agent. Sponsoring Members guarantee to FICC the payment and performance obligations of its Sponsored Members.672 Following FICC’s expansion in 2021 of its Sponsored Service to allow Sponsored Members to clear triparty repos through the program,673 there are now approximately 350 Sponsoring Members and approximately 2,200 Sponsored Members 674 with access to central clearing. During the 12-month period ending on August 15, 2023, the total dollar value of Sponsored Members’ daily repo and reverse repo activity time, the service is generally used only for U.S. Treasury repo transactions. 670 See FICC Rule 3A, section 2(a) and (b), supra note 19; DTCC, FICC GSD Member Directory (Oct. 31, 2023), available at https://www.dtcc.com/-/ media/Files/Downloads/client-center/FICC/MemGOV-by-name.xlsx (identifying Sponsoring Members as those with Omnibus accounts). 671 See FICC Rule 3A, section 3(a), supra note 19; FICC Sponsored Membership Listing, available at https://www.dtcc.com/client-center/ficc-govdirectories. 672 See FICC’s GSD Rule 3A, supra note 663. Sponsored Members have to be Securities Act Rule 144A ‘‘qualified institutional buyers,’’ or otherwise meet the financial standards necessary to be a ‘‘qualified institutional buyer.’’ See id., Rule 3A, section 3(a). 673 See Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Approving a Proposed Rule Change to Expand Sponsoring Member Eligibility in the Government Securities Division Rulebook and Make Other Changes, Exchange Act Release No. 85470 (Mar. 29, 2019). 674 In its 2022 annual report, DTCC reported that FICC’s sponsored service expanded during the year to more than 35 sponsoring members. DTCC 2022 Annual Report, supra note 737, at 29. See also supra note 668. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 ranged from a high of $771.7 billion on June 30, 2023, to a low of $265.8 billion on September 14, 2022.675 Among the various types of financial firms that are Sponsored Members are (i) over 1,400 funds, including a number of hedge funds, many money market funds, other mutual funds, and a smaller number of exchange-traded funds (‘‘ETFs’’); 676 (ii) banks, including a small number of national, regional Federal Home Loan Banks, and international banks; and (iii) other asset managers including a few insurance companies.677 From a direct participant’s perspective, clearing a U.S. Treasury securities transaction at FICC between that participant and its non-participant counterparty (i.e., a dealer-to-client trade) need not result in a separate collection of margin for each transaction. Transactions between direct participants are novated by FICC, and, by virtue of multilateral netting, all of a member’s positions are netted into a single payment obligation—either to or from the CCP. In contrast, in a dealerto-client trade, there is no transaction between two direct participants that FICC membership rules would require to be novated to the CCP, and as a result, FICC does not provide any guaranty of settlement or otherwise risk manage this trade.678 In other words, as one recent publication explained, ‘‘if a dealer were to buy a security from its own customer and submit this transaction to FICC, there would be no effect on the dealer’s net position at, obligations to, or guarantees from FICC.’’ 679 Indeed, except for its sponsored program, because FICC nets all trades at a dealer before calculating margin, as at present, customer trades with their own dealers generate no 675 This information was available from DTCC on the 1 year version of the FICC Sponsored Activity chart as of Aug. 15, 2023. DTCC, Sponsored Membership (last updated Dec. 1, 2023), available at https://www.dtcc.com/charts/membership. 676 For various persons, direct participation in FICC may not be an alternative to the Sponsored Membership program. For example, ‘‘[a] subset of market participants, such as certain money market funds, face legal obstacles to joining FICC because they are prohibited from mutualizing losses from other clearing members in the way that FICC rules currently require.’’ Marta Chaffee and SamSchulhofer-Wohl, infra note 678, at 2. 677 FICC Membership Listing, supra note 670. 678 See Marta Chaffee and Sam-Schulhofer-Wohl, Is a Treasury Clearing Mandate the Path to Increased Central Clearing?, Chicago Fed Insights, https://www.chicagofed.org/publications/blogs/ chicago-fed-insights/2021/treasury-clearingmandate (June 23, 2021) (explaining that this conclusion follows from that fact that ‘‘FICC nets members’ trades for their own accounts against trades by the members’ customers, so the dealer’s and customer’s sides of the trade would cancel out in the netting process.’’). 679 Id. PO 00000 Frm 00074 Fmt 4701 Sfmt 4700 margin requirement and are not collateralized at the CCP. Sponsored Members participating in FICC’s Sponsored Service are indirect members of FICC, and upon novation of their U.S. Treasury transactions, FICC becomes obligated to such Sponsored Members.680 FICC requires that its Sponsoring Members provide margin on a gross basis for its Sponsored Member positions.681 In FICC’s correspondent clearing and prime brokerage clearing models, the client of the netting member does not have a legal relationship with FICC.682 FICC only has CCP obligation to the correspondent clearer or prime broker itself, as applicable, who is a FICC member. Certain aspects of FICC’s Sponsored Service are worth noting, as they may have an effect on some market participants’ willingness to participate in the service. For example, once a trade is novated, FICC makes delivery of cash or securities to the Sponsoring Member as agent for the Sponsored Member.683 Therefore, market participants may consider the ability of their Sponsoring Member to make delivery to them in situations in which the Sponsoring Member is in default, when determining whether to use the Sponsored Service. In addition, if a Sponsoring Member defaults, FICC continues to guarantee any novated sponsored trades and may determine whether to close out a sponsored trade and/or to permit the Sponsored Member to settle the trade.684 This may lead a potential sponsored member to decline to enter a sponsoring relationship unless it was willing to trade bilaterally with those sponsoring firms. The Commission understands that some Sponsoring Members also may limit which market participant’s trades they are willing to sponsor based on firm type. Sponsored triparty repo is a relatively recent addition.685 Volumes of sponsored repo 680 FICC–GSD Rule 3A sections 3 (membership) and 7 (novation), supra note 19. 681 FICC Rule 3A, section 10(c), supra note 19. See also The Depository Trust and Clearing Corporation (DTCC), Making the U.S. Treasury Market Safer for All Participants: How FICC’s Open Access Model Promotes Central Clearing (white paper, Oct. 2021), available at https:// www.dtcc.com/-/media/Files/Downloads/ WhitePapers/Making-the-Treasury-Market-Saferfor-all-Participants.pdf (‘‘DTCC October 2021 White Paper’’) at 5–6. 682 FICC Rule 8, supra note 19. See DTCC October 2021 White Paper, supra note 681, at 5, which reports that $80 billion plus of activity are observed clearing and settling daily through FICC’s correspondent clearing and prime broker clearing models. 683 FICC Rule 3A, sections 8 and 9, supra note 19. 684 FICC Rule 3, section 14(c), supra note 19. 685 See generally DTCC SGCS, supra note 658. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations fluctuate, but they appear to be substantial as Figure 6 shows. In addition, the Commission understands that it is common practice for sponsoring members to only offer clearing services for transactions in which the sponsor is the counterparty to the sponsored member. This bundling of execution and central clearing sponsor services means that should a non-FICC member wish to centrally clear a U.S. 2787 Treasury transaction, it is limited in the counterparties with which it can trade to those FICC direct members with which it has an existing sponsoring member relationship. Figure 6: Sponsored Repo Daily Trading Volumea Sponsored Repo Daily Trading Volume V) $800 C ~ $700 iii 111RBIMraRapo ■ Rapo $600 $500 $400 $300 $200 $100 $0 In order for a CCP to perform as the guarantor of trades that have been novated to it, the CCP must have resources available to absorb the costs of clearing member non-performance. FICC is required by Commission rule to have policies and procedures reasonably designed to maintain financial resources at the minimum to enable it to cover a wide range of foreseeable stress scenarios that include, but are not limited to, the default of the participant family that would potentially cause the largest aggregate credit exposure in extreme but plausible market conditions.686 A CCP’s plan to deal with a clearing member default is referred to as its default waterfall. The default waterfall provides an identification of resources that the CCP will use in attempting to recoup losses from clearing member defaults. The FICC waterfall comprises the defaulting clearing member’s contribution (i.e., margin, as well as any other resources the member has on deposit such as excess margin, the proceeds from liquidating the member’s portfolio, and 686 17 CFR 240.17ad–22(e)(4)(iii). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 any amounts available from crossguaranty agreements), the corporate contribution to the clearing fund, followed by non-defaulting clearing members’ margin.687 In addition, with respect to liquidity risk, the Commission’s rules require FICC to have policies and procedures reasonably designed to meet a ‘‘cover-1’’ standard and hold qualifying liquid resources sufficient to complete its settlement obligations in the event of the default of the largest member and its affiliates.688 For example, if a clearing member has a net long position in a security that has not yet settled, the CCP 687 FICC Rule 4, sections 6 and 7, supra note 19. the Commission’s rules require FICC to have policies and procedures reasonably designed to maintain sufficient liquid resources at the minimum in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under a wide range of foreseeable stress scenarios that includes, but is not limited to, the default of the participant family that would generate the largest aggregate payment obligation for the covered clearing agency in extreme but plausible market conditions, and to hold qualifying liquid resources sufficient to meet that requirement. See 17 CFR 240.17ad–22(e)(7)(i) and (ii). 688 Specifically, PO 00000 Frm 00075 Fmt 4701 Sfmt 4700 must have the cash available to complete the purchase. The securities can be subsequently liquidated and any losses that may result would be covered by the resources in the default waterfall. The first liquidity source that FICC would use in the event of a member default is the cash portion of the clearing fund.689 Second, FICC can pledge securities in the clearing fund as a source of cash, including securities that would have otherwise been delivered to the defaulting member.690 Should additional liquid resources be required FICC could make use of the CCLF.691 The CCLF is a rules-based arrangement in which FICC members are obligated to participate as a condition of their membership. Should FICC declare a CCLF event, each member would be obligated to enter into repurchase agreements with FICC up to 689 FICC Rule 4, sections 5 and 6, supra note 19. 690 Id. 691 FICC E:\FR\FM\16JAR2.SGM Rule 22A, section 2a, supra note 19. 16JAR2 ER16JA24.005</GPH> ddrumheller on DSK120RN23PROD with RULES2 DTCC, Sponsored Membership (last updated Dec. 4, 2023), available at https://www .dtcc.com/charts/membership 2788 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations a member-specific limit.692 The CCLF is not prefunded, and it is separate from FICC’s margin requirements. Each FICC member is required, by FICC’s rules, to attest that its CCLF requirement has been incorporated into its liquidity planning and related operational plans at least annually and in the event of any changes to such Member’s CCLF requirement.693 Thus, the members are obligated to have such resources lined up, which can be costly.694 The CCLF provides a mechanism for FICC to enter into repurchase transactions based on the clearing activity of the defaulted participant. Specifically, in the event that FICC declares a CCLF event, FICC’s members would be required to hold and fund their deliveries to the defaulting member, up to a predetermined capped dollar amount, by entering into repurchase transactions with FICC until FICC completes the associated closeout.695 The aggregate size of the CCLF is the historical cover-1 liquidity requirement (i.e., the largest liquidity need generated by an Affiliated Family during the preceding six-month period) plus a liquidity buffer (i.e., the greater of 20 percent of the historical cover-1 liquidity requirement or $15 billion).696 The first $15 billion of the total amount of the CCLF is shared, on a scaled basis, across all members. Any remaining amount is allocated to members who present liquidity needs greater than $15 billion, using a liquidity tier structure based on frequency of liquidity created across liquidity tiers in $5 billion increments.697 The size of the CCLF and each member’s share is reset every 6 months or as appropriate.698 Figure 7 provides data on the aggregate amount of the CCLF from 2018 quarter 4 through 2023 quarter 1. The aggregate size of the CCLF was over $76 billion in 2023 quarter 1. Figure 7: Aggregate CCLF ($MM) at Quarter Enda 130,000 120,000 110,000 :E :E 'IJ'l. 100,000 90,000 80,000 70,000 60,000 692 These repurchase agreements may continue for up to 30 days. See FICC Rule 22A, section 2a(a)(L), supra note 19. 693 FICC Rule 22A, section 2a(d), supra note 19. 694 See Independent Dealer & Trader Association, White Paper on the Repo Market Affecting U.S. Treasury and Agency MBS 8 (Dec. 6, 2019), available at https://static1.squarespace.com/static/ 5ad0d0abda02bc52f0ad4922/t/5dea7fb6af08dd4 4e68f48cc/1575649207172/IDTA++White+Paper+%2812.6.19%29-c2.pdf (‘‘In light of the fact that a significant component of a firm’s VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 CCLF obligation is based on its overnight liquidity exposures at FICC, middle-market dealers immediately took to reducing their reliance on overnight liquidity. Some middle-market dealers reduced the size of their portfolio and extended liquidity terms in place of overnight funding, adding to both financing and opportunity costs. Others have incorporated liquidity plans for which commitment and administration fees materially added to the cost of doing business.’’). 695 See generally FICC Rule 22A, section 2a(b), supra note 19. For details on the process, see Order Approving a Proposed Rule Change to Implement PO 00000 Frm 00076 Fmt 4701 Sfmt 4725 the Capped Contingency Liquidity Facility in the Government Securities Division Rulebook, Exchange Act Release No. 82090 (Nov. 15, 2017), 82 FR 52457 (Nov. 21, 2017). 696 FICC Rule 1 (definitions of Aggregate Total Amount and Liquidity Buffer) and 22A, section 2, supra note 19. 697 FICC Rule 22A, section 2a(b)(iii), (iv), and (v), supra note 663. See also Exchange Act Release No. 82090, supra note 695, 82 FR at 55429–30. 698 FICC Rule 22A, section 2a(b)(ii), (iii), (iv), and (v), supra note 19. E:\FR\FM\16JAR2.SGM 16JAR2 ER16JA24.006</GPH> ddrumheller on DSK120RN23PROD with RULES2 Calculated using data from CPMI-IOSCO Quantitative Disclosure Results [quarterly] (for FICC), Disclosure Reference 7.1.6, available at https://www .dtcc.com/legal/policy-and-compliance. Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations 5. Margin Practices in U.S. Treasury Secondary Markets As described above, posting of margin is one way to manage the risk of settlement in cash trades. Indeed, for trades that are centrally cleared, the CCP collects margin on an intraday basis, typically twice per day.699 Varying bespoke arrangements appear to characterize current margining practices in the bilateral, non-centrally cleared cash market.700 A recent publication stated that competitive pressures in the bilaterally settled market for repo transactions has exerted downward pressure on haircuts, sometimes to zero.701 The Commission understands that most non-centrally cleared bilateral repo trades go unmargined.702 For noncentrally cleared repo including that which is settled using the triparty platform, haircuts serve as a counterparty credit risk mitigant. The median haircut on U.S. Treasury collateral for non-centrally cleared bilateral repo that is settled on the triparty platform has been 2% since at least 2010.703 In a study of non-centrally cleared bilateral repo trade data collected in its June 2022 pilot study, the OFR reports that 74% of all volume is transacted at zero haircut.704 The report also suggests that this finding is in part due to the use of netted packages, in which a dealer will conduct both a repo and a reverse repo with the same counterparty and the same tenor but over different pieces of Treasury collateral.705 The report also provides evidence that haircuts reflect not only the riskiness of the collateral but also the relative credit risk of the counterparties. For example, haircuts on Treasury repo where dealers are selling repo to hedge fund customers are usually zero or negative, while haircuts 699 TMPG White Paper, supra note 13, at 3. at 3. Non-centrally cleared cash trades are negotiated and settled bilaterally, and the Commission has little direct insight into the arrangements market participants use to manage their counterparty exposure. The TMPG observes in the White Paper that non-centrally cleared trades are ‘‘. . . not margined in a uniform or transparent manner, thereby creating uncertainty about counterparties’ exposure to credit and market risk.’’ Id. 701 G–30 Report, supra note 5, at 13. 702 TMPG White Paper, supra note 13, at 3 (‘‘Margining has not been a common practice for regularly settling bilaterally cleared transactions. . .’’). 703 See Tri-Party/GCF Repo, Federal Reserve Bank of New York, available at https:// www.newyorkfed.org/data-and-statistics/datavisualization/tri-party-repo/#interactive/ margins. 704 See Hempel et al. (2023), supra note 564, at 3 and 7–9. 705 Id. ddrumheller on DSK120RN23PROD with RULES2 700 Id. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 where dealers buying repo from hedge funds are usually zero or positive.706 The reduction of haircuts, which serve as the primary counterparty credit risk mitigant in non-centrally cleared and bilaterally settled repos, could result in greater exposure to potential counterparty default risk in noncentrally cleared repos. Such arrangements (in both cash and repo) may not take into account the value of margin in protecting against systemic events, because they are designed to be optimal for the counterparties rather than the larger financial market. For centrally cleared cash U.S. Treasury transactions, however, FICC rules dictate that margin must be posted based on the net positions of all members with the clearing agency.707 Positions in securities with longer maturities—for example, 20+ year U.S. Treasury bonds—require more margin to be posted because they are more sensitive to interest rate changes. Required margin is also larger for short positions, and it rises with volatility in the U.S. Treasury securities market.708 For example, during the first quarter of 2020, a period which includes the U.S. Treasury securities market disruption of March 2020, total initial margin required was 9.4% higher than the previous quarter and the average total variation margin paid was 72% higher.709 FICC Rules set forth the various components of a member’s margin requirements.710 The largest component is a Value-at-Risk (VaR) charge, which is calculated both intraday and end-of-day and reflects potential price volatility of unsettled positions. FICC typically calculates VaR using ten years of historical data; for securities without the requisite amount of data, FICC instead employs a haircut approach, where the required margin is some percentage of the traded security’s value. Other components of FICC’s margin requirements include a liquidity adjustment charge, which is levied against members who have large, concentrated positions in particular 706 Id. at 7. Part IV.B.3.4, supra for a discussion of how FICC requires for margining of sponsored positions. 708 See FICC Rule 4, section 1b, supra note 19. FICC’s margin requirements are discussed in more detail below. A key component of the margin requirement is a Value-at-Risk charge, where the calculated margin requirement is based in part on the historical volatility of the traded security. Securities that are more sensitive to interest rates should have higher VaR, all else equal. 709 See CPMI IOSCO Quantitative Disclosure Results for 2020Q1 and 2019Q4, items 6.1.1 and 6.6.1, available at https://www.dtcc.com/legal/ policy-and-compliance. 710 FICC Rule 4, section 1b, supra note 19. 707 See PO 00000 Frm 00077 Fmt 4701 Sfmt 4700 2789 securities that FICC determines to be difficult to liquidate, and special charges that can be levied in response to changes in aggregate market conditions (such as increases in marketwide volatility). In the market for bilaterally cleared repo, margin typically comes in the form of haircuts. For example, if a repo buyer is providing $100 of cash in return for $102 of securities from the repo seller, then the haircut would be $2. The difference between the value of the securities sold and the initial price paid, which is essentially a form of initial margin, protects the buyer by making it more costly for the seller to fail to repurchase the securities as agreed at the end of the repo, while also protecting the buyer against the risk that short-term volatility erodes the value of the purchased securities.711 The difference between the cash provided and the value of the securities is known colloquially as a ‘‘haircut.’’ Triparty repo also features overcollateralization, where the haircut is again negotiated bilaterally between the two counterparties.712 Data from the Federal Reserve Bank of New York show that a 2% haircut is the norm in the Triparty/ GCF repo market, though there are occasionally some deviations from the norm.713 Money market funds also generally require margin of 2%, which is generally the case for other investment companies as well.714 Outside of money market funds and 711 With respect to registered investment company lenders seeking to rely on Rule 5b–3 under the 1940 Act, the value of the collateral received under a repo must be at least equal to the resale price, reduced by the transaction costs (including loss of interest) that the investment company reasonably could expect to incur if the cash borrower defaults. See Rule 5b–3(a); (c)(1). 712 Although triparty repo transactions are settled through a clearing bank, the terms of the transactions are bilaterally negotiated. Although haircuts vary by collateral type, the variance of haircuts is small for U.S. Treasury repo compared to other collateral types. See Paddrik et al., supra note 631. 713 For data on the median, 10th, and 90th percentiles of overcollateralization in Triparty repo, see Tri-Party/GCF Repo, Federal Reserve Bank of New York, available at https:// www.newyorkfed.org/data-and-statistics/datavisualization/tri-party-repo. The median level of overcollateralization has been 2% for the entire period from May 2010 through July 2023. The 10th and 90th percentiles are also typically 2%, although the 10th percentile has occasionally fallen to as low as zero—notably, in the summer of 2011, briefly in Sept. 2012, and in the period from Sept. of 2022 through early Jan. of 2023—while the 90th percentile has occasionally spiked to as high as 5%—specifically in Jan. 2017 and again in Apr. of the same year. 714 See Viktoria Baklanova, Isaac Kuznits, Trevor Tatum, Primer: Money Market Funds and the Repo Market (Feb. 18, 2021), available at https:// www.sec.gov/files/mmfs-and-the-repo-market021721.pdf (‘‘MMF Primer’’). E:\FR\FM\16JAR2.SGM 16JAR2 2790 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations other investment companies, due to the lack of reporting requirements for bilateral repo, the Commission lacks good insight into margin practices of participants in the market for bilaterally cleared repo. Anecdotally, the Commission understands that—as with the cash market—some participants may not be required to post any margin.715 While positive haircuts protect the repo buyer, the bilaterally cleared repo market generally does not feature the same level of protection for the repo seller. Indeed, one of the main benefits of the bilateral market to repo buyers is that it allows them to resell the securities purchased in the start leg of the repo. As a result, repo sellers are exposed to settlement risk and must manage that risk as they see fit. In the triparty repo market, securities purchased as part of a repo transaction remain in the custody of the clearing bank and cannot be reused by the repo buyer except as collateral in another triparty repurchase agreement, reducing settlement risk for the repo seller. Unlike bilaterally cleared and triparty repo the counterparties to a centrally cleared repo transaction must post cash margin to the CCP twice per day, as they do with trades in the cash market. Repo sellers may be required to post more margin than repo buyers, similar to how in the bilaterally cleared market repo sellers post margin through haircuts while repo buyers do not. ddrumheller on DSK120RN23PROD with RULES2 6. Disruptions in the U.S. Treasury Securities Market There have been significant disruptions in the U.S. Treasury securities market in recent years. Although different in their scope and magnitude, these events all generally involved dramatic increases in market price volatility and/or sharp decreases in available liquidity.716 U.S. Treasury securities are generally not information sensitive in that their payoff is fixed in nominal terms. Moreover, there is little evidence that information on inflation risk or expectations could have driven the volatility observed in these episodes, raising the possibility that the volatility originated in a buy-sell 715 See G–30 Report, supra note 5, at 13 (noting that minimum margin requirements ‘‘. . . would stop competitive pressures from driving haircuts down (sometimes to zero), which reportedly has been the case in recent years.’’). 716 See 2021 IAWG Report, supra note 4, for further discussion of these and other disruptions. See also Remarks by Under Secretary for Domestic finance Nellie Liang at the 2022 Treasury Market Conference, available at https://home.treasury.gov/ news/press-releases/jy1110. Under Secretary Liang points out that continued liquidity concerns are linked to higher volatility since the COVID–19 shock of Mar. 2020. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 imbalance, as opposed to fundamental factors. While a market failure could be the origin of price volatility, the forward-looking nature of markets can compound liquidity-driven price movements. The fear of being unable to exit a position can lead to a ‘‘rush to the exits,’’ leading to yet greater price swings. Because U.S. Treasury securities are standardized, they generally benefit from a deep, ready market for transactions. Investors count on the ability to move between cash and U.S. Treasury securities seamlessly.717 This makes events that reduce liquidity in these markets especially striking and destabilizing to the overall market. Moreover, since the Proposal, regulators and others have noted the persistence of illiquidity and the mitigating effect of greater central clearing.718 a. COVID–19 Shock of March 2020 The market for U.S. Treasury securities experienced significant disruptions in March 2020, characterized by a spike in volume, whose origins may have been multiple but included high levels of selling by foreign banks and by hedge funds.719 For example, hedge funds, one of the principal sellers of U.S Treasury futures, hedge their short futures position by establishing a long position in the cash market, creating a ‘‘cash-futures basis trade.’’ 720 The cash position of this trade is often highly levered, using the repo market for financing. In March, as the U.S. Treasury securities market came under stress and as repo rates 717 U.S. Treasury securities are often used as substitutes for cash. There is anecdotal evidence that during Mar. 2020, some market participants refused U.S. Treasury securities collateral in favor of cash. 718 See Remarks by Under Secretary for Domestic Finance Nellie Liang at the 2022 Treasury Market Conference available at https://home.treasury.gov/ news/press-releases/jy1110, Enhancing The Resilience of the U.S. Treasury Market: 2022 Staff Progress Report (Nov 10, 2022), available at https:// home.treasury.gov/system/files/136/2022-IAWGTreasury-Report.pdf), and Darrel Duffie, Resilience redux in the US Treasury market, Jackson Hole Symposium (Sept. 2, 2023), available at https:// www.kansascityfed.org/Jackson%20Hole/ documents/9780/JH-2023BW.pdf. See also Darrell Duffie, Michael Fleming, Frank Keane, Claire Nelson, Or Shachar, and Peter Van Tassel, B.6.aa, Internal SEC seminar (July 2023), available at https://www.sec.gov/comments/s7-23-22/s72322260739-614102.pdf. 719 See SEC Staff Report on U.S. Credit Markets Interconnectedness and the Effects of the COVID– 19 Economic Shock (Oct. 2020), available at https:// www.sec.gov/files/US-Credit-Markets_COVID-19_ Report.pdf. 720 See Ayelen Banegas, Phillip J. Monin, and Lubomir Petrasek, Sizing hedge funds’ Treasury market activities and holdings (FEDS Notes Oct. 6, 2021), available at https://www.federalreserve.gov/ econres/notes/feds-notes/sizing-hedge-fundstreasury-market-activities-and-holdings20211006.html. PO 00000 Frm 00078 Fmt 4701 Sfmt 4700 increased in some segments of the repo market, the economics of the cashfutures basis trade worsened and various funds found it necessary to unwind at least a portion of their positions. This unwinding of positions resulted in more outright sales of U.S. Treasury securities in the cash market, adding further stress through a feedback loop.721 During this period, bid-ask spreads increased by a factor of 5, and market depth on inter-dealer brokers decreased by a factor of 10. The price of 30-year U.S. Treasury securities fell by 10% in one two-day period. Arbitrage relations appeared to break down throughout the market.722 This may, as discussed above, have led to the winding down of the cash-futures basis trade, for example, adding to further stress.723 There also appeared to be large-scale selling from foreign investors, including official institutions, to address their domestic currency and liquidity needs.724 Duffie and Liang and Parkinson, among others, have tied these patterns to underlying U.S. Treasury securities market structure, in which intermediation capacity may be reduced relative to the size of the market and ultimate buyers and sellers may have difficulty locating each other. These authors discuss ways in which central clearing could have reduced these problems, mitigating the large price swings due to illiquidity in the market just when it was most needed.725 One view of central clearing is that it may facilitate all-to-all trading, thus helping 721 See supra note 719, at 4. In addition, a similar dynamic was observed in the risk parity trades, where hedge funds lever up (through the repo markets) lower volatility fixed-income positions (e.g., government bonds) to create a risk-equalized portfolio across asset classes. See also id. 722 Duffie, supra note 27. 723 See generally Ayelen Banegas et al., supra note 720; see also Daniel Barth & R. Jay Kahn, Hedge Funds and the Treasury Cash-Futures Disconnect (Apr. 1, 2021), available at https:// www.financialresearch.gov/working-papers/2021/ 04/01/hedge-funds-and-the-treasury-cash-futuresdisconnect/; Mathias S. Kruttli, Phillip J. Monin, Lubomir Petrasek, & Sumudu W. Watugala, Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID–19 Crisis (working paper Fin. and Econ. Disc. Series 2021–038), Fed. Res. Bd (Apr. 2021), available at https:// www.federalreserve.gov/econres/feds/files/ 2021038pap.pdf. 724 See Colin R. Weiss, Foreign Demand for U.S. Treasury Securities during the Pandemic (FEDS Notes, Jan. 28, 2022), available at https:// www.federalreserve.gov/econres/notes/feds-notes/ foreign-demand-for-us-treasury-securities-duringthe-pandemic-20220128.htm. 725 Duffie, supra note 27; Nellie Liang & Pat Parkinson, Enhancing Liquidity of the U.S. Treasury Market Under Stress (Hutchins Ctr. Working Paper No. 72, 2020), available at https:// www.brookings.edu/wp-content/uploads/2020/12/ WP72_Liang-Parkinson.pdf (‘‘Liang & Parkinson’’). E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ultimate buyers and sellers find each other.726 More buyers and sellers of U.S. Treasury securities could potentially act as additional sources of liquidity in a market with central clearing. ddrumheller on DSK120RN23PROD with RULES2 b. September 2019 Repo Market Disruptions The repo market experienced a substantial disruption starting September 16, 2019, when overnight repo rates began to rise, and on September 17, 2019, when the rise in repo rates accelerated dramatically. During the episode, the Secured Overnight Financing Rate (SOFR)—a measure of the average cost of overnight repo borrowing (e.g., the implied cost of borrowing by selling overnight repo)— spiked by 300 basis points to over 5% in the course of 2 days. There was also a wide dispersion around this average; some trades occurred at rates as high as 9%. On top of this, the spread between the 1st and 99th percentile rates increased substantially from its average earlier in 2019 of approximately 25 basis points to approximately 675 basis points during the disruption. The disruption spilled over into the other markets, with the Effective Federal Funds Rate (EFFR) rising above the Federal Reserve target by 5 basis points. The disruption occurred amidst two events: first, a large withdrawal of reserves from the banking system to service corporate tax payments due September 16; and second, the settlement of U.S. Treasury securities auctions. Altogether, the tax payments led approximately $120 billion to flow away from bank reserves, bringing them down to their lowest level in 5 years.727 Moreover, the auction settlement raised the supply of U.S. Treasury securities outstanding, which was accompanied by an increased demand for cash to fund purchases of these securities. The need for cash reserves played a role in what appears to be an unwillingness of banks to lend to one another at very high rates. Less tangibly, market expectations could have played a role; it is possible that the spike in rates could have been interpreted as a signal for a future need of cash reserves, leading banks to conserve cash regardless of what appeared to be strong economic incentives to do otherwise. While the need for the banking system to replace reserves with cash may be 726 See Duffie, supra note 27. Sriya Anbil, Alyssa Anderson, and Zeynep Senyuz, What Happened in Money Markets in September 2019? (FEDS Notes, Feb. 27, 2020), available at https://www.federalreserve.gov/ econres/notes/feds-notes/what-happened-in-moneymarkets-in-september-2019-20200227.htm. 727 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 part of the explanation, in a welloperating market high rates for overnight borrowing collateralized by U.S. Treasury securities (i.e., the implied cost of borrowing by selling overnight repo) would have attracted other market participants. Ultimately, as it did in March 2020, the Federal Reserve injected reserves into the system—the economic equivalent of lending to banks. The overnight repo operations totaled $75 billion on September 17, 2019. Besides directly providing cash, this perhaps signaled the Fed’s willingness and ability to lend as needed to restore rates to levels that would occur in the absence of market frictions. In such a setting, a potential benefit of enhanced clearing for U.S. Treasury repo and cash is its ability to reduce those market frictions directly, without official sector intervention. c. October 2014 Flash Rally In March 2020 U.S. Treasury securities’ prices fell, whereas in September 2019 the rate for lending increased. Both events were associated with an increase in the cost of borrowing (i.e., the implied cost of borrowing by selling overnight repo). The events of October 15, 2014, were different in form: in this instance, yields on U.S. Treasury bonds fell quickly and dramatically, leading to large increases in prices, without any clear explanation. The intraday range for the 10-year bond was 37 basis points, one of the largest on record, and far outside the typical historical distribution.728 October 15, 2014, featured the release of somewhat weaker-than-expected U.S. retail sales data at 8:30 a.m. ET. While the data appeared to prompt the initial decline in interest rates, the reaction was far larger than would have been expected given the modest surprise in the data. Suggestive of some connection is that the dollar amount of standing quotes in the central limit order books on cash and futures trading platforms—a measure of the quantity of liquidity that is commonly referred to as ‘‘market depth’’—fell dramatically in the hour before the event window. A sudden rise in price does not at first appear as potentially disruptive as a decline. However, it appears that levered market participants had taken short positions in anticipation of an increase in yields. Any further increase in price would have forced these participants to cover their positions. Indeed, hedge funds became net buyers of U.S. Treasury securities on the 728 See PO 00000 generally Joint Staff Report, supra note 4. Frm 00079 Fmt 4701 Sfmt 4700 2791 morning of October 15, 2014. The decline in liquidity may have led to a further concern of an inability to exit positions. In particular, although the share of trading volume attributed to PTFs on October 15 does not stand out as unusual relative to the prior period,729 PTFs significantly reduced the dollar amounts of standing quotes in central limit order books,730 leading to greater pressure on the system. This withdrawal of liquidity appears to have been motivated by an attempt to manage risk. Lastly, though broker-dealers increased their trading volume, they provided less liquidity to the order books by widening their spreads and in some cases withdrawing for brief periods from the offer side of the book.731 This disruption showed that market liquidity provision had become more short-term in nature, some liquidity providers were backed by less capital, and liquidity was more vulnerable to shocks as a result of the change in the composition of liquidity providers. In addition, electronic trading permitted rapid increases in orders that removed liquidity. These vulnerabilities are similar to ones observed during the March 2020 events.732 As in the previously described episodes, the price swings illustrate the apparent difficulty for outside capital at accessing the market. Improved market functioning could have allowed economic incentives to help stabilize the system: end-users of U.S. Treasury securities could have reacted to the unusually high prices by selling. However, such participants would have needed access to pricing and to the ability to trade. 7. Affected Parties a. Covered Clearing Agencies for U.S. Treasury Securities: FICC Although the requirement to clear eligible secondary market transactions would apply to all U.S. Treasury securities CCAs, FICC’s Government Securities Division, as noted previously, is the sole provider of clearance and settlement services for U.S. Treasury securities. FICC is a wholly owned subsidiary of The Depository Trust & Clearing Corporation (DTCC); DTCC is a private corporation whose common shares are owned by fee-paying participants in DTCC’s clearing agency 729 See Joint Staff Report, supra note 4, at 21. 2021 IAWG Report, supra note 4, at 18. 731 See id. 732 See id. 730 See E:\FR\FM\16JAR2.SGM 16JAR2 2792 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations subsidiaries, including FICC.733 In 2022 and 2021, FICC’s total clearing revenue was approximately $312.8 million and $310.0 million, respectively, and its net income was approximately $4.6 million and $13.4 million, respectively.734 The G–30 Report estimated that ‘‘roughly 20 percent of commitments to settle U.S. Treasury security trades are cleared through FICC.’’ 735 Although various analyses have noted the increased volume of secondary market U.S. Treasury transactions that are not centrally cleared,736 the dollar value of transactions FICC clears remains substantial. In 2022, FICC’s GSD processed $1.512 quadrillion in DVP transactions of U.S. Government securities.737 In March 2020, clearing dollar volume in U.S. Treasury securities at FICC rose ‘‘to over $6 trillion daily, an almost 43 percent increase over the usual daily average of $4.2 trillion cleared [at that time].’’ 738 There are differences between the degree of central clearing in the cash and the repo markets. Based on 2017 ddrumheller on DSK120RN23PROD with RULES2 733 See generally Notice of No Objection to Advance Notices, Exchange Act Rel. No. 74142 (Jan. 27, 2015), 80 FR 5188 (Jan. 30, 2015) (not objecting to a proposal that DTCC’s new common share ownership formula will be based solely on fees paid to its subsidiary clearing agencies). 734 FICC, Consolidated Financial Statements as of and for the Years Ended Dec. 31, 2022 and 2021, available at https://www.dtcc.com/-/media/Files/ Downloads/legal/financials/2023/DTCC-AnnualFinancial-Statements-2022-and-2021.pdf. 735 G–30 Report, supra note 5, at 11. 736 See, e.g., 2021 IAWG Report, supra note 4, at 5–6 (citing TMPG White Paper); U.S. Department of the Treasury, A Financial System That Creates Economic Opportunities Capital Markets (Oct. 2017), available at https://home.treasury.gov/ system/files/136/A-Financial-System-CapitalMarkets-FINAL-FINAL.pdf (‘‘2017 Treasury Report’’), at 81; Joint Staff Report, supra note 4, at 36–37. 737 Performance Dashboard, DTCC 2022 Annual Report, at 44, available at https://www.dtcc.com/ about/-/media/Files/Downloads/Annual-Report2022/DTCC2022AR-PRINT.pdf. FICC’s GSD also process U.S. Government securities that are not U.S. Treasury securities but the dollar amount processed of such securities is believed to be nominal by comparison to that of U.S. Treasury securities. 738 DTCC May 2021 White Paper, supra note 307, at 3. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 data, the TMPG estimated that 13 percent of cash U.S. Treasury securities transactions are centrally cleared; 68 percent are bilaterally cleared; and 19 percent involve hybrid clearing, in which only one leg of a transaction on an IDB platform is centrally cleared.739 A Federal Reserve staff analysis of primary dealer repo and reverse repo transactions during the first half of 2022 found ‘‘that approximately 20 percent of all repo and 30 percent of reverse repo is centrally cleared via FICC.’’ 740 Measured by dollar volume, repos, according to DTCC, are the largest component of the government fixedincome market.741 In mid-July 2021, according to Finadium and based on DTCC data, FICC processed $1.15 trillion in repo, or roughly 25 percent of the $4.4 trillion U.S. repo market at that time.742 For all of 2022, DTCC reported that FICC processed $235 trillion through its GCF Repo Service.743 b. Direct Participants at U.S. Treasury Securities CCAs: FICC Netting Members The requirement to clear eligible secondary market transactions would 739 See 2021 IAWG Report, supra note 4, at 30; see also TMPG White Paper, supra note 13, at 12. 740 See Sebastian Infante et al., supra note 75 (‘‘Form FR2004 data only cover activities of primary dealers. Therefore, any estimate based on that data is likely to underestimate the total size of the repo market. Discussions with market participants suggest that the nonprimary dealer’s market share is smaller than that attributed to the primary dealers, but growing.’’). The authors also show that all cleared bilateral repo and reverse repo have U.S. Treasury securities and TIPS as collateral (the authors’ Figure 4); Viktoria Baklanova, Adam Copeland, and Rebecca McCaughrin, Reference Guide to U.S. Repo and Securities Lending Markets, N.Y. Fed. Staff Report No. 740, at 11 (rev. Dec. 2015), available at https://www.newyorkfed.org/ medialibrary/media/research/staff_reports/ sr740.pdf. 741 DTCC, A Guide to Clearance and Settlement, Chapter 8: Settling Debt Instruments, available at https://www.dtcc.com/clearance-settlement-guide/ #/chapterEight (last visited Dec. 12, 2023). 742 Finadium, Building Out Industry Data for New Industry Needs 9 (2021), available at https:// finadium.com/wp-content/pdfs/finadium-dtccbuilding-out-repo-data.pdf. 743 DTCC 2022 Annual Report, supra note 737, at 44. PO 00000 Frm 00080 Fmt 4701 Sfmt 4700 directly affect market participants that are direct participants in a U.S. Treasury securities CCA, which currently means only direct participants at FICC’s GSD. FICC direct participants are also referred to as FICC Netting Members. As previously discussed, FICC Netting Members are the only FICC members eligible to become a counterparty to FICC to a U.S. Treasury securities transaction, including repo and reverse repo trades. As of August 14, 2023, FICC’s GSD had 208 Netting Members of which 192 were participants in FICC’s repo netting service.744 FICC Netting Members generally consist of bankaffiliated dealers and registered brokerdealers. These dealers include all 24 financial institutions currently designated by the Federal Reserve Bank of New York (N.Y. Fed) as ‘‘primary dealers.’’ 745 In 2022, the average daily trading dollar value in U.S. Treasury securities by primary dealers was $614.3 billion.746 The relative significance of dealer trading in the cash market for U.S. Treasury securities is shown in Figure 8. 744 DTCC, FICC GSD Member Directory (Oct. 31, 2023), available at https://www.dtcc.com/-/media/ Files/Downloads/client-center/FICC/Mem-GOV-byname.xlsx (107 Netting Members participated in FICC’s GCF service). 745 Primary dealers are counterparties to the N.Y. Fed in its implementation of monetary policy and expected to participate meaningfully in all U.S. Treasury securities auctions for new issuances of U.S. Treasury securities. US Dept of the Treasury, Primary Dealers, available at https:// home.treasury.gov/policy-issues/financing-thegovernment/quarterly-refunding/primary-dealers. For a current list of primary dealers see List of Primary Dealers, Federal Reserve Bank of New York, available at https://www.newyorkfed.org/ markets/primarydealers. 746 SIFMA, 2023 Capital Markets Fact Book, at 56 (July 2023) available at https://www.sifma.org/wpcontent/uploads/2022/07/2023-SIFMA-CapitalMarkets-Factbook.pdf (SIMFA’s term primary dealers refers to N.Y. Fed prime brokers). Id. The dollar value of trading in U.S. Treasury securities by primary dealers has a combined average annual growth rate of 1.7% for the 10-year period ending in 2022. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations 2793 Figure 8 Share of U.S. Treasury Securities Cash Market Activity for All Securities by Participant Type As previously discussed, the total notional transactions amount in the repo market is larger than that of the cash U.S. Treasury securities market. In 2021, average aggregate daily primary dealer outstanding total repo positions were $4.3 trillion consisting of $2.5 trillion in repo (75% of which is collateralized by U.S. Treasury securities) and $1.8 trillion in reverse repo (89% of which is collateralized by U.S. Treasury securities).747 As of December 31, 2021, the repo market as a whole was valued at approximately $5.8 trillion.748 Although a large portion of this activity is cleared by FICC, a large portion is also not centrally cleared. For 2021, DTCC reported that ‘‘FICC matches, nets, settles and risk manages repo transactions valued at more than $3T daily.’’ 749 During the first half of 2022, Federal Reserve staff estimated that a ‘‘large fraction of primary dealers’ repo (38 percent) and reverse repo (60 percent) activity is in the uncleared bilateral segment.’’ 750 See Figure 9. Although these statistics include all collateral types, for the subset of the repo market that includes a primary dealer on one side, the Commission has more detailed data. As Figures 10 and 11 show, the vast majority of uncleared bilateral and triparty primary dealer repo and reverse 747 SIFMA Research, US Repo Markets: A Chart Book, at 6, 7, and 8 (Feb. 2022), available at https:// www.sifma.org/wp-content/uploads/2022/02/ SIFMA-Research-US-Repo-Markets-Chart-Book2022.pdf. Because these are figures for primary dealer repo and reverse repo, they need not be equal. In the aggregate, however, repo must equal reverse repo. 748 The Financial Accounts of the United States, L.207, line 1 (Federal Funds and Security Repurchase Agreements) available at https:// www.federalreserve.gov/releases/z1/20220310/ html/l207.htm. This number includes federal funds and security repurchase agreements (for all collateral types). Federal funds outstanding on Dec. 31, 2021, was $49B. Effective Federal Funds Rate, Federal Reserve Bank of New York, available at https://www.newyorkfed.org/markets/referencerates/effr. The comparable figures for Dec. 31, 2022, were $6.6T and $67B. The Financial Accounts of the United States, L.207, line 1 (Federal Funds and Security Repurchase Agreements), available at https://www.federalreserve.gov/releases/z1/ 20230608/html/l207.htm and Effective Federal Funds Rate, Federal Reserve Bank of New York, available at https://www.newyorkfed.org/markets/ reference-rates/effr. 749 DTCC 2021 Annual Report, supra note 737, at 32. 750 Sebastian Infante et al., supra note 75. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 PO 00000 Frm 00081 Fmt 4701 Sfmt 4700 repo collateral consists of U.S. Treasury securities (including TIPS). The largest remaining components of repo (approximately 40 percent) and reverse repo activity (approximately 8 percent) are not centrally cleared but settle on the triparty platform.751 This is labeled ‘‘Tri-Party (excluding GCF)’’ in Figure 9, and the degree to which Treasury collateral is used in these transactions is displayed in Figure 11. The final and by far the smallest component of repo and reverse repo activity (amounting to about 2% of activity) is triparty repo using FICC’s Sponsored GC service.752 BILLING CODE 8011–01–P 751 While the concentration among the top three dealers in the U.S. Treasury securities (excluding Strips) tri-party repo market ranged between 22% and 50% between 2011 and 2020, between Jan. 2021 and Nov. 2022, the percentage of the volume in this market attributable to the top three dealers grew from 33.8 percent to 77.6% before falling to 67.7% by July 2023. NY Fed, Data & Statistics, Visualization Tri-Party/GCF Repo, available at https://www.newyorkfed.org/data-and-statistics/ data-visualization/tri-party-repo/interactive/concentration. 752 Id. E:\FR\FM\16JAR2.SGM 16JAR2 ER16JA24.007</GPH> ddrumheller on DSK120RN23PROD with RULES2 Source: FINRA TRACE. This figure plots shares of trading volume by participant type for the entire U.S. Treasury securities cash market from April 1, 2019, to Dec. 31, 2019. Figure from Harkrader and Puglia FEDS Notes, supra note 641. Note: "Buy-side share is assumed to capture institutions such as hedge funds and investment firms but ma also include other financial institutions such as banks." Id. 2794 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations Figure 9 Repo Clearing 2021-2022 Repo Reverse Repo 'ftll&ons 3.0 GCF Tlilllons 3_0 Weekly 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 2021 ( , r !l 1 , 0.0 2022 , ) t, ; 2021 , ,, , \ 1 I , I 2022 ' ------------------------------------------ Figure 10 Uncleared Bilateral Repo and Reverse Repo Collateral 2022 Uncleared Bilateral Repo Uncleared Bilateral Reverse Repo Trillions Weekly Gorporalesewrffies Trillions 1.4 1.2 1.2 1.0 1.0 0.8 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 Jan. Feb. Mar. Apr. 2022 May Jun. 1.4 July 0.0 Jan. Feb. Mar. Apr. 2022 Jun. May July Source: Board of Governors of the Federal Reserve System, Government Securities Dealers Reports (FR 2004) Figure 11 Tri-party Repo and Reverse Repo Collateral 2022 Tri-Party Repo Tri-Party Reverse Repo Trillions 1.4 Trillions Weekly 1.2 0.30 025 1.0 020 0.8 0.15 ddrumheller on DSK120RN23PROD with RULES2 0.05 02 0.00 0.0 Jan. Feb. Mar. Apr. May Jun. July Jan. 2022 VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 PO 00000 Frm 00082 Fmt 4701 Sfmt 4725 Feb. Mar. Apr. 2022 E:\FR\FM\16JAR2.SGM May 16JAR2 Jun. July ER16JA24.008</GPH> 0.10 0.4 ER16JA24.009</GPH> ER16JA24.010</GPH> 0.6 2795 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations BILLING CODE 8011–01–C c. Interdealer Brokers Interdealer brokers 753 and the trading platforms they operate play a significant role in the markets for U.S. Treasury securities. As previously discussed, an IDB will generally provide a trading facility for multiple buyers and sellers for U.S. Treasury securities to enter orders at specified prices and sizes and have these orders displayed anonymously to all users. When a trade is executed, the IDB then books two trades, with the IDB functioning as the principal to each respective counterparty, thereby protecting the anonymity of each party, but taking on credit risk from each of them. Although there is no legal requirement for an IDB to be a FICC direct participant/Netting Member, most IDBs are FICC Netting Members.754 Under FICC’s existing rules, if an IDB’s customer in a U.S. Treasury security transaction is not a FICC member, the IDB’s transaction with that customer need not be centrally cleared and may be bilaterally cleared. As discussed in the Proposing Release and in parts II.A.1 and II.A.2.b.ii infra, each transaction at an IDB is split into two pieces: a leg between the buyer and the IDB and a leg between the IDB and the seller.755 If the buyer or seller is a dealer, the respective leg is centrally cleared. Transaction legs involving PTFs are generally not cleared and settled bilaterally. TMPG estimates that ‘‘roughly threequarters of IDB trades clear bilaterally.’’ 756 To help visualize the significance of the role played by IDBs in the centrally cleared market, and given existing data limitations, Table 3, adapted from a table prepared by the TMPG in 2019, presents five clearing and settlement case types that cover the vast majority of secondary market cash trades. The table uses Federal Reserve data collected from primary dealers in the first half of 2017 to estimate the daily volume (dollar and share percentage) attributable to each clearing and settlement case type. TABLE 3—ESTIMATED SECONDARY CASH MARKET PRIMARY DEALER DAILY TRADING DOLLAR (BILLIONS) AND PERCENTAGE VOLUME BY CLEARING AND SETTLEMENT TYPE $ Volume billions Clearing and settlement type Non-IDB share IDB share Overall percentage Bilateral clearing, no IDB ................................................................................. Central clearing, no IDB .................................................................................. Central clearing, with IDB ................................................................................ Bilateral clearing, with IDB .............................................................................. Bilateral/central clearing, with IDB ................................................................... $289 15 52 73 103 95% 5% ........................ ........................ ........................ ........................ ........................ 22.9% 31.9% 45.3% 54.3 2.9 9.8 13.6 19.4 Totals: ....................................................................................................... 531 $304 (57.2%) $228 (42.8%) 100 Source: TMPG White Paper, supra note 13, adapted from a table at p. 12. Table 3 Notes: Figures are estimated using the Federal Reserves’ Form FR2004 data for the first half of 2017 and are based on the following assumptions: a) primary dealers account for all dealer activity, b) 5% of dealers’ trading not through an IDB is with another dealer, c) the shares of dealer and non-dealer activity in the IDB market for coupon securities equal the weighted averages of the shares reported in the Oct. 15 report (that is, 41.5% and 58.5%, respectively), d) only dealers trade bills, FRNs, and TIPS in the IDB market, and e) the likelihood of dealer and non-dealers trading with one another in the IDB market solely reflects their shares of overall volume. The table presents estimates because precise information is not available on the size of the market or on how activity breaks down by the method of clearing and settlement. d. Other Market Participants ddrumheller on DSK120RN23PROD with RULES2 As discussed previously, FICC netting members are generally registered brokerdealers or banks. Some institutional participants that are not FICC Netting Members/FICC direct participants are able to centrally clear repos through FICC’s Sponsored Service.757 In addition to Sponsored Members, various types of direct and indirect market participants hold significant amounts of U.S. Treasury securities and repo, and potentially purchase and sell U.S. Treasury securities in the secondary cash and repo markets. To the extent that these persons engage in secondary market transactions, we expect their trading may be affected by 753 As noted previously, IDB is not used to encompass platforms that provide voice-based or other non-anonymous methods of bringing together buyers and sellers of U.S. Treasury securities. IDB instead refers to electronic platforms providing anonymous methods of bringing together buyers and sellers. 754 See generally TMPG White Paper, supra note 13. The TMPG White Paper assumes throughout that IDBs are CCP direct members (e.g., ‘‘More specifically, the IDB platforms themselves and a VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 increased central clearing resulting from the adoption of the requirement to clear eligible secondary market transactions. Other key market participants, some of which are direct participants and some of which are sponsored members that may be affected by the rule include: i. Broker-Dealers That Are Not Direct Participants/FICC Netting Members Broker-dealers perform a number of functions in the U.S. securities markets including making markets in securities, brokering securities transactions, dealing securities, executing securities transactions, clearing and settling securities transactions, and maintaining custody of securities for investors. Some broker-dealers may perform multiple number of platform participants continue to clear and settle through the CCP.’’ Id. at 2). 755 See supra note 14, 87 FR at 64615. 756 TMPG White Paper, supra note 13, at 2. 757 FICC’s Sponsored Member program also allows the submission of cash transactions; however, as previously noted, the service is generally used only for U.S. Treasury repo transactions at this time. 758 Using Form BD data from Sept. 2022, the Commission has previously stated that 27% of PO 00000 Frm 00083 Fmt 4701 Sfmt 4700 functions whereas others may perform a single function.758 Based on 2022 annual FOCUS filings, third quarter 2023 FOCUS filings, and FICC list of netting members,759 there are 3,215 broker-dealers that are not also FICC netting members. Broker-dealers that are not FICC netting members are typically much smaller than those that are. Average assets of all broker-dealers is approximately $2.4 billion while the average of non-FICC netting member broker-dealers is approximately $276 million. ii. Hedge Funds, Family Offices, and Separately Managed Accounts Hedge funds are active participants in the secondary market for U.S. Treasury Form BD filers are U.S. Government Securities Brokers and 10% are U.S. Government Securities Dealers. See Cybersecurity Risk Management Rule for Broker-Dealers, Clearing Agencies, Major Security-Based Swap Participants, the Municipal Securities Rulemaking Board, National Securities Associations, National Securities Exchanges, Security-Based Swap Data Repositories, SecurityBased Swap Dealers, and Transfer Agents, Exchange Act Release No. 97142 (Oct. 25, 2022) 87 FR 64610, at 64650–1. 759 See supra note 744. E:\FR\FM\16JAR2.SGM 16JAR2 2796 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations securities and their trading activities may be a cause of price movements in the U.S. Treasury securities market.760 Hedge funds can use U.S. Treasury securities, for example, in order to borrow cash (i.e., sell repo) to take leveraged positions in other markets, or to execute trading strategies. As of December 31, 2022, approximately 21 percent of Form PF filers 761 that are qualifying hedge funds reported U.S. Treasury securities holdings totaling $1.70 trillion in notional exposure in the cash market and $2.13 trillion in notional exposure to repos.762 Family offices are entities established by families to manage family wealth.763 ddrumheller on DSK120RN23PROD with RULES2 760 Ron Alquist & Ram Yamarthy, Hedge Funds and Treasury Market Price Impact: Evidence from Direct Exposures (OFR working paper 22–05, Aug. 23, 2022) (‘‘find[ing] economically significant and consistent evidence that changes in aggregate hedge fund [Treasury] exposures are related to Treasury yield changes [and] . . . that particular strategy groups and lower-levered hedge funds display a larger estimated price impact on Treasuries.’’), available at https://www.financialresearch.gov/ working-papers/files/OFRwp-22-05-hedge-fundsand-treasury-market-price-impact.pdf. See also note 720, supra. 761 Qualifying hedge funds refers to those hedge funds that have a net asset value (individually or in combination with any feeder funds, parallel funds and/or dependent parallel managed accounts) of at least $500 million as of the last day of any month in the fiscal quarter immediately preceding its most recently completed fiscal quarter. See Form PF (Glossary of Terms). Although the Proposal would cover any hedge fund, smaller funds’ holdings are not reflected in these statistics because of Form PF’s minimum $150 million reporting threshold. An adviser must file Form PF if (1) it is registered (or required to register) with the Commission as an investment adviser, including if it also is registered (or required to register) with CFTC as a commodity pool operator or commodity trading adviser, (2) it manages one or more private funds, and (3) the adviser and its related persons, collectively had at least $150 million in private fund assets under management as of the last day of its most recently completed fiscal year. See Form PF General Instruction No. 1, available at https:// www.sec.gov/files/formpf.pdf. 762 Division of Investment Management Analytics Office, Private Funds Statistics Fourth Calendar Quarter 2022, Table 46 at 39 (July 22, 2022), available at https://www.sec.gov/files/investment/ private-funds-statistics-2022-q4-accessible.pdf. 763 ‘‘Historically, most family offices have not been registered as investment advisers under the Advisers Act because of the ‘private adviser VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 A recent survey of family offices 764 found that of 385 participating family offices around the world, almost half (46%) are based in North America. Average family office AUM for North American families was $1 billion. Similarly, Separately Managed Accounts (SMAs) are also portfolios of assets managed by an investment adviser, usually targeted towards institutional investors and wealthy individual investors. Because of the end investor’s risk tolerance, SMAs can also pursue high-risk, leveraged strategies. iii. Registered Investment Companies (RICs) Including Money Market Funds, Other Mutual Funds, and ETFs RICs, mainly money market funds, mutual funds, and ETFs, are large holders of U.S. Treasury securities.765 At the end of the first quarter of 2023, money market funds held $1.0 trillion of U.S. Treasury securities ($185 billion in T-Bills and $856 billion in other U.S. Treasury securities).766 Mutual funds exemption’ provided under the Advisers Act to firms that advice fewer than fifteen clients and meet certain other conditions.’’ SEC Staff, Family Office: A Small Entity Compliance Guide (Nov. 21, 2011), available at https://www.sec.gov/rules/final/2011/ ia-3220-secg.htm. 764 Campden Wealth & The Royal Bank of Canada, The North America Family Office Report 2021, available at https:// www.rbcwealthmanagement.com/_assets/ documents/cmp/the-north-america-family-officereport-2021-final-ua.pdf. 765 As of Mar. 2022, investment companies were the third largest holder of U.S. Treasury securities holding just under $3.6 trillion. Viktoria Baklanova, Isaac Kuznits, Trevor Tatum, Money Market Funds in the Treasury Market (Sept. 1, 2022), available at https://www.sec.gov/files/mmfs-treasury-market090122.pdf (‘‘MMFs in the Treasury Market’’), at 3 (citing to Financial Accounts of the United States as of Mar. 2022). The other large (over 5%) holders are: ‘‘other’’ holders (including hedge funds) 30%, the Federal Reserve (23 percent), pension funds (14%), and U.S. banks and state and local governments (each holding 6%). See id. at 2 (figure 5). 766 Federal Reserve Statistical Release, Z.1 Financial Accounts of the U.S, Flow of Funds, Balance Sheets, and Integrated Macroeconomic Accounts, at 119 (L210 Treasury Securities—lines 42–49) (‘‘Financial Accounts of the U.S.’’), available at https://www.federalreserve.gov/releases/z1/ 20220609/z1.pdf. PO 00000 Frm 00084 Fmt 4701 Sfmt 4700 held an additional $1.4 trillion of other U.S. Treasury securities ($14 billion of T-Bills and $1.4 trillion of other U.S. Treasury securities) while exchangetraded funds held an additional $452.4 billion in U.S. Treasury securities.767 The degree to which these entities would be affected depends on the extent to which their trading is likely to take place in the secondary market.768 RICs are also active participants in the repo market with money market funds being active cash investors in U.S. Treasury repo. According to data filed with the Commission, money market funds’ investments in U.S. Treasury repo, both bilateral and triparty, amounted to approximately $2.46 trillion in June 2023. Moreover, as shown in Figure 12, money market fund U.S. Treasury repo volume has grown from approximately $200 billion monthly in 2011 with the vast majority of the most recent year’s growth attributed to investments in the Federal Reserve’s repo facility.769 767 Id. at 119 (L210 Treasury Securities—lines 45– 47 and 49). Filings of Form N–MFP by money market funds show that, as of May 31, 2023, these funds invested approximately $2.8 trillion in Treasury repos. In addition, mutual funds invested $27 billion in repurchase agreements, including those backed by Treasury securities. See supra note 118 and referencing text. 768 For example, an analysis of money market fund portfolios’ turnover of U.S. Treasury securities by the Commission staff indicates only limited secondary market trading activity. Estimates based on monthly filings of Form N–MFP suggest that, on average, money market funds hold around 70% of U.S. Treasury securities to the next month with around 6% of U.S. Treasury securities holdings disposed of before maturity. The remaining approximately 23% of holdings mature during the month. MMFs in the Treasury Market, supra note 765, at 3. These estimates suggest that the final rule’s effect on money market fund cash market transactions in U.S. Treasury securities will be very limited relative the final rule’s effects on money market funds’ repo activities which could be more significant. 769 Id. at 4. The Commission understands the credit rating agencies consider concentration of counterparty credit risk as one factor in determining their rating of money market funds which may drive money market funds to seek diversification of counterparties for the repo transactions. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations 2797 Figure 12: Total Monthly Repo Volume by Money Market Funds by Counterparty Type Monthly Repo Volume (01/2011- 07/2023) 2500 ••••••• FICC -g 2000 •••••••••• All Other V, C: - - Federal Reserve 1500 ~ V, :U 1000 0 0 500 ·····-. .. ·............................... 0 .-I .-I .-I .-I C: 6. QI ~ V) N .-I > ro ~ (V) (V) .-I .-I C: 6. QI ~ V) st .-I > ro ~ LI) LI) .-I .-I C: 6. QI ~ V) <.O .-I > ro ~ r-- .-I r-- .-I C: ~ 6. QI V) 00 .-I > ro ~ en en .-I .-I C: 6. QI ~ V) 0 N > ro ~ .-I N .-I N C: 6. QI ~ V) (V) N N > ro ~ N C: ~ Source: SEC Form N-MFP as summarized by OFR, available at https ://www.fmancialresearch.gov/money-market-funds/us-mmfs-investments-in-the-repo-market/. 770 See Shelly Antoniewicz & Sean Collins, Setting the Record Straight on Bond Mutual Funds’ Sales of Treasuries, ICI Viewpoints (Feb. 24, 2022), available at https://www.ici.org/viewpoints/22view-bondfund-survey-2. 771 See Money Market Fund Reforms; Form PF Reporting Requirements for Large Liquidity Fund Advisers; Technical Amendments to Form N–CSR and Form N–1A, Investment Advisors Act Release No. 6344 (Aug. 3, 2023), 88 FR 51404 (‘‘Money Market Reforms Adopting Release’’). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 Treasury securities, are included in the definition of both daily and weekly liquid assets,772 to the extent that money market funds currently fall below the minimums, their holdings of U.S. Treasuries may increase. iv. Principal Trading Firms (PTFs) The role and importance of PTFs providing liquidity in the U.S. Treasury securities market have been the subject of a number of analyses and reports in recent years.773 For example, using 772 See supra note 771, at 51431. e.g., G–30 Report, supra note 5, at 1; Joint Staff Report, supra note 4, at 3–4, 36, 55 (‘‘PTFs now account for more than half of the trading activity in the futures and electronically brokered interdealer cash markets.’’); Harkrader and Puglia FEDS Notes, supra note 641; Doug Brain, Michiel De Pooter, Dobrislav Dobrev, Michael Fleming, Pete Johansson, Collin Jones, Frank Keane, Michael Puglia, Liza Reiderman, Tony Rodrigues, and Or Shachar, Unlocking the Treasury Market Through TRACE (FEDS Notes, Sept. 28, 2018), available at https://www.federalreserve.gov/econres/notes/fedsnotes/unlocking-the-treasury-market-through-trace20180928.htm. See also Peter Ryan and Robert Toomey, Improving Capacity and Resiliency in US Treasury Markets: Part III (Nov. 15, 2021), available at https://www.sifma.org/resources/news/ improving-capacity-and-resiliency-in-us-treasurymarkets-part-3/. (While in the interdealer cash market, U.S. Treasury securities are often cleared and settled through FICC, ‘‘dealer trades with principal trading firms (‘‘PTFs’’)—a very large share of this market—are generally cleared bilaterally because most PTFs are not members of the FICC.’’). See also 2021 IAWG Report, supra note 4, at 21 (‘‘on February 25, 2021, a large shift in investor sentiment triggered very high trading volumes [ ] that temporarily overwhelmed the intermediation capacity of the Treasury market. Some market 773 See, PO 00000 Frm 00085 Fmt 4701 Sfmt 4700 FINRA’s Regulatory TRACE data in connection with a recent rulemaking proposal, we identified 174 market participants who were active in the U.S. Treasury securities market in July 2021 and were not members of FINRA.774 775 We ‘‘found that these participants accounted for approximately 19 percent participants observed that the stresses on February 25, 2021, were exacerbated by lack of elasticity in liquidity supply resulting from activity limits that IDB platforms impose on some firms, especially PTFs that do not participate in central clearing.’’). 774 Further Definition of ‘‘As a Part of a Regular Business’’ in the Definition of Dealer and Government Securities Dealer, Exchange Act Rel. No. 94524 (Mar. 28, 2022), 87 FR 23054, 23072, and 23080 (Apr. 18, 2022) (‘‘Because regulatory TRACE data pertaining to Treasury securities reported by certain ATSs contains the identity of non-FINRA member trading parties, we are able to analyze PTFs’ importance in the U.S. Treasury market during July 2021 and summarize the number and type of market participants by monthly trading volume . . . .’’). ‘‘Although FNRA membership is not synonymous with dealer registration status, the Commission believes that many of the market participants who are not FINRA members are also likely not registered as government securities dealers.’’ Id. at 23072 n. 167. 775 In Aug. 2023, the SEC adopted amendments to an exemption from the requirement for certain broker-dealers to join a national securities association. The amendments will, among other effects, enhance the oversight of participants in Treasury markets and the transparency of the market by requiring certain broker-dealers significantly involved in the proprietary trading of Treasury securities to become FINRA members and report their Treasury transactions to TRACE. See Exemption for Certain Exchange Members, Exchange Act Release No. 98202 (Sept. 7, 2023), 88 FR 61850 (‘‘Exemption for Certain Exchange Members Release’’). E:\FR\FM\16JAR2.SGM 16JAR2 ER16JA24.011</GPH> ddrumheller on DSK120RN23PROD with RULES2 For RICs, holdings of U.S. Treasury securities play an important role in managing liquidity risk stemming from potential redemptions. Given their highly liquid nature, U.S. Treasury securities can be used to raise cash to meet redemptions. For example, a survey conducted by an industry group showed that in the first quarter of 2020 mutual funds had net sales of $128 billion in Treasury and agency bonds, mainly to meet redemption requests at the onset of the Covid-19 pandemic.770 In addition to reliance on Treasury securities as sources of liquidity, RICs use Treasury securities as another source of liquidity by selling repo. Also, RICs accept Treasury securities as collateral in their securities lending programs established as an additional source of income for the fund shareholders. In July of 2023, the Commission adopted amendments to certain rules that govern money market funds, that among other things, increased daily and weekly liquid asset minimums.771 As direct obligations of the U.S. Government, including U.S. 2798 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations of the aggregate U.S. Treasury security trading volume, with PTFs representing the highest volumes of trading among these participants.’’ 776 We explained that in our analysis: PTFs had by far the highest volumes among identified non-FINRA member participants in the U.S. Treasury market, and the largest PTFs had trading volumes that were roughly comparable to the volumes of the largest dealers. A Federal Reserve staff analysis found that PTFs were particularly active in the interdealer segment of the U.S. Treasury market in 2019, accounting for 61 percent of the volume on [electronic] interdealer broker platforms. . . .777 Based on this Federal Reserve study and assuming that all PTFs are not FICC members and that PTF trading on IDB electronic platforms during the final three quarters 2019 was a reasonable proxy for the average daily current volume of such trading today by PTFs, the requirement to clear eligible secondary market transactions would subject as much as approximately $116.51 billion per day in PTF trades on electronic/automated IDBs to central clearing.778 v. State and Local Governments According to the United States Census Bureau’s 2017 Census of Governments data, there were over 90,000 local governments in the United States, including county, city, municipality, township, and special purpose governments as well as nearly 13,000 independent school district governments.779 These state and local governments are significant holders of U.S. Treasury securities. As of March 2023, state and local governments held approximately $1.6 trillion in U.S. Treasury securities 780 as part of their budgetary and short-term investment duties. ddrumheller on DSK120RN23PROD with RULES2 776 Id. at 23072. 777 Id. at 23080. Harkrader and Puglia FEDS Notes, supra note 641. See also Doug Brain et al. supra note 773. Harkrader and Puglia used FINRA TRACE data on the trading volume shares of different participant types on IDB platforms for nominal coupon securities from April 1, 2019, to Dec. 31, 2019. They identified $191 billion of average daily dollar volume on electronic/ automated IDB platforms during the period. They also noted data limitations, which they estimated amounted to ‘‘a very small fraction of total activity.’’ Id. 778 Harkrader and Puglia FEDS Notes, supra note 641, at table 1 (61% of $191 billion = $116.51 billion). 779 2017 Census of Governments—Organization, Table 2: Local Governments by Type and State: 2017 & Table 9: Public School System by Types of Organization and State: 2017, U.S. Census Bureau, https://www.census.gov/data/tables/2017/econ/gus/ 2017-governments.html. 780 Financial Accounts of the U.S., supra note 766 (Line 19). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 vi. Private Pensions Funds and Insurance Companies. Insurance companies and pension funds also have significant positions in U.S. Treasury securities. As of March 2023, private pension funds and insurance companies are large holders of U.S. Treasury securities, holding $479.3 billion and $405.9 billion respectively.781 e. Triparty Agent: Bank of New York Mellon 782 Although triparty repo transactions are bilaterally negotiated, they are settled through BNY Mellon, which currently plays a central role in the triparty repo market as the sole triparty agent.783 Besides providing collateral valuation, margining, and management services, BNY Mellon also provides back-office support to both parties by settling transactions on its books and confirming that the terms of the repo are met. Additionally, the clearing bank acts as custodian for the securities held as collateral and allocates collateral to trades at the close of the business day. As discussed previously, FICC recently introduced the Sponsored GC Service that extends FICC’s GCF repo service to allow for the clearing of triparty repo.784 An expansion of central clearing under the requirement to clear eligible secondary market transactions could affect BNY Mellon’s triparty business. It is, however, unclear whether increased central clearing would increase or decrease the amount of repo traded that makes use of triparty agent’s services previously described. f. Custodian Banks/Fedwire Securities Service (FSS) Currently, custodian banks handle much of the trading activity for longonly buy-side clients in the U.S. Treasury securities cash and repo markets. When an asset buyer and seller engage bilaterally as principals in a collateralized securities transaction, a repo for example, a custodian bank will often provide various services to support the transaction. Custodian services include transaction settlement 781 Id. (Lines 29, 32, and 35). et al., supra note 631(‘‘The Federal Reserve Board, through the Federal Reserve Bank of New York (FRBNY), supervises triparty custodian banks and, on a mandatory basis pursuant to its supervisory authority, collects transaction-level data at the daily frequency.’’). 783 J.P. Morgan Chase previously served as a custodian in the triparty space but largely exited the market in 2019. Id. at 2–3. 784 Exchange Act Release No. 92808 (Aug. 30, 2021), 86 FR 49580 (Sept. 3, 2021). Currently, the Bank of New York Mellon operates the triparty platform that facilitates trades conducted via the GCF Repo Service and Sponsored GC Service. 782 Paddrik PO 00000 Frm 00086 Fmt 4701 Sfmt 4700 verification, verifying the amount of the relevant credit exposure, calculating required initial and variation margin, and making margin calls. In a triparty repo transaction that is not centrally cleared, a custodian performs a clearing function by settling the transaction on its own books without a corresponding transfer of securities on the books of a central securities depository.785 FSS, operated by the Federal Reserve Bank system, provides issuance, maintenance, transfer and settlement services for all marketable U.S. Treasury securities to its 3,800 participants.786 For example, FSS offers the ability to transfer securities and funds to settle secondary-market trades, to facilitate the pledging of collateral used to secure obligations, and to facilitate repo transactions.787 C. Analysis of Benefits, Costs, and Impact on Efficiency, Competition, and Capital Formation 1. Benefits The amendments being adopted will likely yield benefits associated with increased levels of central clearing in the secondary market for U.S. Treasury securities. The Commission previously has stated that ‘‘the centralization of clearance and settlement activities at covered clearing agencies allows market participants to reduce costs, increase operational efficiency, and manage risks more effectively.’’ 788 These benefits could be particularly significant in times of market stress, as CCPs will mitigate the potential for a single market participant’s failure to destabilize other market participants, destabilize the financial system more broadly, and/or reduce the effects of misinformation and rumors.789 A CCP also will address concerns about counterparty risk by substituting the creditworthiness and 785 The Clearing House, The Custody Services of Banks (July 2016), available at https:// www.davispolk.com/sites/default/files/20160728_ tch_white_paper_the_custody_services_of_ banks.pdf. 786 See Fedwire Securities Service (‘‘FSS brochure’’), FRBservices.org, https:// www.frbservices.org/binaries/content/assets/ crsocms/financial-services/securities/securitiesproduct-sheet.pdf. The Federal Reserve Banks offer highly competitive transaction, per-issue and monthly maintenance prices. Account maintenance fees are waived for accounts holding only U.S. Treasury securities and for certain accounts used to pledge securities to the U.S. Treasury and Federal Reserve Banks. Fees for services are set by the Federal Reserve Banks. See Fedwire Securities Service 2023 Fee Schedules, FRBservices.org, https://www.frbservices.org/resources/fees/ securities-2023. 787 FSS brochure, supra note 786. 788 See CCA Standards Proposing Release, supra note 8, 79 FR at 29587. 789 See, e.g., Liffe Order, supra note 7, 74 FR at 140. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations liquidity of the CCP for the creditworthiness and liquidity of counterparties.790 However, the Commission has also recognized that this centralization of activity at clearing agencies makes risk management at such entities a critical function.791 Commenter(s) agreed that certain benefits of increased central clearing— increasing liquidity, resilience, and intermediation capacity—exist but disagree that these benefits have been ‘‘sufficiently proven’’ to outweigh the potential costs.792 As discussed in part IV.A, supra, improvements to market resilience imply potentially large expected benefits as the cost of financial market crises can be high. As discussed in part IV.C.2, infra, the Commission acknowledges the costs associated with the rule but believes that some of the costs incurred by market participants are commensurate with the risks and particular attributes of the market participants’ transactions. It further believes that the overall benefits of increased clearing U.S. Treasury Securities transactions discussed below, including improvements to market resiliency, justify the costs. Bilateral clearing arrangements do not allow for multilateral netting of obligations, which reduce end-of-day settlement obligations.793 Larger gross settlement obligations, which increase with leverage, increase operational risks and subsequently the possibility of settlement fails. Central clearing of transactions nets down gross exposures across participants, which reduces firms’ exposures while positions are open, and typically reduces the magnitude of cash and securities flows required at settlement.794 These reductions, particularly in cash and securities flow ‘‘would reduce liquidity risks associated with those settlements and counterparty credit risks associated with failures to deliver on the contractual settlement date,’’ not only for CCP members but for the CCP itself.795 It has been suggested that wider central clearing could have lowered dealers’ daily settlement obligations in the cash market by up to 60 percent in the run-up to and aftermath of the 790 Id. ddrumheller on DSK120RN23PROD with RULES2 791 Id. 792 SIFMA/IIB Letter, supra note 37, at 1–2. part IV.A supra for a discussion of central clearing and the mitigation of clearance and settlement risks. However, bilateral clearing does allow for balance sheet netting under certain conditions and for margining of net positions that may include multiple asset classes. 794 See 2021 IAWG Report, supra note 4, at 30. 795 See G–30 Report, supra note 5; see also PIFS Paper, supra note 76 at 28–31. 793 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 2799 March 2020 U.S. Treasury securities market disruption and reduced settlement obligations by up to 70 percent during the disruption itself.796 The reduction in exposure is not limited to the cash market; it has been estimated that the introduction of central clearing for dealer-to-client repos would have reduced dealer exposures from U.S. Treasury repos by over 80% (from $66.5 billion to $12.8 billion) in 2015.797 The benefits of multilateral netting flowing from central clearing can improve market safety by lowering exposure to settlement failures.798 Multilateral netting can also reduce the regulatory capital required to support a given level of intermediation activity 799 and could also enhance capacity to make markets during normal times and stress events because existing bank capital and leverage requirements recognize the risk-reducing effects of multilateral netting of trades that CCP clearing accomplishes.800 By reducing the level of margin required to support a given total level of trading activity, central clearing may reduce total risk to the system. Financial crises are sometimes precipitated by margin calls following a period of increased volatility. If a market participant holds offsetting positions, then margin calls that might occur could be avoided. Because financial markets are forwardlooking, reducing the anticipation of margin calls on other market participants can avoid costly ‘‘bankrun’’ type dynamics.801 Some benefits associated with capital reductions are particularly relevant for overnight and term repo. In the case of financing activity in U.S. Treasury securities market—U.S. Treasury repo— the entire notional value of the position has to be recorded on a dealer’s balance sheet as soon as the start leg of the repo settles, and unless the dealer faces the same legal counterparty with respect to an offsetting financing trade of the same tenor, the dealer will not be able to net such balance sheet impact against any other position. The grossing up of the dealer’s balance sheet in this manner can have implications with respect to the amount of capital the dealer is required to reserve against such activity. When transactions are cleared through a CCP, dealers can offset their centrally cleared repo positions of the same tenor, and thereby free up their capital to increase funding capacity to the market.802 According to research that Finadium conducted among repo dealers, netting can compress High Quality Liquid Asset (HQLA) bilateral trading books by 60% to 80%.803 Cash and repo trades cleared and settled outside of a CCP may not be subject to the same level of uniform and transparent risk management associated with central clearing.804 By contrast, FICC is subject to the Commission’s risk management requirements addressing financial, operational, and legal risk management, which include, among other things, margin requirements commensurate with the risks and particular attributes of each relevant product, portfolio, and market.805 As the Commission believes that the amendments being adopted will incentivize and facilitate additional central clearing in the U.S. Treasury securities market, risk management should improve. To offset the risks it faces as a central counterparty, the CCP requires its members to post margin, 796 Id. See also Michael Fleming & Frank Keane, Netting Efficiencies of Marketwide Central Clearing (Staff Report No. Staff Report No. 964), Federal Reserve Bank Of New York (Apr. 2021) (‘‘Fleming & Keane (2021’’), available at https:// www.newyorkfed.org/medialibrary/media/research/ staff_reports/sr964.pdf. 797 PIFS Paper, supra note 76, at 29 (citing OFFICE OF FINANCIAL RESEARCH, Benefits and Risks of Central Clearing in the Repo Market, 5–6 (Mar. 9, 2017) (‘‘2017 OFR Report’’), available at https://www.financialresearch.gov/briefs/files/ OFRBr_2017_04_CCP-for-Repos.pdf). 798 Duffie, supra note 27, at 15. 799 See part IV.A supra for an example of how multilateral netting can reduce margin required to support a given level of trading activity. 800 See 2021 IAWG Report, supra note 4, at 30; Liang & Parkinson, supra note 725, at 9; Duffie, supra note 27, at 16–17. It is important to note that this netting may offset any potentially higher liquidity charges faced by major participants from clearing at the CCP. See Duffie, supra note 27, at 17 (‘‘To the contrary, the netting of most purchases against sales at a CCP would lower the overall liquidity requirements of dealers, assuming that dealers continue to intermediate the market effectively.’’). 801 See Menkveld and Vuillemey supra note 568. 802 The positive impact on dealer’s ability to increase funding capacity will be offset, in part, by the direct and indirect costs of central clearing. See id. and part IV.C.2 infra. One commenter, although not supporting all aspects of the requirement to clear eligible secondary market transaction, agreed that a clearing mandate applied to bilateral repo transactions would be beneficial, pointing to the balance sheet efficiency resulting from repo clearing. See MFA Letter, supra note 81, at 13. 803 Finadium LLC, Netting Rules for Repo, Securities Lending and Prime Brokerage (Sept. 2014), available at https://finadium.com/finadiumreport-desc/netting-rules-for-repo-securitieslending-and-prime-brokerage/. Assets are considered to be HQLA if they can be easily and immediately converted into cash at little or no loss of value. The test of whether liquid assets are of ‘‘high quality’’ is that, by way of sale or repo, their liquidity-generating capacity is assumed to remain intact even in period of severe idiosyncratic and market stress. See Liquidity Coverage Ratio Standards LCR30.2, LCR 30.3 (Basel Comm. On Banking Supervision 2019), available at https:// www.bis.org/basel_framework/chapter/LCR/ 30.htm?tldate=20191231&inforce=20191215. 804 See TMPG Repo White Paper, supra note 75. 805 G–30 Report, supra note 5, at 13; 17 CFR 240.17ad–22(e)(6). PO 00000 Frm 00087 Fmt 4701 Sfmt 4700 E:\FR\FM\16JAR2.SGM 16JAR2 2800 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 and the CCP actively monitors the positions its members hold. Moreover, in the event that the posted margin is not enough to cover losses from default, the CCP has a loss-sharing procedure that mutualizes loss among its members. By lowering counterparty risk, central clearing also allows for the ‘‘unbundling’’ of counterparty risk from other characteristics of the asset that is being traded. This unbundling makes the financial market for Treasury securities more competitive.806 The Commission also believes that these amendments will help avoid a potential disorderly default by a member of any U.S. Treasury securities CCA. Defaults in bilaterally settled transactions are likely to be disorganized and subject to variable default management techniques, often subject to bilaterally negotiated contracts with potentially limited uniformity. Independent management of bilateral credit risk creates uncertainty about the levels of exposure across market participants and may make runs more likely; any loss stemming from closing out the position of a defaulting counterparty is a loss to the nondefaulting counterparty and hence a reduction in its capital in many scenarios.807 Increased use of central clearing should enhance regulatory visibility in the critically important U.S. Treasury securities market. Specifically, central clearing increases the transparency of settlement risk to regulators and market participants and, in particular, allows the CCP to identify concentrated positions and crowded trades, adjusting margin requirements accordingly, which should help avoid significant risk to the CCP and to the system as a whole.808 As discussed further below, the Commission is unable to quantify certain economic benefits of these amendments. The Commission solicited comment, including estimates and data from interested parties, that would help inform the estimates of the economic effects of the amendments but received only limited data, discussed further in part IV.C.2.a infra, that could be used to improve these estimates. 806 ‘‘One of the conditions for a perfectly competitive market is that [market participants] are happy to [buy or sell] from any of the many [sellers or buyers] of the [asset]. No [buyer or seller] of the [asset] has any particular advantage . . .’’ David M. Kreps, ‘‘A Course in Microeconomic Theory’’ Princeton University Press (1990), at 264 (describing the conditions of a perfectly competitive market.) When the transaction is novated to the CCP, market participants substitute the default risk of the CCP for that of the original counterparty. 807 See TMPG White Paper, supra note 13, at 32. 808 Duffie, supra note 27, at 15; DTCC October 2021 White Paper, supra note 681, at 1; 2021 IAWG Report, supra note 4. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 a. U.S. Treasury Securities CCA Membership Requirements The Commission is amending Rule 17ad–22(e)(18) to require any covered clearing agency that provides central counterparty services for transactions in U.S. Treasury securities to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, require that direct participants of a covered clearing agency submit all eligible secondary market U.S. Treasury securities transactions in which they enter for clearing at a covered clearing agency.809 As previously explained in part II.A.2 supra, as proposed an eligible secondary market transaction in U.S. Treasury securities was defined to include: (1) repurchase agreements and reverse repurchase agreements in which one of the counterparties is a direct participant; (2) any purchases and sales entered into by a direct participant that is an interdealer broker, meaning if the direct participant of the covered clearing agency brings together multiple buyers and sellers using a trading facility (such as a limit order book) and is a counterparty to both the buyer and seller in two separate transactions; (3) any purchases and sales of U.S. Treasury securities between a direct participant and a counterparty that is either a registered broker-dealer, government securities dealer, or government securities broker; a hedge fund; 810 or an account at a registered broker-dealer, government securities dealer, or government securities broker where such account may borrow an amount in excess of one-half of the net value of the account or may have gross notional exposure of the transactions in the account that is more than twice the net value of the account.811 However, any transaction (both cash transactions and repos) where the counterparty to 809 See part II.A.1 supra. the purpose of the proposed rule, a hedge fund is defined as any private fund (other than a securitized asset fund): (a) with respect to which one or more investment advisers (or related persons of investment advisers) may be paid a performance fee or allocation calculated by taking into account unrealized gains (other than a fee or allocation the calculation of which may take into account unrealized gains solely for the purpose of reducing such fee or allocation to reflect net unrealized losses); (b) that may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (c) that may sell securities or other assets short or enter into similar transactions (other than for the purpose of hedging currency exposure or managing duration). This definition of a hedge fund is consistent with the Commission’s definition of a hedge fund in Form PF. See Proposing Release, supra note 14 at 64623. 811 Id. 810 For PO 00000 Frm 00088 Fmt 4701 Sfmt 4700 the direct participant of the CCA is a central bank, sovereign entity, international financial institution, or a natural person would be excluded from the definition of an eligible secondary market transaction. In a change from the proposal, the Commission is modifying the definition of an eligible secondary market transaction in Rule 17ad–22(a) to conditionally exclude inter-affiliate transactions.812 Specifically, the Commission is excluding from that definition any repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities entered into between a direct participant and an affiliated counterparty, provided that the affiliated counterparty submit for clearance and settlement all other repurchase or reverse repurchase agreements collateralized by U.S. Treasury securities to which the affiliated counterparty is a party.813 As discussed in part II.A.2.a.vi, supra, inter-affiliate transactions are used to transfer liquidity and risk within an affiliated group. These transactions may serve different purposes, including, but not limited to, providing U.S. Treasury securities for delivery when an affiliate has taken a long or short position in U.S. Treasury securities as a hedge against other exposures, allowing the movement of U.S. Treasury securities to allow them to be posted as margin on an affiliate’s transaction, ensuring that U.S. Treasury securities can serve as a liquidity buffer for an affiliated bank,814 or to meet liquidity composition targets. To get the U.S. Treasury securities to the appropriate entity with an affiliated group, the affiliate often enters into repos or reverse repos with a direct participant of a U.S. Treasury securities CCA. As discussed above, one commenter stated that requiring inter-affiliate transactions to be centrally cleared would impose additional costs with limited benefits.815 While the costs of clearing inter-affiliate transactions may be similar to those of other transactions, the Commission agrees with the commenter that the potential benefits of clearing these transactions is likely to be less. For example, the commenter noted that a direct participant’s affiliate’s credit risk is already part of the groupwide financial risks to which the Treasury CCP is exposed, and central clearing of inter-affiliate transactions is unlikely to meaningfully impact the risk 812 See part IV.B.3.b.v supra. part II.A.2.a supra. 814 See supra note 238. 815 SIFMA/IIB Letter, supra note 37, at 21–22. 813 See E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations profile.816 As discussed above, in certain circumstances, the counterparty credit risk posed by inter-affiliate transactions may be less than other transactions.817 However, affiliated entities are separate legal entities and, generally, are not legally responsible for each other’s contractual obligations therefore while there may be a benefit of reducing counterparty credit risk by centrally clearing such transactions, the benefit is likely to be less. In additional changes from the proposal and for the reasons discussed above, the Commission is adding additional exclusions to the definition of an eligible secondary market transaction for any repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities in which one counterparty is a state or local government, a covered clearing agency providing central counterparty services, a derivatives clearing organization (see 7 U.S.C. 7a– 1 and 17 CFR 39.3), or is regulated as a central counterparty in its home jurisdiction.818 In the absence of the exclusion, these types of entities may not be able to transact with netting members of a CCA, reducing the available counterparties with which they could transact and likely resulting in adverse impacts on the prices that are available to them. The amendment to Rule 17ad– 22(e)(18) will increase the fraction of secondary market U.S. Treasury securities transactions required to be submitted for clearing at a covered clearing agency. The Commission believes that this should result in achieving the benefits associated with an increased level of central clearing discussed in this section. ddrumheller on DSK120RN23PROD with RULES2 i. Scope of the Requirement To Clear Eligible Secondary Market Transactions A significant share of both cash and repo transactions in U.S. Treasury securities, including those of direct participants in a covered clearing agency, are not currently centrally cleared.819 The Commission believes that covered clearing agency members not centrally clearing cash or repo transactions in U.S. Treasury securities create contagion risk to CCAs clearing and settling such transactions, as well as to the market as a whole, and that this contagion risk can be ameliorated by centrally clearing such transactions. 816 Id. 817 See supra note 239. part II.A.2.a supra. 819 See DTCC May 2021 White Paper, supra note 307, at 5; 2021 IAWG Report, supra note 4, at 6. 818 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 Currently, FICC, the only U.S. Treasury securities CCA, requires its direct participants to submit for central clearing their cash and repo transactions in U.S. Treasury securities with other members.820 However, FICC’s rules do not require its direct participants, such as IDBs, to submit either cash or repo transactions 821 with persons who are not FICC members for central clearing. The expanded scope of the requirement to clear eligible secondary market transactions should reduce instances of ‘‘hybrid’’ clearing, where FICC lacks visibility on the bilaterally cleared component of a trade. As discussed in the Proposing Release, trades cleared and settled outside of a CCP may not be subject to the same level of risk management associated with central clearing, which includes requirements for margin determined by a publicly disclosed method that applies objectively and uniformly to all members of the CCP, loss mutualization, and liquidity risk management.822 The requirement to clear eligible secondary market transactions should not only result in the consistent and transparent application of risk management requirements to trades that are now bilaterally cleared but also increase the CCA’s awareness of those trades, which it now lacks.823 The definition of an eligible secondary market transaction applies to all types of transactions that are of a type currently accepted for clearing at a U.S. Treasury securities CCA; it does not impose a requirement on a U.S. Treasury securities CCA to offer additional products for clearing. One commenter specifically agreed that the proposal should apply to the types of transactions that are eligible for clearing at a U.S. Treasury securities CCA, as those eligibility criteria evolve over time. The commenter stated that such an approach would ensure that the requirement would not inadvertently 820 FICC Rule 2A, section 7(e) (requirement that FICC Netting Members submit to FICC all of their eligible trades with other Netting Members); FICC Rule 18, section 2 (similar requirement with regard to Repo transactions); cf. FICC Rule 3, section 8(e) (providing clearing requirement for FICC IDB Members), supra note 19. 821 With regard to Sponsored GC Repos, as noted above, these transactions can be secured with generic CUSIPs that include U.S. Treasury securities, and with other generic CUSIPs that include other securities, such as agency securities and mortgage backed securities. Because the requirement to clear eligible secondary market transactions is limited to eligible secondary market transactions in U.S. Treasury securities, it would not apply to Sponsored GC Repo generic CUSIPs that do not include U.S. Treasury securities. 822 See supra note 14, 87 FR at 64616; 2021 IAWG Report, supra note 4, at 30; G–30 Report, supra note 5. 823 See supra note 369. PO 00000 Frm 00089 Fmt 4701 Sfmt 4700 2801 give rise to risk or undue costs by forcing into central clearing transaction types that have not gone through a methodical risk analysis or for which the costs may outweigh the benefits, while at the same time, it would allow the requirement to evolve as U.S. Treasury securities CCAs, their direct participants, and regulators identify transaction types that would benefit from central clearing.824 ii. Application of the Requirement To Clear Eligible Repo Transactions The requirement to clear eligible secondary market transactions requires that all direct participants of a U.S. Treasury securities CCA submit for clearing all eligible secondary market transactions that are repurchase agreements or reverse repurchase agreements. As discussed in part IV.B.5 supra, risk management practices in the bilateral clearance and settlement of repos are not uniform across market participants and are less transparent than analogous practices under central clearing.825 Many commenters supported the definition of an eligible secondary market transaction as it relates to repo and reverse repo transactions.826 These commenters encouraged a broad and comprehensive definition to limit market fragmentation and avoidance of central clearing. The benefits of central clearing— including the benefits of netting— increase with the fraction of total volume of similar transactions submitting for clearing at a CCP. Significant gaps persist in the current coverage of transaction data in U.S. Treasury repo.827 The Commission understands that, among bilaterally settled repo, approximately half was centrally cleared as of 2021.828 Centrally 824 DTCC/FICC Letter, supra note 33, at 12–13. Repo White Paper, supra note 75, at 1. 826 See supra note 81. 827 2021 IAWG Report, supra note 4, at 29. Some of the benefits discussed here may be mitigated if central clearing of repo were to occur at multiple CCPs (e.g., in there was an additional registered clearing agency that accepted repo for clearing and in the absence of an agreement between those registered clearing agencies, the netting benefits may be less than those if there were but a single clearing agency accepting repo for clearing). 828 Id. (‘‘Non-centrally cleared bilateral repo represents a significant portion of the Treasury market, roughly equal in size to centrally cleared repo.’’) (citing a 2015 pilot program by the U.S. Treasury Department); see also TMPG Repo White Paper, supra note 804, at 1; Katy Burne, FutureProofing the U.S. Treasury Market, BNY Mellon Aerial View 7 (2021), available at https:// www.bnymellon.com/content/dam/bnymellon/ documents/pdf/aerial-view/future-proofing-the-ustreasury-market.pdf.coredownload.pdf (noting that 63% of repo transactions remain non-centrally cleared according to Office of Financial Research data as of Sept. 10, 2021). 825 TMPG E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 2802 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations cleared triparty repo is a relatively new service, and the proportion may be smaller. Thus, despite the volume of centrally cleared repo transactions as seen in Figure 10 above, and the development of services to encompass more types of repo transactions at FICC, the Commission understands the volume of repo not currently centrally cleared to be substantial. The requirement that all U.S. Treasury CCA members submit all eligible repurchase agreements for central clearing would increase the fraction of total volume of such transactions submitted for central clearing, realizing the benefits described above in this section. In addition, because repo participants tend to be sophisticated market players, the requirement for repo transactions will cover a set of market participants many of whom will have built most of the necessary processes and infrastructure to comply with the rule. One commenter noted an additional potential benefit to money market funds (‘‘MMFs’’).829 The commenter stated that MMFs are only permitted to execute repo transactions with counterparties that are rated by one of the top rating agencies, a benefit typically accessible to only larger participants due to the prohibitive cost of obtaining and maintaining a rating from the top tier rating agencies. The commenter stated that this limits the number of potential counterparties with which MMFs can execute repo transactions, limiting liquidity and pricing options available to the MMFs. If MMFs are able to transact as sponsored members whose trades are centrally cleared and are able to look through the initial counterparty to the credit worthiness of the CCP itself, liquidity and pricing available to MMFs is likely to improve. Some commenters questioned the need for a requirement with respect to repo, noting that the balance sheet netting efficiencies already exist, providing a natural incentive to centrally clear such transactions.830 The Commission agrees that centrally cleared repo already benefits from favorable treatment on balance sheet, but believes that a requirement to clear repo transactions would result in more transactions being centrally cleared and, accordingly, additional balance sheet efficiency and capacity to intermediate repo transactions.831 Although FICC 829 Letter from the Independent Dealer & Trader Association, at 10–11 (Sept. 1, 2023) (‘‘IDTA Letter 2’’). 830 See supra note 84. 831 Duffie supra note 718, provides empirical evidence with supporting theory that the current intermediation capacity of the U.S. Treasury market VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 netting members may wish to increase the fraction of their repo business that is centrally cleared in order to take greater advantage of netting efficiencies, they are only able to do so to the extent that their counterparties have taken the steps necessary to access clearing. Requiring most repo transactions with a FICC netting member on one side to be centrally cleared assures that counterparties will have taken such steps. Thus, there would still be benefits from the requirement, despite the currently existing balance sheet treatment. The OFR published a 2023 report on an OFR pilot data collection of noncentrally cleared bilateral repurchase agreement (‘‘NCCBR’’) trades spanning nine dealers over three reporting dates in June 2022.832 Of the four bilateral repo segments discussed (centrally cleared transactions settled on the triparty platform, centrally cleared transactions using the FICC DVP service, non-centrally cleared transactions settled on the triparty platform, and NCCBR transactions), the NCCBR segment is the largest of the four segments of the repo market in terms of gross repo exposure by primary dealers.833 The OFR’ report uses the pilot data collection to answer the question of why volume in this segment is so high despite the benefits of central clearing, including the ability of dealers to net their repo positions with one counterparty against reverse repo positions with another counterparty for the purpose of calculating certain regulatory ratios, thus reducing the balance sheet costs of participating in repo. The report’s authors estimate that over 60% of all Treasury trades in the NCCBR market are naturally netted (matching repo and reverse repo with the same counterparty and tenor, typically as part of a relative value trade); however, they also show that substantial balance sheet netting benefits could still result from the trades that are not naturally netted if NCCBR trades were moved into central clearing.834 Several commenters recommended excluding triparty repos from the definition of an eligible secondary market transaction.835 Four of these impairs its resilience. Among the improvements he discusses that could increase the market’s intermediation capacity under stress is broader central clearing. See Resilience redux in the US Treasury market, supra note 718. See also Dealer Capacity and US Treasury, presentation to SEC Staff (July 2023), supra note 702. 832 See Hempel et al. (2023), supra note 564. 833 Id. 834 Id. 835 See supra note 85. PO 00000 Frm 00090 Fmt 4701 Sfmt 4700 commenters suggested that the cost of including triparty repos would outweigh the benefits.836 Several commenters argued that including triparty repos would not significantly reduce the risks that the proposal seeks to address because the current triparty market infrastructure inherently mitigates the associated risks.837 Specifically, these commenters argue that credit risk in the triparty market is mitigated by the triparty agent’s provision of custodial, collateral management, and settlement services.838 Moreover, one commenter stated that the infrastructure underlying the triparty repo market is robust and provides credit protections, operational safeguards, and strict internal controls akin to central clearing.839 One commenter added that the triparty market is relatively safe from credit risk because the triparty agent is subject to prudential regulation.840 One commenter added that settlement risk in the triparty market is nearly eliminated because collateral posted to the triparty platform cannot generally be repledged outside the platform.841 The commenter stated, therefore, that the only significant source of settlement risk is the rare occurrence of a counterparty’s nonpayment of the repurchase price, which is generally attributable to operational risk as opposed to credit risk.842 Despite supporting the exclusion of triparty repos from the definition of an eligible secondary market transaction, one commenter acknowledged that the triparty agent ‘‘does not fulfill a CCP role—it does not guarantee either counterparty’s performance through novation or otherwise and does not assume counterparty risk.’’ 843 The Commission recognizes that the current triparty market infrastructure incorporates credit protections, operational safeguards, and strict internal controls. However, as discussed above, the triparty agent does not fulfill a CCP role, and therefore, the Commission disagrees with the contention that the current market infrastructure incorporates controls akin to those available through central 836 See MFA Letter, supra note 81, at 6, 14; SIFMA/IIB Letter, supra note 37, at 20; ICI Letter, supra note 85, at 11; Federated Letter, supra note 85, at 5. 837 See MFA Letter, supra note 81, at 14; SIFMA/ AMG Letter, supra note 35, at 11; ICI Letter, supra note 85, at 12, 22; Citadel Letter, supra note 81, at 6; Federated Letter, supra note 85, at 5. 838 See id. 839 See ICI Letter, supra note 85, at 22. 840 See MFA Letter, supra note 81, at 14. 841 See Federated Letter, supra note 85, at 5. 842 See Federated Letter, supra note 85, at 5. 843 ICI Letter, supra note 85, at 33. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations clearing.844 Therefore, the benefits accruing to additional central clearing using a U.S. Treasury securities CCA apply in varying degree to triparty transactions as well.845 In response to the commenter who stated that most risks are eliminated because collateral cannot be posted outside the triparty platform, the Commission disagrees. For example, significant risks exist if concerns emerge regarding the financial condition of borrowers in the triparty market.846 In such scenarios, even though collateral stays within the triparty platform, the repo buyer could still face the sudden default of a triparty repo counterparty.847 Moreover, the Commission understands that settlement failures occur regularly and tend to spike during market stress events.848 Even though not considered a default, settlement failures create credit exposure to the failing counterparty and market risk exposure with respect to the relevant Treasuries.849 Furthermore, settlement failures may prevent or make more costly the non-failing party’s delivery of the relevant Treasuries in respect of other transactions. One commenter stated that the Commission must address other aspects of the Sponsored Service to better promote the objectives of central clearing, with such issues including the 844 See supra part II.A.2.a supra. ddrumheller on DSK120RN23PROD with RULES2 845 Id. 846 See 2013 Annual Report of the Financial Stability Oversight Council, at 4, 12–13, 133–134, available at https://home.treasury.gov/system/files/ 261/FSOC-2013-Annual-Report.pdf; Begalle et al., supra note 98 (discussing concern that stress caused by a potential default of a triparty repo counterparty can lead to either pre-default fire sales of assets by the counterparty or post-default fire sales of collateral by the triparty repo investor and the related financial stability concerns). 847 See SEC Division of Investment Management Guidance Update: Counterparty Risk Management Practices with Respect to Tri-Party Repurchase Agreements (July 2013), available at https:// www.sec.gov/divisions/investment/guidance/imguidance-2013-03.pdf. 848 See e.g., Adam Copeland, Antoine Martin, Michael Walker, Repo Runs: Evidence from the TriParty Repo Market, N.Y. Fed Staff Report No. 506, at 26–30, available at https://www.newyorkfed.org/ medialibrary/media/research/staff_reports/ sr506.pdf; Tobias Adrian, Christopher R. Burke, and James J. McAndrews, The Federal Reserve’s Primary Dealer Credit Facility, 15 Fed. Res. Bank N.Y. Current Issues in Econ. and Fin. 4, available at https://www.newyorkfed.org/medialibrary/media/ research/current_issues/ci15-4.pdf; see also Michael Fleming & Kenneth Garbade, Explaining Settlement Fails, 11 Fed. Res. Bank N.Y. Current Issues in Econ. and Fin. 1 (Sept. 2005), available at https://www.newyorkfed.org/medialibrary/ media/research/current_issues/ci11-9.pdf. 849 See Treasury Market Practice Group, U.S. Treasury Securities Fails Charge Trading Practice (July 27, 2018), available at https:// www.newyorkfed.org/medialibrary/microsites/ tmpg/files/TMPG-UST-fails-charge-trading-practiceFINAL-07-27-18.pdf. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 treatment of the start leg of the transaction, FICC’s obligations to complete settlement of a Sponsored Member’s positions in the event of a Sponsoring Member’s default, and a Sponsored Member’s ability to engage with FICC to address issues arising from repo transactions that have been submitted through sponsored clearing.850 The commenter stated that, within the Sponsored Service, FICC does not novate the settlement of the start leg of a repo transaction that is submitted for clearing between a sponsoring Member and a sponsored Member, although it does novate the end leg of the transaction, meaning that the counterparties continue to be responsible for settlement outside of FICC and bear the risk of a settlement fail vis a vis one another. The commenter also states that the lack of central clearing for the start leg of repo transactions in the Sponsored Service means that a requirement to clear eligible secondary market transactions may not eliminate counterparty credit risk issues to the extent the Commission anticipates, which, in turn, means that the proposal may not increase competition or reduce spreads as the Commission predicted in the Proposing Release. The Commission understands that, contrary to transactions cleared at FICC outside the Sponsored Service, FICC currently does not novate the start legs of same-day settling Sponsored DVP Repos where the Sponsored Member’s pre-novation counterparty is its Sponsoring Member (i.e., ‘‘done-with’’ Sponsored DVP Repo) or of Sponsored GC Repos. However, the Commission does not believe that this failure to novate is inconsistent with the definition of an eligible secondary market transaction being adopted in this release.851 The Commission acknowledges that settlement of the start leg occurring outside central clearing could somewhat reduce the benefits of central clearing in this limited instance, but the counterparty credit risk arising from the start legs of such transactions are largely addressed by the fact that they usually settle on a delivery-versus-payment basis between the counterparties, meaning that the securities and funds are exchanged simultaneously and resulting in less counterparty credit risk to address. However, the Commission further understands that FICC has stated that it is able to clear the start leg of any repo and currently does clear the start leg of all repos between two direct 850 ICI Letter, supra note 85, at 26–28. Part II.C.2.c, supra. 851 See PO 00000 Frm 00091 Fmt 4701 Sfmt 4700 2803 participants, the start leg of any Sponsored DVP repo where the Sponsored Member’s pre-novation counterparty is a third-party member of FICC (i.e., ‘‘done-away’’ from the Sponsoring Member), and any Sponsored DVP Repo where the start leg of such repo is scheduled to settle on some business day in the future (i.e., forward-settling repos).852 One commenter stated that neither the Sponsored Bilateral DVP Service nor the Sponsored GC Repo Service compel FICC to complete the settlement of a sponsored member’s transactions in the event of a sponsoring member’s default, and that this approach is not consistent with the Commission’s assumption that central clearing increases the likelihood of settlement.853 The Commission understands that this ability to, potentially, terminate the Sponsored Member’s transaction in such circumstances arises from the fact that, within the Sponsored Service, by design, the Sponsoring Member serves as the processing agent for all movement of funds and securities for its Sponsored Members, and FICC is not able to guarantee that an insolvent Sponsoring Member, which may be subject to the control of another legal entity, such as a bankruptcy trustee, would be able to continue processing such transactions. This aspect of FICC’s rules is consistent with how other central counterparties have addressed the potential termination of customer transactions in the event of their agent’s default.854 As discussed in Part II.B.2.c supra, the Commission does not believe that the potential for FICC to terminate these transactions, in the unlikely event of a Sponsoring Member default in which it is unable to work with the controlling legal entity, means that the benefits in the Proposing Release would not be, to a great extent, realized. iii. Application of the Requirement To Clear Eligible Secondary Market Transactions to Purchases and Sales of U.S. Treasury Securities As discussed above, 68 percent of cash market transactions in U.S. Treasury securities are not centrally cleared, and another 19 percent of such transactions are subject to so-called hybrid clearing.855 The Commission has identified certain categories of purchases and sales of U.S. Treasury securities that it believes should be part of the requirement to clear eligible 852 See FICC Rule 11, section 2, supra note 19; FICC Buyside FAQ, supra note 169, at 2–3. 853 ICI Letter, supra note 85, at 27. 854 See supra note 438 and referencing paragraph. 855 Proposing Release, supra note 14, at 64613. E:\FR\FM\16JAR2.SGM 16JAR2 2804 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 secondary market transactions, i.e., for which U.S. Treasury securities CCAs are obligated to impose membership rules to require clearing of such transactions. The benefits of including these categories are described below. As with repurchase transactions, the general benefits of central clearing discussed in part IV.A supra become greater as the fraction of total transaction volume that is centrally cleared increases. In other words, there are positive externalities associated with broader central clearing. However, unlike in the repo market, the Commission is not requiring that all cash market transactions completed with a FICC member be centrally cleared.856 Several commenters suggested that the scope of eligible secondary market transactions in the cash market be broadened. One commenter stated that the Commission should align the scope of the definition with respect to cash transactions with the proposed scope for repos, subject to certain limited exceptions for investors that trade de minimis volumes. The commenter argued that the Commission’s approach with respect to cash transactions will increase costs for a specific subset of market participants, thereby putting them at a competitive disadvantage, while failing to deliver the envisaged market-wide benefits associated with central clearing (i.e., it would materially reduce the associated multilateral netting benefits, impair the risk management practices of clearing agencies, and hinder the evolution in trading protocols that can be expected from a market-wide clearing requirement).857 For similar reasons, another commenter also stated that the benefits of central clearing detailed ‘‘will only materialize if a market-wide mandate is implemented’’ and supported defining the scope of eligible secondary market transactions for cash transactions as broadly as that proposed for repos.858 Another commenter stated that limiting the scope of the cash clearing mandate would result in unwarranted competitive disadvantages 856 The G–30 report recommends an approach to clearing all of repo, and some cash trades. See generally G–30 Report, supra note 5. 857 Citadel Letter, supra note 81, at 5. 858 ARB et al. Letter, supra note 81, at 4 (stating that the netting benefits associated with transitioning only proprietary trading firm (‘‘PTF’’) transactions into central clearing are much smaller, given the substantial netting that already occurs directly with inter-dealer brokers (‘‘IDBs’’); the trading-related benefits of central clearing will only accrue to market participants if their transactions are covered by the proposed mandate; and that clearing agency resiliency will be negatively impacted if only one segment of the market is cleared). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 and related market distortions for some types of investors, such as hedge funds, or some types of trading platforms, such as anonymous trading facilities.859 The Commission proposed a targeted approach to clearing in the cash market in the Proposing Release, limiting the clearing requirement to specific types of entities transacting with members of a U.S. Treasury securities CCA that pose certain risks when clearing cash market treasury transactions bilaterally.860 As discussed in the Proposing Release and discussed in part II.2.b supra, the Commission believed that including within the scope of eligible transactions the cash transactions of levered funds and hedge funds is more important than those of other market participants that were not included in part because the strategies employed by hedge funds ‘‘can increase the likelihood that the fund will experience stress or fail, and amplify the effects on financial markets.’’ 861 The Commission is not including purchases and sales of U.S. Treasury securities between a direct participant and either a hedge fund or a levered account within the definition of an eligible secondary market transaction in light of questions raised by commenters regarding the inclusion of a hedge fund and a leveraged account as proposed that merit further consideration, and the Commission will continue to evaluate the issues raised to determine if any further action is appropriate.862 In response to the comment that characterized a market-wide mandate as a ‘‘necessary condition’’ for adoption of any mandate, the Commission does not believe that all benefits of central clearing exist only if the entire market is centrally cleared. The increased clearing of cash transactions, targeted to address the differing risk profiles of each market segment, would still bring the benefits of central clearing to an important part of the cash market. As explained below, cash and repo markets differ in important ways that suggest a broader definition of eligible secondary market transactions for repo and a less broad definition for cash transactions. Though there are linkages across markets, segments of the Treasury market are distinct, and for this reason, the Commission addresses the risks in each of these categories separately in parts II.A.2.b.ii through iii supra. The Commission understands the set of participants in U.S. Treasury 859 MFA Letter, supra note 81, at 2. part II.A.2.b supra for discussion of the justification for the scope as proposed. 861 Proposing Release, supra note 14 at 64623–4. 862 See part II.A.2.b.i supra. securities cash markets to be far broader and more heterogeneous than in the repo markets. The cash market has many participants that trade in relatively small amounts, whereas the market for repo is dominated by larger, more sophisticated institutions. Although difficult to quantify precisely, the number of participants is one or more orders of magnitude greater in the cash market as compared with the repo market. Because the benefits increase with the number and size of transactions, whereas the costs have a large fixed component, extending the clearing mandate to institutions that are market participants in repo markets and a subset of the institutions that are participants in cash markets should capture a large fraction of market activity, while also capturing the most active market participants who may already have some ability to connect with the clearing agency and experience with central clearing. a. IDB Transactions The amendments being adopted require that all purchases and sales of U.S. Treasury securities entered into by a direct participant of a U.S. Treasury securities CCA and any counterparty, if the direct participant of the CCA brings together multiple buyers and sellers using a trading facility (such as a limit order book) and serves as a counterparty to both the purchaser and seller in two separate transactions executed on its platform, be subject to the requirement to centrally clear eligible secondary market transactions. This requirement encompasses the transactions of those entities serving as IDBs in the U.S. Treasury securities market, in that it covers entities that are standing in the middle of transactions between two counterparties that execute a trade on the IDB’s platform.863 The amendments being adopted will result in more central clearing of IDB trades. FICC Member IDBs do not take directional positions on the securities that trade on the IDB’s platform. Consequently, a requirement that FICC member IDBs centrally clear all of their trades will give FICC better insight into the risk position of its clearing members though the elimination of the hybrid clearing transactions mentioned above. In contrast to other FICC members, FICC members that are also IDBs will be required to centrally clear all of their cash trades (and repo, as described above). As described in the TMPG White Paper and in the recent G–30 860 See PO 00000 Frm 00092 Fmt 4701 Sfmt 4700 863 See Proposing Release, supra note 14, at 64616 for further discussion of IDBs and their role in the cash market for U.S. Treasury securities. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 report,864 IDBs act as central nodes in the system, in effect serving as clearing agencies without the regulatory structure of clearing agency. Furthermore, the netting benefits to IDBs, as described in this section are likely to be particularly high, because each transaction on an IDB is matched by a transaction on the other side. IDBs are sophisticated institutions that have experience managing the central clearing of trades as they already centrally clear all trades with other FICC members. The configuration of counterparty risk presented by hybrid clearing allows FICC to manage the risks arising from the IDB–FICC member trade, but FICC cannot manage the risks arising from the IDB’s offsetting trade with its non-FICC member counterparty and the potential counterparty credit risk and settlement risk arising to the IDB from that trade.865 Thus, the IDB is not able to net all of its positions for clearing at FICC, and the IDB’s positions appear to FICC to be directional, which impacts the amount of margin that FICC collects for the visible leg of the ‘‘hybrid’’ transaction. This lack of visibility can increase risk during stress events, when margin requirements usually increase. Thus, FICC is indirectly exposed to the IDB’s non-centrally cleared leg of the hybrid clearing transaction, but it lacks the information to understand and manage its indirect exposure to this transaction. As a result, in the event that the nonFICC counterparty were to default to the IDB, causing stress to the IDB, that stress to the IDB could be transmitted to the CCP and potentially to the system as a whole.866 In particular, if the IDB’s nonFICC counterparty fails to settle a transaction that is subject to hybrid clearing, such an IDB may not be able to settle the corresponding transaction that has been cleared with FICC, which could lead the IDB to default. As part of its existing default management procedures, FICC could seek to mutualize its losses from the IDB’s default, which could in turn transmit stress to the market as a whole. The Commission has previously stated that membership requirements help to guard against defaults of any CCP member, as well to protect the CCP and the financial system as a whole from the risk that one member’s default 864 See generally G–30 Report, supra note 5. e.g., TMPG White Paper, supra note 13, at 22 (noting that in a hybrid clearing arrangement, an ‘‘IDB’s rights and obligations towards the CCP are not offset and therefore the IDB is not in a net zero settlement position with respect to the CCP at settlement date.’’). 866 See DTCC May 2021 White Paper, supra note 307, at 5. 865 See, VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 could cause others to default, potentially including the CCP itself.867 Further, contagion stemming from a CCP member default could be problematic for the system as a whole, even if the health of the CCP is not implicated. This is so because the default could cause others to back away from participating in the market. This risk of decreased market participation could be particularly acute if the defaulting participant were an IDB, whose withdrawal from the market could jeopardize other market participants’ ability to access the market for on-the-run U.S. Treasury securities.868 And because IDBs facilitate a significant proportion of trading in on-the-run U.S. Treasury securities (that is, they form central nodes), such a withdrawal could have significant consequences for the market as a whole.869 The requirement to clear eligible secondary market transactions should therefore help mitigate this risk by mandating that a U.S. Treasury securities CCA ensure its IDB members clear both sides of their transactions, thereby eliminating the various facets of potential contagion risk posed by socalled hybrid clearing. Commenters generally supported the inclusion of IDB transactions in the definition of an eligible secondary market transaction.870 Another commenter, although not supporting a requirement to clear repos, stated that if such a requirement was adopted it should be limited to IDBs and brokerdealers because (1) the counterparties to such transactions are the most active participants in the Treasury repo markets, thereby allowing the Commission to meaningfully increase central clearing without applying a more categorical requirement, and (2) because such transactions are more interconnected with the rest of the market and have a higher possibility to transfer risk to outside parties (including potentially a U.S. Treasury securities CCA).871 However, certain commenters asserted that this aspect of the definition would inappropriately disadvantage IDBs, with uncertain benefits and potentially significant negative consequences that would result if market participants shifted their trading activity away from IDBs.872 Three 867 See CCA Standards Proposing Release, supra note 8. 868 TMPG White Paper, supra note 13, at 32. 869 See id. 870 See AIMA Letter, supra note 81, at 7. 871 See SIFMA/IIB Letter, supra note 37, at 19–20. 872 See ICI Letter, supra note 85, at 3, 11; MFA Letter, supra note 81, at 19–21; see also Tradeweb Letter, supra note 81, at 3–4. PO 00000 Frm 00093 Fmt 4701 Sfmt 4700 2805 commenters expressed concerns that including IDB transactions in the definition of an eligible secondary market transaction could draw trading activity away from IDBs, thereby reducing market liquidity and market stability.873 The commenters also noted that IDBs are anonymous platforms that currently support all-to-all trading, which the Commission has recognized would improve market structure and stability.874 The commenters argued that including IDB transactions in the definition of an eligible secondary market transaction could, therefore, hinder all-to-all trading.875 One of these commenters further argued that by discouraging market participants from trading on IDBs, the requirement to clear eligible secondary market transactions, as drafted, could limit the choices of market participants with respect to trading venues.876 The Commission disagrees with these commenters. The inclusion of IDB transactions, along with other types of transactions, would not necessarily lead to decreased liquidity and market stability or negatively impact all-to-all trading in the U.S. Treasury market. The benefits to market participants from trading on an IDBs, that is the ability find counterparties and to trade anonymously are significant and will continue even if such transactions are eligible secondary market transactions, meaning that such transactions would incur the costs associated with central clearing and described below. Moreover, even in the event that some of these concerns materialize from the inclusion of IDB transactions, the inclusion of IDB transactions is justified as it would allow the U.S. Treasury securities CCA to better risk manage ‘‘hybrid’’ transactions that are currently not being submitted for central clearing. Specifically, including IDB transactions in the definition of an eligible secondary market transaction would address the potential for contagion risk associated with hybrid clearing. As explained in the Proposing Release, the configuration of counterparty risk presented by hybrid clearing allows the U.S. Treasury securities CCA to manage the risks arising from the IDB–CCA direct participant transaction, on the one hand, but the U.S. Treasury securities CCA cannot manage the risks arising from the IDB’s offsetting transaction with its non-member counterparty and 873 See ICI Letter, supra note 85, at 3, 11; MFA Letter, supra note 81, at 20; Tradeweb Letter, supra note 81, at 3–4. 874 See id. 875 See id. 876 See MFA Letter, supra note 81, at 20. E:\FR\FM\16JAR2.SGM 16JAR2 2806 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 the potential counterparty credit risk and settlement risk arising to the IDB from that trade.877 Thus, under the current hybrid clearing model, the U.S. Treasury securities CCA is indirectly exposed to the IDB’s non-centrally cleared transaction, but it lacks the ability to risk manage its indirect exposure to this non-centrally cleared leg of the transaction. Specifically, it does not know who the ultimate counterparty of the transaction is and cannot collect margin on that transaction. This, in turn, results in margin collection at the CCP which is based upon only one transaction and has been calculated to cover this seemingly directional position, as well as an inability to net these offsetting transactions and provide the benefits of central clearing. In particular, if the IDB’s non-CCP member counterparty fails to settle a transaction that is subject to hybrid clearing, such IDB may not be able to settle the corresponding transaction that has been cleared with the U.S. Treasury securities CCA due to a lack of financial resources at the IDB, which could lead the IDB to default.878 As part of its existing default management procedures, the U.S. Treasury securities CCA could seek to mutualize its losses from the IDB’s default, which could in turn transmit stress to the market as a whole. As noted above, the Commission has previously stated that membership requirements help to guard against defaults of any CCP member, as well as to protect the CCP and the financial system as a whole from the risk that one member’s default could cause others to default, potentially including the CCP itself.879 Further, contagion stemming from a CCP member default could undermine confidence in the financial system as a whole, even if the health of the CCP is not implicated. This is because the default could cause others to back away from participating in the market. This risk of decreased participation could be particularly problematic if the defaulting participant was an IDB, whose withdrawal from the market could impact other market participants’ ability to access the market 877 See, e.g., TMPG White Paper, supra note 13, at 22 (noting that in a hybrid clearing arrangement, an IDB’s rights and obligations to the CCP are not offset and the IDB is not in a net zero settlement position with respect to the CCP at settlement date). Thus, the IDB is not able to net all of its positions for clearing at a U.S. Treasury securities CCA, and the IDB’s positions appear to the CCA to be directional, which impacts the amount of margin that the CCA collects for the transaction. 878 See 2021 IAWG Report, supra note 4, at 31; See also DTCC May 2021 White Paper, supra note 307. 879 See supra note 308. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 for on-the-run U.S. Treasury securities, approximately 49.7% of which trade on IDBs.880 Including such transactions as eligible secondary market transactions would therefore help protect against this risk by requiring that a U.S. Treasury securities CCA ensure that direct participants who are IDBs centrally clear both sides of their transactions, thereby eliminating the various aspects of potential contagion risk posed by socalled hybrid clearing. b. Other Cash Transactions The Commission has identified additional categories of cash transactions of U.S. Treasury securities to include in the membership requirements for a U.S Treasury securities CCA that it believes will provide the benefits of increased central clearing of U.S. Treasury securities transactions described above. The Commission is defining an eligible secondary market transaction to include those cash purchase and sale transactions in which the counterparty of the direct participant is a registered broker-dealer, government securities broker, or dealer.881 These entities, by definition, are engaged in the business of effecting transactions in securities for the account of others (for brokers) or for their own accounts (for dealers). Thus, these entities already are participating in securities markets and have identified mechanisms to clear and settle their transactions.882 More generally, many registered brokers and dealers are familiar with transacting through introducing brokers who pass their transactions to clearing brokers for clearing and settlement. In the Proposing Release, the Commission proposed to include in the definition of eligible secondary market transaction any purchases and sales of U.S. Treasury securities between a direct participant and a counterparty that is: (i) a hedge fund, that is any private fund (other than a securitized asset fund): (a) with respect to which one or more investment advisers (or related persons of investment advisers) may be paid a performance fee or allocation calculated by taking into account unrealized gains (other than a fee or allocation the calculation of which may take into account unrealized gains solely for the purpose of reducing such fee or allocation to reflect net 880 TMPG White Paper, supra note 13, at 32; part IV.B.3 (Table 1) supra. 881 15 U.S.C. 78o(a) and 78o–5(a) (requirement to register) and 78c(4), (5), (43), and (44) (definitions). 882 See, e.g., FICC Rules 3A, 8, 18, supra note 663 (providing for prime brokerage and correspondent clearing and sponsored membership); see also October 2021 White Paper, supra note 681, at 5–7. PO 00000 Frm 00094 Fmt 4701 Sfmt 4700 unrealized losses); (b) that may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (c) that may sell securities or other assets short or enter into similar transactions (other than for the purpose of hedging currency exposure or managing duration) (‘‘hedge fund transactions’’), or (ii) an account at a registered broker-dealer, government securities dealer, or government securities broker where such account may borrow an amount in excess of onehalf of the value of the account or may have gross notional exposure of the transactions in the account that is more than twice the value of the account (‘‘leveraged account transactions’’).883 Some commenters supported the proposed inclusion of transactions with hedge funds within the definition of an eligible secondary market transaction.884 However, other commenters asserted that transactions with a hedge fund should not be within the definition of an eligible secondary market transaction. Specifically, one commenter stated that because of the nature of the definition, eligible secondary market transactions would include those with firms that may (but in practice might not actually) exceed the quantitative thresholds without regard to the risks that these firms actually take on, or their investment models and strategies. Further, the commenter stated that the definition would not reflect any effort to assess whether any particular fund or account actually imposes systemic risk, and would instead treat the mere ability to obtain leverage as a source of risk.885 Another commenter stated that there is no data to support imposing a clearing requirement that targets just hedge funds and leveraged accounts and expressed concern that a partial mandate may result in some dealers choosing to offer liquidity only in a cleared environment thereby reducing the liquidity available today to accounts in the uncleared cash market.886 Another commenter stated that the inclusion of hedge funds within the counterparties to an eligible secondary market transaction would arbitrarily single out hedge funds’ cash Treasury transactions and would leave out other important market participants’ cash 883 See part II.A.2.b supra. DTCC/FICC Letter, supra note 33; Better Markets Letter, supra note 33; AFREF Letter, supra note 33. 885 See MFA Letter, supra note 81 at 19–20. 886 See SIFMA AMG Letter, supra note 35, at 11. 884 See E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations Treasury transactions that also comprise a large segment of Treasury market liquidity.887 As the Commission stated in the Proposing Release, hedge funds generally can engage in trading strategies that may pose heightened risks of potential financial distress to their counterparties, including those who are direct participants of a U.S. Treasury securities CCA. The Commission previously has recognized that the strategies employed by hedge funds ‘‘can increase the likelihood that the fund will experience stress or fail, and amplify the effects on financial markets.’’ 888 The Commission also has stated that significant hedge fund failures, resulting from their investment positions or use of leverage or both, could result in material losses at the financial institutions that lend to them if collateral securing this lending is inadequate, and that these losses could have systemic implications if they require these financial institutions to scale back their lending efforts or other financing activities generally.889 Similar to the risks posed to a U.S. Treasury securities CCA by noncentrally cleared trades entered into by an IDB, non-centrally cleared transactions entered into between hedge funds and direct participants of the CCA could cause risks to the CCA in the event that the hedge fund is not able to meet its obligations to the direct participant, which could, in turn, create stress to the direct participant and through to the CCA. Therefore, including the direct participant’s purchase and sale transactions with hedge funds within the definition of an eligible secondary market transaction would have reduced the potential for financial distress arising from the transactions that could affect the direct participant and the U.S. Treasury securities CCA. This aspect of the proposal would also have resulted in consistent and transparent risk management being applied to such transactions, as discussed further in part II.A.2.a supra. However, in response to comments received and as discussed in part II.A.2.b supra, the Commission is not adopting a definition of eligible secondary market transaction in Rule ddrumheller on DSK120RN23PROD with RULES2 887 See AIMA Letter, supra note 81, at 7. Form PF Proposing Release, supra note 279, 76 FR at 8073 (citing President’s Working Group on Financial Markets, Hedge Funds, Leverage, and the Lessons of Long Term Capital Management (Apr. 1999), at 23). 889 Id. (also noting that the simultaneous failure of several similarly positioned hedge funds could create contagion through the financial markets if the failing funds had to liquidate their investment positions at fire sale prices). 888 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 17ad–22(a) that includes these transactions.890 iv. Exclusions From the Requirement To Clear Eligible Secondary Market Transactions The Commission is excluding certain otherwise eligible secondary market transactions in U.S. Treasury securities from the requirement to clear eligible secondary market transactions. Recognizing the importance of U.S. Treasury securities not only to the financing of the United States government, but also their central role in the formulation and execution of monetary policy and other governmental functions, the Commission is excluding from the requirement to clear eligible secondary market transactions any otherwise eligible secondary market transaction in U.S. Treasury securities between a direct participant of a U.S. Treasury securities CCA and a central bank.891 For similar reasons, the Commission is also excluding from the requirement to clear eligible secondary market transactions otherwise eligible secondary market transactions in U.S. Treasury securities between a direct participant of a U.S. Treasury securities CCA and a sovereign entity or an international financial institution.892 In a change from the proposal, and for the reasons given above, the Commission is excluding from the requirement to clear eligible secondary market transactions otherwise eligible secondary market transactions in U.S. Treasury securities between a direct participant of a U.S. Treasury securities CCA and either a state and local government or a covered clearing agency providing central counterparty services, a derivatives clearing organization (see 7 U.S.C. 7a– 1 and 17 CFR 39.3), or is regulated as a central counterparty in its home jurisdiction.893 One commenter recommended that the Commission exempt transactions in U.S. Treasury securities between affiliates from any central clearing requirement. The commenter stated that inter-affiliate transactions are important to corporate groups, which may use them to achieve efficient risk and capital allocation and obtain flexibility for addressing customer demands.894 890 Id. 891 See Proposing Release, supra note 14, at 64625 for a discussion of the proposed definition of a central bank for the purposes of the rule. 892 See id. for a discussion of the proposed definition of sovereign entity and international financial institution. 893 See part II.A.2.a.vii supra and part II.A.2.a.iii supra. 894 SIFMA/IIB Letter, supra note 37, at 21–22. PO 00000 Frm 00095 Fmt 4701 Sfmt 4700 2807 The commenter further stated that requiring inter-affiliate transactions to be centrally cleared would impose additional costs with limited benefits, for two reasons. First, if an inter-affiliate transaction is part of a ‘‘back-to-back arrangement,’’ meaning that the related external transaction between the affiliated counterparty and a nonaffiliated counterparty is not centrally cleared, then subjecting the interaffiliate transaction to a central clearing requirement does nothing to reduce the contagion risk presented by the nonaffiliated counterparty. The commenter further asserted that if that external transaction is already centrally cleared, the contagion risk would already be addressed and requiring the interaffiliate transaction to be cleared would not create additional benefits. Second, a direct participant’s affiliate’s credit risk is already part of the group-wide financial risks to which the Treasury CCP is exposed, and central clearing of inter-affiliate transactions is unlikely to meaningfully impact the risk profile.895 The Commission agrees and in a change from the proposing release, the Commission is conditionally excluding inter-affiliate repo.896 The Commission believes that, in certain circumstances, the counterparty credit risk posed by inter-affiliate transactions may be less than other transactions.897 However, the credit risk is not eliminated because affiliated entities are separate legal entities and, generally, are not legally responsible for each other’s contractual obligations. In the event that one or more affiliated entities becomes insolvent, the affiliates, as separate legal entities, would be managed as separate estates in a bankruptcy, with the trustee having a duty to the creditors of the affiliate, not the affiliated family. Other benefits of increased central clearing 895 Id. 896 See part II.A.2.a, supra. The Commission is conditioning the availability of the exclusion for inter-affiliate transactions on an obligation for the affiliated counterparty to submit its eligible repo transactions for clearance and settlement. This condition should help ensure that a direct participant cannot rely upon an inter-affiliate transaction to avoid the requirement to clear eligible secondary market transactions. If there were no such condition, a direct participant could simply use inter-affiliate transactions to move securities and funds to affiliates, and the affiliate could then enter into external transactions with counterparties which, if entered into with the direct participant, would be eligible secondary market transactions. 897 See, e.g., Clearing Exemption for Swaps Between Certain Affiliated Entities, 77 FR 50425, 50427 (Mar. 2012) (discussing the internalization of counterparty risk on inter-affiliate swap transactions as wholly owned members of the same corporate group, but also discussing that similar benefits may not accrue for other inter-affiliate swaps when the counterparties are not members of the same group). E:\FR\FM\16JAR2.SGM 16JAR2 2808 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 such as consistent risk management and centralized default management are likely to be less important for transactions within an affiliated family. Therefore, the Commission believes the benefits of clearing such transactions are likely less than those from similar transactions with non-affiliates while the costs of doing so are likely similar. Although the Commission believes that the benefits of central clearing are generally increasing in the fraction of total volume that is centrally cleared, it also believes that the Federal Reserve System should be free to choose the clearance and settlement mechanisms that are most appropriate to effectuating its policy objectives.898 Further, the Commission believes that the exclusion should extend to foreign central banks, sovereign entities and international financial institutions for reasons of international comity.899 In light of ongoing expectations that Federal Reserve Banks and agencies of the Federal Government will not be subject to foreign regulatory requirements in their transactions in the sovereign debt of other nations, the Commission believes principles of international comity counsel in favor of exempting foreign central banks, sovereign authorities, and international institutions. The Commission is also excluding transactions between U.S. Treasury CCA members and natural persons from the requirement to clear eligible secondary market transactions. The Commission believes that natural persons generally transact in small volumes and should not present much, if any, contagion risk to a U.S. Treasury securities CCA and therefore, the benefits discussed above are unlikely to be important for these transactions. Commenters expressed support for these exclusions.900 Two commenters asked the Commission to adopt an exemption that would allow FCMs to continue to engage in eligible secondary market transactions in U.S. Treasury securities outside of central clearing, and another commenter acknowledged the potential interaction between the proposal and the regulatory framework governing FCMs.901 FCMs can also be registered with the Commission as broker898 See Proposing Release, supra note 14, for a discussion of the activities of Federal Reserve Bank of New York’s open market operations conducted at the direction of the Federal Open Market Committee. 899 See id., for a discussion of the Commission’s belief in the principles of international comity. 900 SIFMA/IIB Letter, supra note 37, at 20; CME Letter, supra note 81. 901 See supra note 200. See also part II.A.2.a.iv, supra, for discussion of FCMs and the regulatory framework governing them. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 dealers.902 Commenters expressed concern as to whether the account structure provided by FICC would be consistent with the regulatory framework governing FCMs.903 The Commission recognizes the apparent tension between the rule amendments being adopted and the application of Rule 1.25(d)(2), as described in part II.A.2.a.iv, supra. For the reasons discussed above in part II.A.2.a.iv, the Commission does not believe that an exclusion for FCMs is necessary to accommodate the relevant provisions of the CFTC Rules. Moreover, an exclusion for FCMs would be inconsistent with the purpose of the rule which is to help reduce contagion risk to the CCA and bring the benefits of central clearing to more transactions involving U.S. Treasury securities, particularly in light of their significance to the Treasury market. b. Other Changes to Covered Clearing Agency Standards The Commission believes that certain additional changes to its Covered Clearing Agency Standards that apply only to U.S. Treasury securities CCAs are warranted to facilitate additional clearing. Such changes should help ensure that the U.S. Treasury securities CCA can continue to manage the risks arising from more transactions from additional indirect participants and to facilitate the increased use of central clearing and the accompanying benefits. These changes, by making central clearing more efficient for market participants, also create incentives for greater use of central clearing. i. Policies and Procedures Regarding Direct Participants’ Transactions The Commission is adopting Rule 17ad–22(e)(18)(iv)(B) that requires a U.S. Treasury securities CCA establish, implement, maintain and enforce written policies and procedures to identify and monitor its direct participants’ required submission of transactions for clearing, including, at a minimum, addressing a direct participant’s failure to submit transactions. The Commission believes that such a requirement should help ensure that a U.S. Treasury securities CCA adopts policies and procedures directed at understanding whether and how its participants comply with the policies that will be adopted as part of the requirement to clear eligible secondary market transactions requiring 902 One commenter states that the majority of FCMs are dually registered as FCMs and brokerdealers. See FIA Letter, supra note 200, at 2. 903 See part II.A.2.a.iv, supra. PO 00000 Frm 00096 Fmt 4701 Sfmt 4700 the submission of specified eligible secondary market transactions for clearing. Without such policies and procedures, it would be difficult for the CCA to assess if the direct participants are complying with the requirement to clear eligible secondary market transactions. One commenter supported this aspect of the proposal.904 This commenter anticipated that implementation of this aspect of the proposal would be similar to implementation of other Covered Clearing Agency Standards provisions that use that phrase.905 The commenter stated that it expects a U.S. Treasury securities CCA would take steps to remediate non-compliance on the part of its direct participants in a manner consistent with the Covered Clearing Agency Standards and breaches of the CCA’s own rules.906 ii. Netting and Margin Practices for House and Customer Accounts The Commission is amending Rule 17ad–22(e)(6)(i) to require a U.S. Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate, collect, and hold margin amounts from a direct participant for its proprietary U.S. Treasury securities positions, separately and independently from margin calculated and collected from that direct participant in connection with U.S. Treasury securities transactions by an indirect participant that relies on the services provided by the direct participant to access the covered clearing agency’s payment, clearing, or settlement facilities. As described further below, such changes should allow a U.S. Treasury securities CCA to better understand the source of potential risk arising from the U.S. Treasury securities transactions it clears and potentially further incentivize central clearing. In practice, at FICC, clearing a U.S. Treasury securities transaction between a direct participant and its customer, i.e., a dealer to client trade, would not result in separate collection of margin for the customer transaction. Except for transactions submitted under the FICC sponsored member program,907 FICC margins the transactions in the direct participant’s (i.e., the dealer’s) account on a net basis, allowing any of the trades for the participant’s own accounts to net 904 See FICC/DTCC Letter, supra note 33, at 21– 22. See also part II.A.4 supra for additional discussion. 905 Id. 906 Id. 907 See DTCC October 2021 White Paper, supra note 681. E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations against trades by the participant’s customers.908 Under the amendments to Rule 17ad– 22(e)(6)(i), a U.S. Treasury securities CCA is required to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate margin amounts for all transactions that a direct participant submits to the CCP on behalf of others, separately from the margin that is calculated for transactions that the direct participant submits on its own behalf. Such policies and procedures must also provide that margin collateralizing customer positions be collected separately from margin collateralizing a direct participant’s proprietary positions. Finally, the CCP will also be required to have policies and procedures reasonably designed to, as applicable, ensure that any margin held for customers or other indirect participants of a member is held in an account separate from those of the direct participant. Because the amendments to Rule 17ad–22(e)(6)(i) require separating positions in U.S. Treasury securities transactions of a direct participant in a U.S. Treasury securities CCA from those of customers or other indirect participants, the indirect participants’ positions, including those submitted outside of the sponsored member program, will no longer be netted against the direct participant’s positions. The indirect participants’ positions will be subject to the covered clearing agency’s risk management procedures, including collection of margin specific to those transactions. These changes should allow a U.S. Treasury securities CCA to better understand the source of potential risk arising from the U.S. Treasury securities transactions it clears. In addition, these changes should help avoid the risk of a disorderly default in the event of a direct participant default, in that FICC will be responsible for the central liquidation of the defaulting participant’s trades without directly impacting the trades of the participant’s customers or the margin posted for those trades. Moreover, the amendments to Rule 17ad–22(e)(6)(i) should result in dealerto-customer trades gaining more benefits from central clearing. Because margin for a direct participant’s (i.e., a dealer’s) trades will be calculated, collected, and held separately and independently from those of an indirect participant, such as a customer, the direct participant’s trades with the indirect participant can 908 Id. at 5–6. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 be netted against the direct participant’s position vis-a`-vis other dealers.909 Holding margin amounts from a direct participant of a U.S Treasury securities CCA separately and independently from those of an indirect participant may reduce incentives for indirect participants to trade excessively in times of high volatility.910 Such incentives exist because the customers of a broker-dealer do not always bear the full cost of settlement risk for their trades. Broker-dealers incur costs in managing settlement risk with CCPs. Broker-dealers can recover the average cost of risk management from their customers. However, if a particular trade has above-average settlement risk, such as when market prices are unusually volatile, it is difficult for broker-dealers to pass along these higher costs to their customers because fees typically depend on factors other than those such as market volatility that impact settlement risk. Holding margin of indirect participants separately from direct participants should reduce any such incentives to trade more than they otherwise would if they bore the full cost of settlement risk for their trades. Commenters generally supported the proposed amendment to Rule 17ad– 22(e)(6)(i).911 However, commenters also raised several additional issues with respect to the separation of house and customer margin that are addressed in part II.B.1 supra. As discussed below,912 an additional commenter stated that the proposed separation of house and customer margin would negatively impact small and mid-size broker-dealers who are disproportionately affected by FICC’s Excess Capital Premium (‘‘ECP’’) charge, which is a margin add-on that collects a premium when a member’s VaR charge exceeds the member’s Net Capital, net assets or equity capital (as applicable to that member based on its type of regulation).913 As discussed in part II.B1 supra, the commenter’s concerns regarding the interplay between purported required gross margining and the ECP charge rests on the assumption that gross margin is required under the proposal, which, as discussed in the prior paragraph, is not the case. In addition, FICC recently has 909 See Marta Chaffee and Sam Schulhofer-Wohl, supra note 678, at 3. 910 See Sam Schulhofer-Wohl, Externalities in Securities Clearing and Settlement: Should Securities CCPs Clear Trades for Everyone? (Fed. Res. Bank Chi. Working Paper No. 2021–02, 2021). 911 See note 33 supra. 912 See part IV.C.3.b infra. 913 IDTA Letter, supra note 66, at 4; IDTA Letter 2, supra note 829, at 7; see also FICC Rule 4, section 14, supra note 19. PO 00000 Frm 00097 Fmt 4701 Sfmt 4700 2809 indicated that it intends to make available client clearing models that do not require gross margin, consistent with its current offerings.914 A commenter requested that the SEC encourage FICC to establish a feature allowing (but not requiring) registered fund sponsored members to support their obligations by having margin posted with FICC (‘‘FICC registered fund margin framework’’) rather than by paying fees to the sponsoring member.915 While the commenter noted that the Sponsored Service under current FICC rules does not raise custody issues for registered funds under the 1940 Act because registered funds are not required to post margin to FICC, if a fund’s margin were permitted to be posted with FICC, that could raise custody issues for funds unless such funds had relief from certain provisions of the 1940 Act.916 The commenter stated that permitting registered funds’ margin to be posted with FICC could reduce costs for registered funds and facilitate their use of cleared reverse repos and term repos.917 The Commission understands that FICC’s current rules for the Sponsored Service do not require sponsored and sponsoring member margin to be calculated or held separately implying that the sponsoring member is satisfying all FICC margin requirements. Thus, current practice bundles trade execution and clearing, including the posting of margin. As such, registered funds in effect pay the costs associated with the posting of margin either through fees or through inferior pricing. Enabling registered fund margin to be posted at FICC creates the potential for unbundling these activities, and for greater competition. The Commission agrees that facilitating the ability for a registered fund’s margin to be posted at FICC as an alternative to the sponsoring member satisfying all FICC margin requirements and passing the cost of doing so through to the registered fund may lower the cost of trading for the fund, and the Commission’s five year position discussed in part II.A.2.a.ii supra, will help facilitate the posting of registered fund margin to satisfy a U.S. Treasury securities CCA’s margin deposit 914 See DTCC 2023 White Paper, supra note 107, at 6 (discussing that the proposal would allow the option to calculate and collect margin associated with customer activity on a gross or net basis depending on the client clearing model selected by the member and stating that FICC would offer options via different access models that would allow those parties to balance the benefits of netting and segregation in different ways). 915 See supra note 125. 916 See part II.A.2.a.ii supra. 917 ICI Letter, supra note 85. E:\FR\FM\16JAR2.SGM 16JAR2 2810 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 requirements. The ability to separate the trade execution and clearing services of sponsoring a registered fund’s transactions with the CCA from the posting margin may facilitate done-away trading and enhance the ability of smaller CCA netting members to become sponsoring members or expand the capacity of sponsoring members in the Sponsored Service. iii. Facilitating Access to U.S. Treasury Securities CCAs The various access models currently available to access central clearing in the U.S. Treasury securities market may not meet the needs of the many different types of market participants who transact in U.S. Treasury securities with the direct members of a U.S. Treasury Securities CCA. The additional provision to Rule 17ad–22(e)(18)(iv)(C) requires a U.S. Treasury securities CCA to establish, implement, maintain and enforce certain written policies and procedures regarding access to clearance and settlement services, which, while not prescribing specific methods of access, is intended to ensure that all U.S. Treasury security CCAs have appropriate means to facilitate access to clearance and settlement services in a manner suited to the needs of market participants, including indirect participants. Some market participants have commented on the current practice of tying clearing services to trading under the sponsored clearing model.918 Under this model, the decision to clear the trades of an indirect participant appears to be contingent on that indirect participant trading with the direct participant sponsoring the indirect member.919 If the indirect participant is a competitor of the sponsoring direct participant and the direct participant has discretion on which trades to clear, the indirect participant may have difficulty accessing clearing. The rule requires the U.S. Treasury securities CCA to ensure appropriate means to facilitate access; for some current indirect participants this may imply direct membership (with a potential change in membership criteria); alternatively, requiring something similar to a ‘‘done-away’’ clearing model may be another means of facilitating clearing. Other considerations relate to the services available through the sponsored 918 See Futures Industry Association Principal Traders Group, Clearing a Path to a More Resilient Treasury Market, at 10 (July 2021), available at https://www.fia.org/sites/default/files/2021-07/FIAPTG_Paper_Resilient%20Treasury%20Market_ FINAL.pdf (‘‘FIA–PTG Whitepaper’’). 919 See id. at 7. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 clearing model. For example, buy-side participants, currently engage in both triparty and bilateral repo, across multiple tenors (both overnight and long term), and on either side (selling or buying) of the transaction. At present, it appears that FICC direct members may be able to decline to submit a trade with counterparties who are not FICC direct members for central clearing at their discretion.920 Thus some indirect participants who are unable to enter into a similar transaction using a different FICC direct member who is willing to submit the trade for central clearing would not be able to access central clearing under the current practice. The rule requires FICC to create new policies and procedures to facilitate access to clearing for these participants. One commenter opposed the inclusion of registered funds because the current clearing framework is not sufficiently developed to support such a central clearing requirement.921 The commenter identified several issues to be addressed prior to adopting such a requirement, including improvements to the Sponsored Service and develop a ‘‘done away’’ model (see part II.B.2 supra for additional discussion of the issues raised by this commenter). In addition, the Rule 17ad– 22(e)(18)(iv)(C) requires the CCA’s written policies and procedures be annually reviewed by the CCA’s board of directors to ensure that the CCA has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants. This review should help ensure that such policies regarding access to clearance and settlement services, including for indirect participants, are reviewed annually by the U.S. Treasury securities CCA’s board of directors. The annual review ensures that such policies and procedures be reviewed periodically and potentially updated to address any changes in market conditions. c. Amendments to Rules 15c3–3 and 15c3–3a The rules and rule amendments being adopted and that are discussed above could cause a substantial increase in the margin broker-dealers must post to a U.S. Treasury securities CCA resulting from their customers’ cleared U.S. Treasury securities positions. Currently, Rules 15c3–3 and 15c3–3a do not permit broker-dealers to include a debit in the customer reserve formula equal to the amount of margin required and on deposit at a U.S. Treasury securities CCA. This is because no U.S. Treasury securities CCA has implemented rules and practices designed to segregate customer margin and limit it to being used solely to cover obligations of the broker-dealer’s customers. Therefore, increases in the amount of margin required to be deposited at a U.S. Treasury securities CCA as a result of the requirement to clear eligible secondary market transactions would result in corresponding increases in the need to use broker-dealers’ cash and securities to meet these requirements. The amendment to Rule 15c3–3a permits, under certain conditions, margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula. This new debit item will offset credit items in the Rule 15c3–3a formula and, thereby, free up resources that could be used to meet the margin requirements of a U.S. Treasury securities CCA. The amendment allows a customer’s broker to use customer funds to meet margin requirements at the CCP generated by the customer’s trades, lowering the cost of providing clearing services. As discussed further below, we expect these changes to allow more efficient use of margin for cleared trades relative to the baseline. This change, alone, could create incentives for greater use of central clearing, and thus could promote the benefits described in previous sections. Overall, commenters supported the proposal to permit this debit item.922 One commenter stated that the practical effect of this change would be to allow broker-dealers to use margin collected from customers to satisfy margin requirements associated with such customers’ transactions, rather than using proprietary funds to finance customer margin as is the case today, and expressed its support for this amendment because it will free up broker-dealer resources by reducing the amount of proprietary funds needed to finance customer margin and therefore lower the cost of clearing, while continuing to protect customer funds.923 Another commenter stated that this change would reduce the costs of centrally clearing U.S. Treasury securities transactions and thus incentivize more central clearing of such transactions.924 922 See 920 See part IV.B.3 supra. 921 ICI Letter, supra note 85. PO 00000 Frm 00098 Fmt 4701 Sfmt 4700 supra note 446. MFA Letter, supra note 81, at 10. 924 See SIFMA/IIB Letter, supra note 37, at 12. 923 See E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations 2. Costs The Commission has, where practicable, attempted to quantify the economic effects it expects may result from the amendments and new rules that it is adopting. In some cases, however, data needed to quantify these economic effects is not currently available or depends on the particular changes made to the U.S. Treasury securities CCA policies and procedures. As noted below, in the Proposing Release the Commission was unable to quantify certain economic effects and solicited comment, including estimates and data from interested parties, which could help inform the estimates of the economic effects of the new rules and amendments. Significant costs of central clearing for market participants may include: (i) initial margin requirements (which in practice are held as ‘‘clearing fund’’ at FICC and subject to loss mutualization and the attendant adverse capital implications); (ii) clearing fees; (iii) obligations with respect to FICC’s capped contingency liquidity facility (‘‘CCLF’’); (iv) the operational build necessary to access central clearing (either as a direct participant or as an indirect participant); and (v) legal costs and time associated with onboarding customers for indirect central clearing, including, e.g., the need for Sponsoring Members to file UCC financing statements with respect to Sponsored Members under the Sponsored Member program. These costs are discussed in more detail below. Not all costs are expected to be borne by all participants and may depend on rules of the clearing agency. One commenter stated that the increased costs of centrally clearing U.S. Treasury security transactions may reduce liquidity and diversity in the Treasury market if firms reduce activity, leave the market, or if barriers to entry are too high, given the significant costs of clearing for market participants.925 The commenter identified several types of costs, including initial margin requirements, clearing fees, obligations with respect to FICC’s CCLF, the operational build necessary to access central clearing either as a direct or indirect participant, and legal costs and time associated with onboarding customers for indirect central clearing, including, e.g., the need for Sponsoring Members to file UCC financing statements with respect to Sponsored Members under the Sponsored Member program. The commenter stated that the impact of these costs would be 925 See SIFMA/IIB Letter, supra note 37. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 disproportionately felt by small and mid-sized participants in the U.S. Treasury market, and that they would reduce diversity in the market and further increase concentration among market participants (which may increase systemic risk) if such participants leave the market.926 Increased transaction costs will, all else equal, reduce the expected return of a particular investment. If this were the only effect then the risk/return tradeoff would worsen and transaction volume could fall and liquidity deteriorate. However, central clearing also provides numerous benefits described above, including a possible decrease in transaction costs.927 Many of these benefits could be expected to particularly benefit small and mid-sized participants, for example the reduction in counterparty credit risk that can result from central clearing may particularly benefit smaller market participants. Commenters mentioned the potential concentration risk that would arise because of the requirement to clear eligible secondary market transactions, specifically because only one covered clearing agency currently provides such services. One commenter stated that concentrating such significant levels of settlement, operational, liquidity and credit risk in one institution means that were there operational or liquidity stress at FICC, widespread dysfunction in the Treasury markets could result.928 One commenter agreed that the existence of one covered clearing agency serving the U.S. Treasury market is highly problematic as it creates enormous concentration risk for market participants, and highlighted that, given the importance of the U.S. Treasury market to the overall global economy, there needs to be a compelling reason for increasing the concentration of cleared trading activity in a single clearing house particularly when there is no alternative or fallback venue should the clearing house experience a disruption to its operations or more significantly were to fail.929 The Commission also recognizes the risks associated with increased centralization of clearance and settlement activities. In particular, the Commission has previously noted that ‘‘[w]hile providing benefits to market participants, the concentration of these activities at a covered clearing agency implicitly exposes market participants to the risks faced by covered clearing 926 See SIFMA/IIB Letter, supra note 37, at 8. part IV.C.1 supra. 928 See SIFMA/IIB Letter, supra note 37, at 10. 929 SIFMA/AMG Letter, supra note 37, at 9. 927 See PO 00000 Frm 00099 Fmt 4701 Sfmt 4700 2811 agencies themselves, making risk management at covered clearing agencies a key element of systemic risk mitigation.’’ 930 As discussed previously, currently only FICC provides CCP services for U.S. Treasury securities transactions, including outright cash transactions and repos.931 Were FICC unable to provide its CCP services for any reason then this could have a broad and severe impact on the overall U.S. economy. The FSOC recognized this when it designated FICC as a systemically important financial market utility in 2012,932 which subjects it to heightened risk management requirements and additional regulatory supervision, by both its primary regulator and the Board of Governors.933 In addition, FICC is subject to the Covered Clearing Agency Standards, which address the various types of risk that FICC faces as a CCP, including settlement, operational, liquidity, and credit risk. FICC also must meet its obligations under both Section 19(b) of the Exchange Act, as a self-regulatory organization, and Title VIII of the DoddFrank Act. The Commission believes that this overall supervisory framework, including the Covered Clearing Agency Standards, should help ensure that FICC continues to be subject to robust supervision and oversight and to be able to manage the risks presented to it, even those arising from increased Treasury clearing. a. Costs to FICC and Its Members of the Requirement To Clear Eligible Secondary Market Transactions The Commission believes that many of the direct costs of the rules and amendments it is adopting to the U.S. Treasury securities CCA are a result of new policies and procedures requirements, the costs of which are likely to be modest. This is because all 930 See CCA Standards Proposing Release, supra note 8, 79 FR at 29587. 931 See Proposing Release, supra note 14 at 64612. See also part II.A.1.b supra. 932 See supra note 369. 933 Id. at 119. The Commission previously stated that Congress has recognized in the Clearing Supervision Act that the operation of multilateral payment, clearing or settlement activities may reduce risks for clearing participants and the broader financial system, while also creating new risks that require multilateral payment, clearing or settlement activities to be well-designed and operated in a safe and sound manner. The Clearing Supervision Act is designed, in part, to create a regulatory framework to help deal with such risk management issues, which is generally consistent with the Exchange Act requirement that clearing agencies organize themselves in a manner to facilitate prompt and accurate clearance and settlement, safeguard securities and funds and protect investors. See CCA Standards Proposing Release, supra note 8, 76 FR at 14474; see also 12 U.S.C. 5462(9), 5463(a)(2). E:\FR\FM\16JAR2.SGM 16JAR2 2812 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations but one of these amendments and rules require the CCA to make certain changes to its policies and procedures. The other amends Rule 15c3–3a to permit margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula for broker-dealers, subject to the conditions discussed above. As discussed above, the amendments to Rule 15c3–3a require several conditions to be met, including that the U.S. Treasury securities CCA calculate a separate margin amount for each customer on a gross basis.934 Comments submitted by the single current U.S. Treasury securities CCA acknowledged that it would need to make documentation, operational, organizational, and systems changes in order to comply with the proposal.935 Rule 17ad–22(e)(18)(iv) requires a U.S. Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures, as discussed above.936 Because policies and procedures regarding the clearing of all eligible secondary market transactions entered into by a direct participant in a U.S. Treasury securities CCA are not currently required under existing Rule 17ad–22, the Commission believes that Rule 17ad–22(e)(18)(iv) may require a covered clearing agency to make substantial changes to its policies and procedures. The rule amendment contains similar provisions to existing FICC rules but will also impose additional requirements that do not appear in existing Rule 17ad–22. As a result, the Commission believes that a U.S. Treasury securities CCA will incur burdens of reviewing and updating existing policies and procedures in order to comply with the provisions of Rule 17ad–22(e)(18)(iv) and, in some 934 See part II.C.2.c supra. DTCC/FICC Letter, supra note 33, at v. Although DTCC/FICC acknowledged there would be required system and other changes, it did not provide any estimate of the costs of such changes. 936 See part II.A.4 supra for a discussion of the requirement that a U.S. Treasury securities CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, identify and monitor its direct participants’ required submission of transactions for clearing, including, at a minimum, addressing a direct participant’s failure to submit transactions. See part II.B.2 supra for a discussion of the requirement that U.S. Treasury securities CCA establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the U.S. Treasury securities CCA’s board of directors reviews annually. ddrumheller on DSK120RN23PROD with RULES2 935 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 cases, may need to create new policies and procedures.937 The Commission estimates that U.S. Treasury securities CCAs will incur an aggregate one-time direct cost of approximately $207,000 to create new policies and procedures.938 939 The rule also requires ongoing monitoring and compliance activities with respect to the written policies and procedures created in response to the rule. The Commission estimates that the ongoing activities required by Rule 17ad–22(e)(18)(iv) impose an aggregate ongoing cost on covered clearing agencies of approximately $61,000 per year.940 i. Costs Attendant to an Increase in CCLF The new rules and amendments being adopted will likely result in a significant increase in the volume of U.S. Treasury securities transactions submitted to clearing. The G–30 has reported that FICC differs qualitatively from other CCPs in that counterparty credit risks are relatively small but liquidity risks in the event of member defaults could be extraordinarily large.941 This is because net long positions generate liquidity obligations for FICC since, in the event of a member default, FICC would have to deliver cash in order to complete settlement of such positions with non-defaulting parties. Increased clearing volume of cash and repo transactions as a result of the rule could increase FICC’s credit and liquidity exposure to its largest participant family, including those participants acting as sponsors of nonmembers.942 FICC is obligated by 937 See part IV.C.2.c.ii, infra. monetize the internal costs, the Commission staff used data from SIFMA publications, modified by Commission staff to account for an 1800 hour work-year and multiplied by 5.35 (professionals) or 2.93 (office) to account for bonuses, firm size, employee benefits and overhead. See SIFMA, Management and Professional Earnings in the Security Industry—2013 (Oct. 7, 2013); SIFMA, Office Salaries in the Securities Industry— 2013 (Oct. 7, 2013). These figures have been adjusted for inflation using data published by the Bureau of Labor Statistics. 939 This figure was calculated as follows: Assistant General Counsel for 40 hours (at $518 per hour) + Compliance Attorney for 80 hours (at $406 per hour) + Computer Operations Manager for 20 hours (at $490 per hour) + Senior Risk Management Specialist for 40 hours (at $397 per hour) + Business Risk Analyst for 80 hours (at $305 per hour) = $103,280 × 2 respondent clearing agencies = $206,560. See part V.A infra. 940 This figure was calculated as follows: Compliance Attorney for 25 hours (at $406 per hour) + Business Risk Analyst for 40 hours (at $305 per hour) + Senior Risk Management Specialist for 20 hours (at $397 per hour) = $30,290 × 2 respondent clearing agencies = $60,580. See part V.A infra. 941 G–30 Report, supra note 5, at 14. 942 Participant family means that if a participant directly, or indirectly through one or more 938 To PO 00000 Frm 00100 Fmt 4701 Sfmt 4700 Commission rule to maintain liquidity resources to settle all obligations of its largest participant family, in the event of default.943 These resources include the CCLF in which Members will be required to hold and fund their deliveries to an insolvent clearing member up to a predetermined cap by entering into repo transactions with FICC until it completes the associated close-out. This facility allows clearing members to effectively manage their potential financing requirements with predetermined caps.944 As reported in the CPMI–IOSCO disclosure by FICC for Q2 of 2023, the combined liquidity commitment by clearing members to the FICC’s CCLF was $86.3 billion for all repos and cash trades of U.S. Treasury and Agency securities. Since the inception of the CCLF in 2018, the CCLF has ranged in size from $82.5B to $108B.945 Commitments by bank-affiliated dealers to the CCLF count against regulatory liquidity requirements, including the Liquidity Coverage Ratio (LCR).946 Dealers affiliated with banks may satisfy their CCLF obligations using a guarantee from that affiliated bank but dealers not affiliated with banks may incur costs to obtain commitments to meet CCLF liquidity requirements. FICC states that when examining the impact of the rule amendments being adopted, its findings are inconclusive about the potential impact of the incremental indirect participant Treasury volume on FICC’s liquidity needs or its CCLF.947 The size and cost of a firm’s liquidity plan is tied not only to its own exposure at FICC, but also to the maximum exposure of the largest systemically important financial institution (‘‘SIFI’’) banks. One commenter stated that its members have reduced their portfolios as part of their CCLF liquidity plans.948 At the same time, SIFIs have increased the size of their portfolios, and intermediaries, controls, is controlled by, or is under common control with, another participant then the affiliated participants shall be collectively deemed to be a single participant family. See Rule 17ad–22(a). 943 See part IV.B.3 supra. 944 FICC Disclosure Framework 2021 at 88, available at https://www.dtcc.com/-/media/Files/ Downloads/legal/policy-and-compliance/FICC_ Disclosure_Framework.pdf. 945 See part IV.B.3 supra. 946 LCR is calculated as the ratio of High-Quality Liquid Assets (HQLA) divided by estimated total net cash outflow during a 30-day stress period. Because commitments by bank-affiliated dealers to the CCLF would increase the denominator of the ratio, a bank-affiliated dealer would have to increase HQLA to reach a required level of LCR. 947 See DTCC 2023 White Paper, supra note 107, at 3, 19. 948 IDTA Letter, supra note 66, at 8–9. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations correspondingly, the very risk that the CCLF was designed to reduce.949 ii. Costs of the Requirement To Clear Eligible Secondary Market Transactions in Terms of Increased Margining for Existing FICC Members As discussed above, the Commission recognizes that these amendments could cause an increase in the margin clearing members must post to a U.S. Treasury securities CCA resulting from the additional transactions that will be submitted for clearing as a result of these amendments. Although various SRO margin rules provide for the collection of margin for certain transactions in U.S. Treasury securities, the Commission understands that transactions between dealers and institutional customers are subject to a variable ‘‘good-faith’’ margin standard, which the Commission understands— based on its supervisory experience— can often result in fewer financial resources collected for margin exposures than those that would be collected if a CCP margin model, like the one used at FICC, were used.950 Mitigating the potential for higher margin requirements for transactions submitted for clearing at a U.S. Treasury securities CCA is the benefit of netting that results from additional centrally cleared transactions.951 As described in part IV.C.1 supra, this mitigant is likely to be especially significant in the case of IDB members. Also, potentially substantially mitigating the costs for clearing members is the ability for broker-dealers to include a debit in the customer reserve formula equal to the amount of margin required and on deposit at a U.S. Treasury securities CCA, as described in part II.C supra. Based on a survey of its members, FICC estimates that incremental indirect participant Treasury volume could result in a corresponding increase in Value at Risk (VaR) margin of approximately $26.6 billion across the FICC/GSD membership.952 953 Netting 949 Id. 950 See supra note 27. part IV.C.1 supra for a discussion of the benefits of multilateral netting expected to result from higher volumes of centrally cleared transactions. 952 See DTCC 2023 White Paper, supra note 107, at 3, 16. FICC estimates that, in aggregate, there will be an incremental $500 billion of indirect participant Treasury repo activity, $520 billion of indirect participant Treasury reverse repo activity and $605 billion of indirect participant Treasury cash activity that could be submitted to FICC under the Proposing Release if it were adopted. The increase in margin is based on this estimate of increased central clearing activity. The estimates assume that all incremental indirect participant volume clears through one of FICC’s client clearing models that calculate margin on a gross basis. The ddrumheller on DSK120RN23PROD with RULES2 951 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 members’ required fund deposits to the clearing fund are primarily driven by a VaR charge; however, other margin charges may be collected when applicable.954 The cost to the netting members of the additional required fund deposits estimated by FICC is likely be less than this for three reasons. First, the definition of an eligible secondary market transaction with respect to cash transactions that is being adopted is narrower than that which was proposed and on which FICC’s estimates were based. Second, some fraction of the additional secondary market transactions that will be centrally cleared due to the new rules that would otherwise have been cleared bilaterally would also have been subject to margin requirements. Finally, since margin is only posted pending settlement, the cost to the posting entity is the opportunity cost of the funds. One commenter, on behalf of its broker-dealer members, stated that there is a transaction cost difference between current bilateral trades that are cleared using the triparty platform and an identical transaction that must be centrally cleared.955 The commenter further noted that this cost across a volume of trades is borne by clients of broker-dealers. The commenter stated that while the actual costs may vary across its membership, its members are currently paying about $3.00 per transaction settled on the triparty platform and bilaterally cleared over $7.00 for a similar tri-party transaction that was centrally cleared through FICC. The commenter stated that this is estimates could decrease if the activity were cleared through one of FICC’s client clearing models that calculate margin on a net basis. See also note 377, supra, regarding margin methodologies. BNY Mellon estimates as much as $370 billion in additional Treasury cash activity and $2.8 trillion in additional Treasury repo and reverse repo activity that could be submitted to FICC although they note that exemptions could reduce these amounts. See BNY Mellon, Reassembly Required: Central Clearing could Reshape the U.S. Treasury Market (November 2023), available at https:// www.bnymellon.com/us/en/insights/all-insights/ central-clearing-us-treasury-market.html. 953 There is uncertainty among market participants about how much additional margin would have to be collected by FICC. For example, in an article in the Financial Times’ Alphaville, an analyst at Barclays is quoted as estimating the additional margin could be $45 billion. Bryce Elder, Repo reform is a $2tn mystery wrapped in an enigma of dodgy data, FT Alphaville (Oct.13, 2023), available at https://www.ft.com/content/518cbd3bb1ed-4c3e-bd5e-9ac5bee99d9f. The discussion concluding that the cost to netting members of the additional required fund deposits estimated by FICC applies to this alternative estimate as well. 954 See DTCC, F.A.Q. FICC—Risk Management, available at https://www.dtcc.com/USTclearing/-/ media/Files/Downloads/Microsites/TreasuryClearing/FICC-Risk-Management-FAQ.pdf (last visited Dec. 11, 2023). 955 IDTA Letter, supra note 66, at 4. PO 00000 Frm 00101 Fmt 4701 Sfmt 4700 2813 because FICC imposes intraday and endof-day position management charges, among other charges, making it materially cost prohibitive to transact with FICC and thereby increasing the cost of trading to the end customer. Besides the direct impact of these costs, which could limit trading, costs of central clearing may incentivize nondirect participants of a Treasury CCP to look for ways to trade away from direct participants in order to not have to centrally clear Treasury transactions, negatively affecting both liquidity and competition. Several commenters discussed facilitating cross-margining of indirect participants’ transactions in U.S. Treasury securities with those in U.S. Treasury futures as a method to lower costs of trading and thereby incentivize additional clearing.956 One commenter stated that cross-margining would lower costs for market participants by allowing them to apply margin across positions submitted for clearing through various clearinghouses. The commenter stated that this would ensure that a market participant can post margin adequate to support its positions without having to post margin in excess of regulatory requirements due to an inability to apply margin across platforms.957 As discussed above, other commenters made additional suggestions lowering costs by creating additional cross margining opportunities.958 The current crossmargining agreement between FICC and CME is part of the GSD rulebook, and any changes to it have to be filed with the Commission pursuant to Section 19(b) of the Exchange Act. The Commission agrees that cross-margining can be beneficial to market participants.959 Rules requiring segregation of client margin should facilitate cross-margining. If such crossmargining were adopted, some costs of clearing would be mitigated. One commenter stated that central clearing can have procyclical effects in times of market stress due to the margin requirements of clearing agencies, further reducing liquidity when it is most needed.960 The commenter stated that, depending on the applicable margin models, clearing can be procyclical in times of market turmoil, as increased margin requirements (including intraday and ad hoc calls) drive demand for liquid assets, which, 956 MFA Letter at 11; SIFMA/IIB Letter, supra note 37, at 13; SIFMA AMG Letter at 8. 957 MFA Letter at 11. 958 See part II.A.1.0 supra. 959 Id. 960 SIFMA/IIB Letter, supra note 37, at 9. E:\FR\FM\16JAR2.SGM 16JAR2 2814 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations in turn, increases the scarcity of those assets and further drives market stress. The commenter described FICC’s rules as allowing FICC to demand, at any time in its discretion, additional margin from its members in times of market volatility, including through intraday calls, to safeguard the clearing infrastructure.961 The Commission acknowledges that, in times of market stress, margin calls may increase to address the ongoing market volatility. This is by design, as margin models are built to be responsive to current market conditions. The Commission has specifically required that CCAs have the authority and operational capacity to make intraday margin calls in defined circumstances.962 This ability is important to the CCA’s ability to manage the risk and cover the credit exposures that its participants may bring to the CCA. When considering a CCA’s authority with respect to intraday margin, the Commission may consider its potential procyclicality.963 In addition, the Commission may consider the transparency of the margin model, such that market participants can understand when the CCA may make margin calls.964 In addition to the FICC rules cited by the commenter, FICC has provided additional transparency regarding how it determines the need for intraday margin calls, including the specific criteria that it uses to assess the need.965 FICC is also subject to Rule 961 Id. 962 17 CFR 240.17ad–22(e)(6)(ii). e.g., Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Approving a Proposed Rule Change to Modify the Calculation of the MBSD VaR Floor to Incorporate a Minimum Margin Amount, Exchange Act Release No. 92303, at 32 (June 30, 2021) (discussing commenter’s concern regarding potential procyclical nature of a margin methodology change); Self-Regulatory Organizations; The Options Clearing Corporation; Order Granting Approval of Proposed Rule Change Concerning The Options Clearing Corporation’s Margin Methodology for Incorporating Variations in Implied Volatility, Exchange Act Release No. 95319, at 3 (July 19, 2022) (referencing the impact of a change to margin methodology on procyclicality of margin). 964 See, e.g., Self-Regulatory Organizations; National Securities Clearing Corporation; Order Approving a Proposed Rule Change to Enhance National Securities Clearing Corporation’s HaircutBased Volatility Charge Applicable to Illiquid Securities and UITs and Make Certain Other Changes to Procedure XV, Exchange Act Release No. 34–90502, at 56–59 (Nov. 24, 2020) (discussing commenter’s concerns regarding transparency of change to margin methodology). 965 See Self-Regulatory Organizations; Fixed Income Clearing Corporation; Notice of Filing of Proposed Rule Changes to the Required Fund Deposit Calculation in the Government Securities Division Rulebook, Exchange Act Release No. 82588 (Jan. 26, 2018) (identifying the following specific parameter breaks: (i) a dollar threshold that evaluates whether a Netting Member’s Intraday VaR ddrumheller on DSK120RN23PROD with RULES2 963 See, VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 17ad–22(e)(23), which requires certain levels of public disclosure regarding FICC’s margin methodology and the costs of participating in FICC, as discussed further in part II.B.2 supra. The Commission’s ongoing consideration of the role and function of intraday margin calls, as well as market participants’ ability to understand such calls, obviates the need for separate study in connection with this proposal.966 iii. Other Costs Several commenters raised additional issues related to costs or limitations on benefits of the new rules and amendments. One commenter explained that registered funds’ access to the Treasury repo market could be restricted by the number or willingness of the FICC netting members to provide sponsoring services, with attending negative effect on the market liquidity.967 Commenters have raised concerns that increases in demand for the Sponsored Service may put pressure on existing sponsoring members and reduce their ability or willingness to onboard additional clients. Such outcomes may result in these market participants not being able to trade with some of the largest banks and broker dealers who are direct members of FICC unless they are able to access clearing using an alternative clearing model, reducing the number of potential counterparties, possibly raising trading costs. Demand for sponsored access to clearing could also drive up the price of providing such services and provide an incentive for new competitors to enter Charge equals or exceeds a set dollar amount (then set at $1,000,000) when compared to the VaR Charge that was included in the most recently collected Required Fund Deposit including, any subsequently collected Intraday Supplemental Fund Deposit; (ii) a percentage threshold, that evaluates whether the Intraday VaR Charge equals or exceeds a percentage increase (then set at 100%) of the VaR Charge that was included in the most recently collected Required Fund Deposit including, if applicable, any subsequently collected Intraday Supplemental Fund Deposit; (iii) the coverage target, that evaluates whether a Netting Member is experiencing backtesting results below the 99% confidence level). FICC has updated this information via Important Notices to its participants. See, e.g., Important Notice GOV1244– 22, GSD Intraday Supplemental Fund Deposit Parameter Change (Apr. 11, 2022), available at https://www.dtcc.com/-/media/Files/pdf/2022/4/ 11/GOV1244-22.pdf (raising the coverage target). 966 See also Proposed Rule, Covered Clearing Agency Resilience and Recovery and Wind-Down Plans, Exchange Act Release No. 97516 (May 17, 2023), 88 FR 34708 (May 30, 2023) (proposing additional requirements with respect to intraday margin that CCAs require intraday monitoring of their exposures and specifying particular circumstances in which the CCA should make intraday margin calls). 967 ICI Letter, supra note 85, at 30–31. PO 00000 Frm 00102 Fmt 4701 Sfmt 4700 the market for providing sponsored clearing services. Alternatively, it is possible that as part of review of its access models and related policies and procedures required by Rule 17ad– 22(e)(18)(iv)(C), that FICC may modify its access models in a way that results in improved access for market participants who otherwise be so affected. Another commenter explained the impact of the ECP charge in conjunction with FICC’s Sponsored Service, stating that ‘‘the combination of gross margining and ECP currently in use under the Sponsored Model, and what is prescribed in the Proposed Rule, effectively prevents smaller and middle market broker dealers from materially participating in the Treasury market.968 However, another commenter explained that, in addition to the Sponsored Service, the U.S. Treasury securities CCA offers a variety of way to access central clearing for indirect participants.969 For example, FICC’s Prime Brokerage Clearing and Correspondent Clearing models currently support clearing of transactions between indirect participants although, at present, these models are rarely used.970 As stated in the Proposing Release, the Commission continues to believe that the U.S. Treasury securities CCA generally should consider a wide variety of appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants. In view of the critical services it provides, the U.S. Treasury securities CCA generally should seek to provide access in as flexible a means as possible, consistent with its responsibility to provide sound risk management and comply with other provisions of the Exchange Act, the Covered Clearing Agency Standards, and other applicable regulatory requirements. b. Costs to Non-Members of a U.S Treasury Securities CCA as a Result of the Requirement To Clear Eligible Secondary Market Transactions The requirement to clear eligible secondary market transactions requires that all repo transactions with a direct participant be centrally cleared and that 968 IDTA Letter, supra note 66, at 5. This commenter’s stated concern regards the interplay between the ECP and gross margining and rests on the assumption that gross margining is required by the rule which is not the case. See supra part II.B.1. However, the ECP in its current form may impact the willingness of small and middle market broker dealers from sponsoring additional market participants. 969 DTCC Letter, supra note 33, at 18–21. 970 Id. at 20. E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations certain cash transactions with a direct participant to be centrally cleared. The costs incurred by non-members of a U.S. Treasury securities CCA to comply with this requirement will depend on the policies and procedures developed by the CCA, as discussed in parts IV.C.2.a supra and IV.C.2.d infra. As stated above, the Commission believes that these amendments will increase central clearing in the U.S Treasury securities market. Transactions that are not currently submitted for central clearing but would be under the amendments being adopted will be subject to certain transaction, position, and other fees as determined by the U.S. Treasury securities CCA.971 Market participants who enter into eligible secondary market transactions with members of U.S. Treasury securities CCAs who do not have access to clearing may incur costs related to establishing the required relationships with a clearing member in order to submit the eligible transactions for clearing. These market participants may also incur additional costs related to the submission and management of margin. It is possible that such market participants may seek alternative counterparties that are not U.S. Treasury securities CCA members in order to avoid incurring these costs. As discussed in the baseline, the majority of repo and cash transactions in the dealer-to-customer segment are not centrally cleared. This differentiates the U.S. Treasury securities market from the markets for swaps and for futures. There is currently some clearing of customer repo; the majority of this clearing is ‘‘done-with’’—the clearing broker and the counterparty are one and the same. However, in the swaps and futures markets, and in the equities market, clearing is ‘‘done-away’’— meaning that the clearing broker may be other than the trading counterparty. Market participants have identified costs with the done-with model. Market participants in the secondary market for U.S Treasury securities that will be required to be centrally cleared could incur direct costs for arranging clearingrelated legal agreements with every potential counterparty. Depending on the customer there may be a large number of such arrangements. There are indirect costs arising when a trading counterparty is a competitor. For example, the pricing and offering of clearing services may be determined by forces other than the costs and benefits of the clearing relationship itself, such as the degree of competition between the counterparties. Other economic arrangements facilitating customer clearing are possible and may develop, as in other markets.972 One such arrangement is direct CCA membership. However, for smaller entities, CCA membership may not be economically viable, and for some entities, legal requirements may prevent direct membership. Another possibility is seeking out counterparties other than CCA members. The ‘‘done away’’ structure of clearing has worked effectively in other markets, and, if it were to develop so that all market participants with demand could trade using the ‘‘done-away’’ structure, would significantly mitigate these costs. Some participants may not currently post margin for cash clearing and may be now required to do so, depending on the form the clearing relationship takes. There may be costs associated with the transfer of margin. An institutional investor self-managing its account would instruct its custodian to post margin with the CCA on the execution date, and post a transaction in its internal accounting system showing the movement of margin. The day after trade execution, the investor would oversee the return of margin from FICC, with an attendant mark of a transaction on the investor’s internal accounting system. Similar steps would occur for an institutional investor trading through an investment adviser, though in this case the adviser might instruct the custodian and mark the transaction, depending on whether the adviser has custody. The institutional investor might also pay a wire fee associated with the transfer of margin. Besides the costs of developing new contracts with counterparties to support central clearing, there will also be a cost to non-CCA members associated with margin, to the extent that more margin is required than in a bilateral agreement. This cost of margining is analogous to that borne by CCA members and is discussed further above. As a result of the rule, a potential cost to money market fund participants that face FICC as a counterparty is that the funds’ credit ratings could be affected if FICC becomes a substantially large counterparty of these participants, which could be interpreted by credit models and ratings methodologies as a heightened concentration risk factor. As concentration risk in a CCP is typically not viewed in the same way as concentration risk with a bilateral trading party, credit rating agencies may quickly adapt their methods to 971 The fee structure for FICC is described in its rulebook. See FICC Rules, supra note 19, at 307. 972 See FIA–PTG Whitepaper, supra note 918 (for a description of different client clearing models). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 PO 00000 Frm 00103 Fmt 4701 Sfmt 4700 2815 distinguish the CCA from a conventional counterparty. In the absence of such changes at credit rating agencies, money market fund participants may find it necessary to either alter their investment strategies to substitute purchases of Treasury securities for repo or to enter into repo transactions with entities that are not direct members of a Treasury securities CCA. As discussed above, increased demand for the Sponsored Service and the existence of compliance and capital costs for sponsoring members may limit the ability of some market participants to access clearing through the Sponsored Service. Unless these market participants are able to access clearing through alternative clearing models, they may be unable to trade repo with some of the largest banks and broker dealers who are direct members of FICC, reducing the number of potential counterparties, and possibly resulting in inferior pricing for such market participants. Alternatively, it is possible that as part of review of its access models and related policies and procedures required by Rule 17ad– 22(e)(18)(iv)(C), that FICC may modify its access models in a way that results in improved access for market participants who otherwise be so affected. One commenter argued that including triparty repos in the definition of an eligible secondary market transaction would likely impair the cash and collateral management processes of hedge funds and alternative asset managers.973 Specifically, the commenter suggested that such firms currently conduct same-day bilateral transactions that they would not be able to conduct with a direct participant of a U.S. Treasury securities CCA required to centrally clear its repo transactions.974 The Commission disagrees with this commenter. In its supervisory capacity, the Commission is aware that registered funds, hedge funds, and alternative asset managers currently conduct centrally cleared triparty repo transactions. For example, the Commission is aware that numerous hedge funds conduct such same-day transactions as sponsored members of FICC. Therefore, the existing operational infrastructure supports centrally cleared triparty repo transactions. As discussed above, two commenters asked the Commission to adopt an exemption that would allow FCMs to continue to engage in eligible secondary 973 See 974 See E:\FR\FM\16JAR2.SGM MFA Letter at 17. id. 16JAR2 2816 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations market transactions in U.S. Treasury securities outside of central clearing.975 For the reasons discussed above in part II.A.2.a.iv supra, the Commission is not excluding repo transactions between FICC netting members and FCMs from the definition of eligible secondary market transactions. However, the Commission recognizes that the tension between the rules governing FCMs and the rule amendments being adopted may raise costs for FCMs if it restricts the choice of models that can be used to access central clearing or reduces the number of potential counterparties. For example, one of the commenters explained that FCMs are permitted to invest customer funds in certain securities determined by the CFTC to be ‘‘consistent with the objectives of preserving capital and maintaining liquidity.’’ 976 The commenter stated that permitted investments include, among other things, U.S. Treasury securities, and investments with U.S. Treasury securities may be made by either direct purchase or sale or by entering into repo transactions.977 The commenter further explained that, for repo transactions, an FCM’s ‘‘permitted counterparties are limited to a bank . . . , securities broker-dealer, or government securities dealer registered with the [Commission],’’ and a clearing agency is not a permitted counterparty.978 If an FCM is unable to clear repo transactions then it would not be able to trade with FICC netting members, reducing the number of potential counterparties available to it. ddrumheller on DSK120RN23PROD with RULES2 c. Other Changes to Covered Clearing Agency Standards i. Netting and Margin Practices for House and Customer Accounts The amendments to Rule 17ad– 22(e)(6)(i) require a U.S. Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, calculate, collect, and hold margin amounts from a direct participant for its proprietary U.S. Treasury securities positions, separately and independently from margin calculated and collected from that direct participant in connection with U.S. Treasury securities transactions by an indirect participant that relies on the services provided by the direct participant to access the covered 975 See supra note 901 and referencing text. Letter, supra note 200, at 4–5 (discussing 17 CFR 1.25(b)). 977 FIA Letter, supra note 200, at 4–5 (discussing 17 CFR 1.25(a)). 978 FIA Letter, supra note 200, at 5 (discussing 17 CFR 1.25(d)(2))). 976 FIA VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 clearing agency’s payment, clearing, or settlement facilities.979 The amendments to Rule 17ad–22(e)(6)(i) contain similar provisions to existing FICC rules, specifically with respect to its Sponsored Member program, but also impose additional requirements that do not appear in existing Rule 17ad–22. As a result, the Commission believes that a U.S. Treasury securities CCA will incur burdens of reviewing and updating existing policies and procedures in order to comply with the amendments to Rule 17ad–22(e)(6) and, in some cases, may need to create new policies and procedures.980 The Commission estimates that U.S. Treasury securities CCAs will incur an aggregate one-time cost of approximately $106,850 to create new policies and procedures.981 The amendments to the rule also require ongoing monitoring and compliance activities with respect to the written policies and procedures created in response to the rule. The Commission estimates that the ongoing activities required by the amendments to Rule 17ad–22(e)(6) will impose an aggregate ongoing cost on covered clearing agencies of approximately $60,580 per year.982 ii. Facilitating Access to U.S. Treasury Securities CCAs Rule 17ad–22(e)(18)(iv)(C) requires a U.S. Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the U.S. Treasury 979 See part II.B.1 supra. general information and statistics regarding the Sponsored Service, see DTCC, Sponsored Service, supra note 669. The Sponsored Service also allows the submission of cash transactions; however, at this time, the service is generally used only for U.S. Treasury repo transactions. 981 This figure was calculated as follows: Assistant General Counsel for 20 hours (at $518 per hour) + Compliance Attorney for 40 hours (at $406 per hour) + Computer Operations Manager for 12 hours (at $490 per hour) + Senior Programmer for 20 hours (at $368 per hour) + Senior Risk Management Specialist for 25 hours (at $397 per hour) + Senior Business Analyst for 12 hours (at $305 per hour) = $53,425 × 2 respondent clearing agencies = $106,850. See part V.B infra. 982 This figure was calculated as follows: Compliance Attorney for 25 hours (at $406 per hour) + Business Risk Analyst for 40 hours (at $305 per hour) + Senior Risk Management Specialist for 20 hours (at $397 per hour) = $30,290 × 2 respondent clearing agencies = $60,580. See part V.B infra. 980 For PO 00000 Frm 00104 Fmt 4701 Sfmt 4700 securities CCA’s board of directors reviews annually. The rule requires a U.S. Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures. The Commission believes that a respondent U.S. Treasury securities CCA will incur burdens of reviewing and updating existing policies and procedures and will need to create new policies and procedures in order to comply with the provisions of Rule 17ad–22(e)(18)(iv)(C). These costs are included in the costs of creating new policies and procedures associated with Rule 17ad–22(e) discussed above. Commenters generally supported the Commission’s attention to the need for appropriate access to the U.S. Treasury securities CCA, and several commenters specifically agreed that the Commission should not prescribe any particular model. One commenter stated that the commenter ‘‘fully agree[s] with the Commission that flexibility and an open-access approach are critical to facilitating access to clearing. [ ], dictating a single model of clearing would close off clearing to many market participants, force indirect participants to bear additional clearing costs, increase concentration, reduce competition, and negatively impact market liquidity.’’ 983 In addition, another commenter supported the proposal to rely on the clearing agencies to develop the model and infrastructure and that clearing agencies should have flexibility to innovate in this area. This commenter also noted many market stakeholders may prefer an agency model or some form of limited membership with a clearing agency.984 Another commenter stated that the Commission should encourage FICC to improve the existing Sponsored Service in several ways: (1) to further develop a ‘‘give up’’ structure to facilitate best execution (and accommodate ‘‘doneaway’’ trades), noting that FICC’s prime broker/correspondent clearing infrastructure could be leveraged to develop a give up model outside of prime brokerage (which would need to provide for standardized documentation that facilitates additions and deletions of approved brokers, agreed-upon terms for rejection of trades by a sponsoring member and centralized storage of delegations); and (2) to add a feature permitting (but not requiring) sponsored members to directly support their obligations to FICC through margin posting rather than by paying fees to the sponsoring member reflecting the cost of 983 FICC/DTCC 984 ICE E:\FR\FM\16JAR2.SGM Letter, supra note 33, at 18. Letter, supra note 85, at 3. 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations its clearing fund contributions.985 As stated in the Proposing Release, the Commission believes that U.S. Treasury securities CCAs should continue to develop access models that would best serve the needs of market participants, and the Commission encourages such CCAs to take all appropriate steps to accommodate ‘‘done-away’’ trades. The Commission would consider any proposals in this regard consistent with its obligations under Section 19 of the Exchange Act. d. Amendments to Rules 15c3–3 and 15c3–3a The amendment to Rule 15c3–3a permits, under certain conditions, margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula. This new debit item offset credit items in the Rule 15c3–3a formula and, thereby, free up resources that could be used to meet the margin requirements of a U.S. Treasury securities CCA. The amendment allows a customer’s broker to use customer funds to meet margin requirements at the CCP generated by the customer’s trades, lowering the cost of providing clearing services. Broker-dealers may incur costs from updating procedures and systems to be able to use customer funds to meet customer margin requirements. However, the amended rule does not require that the brokerdealer does so. Overall, commenters supported the proposal to permit this debit item.986 Commenters stated that the proposed amendments would make clearing more efficient and free up resources that could be used to meet the CCA’s margin requirements, while continuing to protect customer funds.987 Commenters also stated that the proposal would incentivize central clearing.988 A commenter stated that the proposal would extend to margin held at a U.S. Treasury securities CCA the same treatment as margin posted to other clearing organizations.989 As a result, this commenter stated that the proposal would facilitate greater access to clearing and eliminate an undue burden on competition. Another commenter— in supporting the proposal—stated that ddrumheller on DSK120RN23PROD with RULES2 985 ICI Letter, supra note 85. AIMA Letter, supra note 81; CME Letter, supra note 81; DTCC/FICC Letter, supra note 33; ICE Letter, supra note 33; MFA Letter, supra note 81; ISDA Letter, supra note 391; SIFMA AMG Letter, supra note 35. 987 See AIMA Letter, supra note 81; MFA Letter, supra note 81; SIFMA/IIB Letter supra note 37. 988 See CME Letter, supra note 81; SIFMA AMG Letter, supra note 35. 989 See DTCC/FICC Letter, supra note 33. 986 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 it does not make sense that margin cannot be freely rehypothecated from a customer through a broker-dealer to a U.S. Treasury securities CCA without the broker-dealer receiving a beneficial adjustment as part of its customer reserve formula calculation.990 For greater and more efficient client clearing, another commenter encouraged the Commission to adopt this proposal irrespective of whether the requirement to clear eligible secondary market transactions is adopted.991 One commenter sought clarification that the conditions of Rule 15c3–3 would not preclude a U.S. Treasury securities CCA from entering into a repurchase transaction involving customer cash margin, so long as the purchased securities under such repurchase transaction consist of U.S. Treasury securities held in a segregated account for the benefit of customers and satisfy certain other requirements.992 The commenter provided a summary of potential protections that could be put in place to ensure that—if a U.S. Treasury securities CCA uses cash in the broker-dealer’s segregated account for liquidity purposes—the cash would be protected through collateral comprising U.S. Treasury securities deposited into the account and other measures.993 As discussed in part II.C.4.iii, supra the Commission would need to review a more detailed plan for how the cash will be used and customers protected before taking any action on the commenter’s request. The Commission acknowledges that the degree to which costs that are incurred in order to maintain sufficient qualifying liquid resources are directly born by various participants depends in part on the use of customer margin as a qualifying liquid resource.994 e. Other Costs One commenter stated that the Commission should consider that ‘‘the sheer number and complexity of the Proposals, when considered in their totality, if adopted, would impose staggering aggregate costs, as well as unprecedented operational and other practical challenges.’’ 995 But, consistent 990 See SIFMA AMG Letter, supra note 35. ISDA Letter, supra note 391. 992 DTCC/FICC Letter II, supra note 503. See also part II.C.4.iii, supra for additional discussion of the issue raised by this comment letter. 993 Id. 994 One such source is FICC’s CCLF. See part IV.B.4, supra and part IV.C.2.a.i, supra. See also supra note 688, and referencing text regarding the Commission’s requiring FICC to hold qualifying liquid resources sufficient to meet a cover-1 standard. 995 MFA Letter 2, supra note 600, at 3; see ICI Letter 2, supra note 600, at 3 (stating that the Commission should consider ‘‘practical realities 991 See PO 00000 Frm 00105 Fmt 4701 Sfmt 4700 2817 with its long-standing practice, the Commission’s economic analysis in each adopting release considers the incremental benefits and costs for the specific rule—that is the benefits and costs stemming from that rule compared to the baseline. In doing so, the Commission acknowledges that in some cases resource limitations can lead to higher compliance costs when the compliance period of the rule being considered overlaps with the compliance period of other rules. In determining compliance periods, the Commission considers the benefits of the rules as well as the costs of delayed compliance periods and potential overlapping compliance periods. In this regard, some commenters mentioned the proposals which culminated in the recent adoptions of the May 2023 SEC Form PF Amending Release, the Beneficial Ownership Amending Release, the Private Fund Advisers Adopting Release, the Rule 10c–1a Adopting Release, the Short Position Reporting Adopting Release, and the Securitizations Conflicts Adopting Release.996 The Commission acknowledges that there are compliance periods for certain requirements of these rules that overlap in time with the final rule, which may impose costs on resource constrained entities affected by multiple rules.997 However, the Commission does not think these increased costs from overlapping compliance periods will be significant for several reasons. First, the number of market participants who directly or indirectly engage in eligible secondary market transactions in Treasury securities that will be subject to the final rule and who will be subject to one or more of the other recently adopted rules could be limited based on whether those participants’ activities fall within the scope of the other rules.998 Second, for the reasons such as the implementation timelines as well as operational and compliance requirements’’). 996 See supra note 600. As stated above, commenters also specifically suggested the Commission consider potential overlapping compliance costs between the final rule and certain proposing releases. See supra note 608. These proposals have not been adopted and thus have not been considered as part of the baseline here. To the extent those proposals are adopted in the future, the baseline in those subsequent rulemakings will reflect the regulatory landscape that is current at that time. 997 See supra notes 602 to 607 (summarizing compliance dates). 998 The Rule 10c–1a Adopting Release will require only persons who agree to a covered securities loan to report that activity. The Short Position Reporting Adopting Release will require only institutional investment managers that meet or exceed certain reporting thresholds to report short position and short activity data for equity securities. E:\FR\FM\16JAR2.SGM Continued 16JAR2 2818 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations discussed above, we have adopted a phased approach to implementation and compliance based on input from commenters.999 Further, all of the other rules have long compliance periods, which is expected to facilitate planning, preparation and investment and thereby limit the cost of overlapping compliance periods.1000 Third, commenters’ concerns about the costs of overlapping compliance periods were raised in response to the proposal and as discussed above, we have taken steps to reduce costs of the final rule.1001 3. Effect on Efficiency, Competition, and Capital Formation a. Efficiency ddrumheller on DSK120RN23PROD with RULES2 i. Price Transparency As mentioned in part IV.B supra, the majority of trading in on-the-run U.S. Treasury securities in the interdealer market occurs on electronic platforms operated by IDBs that bring together buyers and sellers anonymously using order books or other trading facilities supported by advanced electronic trading technology. These platforms are usually run independently in the sense that there is no centralized market for price discovery or even a ‘‘single virtual market with multiple points of entry’’.1002 As a result, pre-trade transparency is suboptimal: quotations and prices coming from and going to an IDB may be distributed unevenly to market participants who have a relationship with that IDB. Efficiency, which measures the degree to which prices can quickly respond to relevant information, is impaired because of this market fragmentation; some areas of the And the Securitizations Conflicts Adopting Release will affect only certain entities—and their affiliates and subsidiaries—that participate in securitization transactions. See supra notes 605 to 607. In addition, FICC will not be affected by any of the six rules identified by commenters. 999 See part III supra. 1000 See supra notes 602 to 607. 1001 The final rule mitigates costs relative to the proposal in the following ways. First, the scope of the definition of eligible secondary market transaction in Rule 17ad–22(a) has been revised to exclude repos by other clearing organizations, repos by state and local governments, and inter-affiliate repos. Second, the scope of the definition of eligible secondary market transaction has been modified to no longer include cash transactions by hedge funds and leveraged accounts. Third, the Commission is modifying paragraph (a) of Note H to Rule 15c3– 3a to permit ‘‘qualified customer securities’’ to be used to meet the customer position margin requirement in addition to cash and U.S. Treasury securities. Finally, to reduce operational burdens on broker-dealers, the Commission is removing the proposed requirement to return excess collateral within one business day that was part of fifth rule set—identified in paragraph (b)(2)(v) of proposed Note H. 1002 Maureen O’Hara and Mao Ye, Is Market Fragmentation Harming Market Quality?, 100 J. Fin. Econ. 459 (2011). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 market may not reflect information passed on by prices in other sectors. Central clearing can promote price discovery in several ways: first, the clearing agency itself becomes a source of data; 1003 and second, the accessibility of central clearing could promote all-to-all trading as previously mentioned in part II.A.1 supra, which should reduce the obstacles to information flow that come from fragmentation.1004 ii. Operational and Balance Sheet Efficiency Greater use of central clearing could also increase the operational efficiency of trading U.S. Treasury securities. Central clearing replaces a complex web of bilateral clearing relationships with a single relationship to the CCP. In that sense, the complex network of relationships that a market participant may have for bilaterally clearing U.S. Treasury securities would shrink, with attendant reductions in paperwork, administrative costs, and operational risk. Central clearing also enhances balance sheet efficiency, allowing firms to put capital to more productive uses. The amendments to Rule 15c3–3a permit, under certain conditions, margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula. This new debit item offset credit items in the Rule 15c3–3a formula and, thereby, free up resources that could be used to meet the margin requirements of a U.S. Treasury securities CCA. The amendment allows a customer’s broker to use customer funds to meet margin requirements at the CCP generated by the customer’s trades, lowering the cost of providing clearing services. Though these lower costs may or may not be fully passed on to customers, in a competitive environment the Commission expects that at least some of these savings will pass through to customers. b. Competition With respect to the market for execution of U.S. Treasury securities by broker-dealers, increased central clearing can enhance the ability of smaller participants to compete with incumbent dealers.1005 Similarly, decreased counterparty credit risk—and potentially lower costs for intermediation—could result in narrower spreads, thereby enhancing 1003 FIA–PTG Whitepaper, supra note 918. supra note 31. 1005 See G–30 Report, supra note 5, at 13. 1004 See PO 00000 Frm 00106 Fmt 4701 Sfmt 4700 market quality.1006 While estimating this quantitatively is difficult, research has demonstrated lower costs associated with central clearing in other settings.1007 Moreover, increased accessibility of central clearing in U.S. Treasury securities markets could support all-to-all trading, which should further improve competitive pricing, market structure and resiliency.1008 Commenters suggest that costs of clearing may be disproportionately felt by small and mid-size participants in the Treasury market.1009 An additional commenter stated that the proposed separation of house and customer margin would negatively impact small and mid-size broker-dealers who are disproportionately affected by FICC’s Excess Capital Premium (‘‘ECP’’) charge, which is a margin add-on that collects a premium when a member’s VaR charge exceeds the member’s Net Capital, net assets or equity capital (as applicable to that member based on its type of regulation).1010 The commenter explained the impact of the ECP charge in conjunction with FICC’s Sponsored Service, stating that ‘‘the combination of gross margining and ECP currently in use under the Sponsored Model, and what is prescribed in the Proposed Rule, effectively prevents smaller and middle market broker dealers from materially participating in the Treasury market.1011 The commenter states that the ultimate effect of the ECP charge is exacerbated when customer/institutional counterparty margin is included in the calculation, and the surcharge prevents smaller independent broker-dealers from sponsoring institutional counterparties/customers.1012 The commenter’s concerns regarding the interplay between purported required gross margining and the ECP charge rests on the assumption that gross margin is required under the proposal, which, as discussed in part II.B.1 supra, is not the case.1013 With respect to the 1006 Id. 1007 See Y.C. Loon & Z.K. Zhong, The Impact of Central Clearing on Counterparty Risk, Liquidity, and Trading: Evidence From the Credit Default Swap Market, 112 J. Fin. Econ. 91 (2014). 1008 See 2021 IAWG Report, supra note 4, at 30; Duffie, supra note 27, at 16; G–30 Report, supra note 5, at 13. 1009 Letter from Evan Gerhard, President and CEO of ASL Capital Markets (Dec. 23, 2022) and letter from SIA Partners (Aug. 31, 2023) at 22 (‘‘SIA Partners 2’’). 1010 IDTA Letter, supra note 66, at 4; see also FICC Rule 4, section 14, supra note 19. 1011 IDTA Letter, supra note 66, at 5. 1012 IDTA Letter, supra note 66, at 5. 1013 The rule does require that a proprietary position not be netted against a customer position. This could enhance competition because dealers with customers are no longer advantaged relative to those without. It enhances the unbundling of E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 ECP charge on its own, the Commission is not taking any action with respect to the ECP charge as part of adopting these new requirements. The ECP charge is part of FICC’s existing rulebook, which is an SRO rule, and any change to that rulebook would be made pursuant to the proposed rule change process under Section 19(b).1014 While the rule does not require gross margining of customers, the rule does require members to clear additional transactions relative to the baseline. Because the dominant clearing model is the sponsored model, and because the sponsored model does use gross margining, which implicates the ECP, the Commission acknowledges the commenter’s concerns regarding possible competitive effects on the Treasury market. Specifically, the existence of the ECP links the costs of sponsorship with the capital of the entity, and hence sponsorship is more economical for some than for others. Because current market practice is to bundle execution with clearing, some entities may face additional hurdles in trade execution in that it may be uneconomical for them to serve as sponsoring members for a large dollar value of trades. There are two factors that mitigate any potential impact of the ECP on competitiveness. First, there are alternatives to the sponsored clearing model that do not require gross margining. The commenter cites one such model, and notes ambiguity as to whether this model can indeed be used by independent dealers.1015 The Commission acknowledges the commenter’s concern but notes that FICC recently has indicated that it intends to make available client clearing models that do not require gross margin, consistent with its current offerings.1016 Second, the amendments to Rule 15c3– 3a, which permit margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula makes it economical for dealers to post margin on behalf of their customers. This may encourage the development of clearing models that are based on counterparty clearing and trading services described in part IV.C.1 supra. 1014 Exchange Act Section 19(b); see also Section 19(c). 1015 See IDTA Letter, supra note 66, at 7. 1016 See DTCC 2023 White Paper, supra note 107, at 6 (discussing that the proposal would allow the option to calculate and collect margin associated with customer activity on a gross or net basis depending on the client clearing model selected by the member and stating that FICC would offer options via different access models that would allow those parties to balance the benefits of netting and segregation in different ways). VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 risk, rather than the capital of the trading entity. In a second letter, the same commenter advocates for a common margining regime for FICC, where members participating in the MBSD, GSD, or the CME are accounted for properly in terms of offsetting positions 1017 and while that subject is not within the scope of this release, permitting rehypothecation of margin may have directionally similar effects. With respect to the market for U.S. Treasury securities clearing services, currently there is a single provider of central clearing. The amendments will likely engender indirect costs associated with increased levels of central clearing in the secondary market for U.S. Treasury securities. Generally, the economic characteristics of a financial market infrastructure (‘‘FMI’’), including clearing agencies, include specialization, economies of scale, barriers to entry, and a limited number of competitors.1018 1019 The Commission noted in its proposal of rules applicable to covered clearing agencies that such characteristics, coupled with the particulars of an FMI’s legal mandate, could result in market power, leading to lower levels of service, higher prices, and under-investment in risk management systems.1020 Market power may also affect the allocation of benefits and costs flowing from these new rules and amendments that are being adopted, namely the extent to which these benefits and costs are passed through by FICC to participants.1021 The centralization of clearing activities for a particular class of transaction in a single clearing agency may also result in a reduction in its incentives to innovate and to invest in the development of 1017 IDTA Letter 2, supra note 829, at 2. Comm. on Payment and Settlement Sys. and Tech. Comm. Int’l Org. Sec. Comms, Principles for Financial Market Infrastructures (Apr. 16, 2012), available at https://www.bis.org/cpmi/publ/ d101a.pdf. 1019 See generally Nadia Linciano et al., The Clearing and Settlement Industry: Structure Competition and Regulatory Issues (Italian Secs. & Exch. Comm’n Research Paper 58, May 2005), available at https://www.ssrn.com/abstract=777508 (concluding in part that the core services offered by the clearance and settlement industry tend toward natural monopolies because the industry can be characterized as a network industry, where consumers buy systems rather than single goods, consumption externalities exist, costs lock-in consumers once they choose a system, and production improves with economies of scale). 1020 See CCA Standards Proposing Release, supra note 8. See also ICE Letter, supra note 31, at 2. 1021 For a discussion of cost pass-through, including when there lacks competition, see for example, RBB Econ., Cost pass-through: theory, measurement and policy implications, A Report prepared for the Office of Fair Trading (2014), available at https://www.gov.uk/government/ publications/cost-pass-through-theorymeasurement-and-policy-implications. 1018 See PO 00000 Frm 00107 Fmt 4701 Sfmt 4700 2819 appropriate risk management practices on an ongoing basis. Finally, the scope of the rule does not preclude members of FICC from strategically renouncing membership if they assess that the benefits of maintaining their ability to trade without centrally clearing their trades exceed their costs of surrendering their membership with the CCA. If this scenario materializes for a number of FICC members, then there will be costs to the overall market. Those costs could be the product of a smaller number of clearing members competing in the market for clearing services. Costs could also manifest themselves as increased risk from non-centrally cleared transactions and a reduction in the margin, operational and capital efficiencies related to central clearing. Further, if the number of clearing members falls, then the exposure of FICC to its largest clearing member could increase resulting in additional increases in the required size of the CCLF. In addition, as stated above, some commenters requested the Commission consider interactions between the economic effects of the proposed rule and other recent Commission rules, as well as practical realities such as implementation timelines.1022 As discussed above, the Commission acknowledges that overlapping compliance periods may in some cases increase costs. This may be particularly true for smaller entities with more limited compliance resources. This effect can negatively impact competition because these entities may be less able to absorb or pass on these additional costs, making it more difficult for them to remain in business or compete. However, we have mitigated the overall costs of the final rules relative to the proposal.1023 Moreover, all of the other rules have long compliance periods to facilitate planning, preparation and investment, thereby mitigating the cost to smaller entities of overlapping compliance periods.1024 We therefore do not expect the risk of negative competitive effects from increased compliance costs from simultaneous compliance periods to be significant. c. Capital Formation The new rule and amendments may encourage private-sector capital formation. U.S. Treasury securities form a benchmark for fixed income and even equity rates of return, and the new rule could lower the cost of capital for 1022 See parts IV.B, supra. supra note 1003. 1024 See supra notes 604 to 607. 1023 See E:\FR\FM\16JAR2.SGM 16JAR2 2820 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations private-sector issuers.1025 If the yield required by investors to hold U.S. Treasury securities reflects, in part, the risks associated with the buying and selling of U.S. Treasury securities, and increased central clearing of these transactions lowers those risks, then the new rule may put downward pressure on required yields. Research has shown that investors value both the safety and liquidity of U.S. Treasury securities. Because prices in the primary market both reflect and are driven by prices in the secondary market, liquidity could be one of the factors translating into lower rates of borrowing costs for U.S. taxpayers.1026 D. Reasonable Alternatives ddrumheller on DSK120RN23PROD with RULES2 1. Require U.S. Treasury Securities CCAs To Have Policies and Procedures Requiring Only IDB Clearing Members To Submit U.S. Treasury Securities Cash Trades With Non-Members for Central Clearing In the Proposing Release, the Commission considered the alternative of narrowing the scope of the requirement to clear eligible secondary market transactions as it pertains to cash transactions in the secondary market for U.S. Treasury securities. The narrower definition of eligible secondary market transaction contemplated in this alternative included (1) a repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities, in which one of the counterparties is a direct participant; or (2) a purchase or sale between a direct participant and any counterparty, if the direct participant of the covered clearing agency (A) brings together multiple buyers and sellers using a trading facility (such as a limit order book) and (B) is a counterparty to both the buyer and seller in two separate transactions.1027 This alternative differs from the proposal by omitting from the definition of eligible transactions those cash transactions between a direct participant and a registered brokerdealer, government securities broker, 1025 Standard textbook treatments of finance use the U.S. Treasury rate of return as a benchmark in computing the cost of capital for private companies. The link between interest rates of government debt and corporate debt is a long-standing feature of the financial landscape. See, e.g., Benjamin Friedman, Implications of Government Deficits for Interest Rates, Equity Returns, and Corporate Financing, Fin. Corp. Cap. Form. (1986). See also Philippon, The Bond Market’s Q, Q. J. Econ. (Aug. 2009) (noting a link between the level of interest rates and investment). 1026 See Arvind Krishnamurthy & Annette Vissing-Jorgensen, The Aggregate Demand for Treasury Debt, 120 J. Pol. Econ. (Apr. 2012). 1027 See Proposing Release. Such direct participants are referred to in this section and the alternatives below as ‘‘IDBs’’. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 government securities dealer, hedge fund, or account at a registered brokerdealer, government securities dealer, or government securities broker where such account may borrow an amount in excess of one-half of its net assets or may have gross notional exposure in excess of twice its net assets.1028 Several commenters supported the Commission’s proposal overall, including the cash clearing requirement.1029 By contrast, other commenters opposed cash clearing generally.1030 Other commenters suggested that the scope of eligible secondary market transactions in the cash market be broadened.1031 As discussed in the proposing release, the benefits arising from cash clearing for IDB members are particularly high. Hybrid clearing creates unique issues for FICC because FICC is able to manage the risks arising from the IDB–FICC member trade, but it lacks any knowledge of the IDB’s offsetting trade with its other counterparty and the potential exposure arising to the IDB from that trade, leaving the IDB, from FICC’s perspective, as apparently having a directional exposure despite the noncentrally cleared trade that would leave the IDB flat.1032 This lack of knowledge could prevent FICC from ‘‘accurately identifying, measuring and managing its direct and indirect counterparty risk exposure and can affect its decisionmaking,’’ 1033 which in turn potentially increases the likelihood that a default of an IDB member could in turn harm the CCP or the system as a whole. As stated in the Proposing Release, the Commission has previously stated that membership requirements help to guard against defaults of any CCP member, as well to protect the CCP and the financial system as a whole from the risk that one member’s default could cause others to default, potentially including the CCP itself. Further, contagion stemming from a CCP member default could be problematic for the system as a whole, even if the health of the CCP is not implicated. The default could cause others to back away from participating 1028 See Proposing Release, supra note 14, 88 FR at 64663; see also id. at 64622 for a discussion of cash transactions included in the definition of eligible transactions. 1029 AFREF Letter, supra note 33, at 2; Better Markets Letter, supra note 33, at 2, 6–8. 1030 See part II.A.2.b supra for a discussion of comments received regarding cash clearing. 1031 Id. 1032 See TMPG White Paper, supra note 13 at 22 (noting that in a hybrid clearing arrangement, an ‘‘IDB’s rights and obligations vis-a-vis the CCP are not offset and therefore the IDB is not in a net zero settlement position with respect to the CCP at settlement date.’’). 1033 See TMPG White Paper, supra note 13, at 27. PO 00000 Frm 00108 Fmt 4701 Sfmt 4700 in the market, particularly if the defaulting participant was an IDB, whose withdrawal from the market could jeopardize other market participants’ ability to access the market for U.S. Treasury securities.1034 This alternative would, with a more limited scope, move a large portion of secondary market transactions in U.S. Treasury securities that are not currently centrally cleared into central clearing.1035 The degree of central clearing would still allow for a partial picture of concentrated positions to the clearing agency. That said, there would be a limited benefit in terms of operational and balance sheet efficiency, and the benefits other than those specifically related to the IDB would be greatly reduced. Specifically, the reduced scope of this alternative would not capture types of participants that are usually leveraged such as hedge funds. As discussed in part II.A.2.b supra, the Commission is not including transactions with hedge funds and leveraged accounts in the definition of eligible transactions. The definition of eligible secondary market transaction in Rule 17ad–22(a) is being adopted as proposed with respect to IDB transactions and transactions that involve a purchase or sale between a direct participant and a registered broker-dealer, government securities broker, or government securities dealer. Including these transactions within the scope of eligible transactions increases the benefits discussed above associated with an increased proportion of transactions being centrally cleared.1036 However, as discussed above, the costs associated with including these transactions within the scope of eligible transactions may be less than those transactions not included by this alternative.1037 1034 See TMPG White Paper, supra note 13, at 32. 1035 Id. 1036 See Proposing Release, supra note 14, and part IV.A, supra of this release for a discussion of the benefits associated with increased central clearing. 1037 See Proposing Release, supra note 14, at 64665 for a discussion of the familiarity of many registered brokers with methods of central clearing of U.S. Treasury securities transactions. See also Id at 64669 for a discussion of the costs to non-FICC members, including the entities included within this alternative, of the requirement to clear eligible secondary market transactions. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 2. Require U.S. Treasury Securities CCAs To Have Policies and Procedures Requiring the Submission of All Repurchase Agreements Without Requirements for the Submission of Cash Transactions In the Proposing Release, the Commission considered excluding the cash U.S. Treasury securities market from the proposed rule, and instead only requiring that covered clearing agencies have policies and procedures reasonably designed to require that direct participants of the covered clearing agency submit for central clearing all transactions in U.S. Treasury repo transactions into which it enters.1038 Several commenters supported the Commission’s proposal overall, including the cash clearing requirement.1039 By contrast, other commenters opposed cash clearing generally.1040 The Commission understands that there is a likely benefit of additional balance sheet capacity that flows from clearing repo transactions in U.S. Treasury securities that might not occur with the clearing of cash transactions. Multilateral netting can reduce the amount of balance sheet capacity required for intermediation of repo and could enhance dealer capacity to make markets during normal times and stress events, because existing bank capital and leverage requirements recognize the risk-reducing effects of multilateral netting of trades that CCP clearing accomplishes.1041 The upfront costs of adjusting to the rule would be lower under this alternative than under the current proposal, as a result of a smaller number of participants and activities in scope and also the current level of interconnectedness among those participants. As previously mentioned, the number of participants in the U.S. Treasury repo market is significantly smaller than the number of participants in the cash market and is composed of sophisticated investors who have already incurred the costs of building the ability to novate transactions to the CCP. Infrastructure for Sponsored Clearing already exists, so processing changes should be less than in other more comprehensive alternatives and costs would be concentrated on the 1038 See Proposing Release, supra note 14. Letter, supra note 33, at 2; Better Markets Letter, supra note 33, at 2, 6–8. 1040 See part II.A.2.b supra for a discussion of comments received regarding cash clearing. 1041 See 2021 IAWG Report, supra note 4; Liang & Parkinson, supra note 725, at 9; Duffie, supra note 27, at 16–17. 1039 AFREF VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 implementation of similar agreements at a larger scale. Nevertheless, excluding the cash U.S. Treasury securities market from the rule would omit the largest sector of the U.S. Treasury market, both in terms of activity and number of participants. This alternative would yield smaller benefits in the areas of financial stability, risk visibility, margin offset efficiencies, and capital requirement reductions. The Commission believes that, given the scale-intensive nature of clearing, there are economies of scale that can only be realized when a larger number of financial market participants clear their U.S. Treasury securities cash trades. 3. Include All Cash Transactions Within the Scope of Eligible Secondary Market Transactions With Exceptions for Central Banks, Sovereign Entities, International Financial Institutions, and Natural Persons In the Proposing Release, the Commission considered requiring covered clearing agencies to have policies and procedures reasonably designed to require that direct participants of the covered clearing agency submit for central clearing all cash and repo transactions in U.S. Treasury securities into which they enter, except for natural persons, central banks, sovereign entities and international finance institutions. This policy option would include cash transactions between direct participants of a U.S. Treasury securities CCA and any counterparty except for those that fall within one of the aforementioned exceptions.1042 Several commenters opposed cash clearing generally.1043 This alternative would capture more of the potential benefits and positive externalities that result from increased central clearing, more closely resembling the assumptions and estimated benefits of Fleming and Keane’s calculations on clearing benefits.1044 By virtue of requiring all repo and most cash transactions to be centrally cleared, the alternative goes the furthest in solving the underlying collective action problem whereby some participants may find it optimal to not participate in central clearing, reducing the benefits that may accrue to the market as a whole. Several commenters suggested that the scope of eligible secondary market transactions in the cash market be broadened. One commenter stated that 1042 See Proposing Release, supra note 14. part II.A.2.b supra for a discussion of comments received regarding cash clearing. 1044 Fleming & Keane (2021), supra note 796. 1043 See PO 00000 Frm 00109 Fmt 4701 Sfmt 4700 2821 the Commission should align the scope of the definition with respect to cash transactions with the proposed scope for repos, subject to certain limited exceptions for investors that trade de minimis volumes. The commenter argued that the Commission’s approach with respect to cash transactions will increase costs for a specific subset of market participants, thereby putting them at a competitive disadvantage, while failing to deliver the envisaged market-wide benefits associated with central clearing (i.e., it would materially reduce the associated multilateral netting benefits, impair the risk management practices of clearing agencies, and hinder the evolution in trading protocols that can be expected from a market-wide clearing requirement).1045 For similar reasons, another commenter also stated that the benefits of central clearing detailed will only materialize if ‘‘a market-wide mandate is implemented’’ and supported defining the scope of eligible secondary market transactions for cash transactions as broadly as that proposed for repos.1046 Another commenter stated that limiting the scope of the cash clearing mandate would result in unwarranted competitive disadvantages and related market distortions for some types of investors, such as hedge funds, or some types of trading platforms, such as anonymous trading facilities.1047 An additional commenter stated that the proposed definition leaves out other important market participants’ cash Treasury transactions that also comprise a large segment of Treasury market liquidity, and that the Commission should require other market participants’ cash Treasury transactions in which a direct participant is involved to be cleared, so that the benefits of central clearing that the Commission cites will accrue throughout the broader cash Treasury market.1048 In addition, another commenter acknowledged the benefits of a comprehensive clearing requirement, but acknowledged the need for a pragmatic approach and supported the Commission’s proposed requirements as a reasonable foundation 1045 Citadel Letter, supra note 81, at 5. et al. Letter, supra note 81, at 4 (stating that the netting benefits associated with transitioning only proprietary trading firm (‘‘PTF’’) transactions into central clearing are much smaller, given the substantial netting that already occurs directly with inter-dealer brokers (‘‘IDBs’’); the trading-related benefits of central clearing will only accrue to market participants if their transactions are covered by the proposed mandate; and that clearing agency resiliency will be negatively impacted if only one segment of the market is cleared). 1047 MFA Letter, supra note 81, at 2. 1048 AIMA Letter, supra note 81, at 7. 1046 ARB E:\FR\FM\16JAR2.SGM 16JAR2 2822 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations to begin mandatory central clearing in this market.1049 As discussed above, the benefits of clearing are scale-dependent, so that a more comprehensive clearing directive would result in larger positive externalities (e.g., lower contagion risk, less financial network complexity) and larger economies of scale (e.g., larger margin offsets) for the U.S. Treasury securities market. Another benefit of this alternative would be an enhanced ability of FICC (and, by extension, regulatory agencies) to observe the dynamics and manage the risks in the U.S. Treasury securities markets. Nevertheless, there are compelling reasons for the exclusions that the proposal makes for a specific sample of market participants. Buy-side participants in the U.S. Treasury securities markets that do not take on any leverage, or take less than one-half their assets in leverage, such as the majority of bond mutual funds, typically have lower daily turnover. As a result of their lower turnover and subsequent lower volume, they typically do not have the existing infrastructure to readily connect to the CCP, making their up-front costs significantly higher than for other participants. This implies that the costs of subjecting these participants to the requirement to clear eligible secondary market transactions are likely higher than those of participants included in the proposal and the benefits smaller. 4. Require U.S. Treasury Securities CCAs To Change CCA Access Provisions and Netting and Margin Practices for House and Customer Accounts and Rule 15c3–3 ddrumheller on DSK120RN23PROD with RULES2 In the Proposing Release the Commission considered, as an alternative to the policy choices it proposed, only amending Rules 15c3–3, 17ad–22(e)(6)(i), and 17ad– 22(e)(18)(iv)(C).1050 This alternative would not include a requirement to clear eligible secondary market transactions, as set forth in Proposed Rule 17ad–22(e)(18)(iv)(A) and (B).1051 Overall, commenters supported the proposed amendments to Rule 15c3– 3a.1052 For increased and more efficient client clearing, another commenter encouraged the Commission to adopt 1049 GTS 1050 See Letter, supra note 81, at 3–5. Proposing Release, supra note 14. 1051 Id. 1052 See AIMA Letter, supra note 81, at 8; CME Letter, supra note 81, at 4; DTCC/FICC Letter, supra note 33, at 28–29; ICE Letter, supra note 33, at 3; MFA Letter, supra note 81, at 10; ISDA Letter, supra note 391, at 2; SIFMA AMG Letter, supra note 35, at 8. See part II.C supra for a discussion of comments received. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 this proposal irrespective of whether the Commission adopts the requirement to clear eligible secondary market transactions, as set forth in Proposed Rule 17ad–22(e)(18)(iv)(A) and (B).1053 This alternative would require a U.S. Treasury securities CCA to establish, implement, maintain and enforce certain written policies and procedures that would be reasonably designed to, as applicable, calculate, collect, and hold margin amounts from a direct participant for its proprietary U.S. Treasury securities positions separately and independently from margin that would be held for an indirect participant. Specifically, the requirement to separately and independently hold an indirect participant’s margin would apply to margin calculated by and collected from a direct participant in connection with its U.S. Treasury securities transactions with an indirect participant that relies on the direct participant’s services to access the covered clearing agency’s payment, clearing, or settlement facilities. The alternative would also include changes to 17ad–22(e)(18)(iv)(C), directing FICC to, as more fully described above, have policies and procedures, to be annually reviewed by its board of directors, to have appropriate means to facilitate access to clearing all eligible secondary market transactions in U.S. Treasury securities. This alternative would also include changes to Rule 15c3–3a, to permit margin required and on deposit at a U.S. Treasury securities CCA to be included as a debit item in the customer reserve formula, subject to the conditions discussed below. This new debit item would offset credit items in the Rule 15c3–3a formula and, thereby, free up resources that could be used to meet the margin requirements of a U.S. Treasury securities CCA. The new debit item would be reported on a newly created Item 15 of the Rule 15c3–3a reserve formula. As discussed in part IV.C.2.b supra, the proposed amendments to Rule 17ad–22(e)(6)(i) should produce benefits for dealer-to-customer trades. Because margin for a direct participant’s (i.e., a dealer’s) trades that have been novated to the CCP would be calculated, collected, and held separately and independently from those of an indirect participant, such as a customer, the direct participant’s trades with the indirect participant that have been novated to the CCP would be able to be netted against the direct participant’s position with other dealers. Such 1053 See PO 00000 ISDA Letter, supra note 391, at 2. Frm 00110 Fmt 4701 Sfmt 4700 netting is not currently available. In summary, the Commission expects changes in the customer reserve formula and expanded margin offset possibilities to allow more efficient use of margin for cleared trades relative to current market practice. As discussed in part II.A.1.a supra, commenters identified several methods by which the Commission could or should incentivize additional central clearing without adopting a requirement to clear eligible secondary market transactions. One of the methods commenters identified was to adopt Rule 15c3–3 discussed in part II.C infra as a method to incentivize additional central clearing.1054 As discussed in part II.5 supra the Commission agrees that the methods identified by the commenters could incentivize and facilitate additional central clearing. The Commission therefore is adopting the amendments to Rule 15c3–3, the requirement to segregate house and customer margin, and the need to ensure access to central clearing, as discussed in parts II.C, II.B.1, and II.B.2 supra respectively. The Commission does not believe that these changes should be made without also requiring that U.S. Treasury securities CCAs obligate their direct participants to submit eligible secondary market transactions for clearing. Merely incentivizing and facilitating greater central clearing, as opposed to requiring central clearing, would not sufficiently address the current risks to U.S. Treasury securities CCAs. Therefore, for the reasons discussed in part II.2.a and b, the requirement to clear is also necessary. V. Paperwork Reduction Act A. Proposed Changes to Covered Clearing Agency Standards As discussed in the Proposing Release,1055 the amendments to Rule 17ad–22(e) contain ‘‘collection of information’’ requirements within the meaning of the Paperwork Reduction Act of 1995 (‘‘PRA’’).1056 The Commission submitted the proposed collections of information to the Office of Management and Budget (‘‘OMB’’) for review in accordance with the PRA. The title of the information collection for Rule 17ad–22(e) is ‘‘Clearing Agency Standards for Operation and Governance’’ (OMB Control No. 3235– 0695). The amendments to Rule 17ad– 22(e) add two new information collections, titled ‘‘17ad–22(e)(6) 1054 See supra note 344. Release, supra note 14, 87 FR at 1055 Proposing 64675–77. 1056 See 44 U.S.C. 3501 et seq. E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations (Treasury Clearing)’’ and ‘‘17ad– 22(e)(18) (Treasury Clearing),’’ respectively, to OMB Control No. 3235– 0695. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid OMB control number. Respondents under this rule are Treasury securities CCAs, of which there is currently one. The Commission anticipates that one additional entity may seek to register as a clearing agency to provide CCP services for Treasury securities in the next three years, and so for purposes of this rulemaking the Commission has assumed two respondents. As described above in parts II.A and B supra, the Commission is adopting the amendments to Rules 17ad–22(e)(6) and (e)(18) as proposed, and the Commission has received no comments on the burden estimates provided in the Proposing Release. Accordingly, the Commission is not adjusting the burden estimates from the Proposing Release, except with respect to minor changes to correct mathematical errors, as described more fully below. 1. Amendment to Rule 17ad–22(e)(6) The purpose of this collection of information is to enable a covered clearing agency for Treasury securities to better understand and manage the risks presented by transactions that a direct participant may submit on behalf of its customer, i.e., an indirect participant which relies upon the direct participant to access the covered clearing agency. The collection is mandatory. To the extent that the Commission receives confidential information pursuant to this collection of information, such information would be kept confidential subject to the provisions of applicable law.1057 The amendment to Rule 17ad–22(e)(6) requires a Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures. The amendment contains similar provisions to existing FICC rules, specifically with respect to its Sponsored Member program, but also imposes additional requirements that did not previously appear in Rule 17ad– 22. As a result, the Commission believes that a respondent Treasury securities CCA will incur burdens of reviewing and updating existing policies and procedures in order to comply with the amendment to Rule 17ad–22(e)(6) and, in some cases, may need to create new policies and procedures.1058 The Commission believes that the PRA burdens for the amendment to Rule 17ad–22(e)(6) may require a respondent clearing agency to make substantial changes to its policies and procedures. Based on the similar policies and 2823 procedures requirements and the corresponding burden estimates previously made by the Commission for several rules in the Covered Clearing Agency Standards where the Commission anticipated similar burdens,1059 the Commission estimates that the amendment to Rule 17ad– 22(e)(6) would impose on each respondent Treasury securities CCA an initial burden of 129 hours in the first year.1060 In addition, the amendment to Rule 17ad–22(e)(6) imposes ongoing burdens on a respondent Treasury securities CCA. The amended rule requires ongoing monitoring and compliance activities with respect to the written policies and procedures created in response to the amended rule. Based on the similar reporting requirements and the corresponding burden estimates previously made by the Commission for several rules in the Covered Clearing Agency Standards where the Commission anticipated similar burdens,1061 the Commission estimates that the ongoing activities required by the amendment to Rule 17ad–22(e)(6) would impose an ongoing burden of 85 hours per year (including the first year).1062 Therefore, the aggregate ongoing industry burden associated with the amendments to Rule 17ad– 22(e)(6) for the two respondents is approximately 170 hours per year.1063 Name of information collection Type of burden Number of respondents Initial burden per entity (hours) Aggregate initial burden (hours) Ongoing burden per entity (hours) Aggregate ongoing burden (hours) 17ad–22(e)(6) (Treasury Clearing) ....................... Recordkeeping .............. 2 129 258 a 85 b 170 a See supra note 963. b See id. ddrumheller on DSK120RN23PROD with RULES2 2. Amendment to Rule 17ad– 22(e)(18)(iv) The purpose of the collection of information under Rule 17ad– 22(e)(18)(iv) is to enable a U.S. Treasury securities CCA to ensure that its direct participants submit for clearance and settlement, as a requirement of membership in the CCA, all eligible secondary market transactions in U.S. Treasury securities to the U.S. Treasury securities CCA to which the direct participants are a counterparty. This should, in turn, help ensure that the risk presented by the eligible secondary market transactions of that direct participant that are not centrally cleared would not be transmitted to the U.S. Treasury securities CCA, and to enable the CCA to identify and manage the risks posed by those transactions that are currently not submitted for central clearing. In addition, the purpose of this rule is to ensure that the U.S. Treasury 1057 See, e.g., 5 U.S.C. 552. Exemption 4 of the Freedom of Information Act provides an exemption for trade secrets and commercial or financial information obtained from a person and privileged or confidential. See 5 U.S.C. 552(b)(4). Exemption 8 of the Freedom of Information Act provides an exemption for matters that are contained in or related to examination, operating, or condition reports prepared by, on behalf of, or for the use of an agency responsible for the regulation or supervision of financial institutions. See 5 U.S.C. 552(b)(8). 1058 See Proposing Release, supra note 14, 87 FR at 64622 (discussing existing FICC rules for sponsored member program). 1059 See CCA Standards Adopting Release, supra note 10, 81 FR at 70895–97 (discussing Rules 17ad– 22(e)(13), (15), and (18)). Although the rule amendment is with respect to Rule 17ad–22(e)(6), the Commission believes that these Rules present the best overall comparison to the rule amendment, in light of the nature of the changes needed to implement the rule amendment here and what was proposed in the Covered Clearing Agency Standards. 1060 This figure was calculated as follows: (Assistant General Counsel for 20 hours) + (Compliance Attorney for 40 hours) + (Computer Operations Manager for 12 hours) + (Senior Programmer for 20 hours) + (Senior Risk Management Specialist for 25 hours) + (Senior Business Analyst for 12 hours) = 129 hours × 2 respondent clearing agencies = 258 hours. 1061 See CCA Standards Adopting Release, supra note 10, 81 FR at 70893 and 70895–96 (discussing Rules 17ad–22(e)(6) and (13)). 1062 This figure was calculated as follows: (Compliance Attorney for 25 hours + Business Risk Analyst for 40 hours + Senior Risk Management Specialist for 20 hours) = 85 hours × 2 respondent clearing agencies = 170 ongoing burden hours. (This figure is a corrected version from that in the 2022 Proposing Release, which contained a calculation error in the chart that overstated the estimated burden by 6 hours per respondent, and another calculation error in the accompanying footnote that understated the estimated burden by 5 hours per respondent. See Proposing Release, supra note 14, 87 FR at 64675, footnote 505 and accompanying text.) 1063 This figure was calculated as follows: 85 hours × 2 respondent clearing agencies = 170 hours. VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 PO 00000 Frm 00111 Fmt 4701 Sfmt 4700 E:\FR\FM\16JAR2.SGM 16JAR2 2824 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations securities CCA adopts policies and procedures to identify and monitor its direct participants’ submission of transactions for clearance and settlement, including how the CCA would address a failure to submit transactions that are required to be submitted. Finally, the purpose of the rule is to ensure that the CCA has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the board of directors of such covered clearing agency reviews annually. This additional collection is mandatory. To the extent that the Commission receives confidential information pursuant to this collection of information, such information would be kept confidential subject to the provisions of applicable law.1064 The amendment to Rule 17ad– 22(e)(18)(iv) requires a U.S. Treasury securities CCA to establish, implement, maintain and enforce written policies and procedures, as discussed above. Because such policies and procedures are not currently required under existing Rule 17ad–22, the Commission believes that the estimated PRA burdens for the amendment to Rule 17ad– 22(e)(18)(iv) would be significant and may require a respondent clearing agency to make substantial changes to its policies and procedures. The amendment contains similar provisions to existing rules, but also imposes additional requirements that did not previously appear in Rule 17ad–22.1065 As a result, the Commission believes that a respondent U.S. Treasury securities CCA would incur burdens of reviewing and updating existing policies and procedures in order to comply with the provisions of amended Rule 17ad–22(e)(18)(iv) and, in some cases, may need to create new policies and procedures. Based on the similar policies and procedures requirements and the corresponding burden estimates previously made by the Commission for several rules in the Covered Clearing Agency Standards where the Commission anticipated similar burdens,1066 the Commission estimates that the amendment to Rule 17ad– 22(e)(18)(iv) would impose on each respondent Treasury securities CCA an initial burden of 260 hours in the first year.1067 In addition, the amendment to Rule 17ad–22(e)(18)(iv) imposes ongoing burdens on a respondent Treasury securities CCA. The amended rule requires ongoing monitoring and compliance activities with respect to the written policies and procedures created in response to the amendment. Based on the similar reporting requirements and the corresponding burden estimates previously made by the Commission for several rules in the Covered Clearing Agency Standards where the Commission anticipated similar burdens,1068 the Commission estimates that the ongoing activities required by the amendment to Rule 17ad– 22(e)(18)(iv) would impose an ongoing burden of 85 hours per year (including the first year).1069 Therefore, the aggregate ongoing industry burden associated with the amendment to Rule 17ad–22(e)(18)(iv) for the two respondents is approximately 170 hours per year.1070 Name of information collection Type of burden Number of respondents Initial burden per entity (hours) Aggregate initial burden (hours) Ongoing burden per entity (hours) Aggregated ongoing burden (hours) 17ad–22(e)(18) (Treasury Clearing) ..................... Recordkeeping .............. 2 260 520 a 85 170 a This figure is a corrected version from that in the 2022 Proposing Release, which contained an error in the calculation that understated the estimated burden by 5 hours. See Proposing Release, supra note 13, 87 FR 64675. Proposing Release, the Commission certified that the proposed amendments to Rules 17ad–22 and 15c3–3a would not have a significant economic impact on a substantial number of small entities for purposes of the RFA. The Proposing Release solicited comment on the certification. The Commission received no comments on this certification. The Regulatory Flexibility Act (‘‘RFA’’) requires the Commission, in promulgating rules, to consider the impact of those rules on small entities.1071 Section 603(a) of the Administrative Procedure Act,1072 as amended by the RFA, generally requires the Commission to undertake a final regulatory flexibility analysis of all proposed rules to determine the impact of such rulemaking on ‘‘small entities.’’ 1073 Section 605(b) of the RFA states that this requirement shall not apply to any proposed rule which, if adopted, would not have a significant economic impact on a substantial number of small entities.1074 In the 1064 See, e.g., 5 U.S.C. 552 et seq. Exemption 4 of the Freedom of Information Act provides an exemption for trade secrets and commercial or financial information obtained from a person and privileged or confidential. See 5 U.S.C. 552(b)(4). Exemption 8 of the Freedom of Information Act provides an exemption for matters that are contained in or related to examination, operating, or condition reports prepared by, on behalf of, or for the use of an agency responsible for the regulation or supervision of financial institutions. See 5 U.S.C. 552(b)(8). 1065 See Proposing Release, supra note 14, 87 FR n.34 and accompanying text (discussing current FICC rules). 1066 See CCA Standards Adopting Release, supra note 10, 81 FR at 70895–97 (discussing Rules 17ad– 22(e)(13), (15), and (18)). The Commission believes that these Rules present the best comparison to the rule amendment, in light of the nature of the rule amendment. Although the rule amendment is with respect to Rule 17ad–22(e)(18), the Commission believes that considering additional rules in the Covered Clearing Agency Standards is reasonable in light of the nature of the rule amendment and the changes necessary to establish and implement the requirements of the rule amendment, as compared to the current Commission rules and U.S. Treasury securities CCA rules. 1067 This figure was calculated as follows: Assistant General Counsel for 40 hours + Compliance Attorney for 80 hours + Computer Operations Manager for 20 hours + Senior Risk Management Specialist for 40 hours + Business Risk Analyst for 80 hours = 260 hours × 2 respondent clearing agencies = 520 hours. 1068 See supra note above (discussing relevant aspects of the Covered Clearing Agency Standards). 1069 This figure was calculated as follows: (Compliance Attorney for 25 hours + Business Risk Analyst for 40 hours + Senior Risk Management Specialist for 20 hours) = 85 ongoing burden hours per year. 1070 This figure was calculated as follows: 85 hours × 2 respondent clearing agencies = 170 hours. 1071 See 5 U.S.C. 601 et seq. 1072 5 U.S.C. 603(a). 1073 Section 601(b) of the RFA permits agencies to formulate their own definitions of ‘‘small entities.’’ See 5 U.S.C. 601(b). The Commission has adopted definitions for the term ‘‘small entity’’ for the purposes of rulemaking in accordance with the RFA. These definitions, as relevant to this rulemaking, are set forth in 17 CFR 240.0–10. 1074 See 5 U.S.C. 605(b). B. Broker-Dealers The final rule amendment to Rule 15c3–3a does not require a new collection of information on the part of any entities subject to these rules. Accordingly, the requirements imposed by the PRA are not applicable to this rule. ddrumheller on DSK120RN23PROD with RULES2 VI. Regulatory Flexibility Act VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 PO 00000 Frm 00112 Fmt 4701 Sfmt 4700 A. Clearing Agencies The amendments to Rule 17ad–22 would apply to covered clearing agencies, which would include E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations registered clearing agencies that provide the services of a central counterparty or central securities depository.1075 For the purposes of Commission rulemaking and as applicable to the proposed amendments to Rule 17ad–22, a small entity includes, when used with reference to a clearing agency, a clearing agency that (i) compared, cleared, and settled less than $500 million in securities transactions during the preceding fiscal year, (ii) had less than $200 million of funds and securities in its custody or control at all times during the preceding fiscal year (or at any time that it has been in business, if shorter), and (iii) is not affiliated with any person (other than a natural person) that is not a small business or small organization.1076 Based on the Commission’s existing information about the clearing agencies currently registered with the Commission, the Commission believes that such entities exceed the thresholds defining ‘‘small entities’’ set out above. While other clearing agencies may emerge and seek to register as clearing agencies, the Commission does not believe that any such entities would be ‘‘small entities’’ as defined in Exchange Act Rule 0–10.1077 In any case, clearing agencies can only become subject to the new requirements under Rule 17ad– 22(e) should they meet the definition of a covered clearing agency, as described above. Accordingly, the Commission believes that any such registered clearing agencies will exceed the thresholds for ‘‘small entities’’ set forth in Exchange Act Rule 0–10. ddrumheller on DSK120RN23PROD with RULES2 B. Broker-Dealers For purposes of Commission rulemaking in connection with the RFA, a small entity includes a broker-dealer that: (1) had total capital (net worth plus subordinated liabilities) of less than $500,000 on the date in the prior fiscal year as of which its audited financial statements were prepared pursuant to Rule 17a–5(d) under the Exchange Act, or, if not required to file such statements, a broker-dealer with total capital (net worth plus subordinated liabilities) of less than $500,000 on the last day of the preceding fiscal year (or in the time that it has been in business, if shorter); and (2) is not affiliated with any person (other than a natural person) that is not a small business or small 1075 17 CFR 240.17ad–22(a)(5). 17 CFR 240.0–10(d). 1077 See 17 CFR 240.0–10(d). The Commission based this determination on its review of public sources of financial information about registered clearing agencies and lifecycle event service providers for OTC derivatives. 1076 See VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 2825 organization.1078 Under the standards adopted by the Small Business Administration, small entities in the finance and insurance industry include the following: (1) for entities in credit intermediation and related activities, firms with $175 million or less in assets; (2) for non-depository credit intermediation and certain other activities, firms with $7 million or less in annual receipts; (3) for entities in financial investments and related activities, firms with $7 million or less in annual receipts; (4) for insurance carriers and entities in related activities, firms with $7 million or less in annual receipts; and (5) for funds, trusts, and other financial vehicles, firms with $7 million or less in annual receipts. The final rule amendment to Rule 15c3–3a would permit margin required and on deposit with covered clearing agencies for U.S. Treasury securities to be included by broker-dealers as a debit in the reserve formulas for accounts of customers and proprietary accounts of broker-dealers, subject to certain conditions. Only carrying broker-dealers will be impacted by the final rule amendment. This is because only carrying broker-dealers are required to maintain a customer or PAB reserve account and may collect customer margin. Based on FOCUS Report data, the Commission estimates that as of June 30, 2023, there were approximately 772 broker-dealers that were ‘‘small’’ for the purposes of Rule 0–10. Of these, the Commission estimates that there are less than ten broker-dealers that are carrying broker-dealers (i.e., can carry customer or PAB margin accounts and extend credit). However, based on June 30, 2023, FOCUS Report data, none of these small carrying broker-dealers carried debit balances. This means that any ‘‘small’’ carrying firms are not extending margin credit to their customers, and therefore, the final rule amendment likely would not apply to them. Therefore, while the Commission believes that some small broker-dealers could be affected by the final amendment, the amendment will not have a significant impact on a substantial number of small brokerdealers. VII. Other Matters If any of the provisions of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. Pursuant to the Congressional Review Act,1079 the Office of Information and Regulatory Affairs has designated these rules as a ‘‘major rule,’’ as defined by 5 U.S.C. 804(2). C. Certification For the reasons described above, the Commission certifies that the final amendments to Rules 17ad–22 and 15c3–3a would not have a significant economic impact on a substantial number of small entities for purposes of the RFA. * 1078 See PO 00000 17 CFR 240.0–10(c). Frm 00113 Fmt 4701 Sfmt 4700 Statutory Authority The Commission is amending Rule 17ad–22 under the Commission’s rulemaking authority set forth in section 17A of the Exchange Act, 15 U.S.C. 78q– 1, and section 805 of the Clearing Supervision Act, 15 U.S.C. 5464 respectively. Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and particularly, sections 15 and 23(a) (15 U.S.C. 78o and 78w(a)), thereof, the Commission is amending § 240.15c3–3a under the Exchange Act. List of Subjects in 17 CFR Part 240 Reporting and recordkeeping requirements, Securities. Text of Amendments In accordance with the foregoing, title 17, chapter II of the Code of Federal Regulations is amended as follows: PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934 1. The general authority citation for part 240 continues to read, and the sectional authority for § 240.17ad–22 is revised to read, as follows: ■ Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f, 78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m, 78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q, 78q–1, 78s, 78u–5, 78w, 78x, 78dd, 78ll, 78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b– 3, 80b–4, 80b–11, 7201 et seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; Pub. L. 111–203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112–106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted. * * * * Section 240.15c3–3a is also issued under Pub. L. 111–203, § 939, 939A, 124. Stat. 1376 (2010) (15 U.S.C. 78c, 15 U.S.C. 78o–7 note). * * * * * Section 240.17ad–22 is also issued under 12 U.S.C. 5461 et seq. * * 1079 5 E:\FR\FM\16JAR2.SGM * * U.S.C. 801 et seq. 16JAR2 * 2826 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations 2. Revise and republish § 240.15c3–3a to read as follows: ■ § 240.15c3–3a Exhibit A—Formula for determination of customer and PAB account reserve requirements of brokers and dealers under § 240.15c3–3. Credits Debits XXX XXX XXX XXX XXX XXX XXX ................ ................ ................ XXX ................ XXX ................ ................ XXX ................ ................ XXX XXX ................ XXX ................ XXX ................ XXX Total credits ...................................................................................................................................................................... Total debits ....................................................................................................................................................................... ................ ................ ................ ................ 16. Excess of total credits (sum of items 1–9) over total debits (sum of items 10–15) required to be on deposit in the ‘‘Reserve Bank Account’’ (§ 240.15c3–3(e)). If the computation is made monthly as permitted by this section, the deposit must be not less than 105 percent of the excess of total credits over total debits ................................................... ................ XXX 1. 2. 3. 4. 5. 6. 7. 8. Free credit balances and other credit balances in customers’ security accounts. (See Note A) ...................................... Monies borrowed collateralized by securities carried for the accounts of customers (See Note B) .................................. Monies payable against customers’ securities loaned (See Note C) ................................................................................. Customers’ securities failed to receive (See Note D) ......................................................................................................... Credit balances in firm accounts which are attributable to principal sales to customers ................................................... Market value of stock dividends, stock splits and similar distributions receivable outstanding over 30 calendar days .... Market value of short security count differences over 30 calendar days old ..................................................................... Market value of short securities and credits (not to be offset by longs or by debits) in all suspense accounts over 30 calendar days ....................................................................................................................................................................... 9. Market value of securities which are in transfer in excess of 40 calendar days and have not been confirmed to be in transfer by the transfer agent or the issuer during the 40 days .......................................................................................... 10. Debit balances in customers’ cash and margin accounts excluding unsecured accounts and accounts doubtful of collection. (See Note E) ............................................................................................................................................................ 11. Securities borrowed to effectuate short sales by customers and securities borrowed to make delivery on customers’ securities failed to deliver .................................................................................................................................................... 12. Failed to deliver of customers’ securities not older than 30 calendar days ..................................................................... 13. Margin required and on deposit with the Options Clearing Corporation for all option contracts written or purchased in customer accounts. (See Note F) ........................................................................................................................................ 14. Margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Act (15 U.S.C. 78q–1) or a derivatives clearing organization registered with the Commodity Futures Trading Commission under section 5b of the Commodity Exchange Act (7 U.S.C. 7a–1) related to the following types of positions written, purchased or sold in customer accounts: (1) security futures products and (2) futures contracts (and options thereon) carried in a securities account pursuant to an SRO portfolio margining rule (See Note G) .............................................. 15. Margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Act (15 U.S.C. 78q–1) resulting from the following types of transactions in U.S. Treasury securities in customer accounts that have been cleared, settled, and novated by the clearing agency: (1) purchases and sales of U.S. Treasury securities; and (2) U.S. Treasury securities repurchase and reverse repurchase agreements (See Note H) ............................ ddrumheller on DSK120RN23PROD with RULES2 Notes Regarding the Customer Reserve Bank Account Computation Note A. Item 1 must include all outstanding drafts payable to customers which have been applied against free credit balances or other credit balances and must also include checks drawn in excess of bank balances per the records of the broker or dealer. Note B. Item 2 must include the amount of options-related or security futures productrelated Letters of Credit obtained by a member of a registered clearing agency or a derivatives clearing organization which are collateralized by customers’ securities, to the extent of the member’s margin requirement at the registered clearing agency or derivatives clearing organization. Item 2 must also include the amount of Letters of Credit which are collateralized by customers’ securities and related to other futures contracts (and options thereon) carried in a securities account pursuant to an SRO portfolio margining rule. Item 2 must include the market value of customers’ securities on deposit at a ‘‘qualified clearing agency’’ as defined in Note H below. Note C. Item 3 must include in addition to monies payable against customers’ securities loaned the amount by which the market value of securities loaned exceeds the VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 collateral value received from the lending of such securities. Note D. Item 4 must include in addition to customers’ securities failed to receive the amount by which the market value of securities failed to receive and outstanding more than thirty (30) calendar days exceeds their contract value. Note E. (1) Debit balances in margin accounts must be reduced by the amount by which a specific security (other than an exempted security) which is collateral for margin accounts exceeds in aggregate value 15 percent of the aggregate value of all securities which collateralize all margin accounts receivable; provided, however, the required reduction must not be in excess of the amounts of the debit balance required to be excluded because of this concentration rule. A specified security is deemed to be collateral for a margin account only to the extent it represents in value not more than 140 percent of the customer debit balance in a margin account. (2) Debit balances in special omnibus accounts, maintained in compliance with the requirements of Section 7(f) of Regulation T (12 CFR 220.7(f)) or similar accounts carried on behalf of another broker or dealer, must be reduced by any deficits in such accounts (or if a credit, such credit must be increased) less any calls for margin, mark to the market, PO 00000 Frm 00114 Fmt 4701 Sfmt 4700 ................ ................ ................ or other required deposits which are outstanding five business days or less. (3) Debit balances in customers’ cash and margin accounts included in the formula under Item 10 must be reduced by an amount equal to 1 percent of their aggregate value. (4) Debit balances in cash and margin accounts of household members and other persons related to principals of a broker or dealer and debit balances in cash and margin accounts of affiliated persons of a broker or dealer must be excluded from the Reserve Formula, unless the broker or dealer can demonstrate that such debit balances are directly related to credit items in the formula. (5) Debit balances in margin accounts (other than omnibus accounts) must be reduced by the amount by which any single customer’s debit balance exceeds 25 percent (to the extent such amount is greater than $50,000) of the broker-dealer’s tentative net capital (i.e., net capital prior to securities haircuts) unless the broker or dealer can demonstrate that the debit balance is directly related to credit items in the Reserve Formula. Related accounts (e.g., the separate accounts of an individual, accounts under common control or subject to cross guarantees) will be deemed to be a single customer’s accounts for purposes of this provision. If the registered national securities exchange or the registered national securities association having responsibility for E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations examining the broker or dealer (‘‘designated examining authority’’) is satisfied, after taking into account the circumstances of the concentrated account including the quality, diversity, and marketability of the collateral securing the debit balances or margin accounts subject to this provision, that the concentration of debit balances is appropriate, then such designated examining authority may grant a partial or plenary exception from this provision. The debit balance may be included in the reserve formula computation for five business days from the day the request is made. (6) Debit balances in joint accounts, custodian accounts, participation in hedge funds or limited partnerships or similar type accounts or arrangements that include both assets of a person or persons who would be excluded from the definition of customer (‘‘noncustomer’’) and assets of a person or persons who would be included in the definition of customer must be included in the Reserve Formula in the following manner: if the percentage ownership of the non-customer is less than 5 percent then the entire debit balance shall be included in the formula; if such percentage ownership is between 5 percent and 50 percent then the portion of the debit balance attributable to the non-customer must be excluded from the formula unless the broker or dealer can demonstrate that the debit balance is directly related to credit items in the formula; or if such percentage ownership is greater than 50 percent, then the entire debit balance must be excluded from the formula unless the broker or dealer can demonstrate that the debit balance is directly related to credit items in the formula. Note F. Item 13 must include the amount of margin required and on deposit with the Options Clearing Corporation to the extent such margin is represented by cash, proprietary qualified securities and letters of credit collateralized by customers’ securities. Note G. (a) Item 14 must include the amount of margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Act (15 U.S.C. 78q–1) or a derivatives clearing organization registered with the Commodity Futures Trading Commission under section 5b of the Commodity Exchange Act (7 U.S.C. 7a–1) for customer accounts to the extent that the margin is represented by cash, proprietary qualified securities, and letters of credit collateralized by customers’ securities. (b) Item 14 will apply only if the broker or dealer has the margin related to security futures products, or futures (and options thereon) carried in a securities account pursuant to an approved SRO portfolio margining program on deposit with: (1) A registered clearing agency or derivatives clearing organization that: (i) Maintains security deposits from clearing members in connection with regulated options or futures transactions and assessment power over member firms that equal a combined total of at least $2 billion, at least $500 million of which must be in the form of security deposits. For the purposes of this Note G, the term ‘‘security deposits’’ refers to a general fund, other than margin deposits or their equivalent, that consists of VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 cash or securities held by a registered clearing agency or derivative clearing organization; or (ii) Maintains at least $3 billion in margin deposits; or (iii) Does not meet the requirements of paragraphs (b)(1)(i) through (b)(1)(iii) of this Note G, if the Commission has determined, upon a written request for exemption by or for the benefit of the broker or dealer, that the broker or dealer may utilize such a registered clearing agency or derivatives clearing organization. The Commission may, in its sole discretion, grant such an exemption subject to such conditions as are appropriate under the circumstances, if the Commission determines that such conditional or unconditional exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors; and (2) A registered clearing agency or derivatives clearing organization that, if it holds funds or securities deposited as margin for security futures products or futures in a portfolio margin account in a bank, as defined in section 3(a)(6) of the Act (15 U.S.C. 78c(a)(6)), obtains and preserves written notification from the bank at which it holds such funds and securities or at which such funds and securities are held on its behalf. The written notification will state that all funds and/or securities deposited with the bank as margin (including customer security futures products and futures in a portfolio margin account), or held by the bank and pledged to such registered clearing agency or derivatives clearing agency as margin, are being held by the bank for the exclusive benefit of clearing members of the registered clearing agency or derivatives clearing organization (subject to the interest of such registered clearing agency or derivatives clearing organization therein), and are being kept separate from any other accounts maintained by the registered clearing agency or derivatives clearing organization with the bank. The written notification also will provide that such funds and/or securities will at no time be used directly or indirectly as security for a loan to the registered clearing agency or derivatives clearing organization by the bank, and will be subject to no right, charge, security interest, lien, or claim of any kind in favor of the bank or any person claiming through the bank. This provision, however, will not prohibit a registered clearing agency or derivatives clearing organization from pledging customer funds or securities as collateral to a bank for any purpose that the rules of the Commission or the registered clearing agency or derivatives clearing organization otherwise permit; and (3) A registered clearing agency or derivatives clearing organization establishes, documents, and maintains: (i) Safeguards in the handling, transfer, and delivery of cash and securities; (ii) Fidelity bond coverage for its employees and agents who handle customer funds or securities. In the case of agents of a registered clearing agency or derivatives clearing organization, the agent may provide the fidelity bond coverage; and (iii) Provisions for periodic examination by independent public accountants; and PO 00000 Frm 00115 Fmt 4701 Sfmt 4700 2827 (iv) A derivatives clearing organization that, if it is not otherwise registered with the Commission, has provided the Commission with a written undertaking, in a form acceptable to the Commission, executed by a duly authorized person at the derivatives clearing organization, to the effect that, with respect to the clearance and settlement of the customer security futures products and futures in a portfolio margin account of the broker or dealer, the derivatives clearing organization will permit the Commission to examine the books and records of the derivatives clearing organization for compliance with the requirements set forth in § 240.15c3–3a, Note G (b)(1) through (3). (c) Item 14 will apply only if a broker or dealer determines, at least annually, that the registered clearing agency or derivatives clearing organization with which the broker or dealer has on deposit margin related to securities future products or futures in a portfolio margin account meets the conditions of this Note G. Note H. (a) Item 15 must include the amount of margin required and on deposit with a clearing agency registered with the Commission under section 17A of the Act (15 U.S.C. 78q–1) that clears, settles, and novates transactions in U.S. Treasury securities (‘‘qualified clearing agency’’) to the extent that the margin is: (1) In the form of cash, U.S. Treasury securities, or qualified customer securities; and (2) Being used to margin U.S. Treasury securities positions of the customers of the broker or dealer that are cleared, settled, and novated by the qualified clearing agency. (b) Item 15 will apply only if the cash and securities required and on deposit at the qualified clearing agency: (1)(i) Are cash owed by the broker or dealer to the customer of the broker or dealer that was delivered by the broker or dealer to the qualified clearing agency to meet a margin requirement resulting from that customer’s U.S. Treasury securities positions cleared, settled, and novated at the qualified clearing agency and not for any other customer’s or the broker’s or dealer’s U.S. Treasury securities positions cleared, settled, and novated at the qualified clearing agency; (ii) U.S. Treasury securities or qualified customer securities held in custody by the broker or dealer for the customer of the broker or dealer that were delivered by the broker or dealer to the qualified clearing agency to meet a margin requirement resulting from that customer’s U.S. Treasury securities positions cleared, settled, and novated at the qualified clearing agency and not for any other customer’s or the broker’s or dealer’s U.S. Treasury securities positions cleared, settled, and novated at the qualified clearing agency; or (iii) U.S. Treasury securities owned by the broker or dealer that were delivered by the broker or dealer to the qualified clearing agency to meet a margin requirement resulting from a customer’s U.S. Treasury securities positions cleared, settled, and novated at the qualified clearing agency under the following conditions: (A) The broker or dealer did not owe to the customer or hold in custody for the customer E:\FR\FM\16JAR2.SGM 16JAR2 ddrumheller on DSK120RN23PROD with RULES2 2828 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations sufficient cash, U.S. Treasury securities, and/ or qualified customer securities to meet a margin requirement resulting from that customer’s U.S. Treasury securities positions cleared, settled, and novated at the qualified clearing agency at the time the margin requirement arose; (B) The broker or dealer calls for the customer to deliver a sufficient amount of cash, U.S. Treasury securities, and/or qualified customer securities to meet the margin requirement on the day the margin requirement arose; and (C) The broker or dealer receives a sufficient amount of cash, U.S. Treasury securities, and/or qualified customer securities to meet the margin requirement by the close of the next business day after the margin requirement arose. (2) Are treated in accordance with rules of the qualified clearing agency that impose the following requirements and the qualified clearing agency and broker or dealer are in compliance with the requirements of the rules (as applicable): (i) Rules requiring the qualified clearing agency to calculate a separate margin amount for each customer of the broker or dealer and the broker or dealer to deliver that amount of margin for each customer on a gross basis; (ii) Rules limiting the qualified clearing agency from investing cash delivered by the broker or dealer to margin U.S. Treasury security transactions of the customers of the broker or dealer or cash realized through using U.S. Treasury securities delivered by the broker or dealer for that purpose in any asset other than U.S. Treasury securities with a maturity of one year or less; (iii) Rules requiring that the cash, U.S. Treasury securities, and qualified customer securities used to margin the U.S. Treasury securities positions of the customers of the broker or dealer be held in an account of the broker or dealer at the qualified clearing agency that is segregated from any other account of the broker or dealer at the qualified clearing agency and that is: (A) Used exclusively to clear, settle, novate, and margin U.S. Treasury securities transactions of the customers of the broker or dealer; (B) Designated ‘‘Special Clearing Account for the Exclusive Benefit of the Customers of [name of broker or dealer]’’; (C) Subject to a written notice of the qualified clearing agency provided to and retained by the broker or dealer that the cash, U.S. Treasury securities, and qualified customer securities in the account are being held by the qualified clearing agency for the exclusive benefit of the customers of the broker or dealer in accordance with the regulations of the Commission and are being kept separate from any other accounts maintained by the broker or dealer or any other clearing member at the qualified clearing agency; and (D) Subject to a written contract between the broker or dealer and the qualified clearing agency which provides that the cash, U.S. Treasury securities, and qualified customer securities in the account are not available to cover claims arising from the broker or dealer or any other clearing member defaulting on an obligation to the VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 qualified clearing agency or subject to any other right, charge, security interest, lien, or claim of any kind in favor of the qualified clearing agency or any person claiming through the qualified clearing agency, except a right, charge, security interest, lien, or claim resulting from a cleared U.S. Treasury securities transaction of a customer of the broker or dealer effected in the account; (iv) Rules requiring the qualified clearing agency to hold the customer cash, U.S. Treasury securities, and qualified customer securities used to margin the U.S. Treasury securities positions of the customers of the broker or dealer itself or in an account of the clearing agency at a U.S. Federal Reserve Bank or a ‘‘bank,’’ as that term is defined in section 3(a)(6) of the Act (15 U.S.C. 78c(a)(6)), that is insured by the Federal Deposit Insurance Corporation, and that the account at the U.S. Federal Reserve Bank or bank must be: (A) Segregated from any other account of the qualified clearing agency or any other person at the U.S. Federal Reserve Bank or bank and used exclusively to hold cash, U.S. Treasury securities, and qualified customer securities to meet current margin requirements of the qualified clearing agency resulting from positions in U.S. Treasury securities of the customers of the broker or dealer members of the qualified clearing agency; (B) Subject to a written notice of the U.S. Federal Reserve Bank or bank provided to and retained by the qualified clearing agency that the cash, U.S. Treasury securities, and qualified customer securities in the account are being held by the U.S. Federal Reserve Bank or bank pursuant to § 240.15c3–3 and are being kept separate from any other accounts maintained by the qualified clearing agency or any other person at the U.S. Federal Reserve Bank or bank; and (C) Subject to a written contract between the qualified clearing agency and the U.S. Federal Reserve Bank or bank which provides that the cash, U.S. Treasury securities, and qualified customer securities in the account are subject to no right, charge, security interest, lien, or claim of any kind in favor of the U.S. Federal Reserve Bank or bank or any person claiming through the U.S. Federal Reserve Bank or bank; and (v) Rules requiring systems, controls, policies, and procedures to return cash, U.S. Treasury securities, and qualified customer securities to the broker or dealer that are no longer needed to meet a current margin requirement resulting from positions in U.S. Treasury securities of the customers of the broker or dealer; and (3) The Commission has approved rules of the qualified clearing agency that meet the conditions of this Note H and has published (and not subsequently withdrawn) a notice that brokers or dealers may include a debit in the customer reserve formula when depositing cash, U.S. Treasury securities, and/or qualified customer securities to meet a margin requirement of the qualified clearing agency resulting from positions in U.S. Treasury securities of the customers of the broker or dealer. (c) As used in this Note H, the term ‘‘qualified customer securities’’ means the PO 00000 Frm 00116 Fmt 4701 Sfmt 4700 securities of a customer of the broker or dealer (other than U.S. Treasury securities) that are held in custody by the broker or dealer for the customer and that under the rules of the qualified clearing agency are eligible to be used to margin U.S. Treasury securities positions of the customer that are cleared, settled, and novated by the qualified clearing agency. Notes Regarding the PAB Reserve Bank Account Computation Note 1. Broker-dealers should use the formula in Exhibit A for the purposes of computing the PAB reserve requirement, except that references to ‘‘accounts,’’ ‘‘customer accounts, or ‘‘customers’’ will be treated as references to PAB accounts. Note 2. Any credit (including a credit applied to reduce a debit) that is included in the computation required by § 240.15c3–3 with respect to customer accounts (the ‘‘customer reserve computation’’) may not be included as a credit in the computation required by § 240.15c3–3 with respect to PAB accounts (the ‘‘PAB reserve computation’’). Note 3. Note E(1) to § 240.15c3–3a does not apply to the PAB reserve computation. Note 4. Note E(3) to § 240.15c3–3a which reduces debit balances by 1 percent does not apply to the PAB reserve computation. Note 5. Interest receivable, floor brokerage, and commissions receivable of another broker or dealer from the broker or dealer (excluding clearing deposits) that are otherwise allowable assets under § 240.15c3– 1 need not be included in the PAB reserve computation, provided the amounts have been clearly identified as payables on the books of the broker or dealer. Commissions receivable and other receivables of another broker or dealer from the broker or dealer that are otherwise non-allowable assets under § 240.15c3–1 and clearing deposits of another broker or dealer may be included as ‘‘credit balances’’ for purposes of the PAB reserve computation, provided the commissions receivable and other receivables are subject to immediate cash payment to the other broker or dealer and the clearing deposit is subject to payment within 30 days. Note 6. Credits included in the PAB reserve computation that result from the use of securities held for a PAB account (‘‘PAB securities’’) that are pledged to meet intraday margin calls in a cross-margin account established between the Options Clearing Corporation and any regulated derivatives clearing organization may be reduced to the extent that the excess margin held by the other clearing corporation in the crossmargin relationship is used the following business day to replace the PAB securities that were previously pledged. In addition, balances resulting from a portfolio margin account that are segregated pursuant to Commodity Futures Trading Commission regulations need not be included in the PAB Reserve Bank Account computation. Note 7. Deposits received prior to a transaction pending settlement which are $5 million or greater for any single transaction or $10 million in aggregate may be excluded as credits from the PAB reserve computation if such balances are placed and maintained in a separate PAB Reserve Bank Account by E:\FR\FM\16JAR2.SGM 16JAR2 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations 12 p.m. Eastern Time on the following business day. Thereafter, the money representing any such deposits may be withdrawn to complete the related transactions without performing a new PAB reserve computation. Note 8. A credit balance resulting from a PAB reserve computation may be reduced by the amount that items representing such credits are swept into money market funds or mutual funds of an investment company registered under the Investment Company Act of 1940 on or prior to 10 a.m. Eastern Time on the deposit date provided that the credits swept into any such fund are not subject to any right, charge, security interest, lien, or claim of any kind in favor of the investment company or the broker or dealer. Any credits that have been swept into money market funds or mutual funds must be maintained in the name of a particular broker or for the benefit of another broker. Note 9. Clearing deposits required to be maintained at registered clearing agencies may be included as debits in the PAB reserve computation to the extent the percentage of the deposit, which is based upon the clearing agency’s aggregate deposit requirements (e.g., dollar trading volume), that relates to the proprietary business of other brokers and dealers can be identified. However, Note H to Item 15 of § 240.15c3–3a applies with respect to margin delivered to a U.S. Treasury securities clearing agency. Note 10. A broker or dealer that clears PAB accounts through an affiliate or third party clearing broker must include these PAB account balances and the omnibus PAB account balance in its PAB reserve computation. 3. Redesignate § 240.17Ad–22 as § 240.17ad–22 and amend newly redesignated § 240.17ad–22 by: ■ a. In paragraph (a): ■ i. Removing the designations for paragraphs (a)(1) through (19) and placing the paragraphs alphabetical order, and ■ ii. Adding in alphabetical order definitions for ‘‘Affiliated counterparty’’, ‘‘Central bank’’, ‘‘Eligible secondary market transaction’’, ‘‘International financial institution’’, ‘‘State or local government’’, ‘‘Sovereign entity’’, and ‘‘U.S. Treasury security’’. ■ b. Revising paragraphs (e)(6)(i) and (18). The revisions and additions read as follows: ■ ddrumheller on DSK120RN23PROD with RULES2 § 240.17ad–22 agencies. Standards for clearing (a) * * * Affiliated counterparty means any counterparty which meets the following criteria: (i) The counterparty is either a bank (as defined in 15 U.S.C. 78c(6)), broker (as defined in 15 U.S.C. 78c(4)), dealer (as defined in 15 U.S.C. 78c(5)), or futures commission merchant (as defined in 7 U.S.C. 1a(28)), or any entity regulated as a bank, broker, dealer, or VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 futures commission merchant in its home jurisdiction; (ii) The counterparty holds, directly or indirectly, a majority ownership interest in the direct participant, or the direct participant, directly or indirectly, holds a majority ownership interest in the counterparty, or a third party, directly or indirectly, holds a majority ownership interest in both the direct participant and the counterparty; and (iii) The counterparty, direct participant, or third party referenced in paragraph (ii) of this definition as holding the majority ownership interest would be required to report its financial statements on a consolidated basis under U.S. Generally Accepted Accounting Principles or International Financial Reporting Standards, and such consolidated financial statements include the financial results of the majority-owned party or of both majority-owned parties. * * * * * Central bank means a reserve bank or monetary authority of a central government (including the Board of Governors of the Federal Reserve System or any of the Federal Reserve Banks) and the Bank for International Settlements. * * * * * Eligible secondary market transaction refers to a secondary market transaction in U.S. Treasury securities of a type accepted for clearing by a registered covered clearing agency that is: (i) A repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities, in which one of the counterparties is a direct participant; or (ii) A purchase or sale, between a direct participant and: (A) Any counterparty, if the direct participant of the covered clearing agency brings together multiple buyers and sellers using a trading facility (such as a limit order book) and is a counterparty to both the buyer and seller in two separate transactions; or (B) Registered broker-dealer, government securities broker, or government securities dealer; except that: (iii) Any purchase or sale transaction in U.S. Treasury securities or repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities in which one counterparty is a central bank, a sovereign entity, an international financial institution, or a natural person shall be excluded from the definition set forth in this section of an eligible secondary market transaction; (iv) Any repurchase or reverse repurchase agreement collateralized by PO 00000 Frm 00117 Fmt 4701 Sfmt 4700 2829 U.S. Treasury securities in which one counterparty is a covered clearing agency providing central counterparty services or a derivatives clearing organization (see 7 U.S.C. 7a–1 and 17 CFR 39.3), or is regulated as a central counterparty in its home jurisdiction, shall be excluded from the definition set forth in this section of an eligible secondary market transaction; (v) Any repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities in which one counterparty is a state or local government shall be excluded from the definition set forth in this section of an eligible secondary market transaction; (vi) Any repurchase or reverse repurchase agreement collateralized by U.S. Treasury securities entered into between a direct participant and an affiliated counterparty shall be excluded from the definition set forth in this section of an eligible secondary market transaction, provided that the affiliated counterparty submit for clearance and settlement all other repurchase or reverse repurchase agreements collateralized by U.S. Treasury securities to which the affiliate is a party. * * * * * International financial institution means the African Development Bank; African Development Fund; Asian Development Bank; Banco Centroamericano de Integracio´n Econo´mica; Bank for Economic Cooperation and Development in the Middle East and North Africa; Caribbean Development Bank; Corporacio´n Andina de Fomento; Council of Europe Development Bank; European Bank for Reconstruction and Development; European Investment Bank; European Investment Fund; European Stability Mechanism; InterAmerican Development Bank; InterAmerican Investment Corporation; International Bank for Reconstruction and Development; International Development Association; International Finance Corporation; International Monetary Fund; Islamic Development Bank; Multilateral Investment Guarantee Agency; Nordic Investment Bank; North American Development Bank; and any other entity that provides financing for national or regional development in which the U.S. Government is a shareholder or contributing member. * * * * * Sovereign entity means a central government (including the U.S. Government), or an agency, department, or ministry of a central government. * * * * * E:\FR\FM\16JAR2.SGM 16JAR2 2830 Federal Register / Vol. 89, No. 10 / Tuesday, January 16, 2024 / Rules and Regulations ddrumheller on DSK120RN23PROD with RULES2 State or local government means a state or any political subdivision thereof, or an agency or instrumentality of a State or any political subdivision thereof, but shall not include any pension or retirement plan established and maintained by a State, its political subdivisions, or any agency or instrumentality of a State or its political subdivisions, for the benefit of its employees. * * * * * U.S. Treasury security means any security issued by the U.S. Department of the Treasury. * * * * * (e) * * * (6) * * * (i) Considers, and produces margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market, and, if the covered clearing agency provides central counterparty services for U.S. Treasury securities, calculates, collects, and holds margin amounts from a direct participant for its proprietary positions in Treasury securities separately and independently from margin calculated VerDate Sep<11>2014 20:19 Jan 12, 2024 Jkt 262001 and collected from that direct participant in connection with U.S. Treasury securities transactions by an indirect participant that relies on the services provided by the direct participant to access the covered clearing agency’s payment, clearing, or settlement facilities; * * * * * (18) Establish objective, risk-based, and publicly disclosed criteria for participation, which: (i) Permit fair and open access by direct and, where relevant, indirect participants and other financial market utilities; (ii) Require participants to have sufficient financial resources and robust operational capacity to meet obligations arising from participation in the clearing agency; (iii) Monitor compliance with such participation requirements on an ongoing basis; and (iv) When the covered clearing agency provides central counterparty services for transactions in U.S. Treasury securities, (A) Require that any direct participant of such covered clearing agency submit PO 00000 Frm 00118 Fmt 4701 Sfmt 9990 for clearance and settlement all of the eligible secondary market transactions to which such direct participant is a counterparty; (B) Identify and monitor its direct participants’ submission of transactions for clearing as required in paragraph (e)(18)(iv)(A) of this section, including how the covered clearing agency would address a failure to submit transactions in accordance with paragraph (e)(18)(iv)(A) of this section; and (C) Ensure that it has appropriate means to facilitate access to clearance and settlement services of all eligible secondary market transactions in U.S. Treasury securities, including those of indirect participants, which policies and procedures the board of directors of such covered clearing agency reviews annually. * * * * * By the Commission. Dated: December 13, 2023. J. Matthew DeLesDernier, Deputy Secretary. [FR Doc. 2023–27860 Filed 1–12–24; 8:45 am] BILLING CODE 8011–01–P E:\FR\FM\16JAR2.SGM 16JAR2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 89, Number 10 (Tuesday, January 16, 2024)]
[Rules and Regulations]
[Pages 2714-2830]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-27860]

[[Page 2713]]

Vol. 89

Tuesday,

No. 10

January 16, 2024

Part II

Securities and Exchange Commission

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

17 CFR Part 240

Standards for Covered Clearing Agencies for U.S. Treasury Securities
and Application of the Broker-Dealer Customer Protection Rule With
Respect to U.S. Treasury Securities; Final Rule

Federal Register / Vol. 89 , No. 10 / Tuesday, January 16, 2024 /
Rules and Regulations

[[Page 2714]]

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

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240

[Release No. 34-99149; File No. S7-23-22]
RIN 3235-AN09

Standards for Covered Clearing Agencies for U.S. Treasury
Securities and Application of the Broker-Dealer Customer Protection
Rule With Respect to U.S. Treasury Securities

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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

SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting rules under the Securities Exchange Act of 1934 (``Exchange
Act'') to amend the standards applicable to covered clearing agencies
for U.S. Treasury securities to require that such covered clearing
agencies have written policies and procedures reasonably designed to
require that every direct participant of the covered clearing agency
submit for clearance and settlement all eligible secondary market
transactions in U.S. Treasury securities to which it is a counterparty.
In addition, the Commission is adopting additional amendments to the
Covered Clearing Agency Standards with respect to risk management.
These requirements are designed to protect investors, reduce risk, and
increase operational efficiency. Finally, the Commission is amending
the broker-dealer customer protection rule to permit margin required
and on deposit with covered clearing agencies for U.S. Treasury
securities to be included as a debit in the reserve formulas for
accounts of customers and proprietary accounts of broker-dealers
(``PAB''), subject to certain conditions.

DATES:
Effective date: March 18, 2024.
Compliance date: The applicable compliance dates are discussed in
Part III of this release.

FOR FURTHER INFORMATION CONTACT: Elizabeth L. Fitzgerald, Assistant
Director, and Robert Zak, Special Counsel, Office of Clearance and
Settlement at (202) 551-5710, Division of Trading and Markets; Michael
A. Macchiaroli, Associate Director, at (202) 551-5525; Thomas K.
McGowan, Associate Director, at (202) 551-5521; Randall W. Roy, Deputy
Associate Director, at (202) 551-5522; Raymond Lombardo, Assistant
Director, at 202-551-5755; Sheila Dombal Swartz, Senior Special
Counsel, at (202) 551-5545; or Nina Kostyukovsky, Special Counsel, at
(202) 551-8833, Office of Broker-Dealer Finances, Division of Trading
and Markets; U.S. Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: First, the Commission is amending 17 CFR
240.17ad-22(e)(18) (``Rule 17ad-22(e)(18)'') to require covered
clearing agencies that provide central counterparty (``CCP'') services
for U.S. Treasury securities to establish, implement, maintain and
enforce written policies and procedures reasonably designed, as
applicable, to establish objective, risk-based and publicly disclosed
criteria for participation, which require that any direct participant
of such a covered clearing agency submit for clearance and settlement
all the eligible secondary market transactions in U.S. Treasury
securities to which such direct participant is a counterparty. In
addition, these policies and procedures must be reasonably designed, as
applicable, to identify and monitor the covered clearing agency's
direct participants' submission of transactions for clearing as
required above, including how the covered clearing agency would address
a failure to submit transactions. These policies and procedures must
also be reasonably designed, as applicable, to ensure that the covered
clearing agency has appropriate means to facilitate access to clearance
and settlement services of all eligible secondary market transactions
in U.S. Treasury securities, including those of indirect participants,
which policies and procedures the board of directors of such U.S.
Treasury securities covered clearing agency (``CCA'') must review
annually. The Commission is defining an eligible secondary market
transaction as a secondary market transaction in U.S. Treasury
securities of a type accepted for clearing by a registered covered
clearing agency that is either a repurchase or reverse repurchase
agreement collateralized by U.S. Treasury securities, in which one of
the counterparties is a direct participant, or certain specified
categories of cash purchase or sale transactions, including certain
exclusions for transactions with sovereign entities, international
financial institutions, natural persons, inter-affiliate repo
transactions, state/local governments, and other clearing
organizations. Second, the Commission is amending 17 CFR 240.17ad-
22(e)(6)(i) (``Rule 17ad-22(e)(6)(i)'') to require that a covered
clearing agency providing central counterparty services for U.S.
Treasury securities establish, implement, maintain and enforce written
policies and procedures reasonably designed to, as applicable,
calculate, collect, and hold margin for transactions in U.S. Treasury
securities submitted on behalf of an indirect participant separately
from those submitted on behalf of the direct participant. Third, the
Commission is amending Rule 17ad-22(e)(18) to require that a covered
clearing agency providing central counterparty services for U.S.
Treasury securities establish, implement, maintain and enforce written
policies and procedures reasonably designed to, as applicable, ensure
that it has appropriate means to facilitate access to clearance and
settlement services of all eligible secondary market transactions in
U.S. Treasury securities, including those of indirect participants,
which policies and procedures the board of directors of such covered
clearing agency reviews annually. In connection with these proposed
amendments, the Commission is including as part of 17 CFR 240.17ad-
22(a) (``Rule 17ad-22(a)'') definitions of ``U.S. Treasury security,''
``central bank,'' ``eligible secondary market transaction,''
``international financial institution,'' ``sovereign entity,'' ``state
and local government,'' and ``affiliated counterparty.'' As part of
this rulemaking, the Commission is also amending the CFR designation of
Rule 17Ad-22 to Rule 17ad-22.\1\ Fourth, the Commission is amending 17
CFR 240.15c3-3a (``Rule 15c3-3a'') to permit margin required and on
deposit at covered clearing agencies providing central counterparty
services for U.S. Treasury securities to be included by broker-dealers
as a debit in the customer and PAB reserve formulas, subject to certain
conditions.
---------------------------------------------------------------------------

\1\ See note 71 infra for further discussion of this amendment.
The Commission refers to the redesignated Rule 17ad-22 throughout
this release.
---------------------------------------------------------------------------

Table of Contents

I. Introduction
II. Discussion of Comments Received and Final Rules
A. U.S. Treasury Securities CCA Membership Requirements
1. Requirement To Clear Eligible Secondary Market Transactions
a. Comments Regarding the Requirement To Clear Eligible
Secondary Market Transactions
b. Comments Regarding the Concentration of Risk in One Covered
Clearing Agency
c. Final Rule
2. Definition of Eligible Secondary Market Transactions
a. Repo Transactions
i. Triparty Repo
ii. Repos by Registered Funds
iii. Repos by Other Clearing Organizations
iv. Repos by FCMs
v. Repos Involving ``End Users''

[[Page 2715]]

vi. Interaffiliate Repos
vii. Repos by State and Local Governments
viii. Other Repo Comments
ix. Final Rule
b. Purchases and Sales of U.S. Treasury Securities
i. Comments Regarding Cash Clearing Generally
ii. IDB Transactions
iii. Other Cash Transactions
iv. Comments Regarding Cash Transactions for Registered Funds
v. Final Rule
3. Other Exclusions From the Definition of an Eligible Secondary
Market Transaction
4. Policies and Procedures Regarding U.S. Treasury Securities
CCA's Monitoring of Its Direct Participants' Transactions
5. Alternative Approaches Proposed by Commenters
B. Additional Changes to Covered Clearing Agency Standards
1. Netting and Margin Practices for House and Customer Accounts
2. Facilitating Access to U.S. Treasury Securities CCAs
a. Comments Supporting the Commission's Proposed Rule
b. Comments Regarding the Commission's Authority To Require a
CCA To Accept Done Away Transactions
c. Other Comments Regarding Access
d. Final Rule
C. Amendments to Rule 15c3-3a
1. Introduction
2. Credit Items
3. New Debit Item
4. Note to New Debit Item
a. First Condition--Permitted Collateral
b. Second Condition--Customer Position Margin
c. Third Condition--Rules of U.S. Treasury Securities CCA
d. Fourth Condition--Commission Approval of Rules of U.S.
Treasury Securities CCA
5. PAB Reserve Computation
III. Compliance Dates
IV. Economic Analysis
A. Broad Economic Considerations
B. Baseline
1. U.S. Treasury Securities
2. U.S. Treasury Repurchase Transactions
3. Clearance and Settlement of U.S. Treasury Security
Transactions
a. Cash Market
i. Interdealer
ii. Dealer-to-Customer
b. U.S. Treasury Repo Market
i. Non-Centrally Cleared Bilateral Repo
ii. Centrally Cleared Bilateral Repo
iii. Non-Centrally Cleared Repo Settled on a Triparty Platform
iv. Centrally Cleared Repo Settled on a Triparty Platform
v. Inter-Affiliate Repo
4. Central Clearing in the U.S. Treasury Securities Market
5. Margin Practices in U.S. Treasury Secondary Markets
6. Disruptions in the U.S. Treasury Securities Market
a. COVID-19 Shock of March 2020
b. September 2019 Repo Market Disruptions
c. October 2014 Flash Rally
7. Affected Parties
a. Covered Clearing Agencies for U.S. Treasury Securities: FICC
b. Direct Participants at U.S. Treasury Securities CCAs: FICC
Netting Members
c. Interdealer Brokers
d. Other Market Participants
i. Broker-Dealers That Are Not Direct Participants/FICC Netting
Members
ii. Hedge Funds, Family Offices, and Separately Managed Accounts
iii. Registered Investment Companies (RICs) Including Money
Market Funds, Other Mutual Funds, and ETFs
iv. Principal Trading Firms (PTFs)
v. State and Local Governments
vi. Private Pensions Funds and Insurance Companies
e. Triparty Agent: Bank of New York Mellon
f. Custodian Banks/Fedwire Securities Service (FSS)
C. Analysis of Benefits, Costs, and Impact on Efficiency,
Competition, and Capital Formation
1. Benefits
a. U.S. Treasury Securities CCA Membership Requirements
i. Scope of the Requirement To Clear Eligible Secondary Market
Transactions
ii. Application of the Requirement To Clear Eligible Repo
Transactions
iii. Application of the Requirement To Clear Eligible Secondary
Market Transactions to Purchases and Sales of U.S. Treasury
Securities
iv. Exclusions From the Requirement To Clear Eligible Secondary
Market Transactions
b. Other Changes to Covered Clearing Agency Standards
i. Policies and Procedures Regarding Direct Participants'
Transactions
ii. Netting and Margin Practices for House and Customer Accounts
iii. Facilitating Access to U.S. Treasury Securities CCAs
c. Amendments to Rules 15c3-3 and 15c3-3a
2. Costs
a. Costs to FICC and Its Members of the Requirement To Clear
Eligible Secondary Market Transactions
i. Costs Attendant to an Increase in CCLF
ii. Costs of the Requirement To Clear Eligible Secondary Market
Transactions in Terms of Increased Margining for Existing FICC
Members
iii. Other Costs
b. Costs to Non-Members of a U.S Treasury Securities CCA as a
Result of the Requirement To Clear Eligible Secondary Market
Transactions
c. Other Changes to Covered Clearing Agency Standards
i. Netting and Margin Practices for House and Customer Accounts
ii. Facilitating Access to U.S. Treasury Securities CCAs
d. Amendments to Rules 15c3-3 and 15c3-3a
e. Other Costs
3. Effect on Efficiency, Competition, and Capital Formation
a. Efficiency
i. Price Transparency
ii. Operational and Balance Sheet Efficiency
b. Competition
c. Capital Formation
D. Reasonable Alternatives
1. Require U.S. Treasury Securities CCAs To Have Policies and
Procedures Requiring Only IDB Clearing Members To Submit U.S.
Treasury Securities Cash Trades With Non-Members for Central
Clearing
2. Require U.S. Treasury Securities CCAs To Have Policies and
Procedures Requiring the Submission of All Repurchase Agreements
Without Requirements for the Submission of Cash Transactions
3. Include All Cash Transactions Within the Scope of Eligible
Secondary Market Transactions With Exceptions for Central Banks,
Sovereign Entities, International Financial Institutions, and
Natural Persons
4. Require U.S. Treasury Securities CCAs To Change CCA Access
Provisions and Netting and Margin Practices for House and Customer
Accounts and Rule 15c3-3
V. Paperwork Reduction Act
A. Proposed Changes to Covered Clearing Agency Standards
1. Amendment to Rule 17ad-22(e)(6)
2. Amendment to Rule 17ad-22(e)(18)(iv)
B. Broker-Dealers
VI. Regulatory Flexibility Act
A. Clearing Agencies
B. Broker-Dealers
C. Certification
VII. Other Matters
Statutory Authority

I. Introduction

The Commission is responsible for facilitating the establishment of
a national system for the prompt and accurate clearance and settlement
of securities transactions.\2\ This responsibility includes the
authority to regulate clearing agencies engaged in the clearance and
settlement of government securities transactions, including U.S.
Treasury securities.\3\ This inclusion of government securities,
including U.S. Treasury securities, within the Commission's authority
for the national system of clearance and settlement underscores the
importance of, among other things, the U.S. Treasury market.
---------------------------------------------------------------------------

\2\ See 15 U.S.C. 78q-1.
\3\ Government Securities Act of 1986, section 102(a); 15 U.S.C.
78c(a)(12)(B)(i).
---------------------------------------------------------------------------

U.S. Treasury securities play a critical and unique role in the
U.S. and global economy, serving as a significant investment instrument
and hedging vehicle for investors, a risk-free benchmark for other
financial instruments, and an important mechanism for the Federal
Reserve's

[[Page 2716]]

implementation of monetary policy.\4\ Consequently, confidence in the
U.S. Treasury market, and in its ability to function efficiently, even
in times of stress, is critical to the stability of the global
financial system.\5\
---------------------------------------------------------------------------

\4\ See, e.g., Staffs of the U.S. Department of the Treasury,
Board of Governors of the Federal Reserve System, Federal Reserve
Bank of New York, U.S. Securities and Exchange Commission, and U.S.
Commodity Futures Trading Commission, Recent Disruptions and
Potential Reforms in the U.S. Treasury Market: A Staff Progress
Report, at 1 (Nov. 2021), available at https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf (``Inter-Agency Working
Group for Treasury Market Surveillance (``2021 IAWG Report'');
Staffs of the U.S. Department of the Treasury, Board of Governors of
the Federal Reserve System, Federal Reserve Bank of New York, U.S.
Securities and Exchange Commission, and U.S. Commodity Futures
Trading Commission, Joint Staff Report: The U.S. Treasury Market on
October 15, 2014, at 1, 8 (2015), available at https://home.treasury.gov/system/files/276/joint-staff-report-the-us-treasury-market-on-10-15-2014.pdf (``Joint Staff Report''). These
reports represent the views of Commission and other Federal
regulatory staff. The reports are not a rule, regulation, or
statement of the Commission. The Commission has neither approved nor
disapproved the content in the reports. These reports, like all
staff reports, have no legal force or effect: they do not alter or
amend applicable law, and they create no new or additional
obligations for any person.
\5\ Group of Thirty Working Group on Treasury Market Liquidity,
U.S. Treasury Markets: Steps Toward Increased Resilience, at 1
(2021), available at https://group30.org/publications/detail/4950
(``G-30 Report'').
---------------------------------------------------------------------------

CCPs provide an important role for securities markets, interposing
themselves between the counterparties to securities transactions,
acting functionally as the buyer to every seller and the seller to
every buyer. The Commission regulates CCPs as covered clearing agencies
(``CCA'').\6\ The Commission historically has acknowledged the benefits
that a CCP brings to the markets it serves. By novating transactions
(that is, becoming the counterparty to both sides of a transaction), a
CCP addresses concerns about counterparty risk by substituting its own
creditworthiness and liquidity for the creditworthiness and liquidity
of the counterparties.\7\ Further, the Commission has recognized that
``the centralization of clearance and settlement activities at covered
clearing agencies allows market participants to reduce costs, increase
operational efficiency, and manage risks more effectively.'' \8\ A CCP
also provides a centralized system of default management that can
mitigate the potential for a single market participant's failure to
destabilize other market participants or the financial system more
broadly.\9\ However, the Commission has also recognized that this
centralization of activity at clearing agencies makes risk management
at such entities a critical function.
---------------------------------------------------------------------------

\6\ See Rule 17ad-22(a) (defining covered clearing agency and
central counterparty) and Exchange Act Section 3(a)(23) (defining
clearing agency).
\7\ See, e.g., Order Granting Temporary Exemptions Under the
Securities Exchange Act of 1934 in Connection with Request of Liffe
Administration and Management and Lch.Clearnet Ltd. Related to
Central Clearing of Credit Default Swaps, and Request for Comments,
Exchange Act Release No. 59164 (Dec. 24, 2008), 74 FR 139, 140 (Jan.
2, 2009) (``Liffe Order'').
\8\ Covered Clearing Agency Standards Proposing Release,
Exchange Act Release No. 71699 (Mar. 12, 2014), 79 FR 29507, 29587
(May 27, 2014) (``CCA Standards Proposing Release'').
\9\ See, e.g., Liffe Order, supra note 7, 74 FR 140.
---------------------------------------------------------------------------

Because of the importance of risk management at CCPs and to further
the establishment of linked and coordinated facilities for clearance
and settlement of securities transactions, in 2016, the Commission
adopted the Covered Clearing Agency Standards.\10\ These standards
address all aspects of a CCP's operations, including financial risk
management, operational risk, default management, governance, and
participation requirements.\11\ The Commission has had the opportunity
to administer this new regulatory framework, considering many rule
filings with respect to proposed rule changes filed by CCAs pursuant to
their rule filing obligations as self-regulatory organizations
(``SROs'') under Section 19(b) of the Exchange Act that address how the
proposed rule changes are consistent with the Exchange Act and the
Covered Clearing Agency Standards thereunder.
---------------------------------------------------------------------------

\10\ See Covered Clearing Agency Standards Adopting Release,
Exchange Act Release No. 78961 (Sept. 28, 2016), 81 FR 70786 (Oct.
13, 2016) (``CCA Standards Adopting Release'').
\11\ See generally id.
---------------------------------------------------------------------------

The Commission also has had the opportunity to observe the U.S.
Treasury market, including with respect to the clearance and settlement
of U.S. Treasury security transactions in both the cash and repo
market. In particular, the Commission understands that the proportion
of transactions that are centrally cleared has declined over the past
years. One recent analysis by the Treasury Market Practice Group \12\
estimates that only 13 percent of the overall volume in U.S. dollars of
U.S. Treasury cash transactions were centrally cleared as of the first
half of 2017, and that an additional 19 percent were what the TMPG
refers to as ``hybrid'' clearing, that is, executed on an interdealer
broker platform (as discussed in parts II.A.1 and II.A.2.b.ii infra) in
which one counterparty is a member of a CCA and submits its transaction
with the interdealer broker for central clearing, while the other
counterparty is not a member of a CCA and bilaterally clears its
transaction with the interdealer broker.\13\ This use of both centrally
cleared and not centrally cleared transactions introduces risk into the
market, because bilateral clearing involves varying risk management
practices that are less uniform and less transparent to the broader
market and may be less efficient with regard to netting exposures and
use of collateral as compared to central clearing.
---------------------------------------------------------------------------

\12\ The Treasury Market Practices Group (``TMPG'') is a group
of ``market professionals committed to supporting the integrity and
efficiency of the Treasury, agency debt, and agency mortgage-backed
securities markets.'' See Treasury Mark Practice Group, About the
TMPG, available at https://www.newyorkfed.org/TMPG/. The
TMPG is sponsored by the Federal Reserve Bank of New York. Id.
\13\ TMPG, White Paper on Clearing and Settlement in the
Secondary Market for U.S. Treasury Securities, at 12 (July 2019),
available at https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/CS_FinalPaper_071119.pdf (``TMPG White Paper''). These
estimates use FR2004 data, which are reports provided to the Federal
Reserve Bank of New York regarding primary dealer market activity in
U.S. Government securities, covering the first half of 2017 and are
based on various assumptions specified in the TMPG White Paper. See
also FR2004, Government Securities Dealer Reports, available at
https://www.federalreserve.gov/apps/reportforms/reportdetail.aspx?sOoYJ+5BzDZq2f74T6b1cw.
---------------------------------------------------------------------------

Therefore, the Commission proposed amendments to Rule 17ad-
22(e)(18) to help reduce contagion risk to the CCA and bring the
benefits of central clearing to more transactions involving U.S.
Treasury securities, thereby lowering overall systemic risk in the
market.\14\ Specifically, the Commission proposed amendments that would
require CCAs for the U.S. Treasury market to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to require that their direct participants submit for clearance
and settlement certain eligible secondary market transactions, both for
repos and certain categories of cash transactions. In addition, the
Commission proposed amendments to address certain other issues that
could help facilitate increased central clearing in the U.S. These
proposed changes included amending Rule 17ad-22(e)(6)(i) to require
that a CCA establish, implement, maintain and

[[Page 2717]]

enforce written policies and procedures reasonably designed to
calculate, collect, and hold proprietary margin separate from customer
margin, amending Rule 17ad-22(e)(18) to require that CCAs establish,
implement, maintain and enforce written policies and procedures
reasonably designed to ensure that they have appropriate means to
facilitate access to clearance and settlement services of all eligible
secondary market transactions in U.S. Treasury securities, including
those of indirect participants, and amending Rule 15c3-3 to permit
margin required and on deposit at covered clearing agencies providing
central counterparty services for U.S. Treasury securities to be
included by broker-dealers as a debit in the customer and PAB reserve
formulas.
---------------------------------------------------------------------------

\14\ Proposing Release, Standards for Covered Clearing Agencies
for U.S. Treasury Securities and Application of the Broker-Dealer
Customer Protection Rule With Respect to U.S. Treasury Securities,
Exchange Act Release No. 95763 (Sept. 14, 2022), 87 FR 64610 (Oct.
25, 2022) (``Proposing Release''). See also Report of the Joint
Treasury-Federal Reserve Study of the U.S. Government Securities
Market (Apr. 1969), available at https://fraser.stlouisfed.org/title/joint-treasury-federal-reserve-study-us-government-securities-market-318/report-joint-treasury-federal-reserve-study-us-government-securities-market-6282.
---------------------------------------------------------------------------

The Commission received many comments on the proposal.\15\ Having
considered the comments received, the Commission is adopting the
proposed new rules and rule amendments with modifications, as discussed
further below.
---------------------------------------------------------------------------

\15\ Copies of all comment letters received by the Commission
are available at https://www.sec.gov/comments/s7-23-22/s72322.htm.
---------------------------------------------------------------------------

II. Discussion of Comments Received and Final Rules

A. U.S. Treasury Securities CCA Membership Requirements

1. Requirement To Clear Eligible Secondary Market Transactions
Proposed Rule 17ad-22(e)(18)(iv)(A) would require that U.S.
Treasury securities CCAs establish, implement, maintain and enforce
written policies and procedures reasonably designed to, as applicable,
establish objective, risk-based, and publicly disclosed criteria for
participation, which require that the direct participants of such
covered clearing agency submit for clearance and settlement all of the
eligible secondary market transactions to which they are a
counterparty. The proposed amendment would apply to ``direct
participants'' in a U.S. Treasury securities CCA, which distinguishes
entities that access a CCA directly (i.e., members of the CCA) from
indirect participants who ``rely on the services provided by direct
participants to access the covered clearing agency's payment, clearing
or settlement facilities.'' \16\ For purposes of the Covered Clearing
Agency Standards, ``participants'' of a CCA are referred to as
``members'' or ``direct participants'' to differentiate these entities
from ``direct participants' customers'' or ``indirect participants.''
\17\ Consequently, for purposes of this amendment and consistent with
the terminology already used in the Covered Clearing Agency
Standards,\18\ the term ``direct participants'' refers to the entities
that directly access a U.S. Treasury securities CCA (generally banks
and broker-dealers), and the term ``indirect participants'' would refer
to those entities which rely on a direct participant to clear and
settle their U.S. Treasury securities transactions with the U.S.
Treasury securities CCA (generally their customers or clients, which
typically include market participants such as money market funds, hedge
funds, other asset managers, and smaller banks or broker-dealers).\19\
---------------------------------------------------------------------------

\16\ 17 CFR 240.17ad-22(e)(19). See also CCA Standards Proposing
Release, supra note 8, at 29553 (noting that some market
participants would not meet a covered clearing agency's direct
participation requirements and proposing risk management
requirements for indirect and tiered participants).
\17\ See, e.g., 17 CFR 240.17ad-22(e)(6) (referring to
participants) and (e)(2)(vi) (referring to direct participants'
customers). In addition, the Exchange Act defines a participant of a
clearing agency as ``any person who uses a clearing agency to clear
or settle securities transactions or to transfer, pledge, lend, or
hypothecate securities.'' 15 U.S.C. 78c(a)(24). Indirect
participants are expressly excluded from the Exchange Act definition
of a ``participant'' of a clearing agency because the Exchange Act
provides that a person whose only use of a clearing agency is
through another person who is a participant or as a pledgee of
securities is not a ``participant'' of the clearing agency. Id.
\18\ See 17 CFR 240.17ad-22(e)(19) (referring to firms that are
indirect participants in a covered clearing agency as those that
``rely on the services provided by direct participants to access the
covered clearing agency's payment, clearing, or settlement
facilities'').
\19\ For example, FICC maintains the Sponsored Service. See
Fixed Income Clearing Corporation, Government Securities Division
Rulebook, Rule 3A, available at https://www.dtcc.com/~/media/Files/
Downloads/legal/rules/ficc_gov_rules.pdf (``FICC Rule''). Because
sponsored members cannot clear or settle government securities
transactions without a sponsoring member, the Commission believes
that these sponsored members are not ``direct participants.'' As
noted above, such persons are referred to in this release as
``indirect participants'' or ``customers.''
---------------------------------------------------------------------------

Moreover, persons who provide services in connection with clearance
and settlement, such as settlement agent, settlement bank, or clearing
bank services, and do not submit trades for clearing to a U.S. Treasury
securities CCA would not be ``direct participants'' or ``indirect
participants'' within the meaning of this amendment and the terminology
used in the Covered Clearing Agency Standards.\20\
---------------------------------------------------------------------------

\20\ The Commission recognizes that some entities may access
more limited services of a U.S. Treasury securities CCA without use
of its CCP services. For example, FICC provides ``comparison only''
services for a certain membership type. See FICC Rule 8, supra note
19. Consistent with the definition of a ``participant'' under the
Exchange Act, such entities would not be considered participants of
a CCA and therefore would not be subject to any rules with respect
to the clearing of eligible secondary market transactions that a CCA
may adopt for its direct participants.
---------------------------------------------------------------------------

In the Proposing Release, the Commission stated that it believes
that the requirement to clear eligible secondary market transactions
would promote the prompt and accurate clearance and settlement of U.S.
Treasury securities transactions, providing several benefits to the
market for U.S. Treasury securities as a whole,\21\ which are
summarized briefly here.
---------------------------------------------------------------------------

\21\ See generally Proposing Release, supra note 14, 87 FR
64626-29; see also part IV.C.1 infra.
---------------------------------------------------------------------------

First, the Commission stated that it believes that the requirement
to clear eligible secondary market transactions would decrease the
overall amount of counterparty credit risk in the secondary market for
U.S. Treasury securities. Because a U.S. Treasury securities CCA would
novate and guarantee each transaction submitted for central clearing,
it would become a counterparty to each transaction, as the buyer to
every seller and the seller to every buyer. The U.S. Treasury
securities CCA would be able to risk manage these transactions
centrally, pursuant to risk management procedures that the Commission
has reviewed and approved,\22\ and would guarantee settlement of the
trade in the event of a direct participant default.
---------------------------------------------------------------------------

\22\ See Section 19(b) of the Exchange Act and Rule 19b-4
thereunder.
---------------------------------------------------------------------------

In particular, the requirement to clear eligible secondary market
transactions is designed to reduce the amount of ``contagion risk'' to
a U.S. Treasury securities CCA arising from what has been described as
``hybrid clearing,'' as discussed in more detail in part II.A.2.b.iii.
With this type of clearing, a direct participant's transactions that
are not submitted for central clearing pose an indirect risk to the
covered clearing agency, as any default on a bilaterally settled
transaction could impact the direct participant's financial resources
and ability to meet its obligations to the covered clearing agency. The
Commission stated that it believes that requiring U.S. Treasury
securities CCAs to impose, as a condition of membership, an obligation
on their direct participants to submit all eligible secondary market
transactions for central clearing should address the transactions most
likely to cause contagion risk to the CCA.
Second, the Commission stated that it believes that the requirement
to clear eligible secondary market transactions would also help any
U.S. Treasury securities CCA to avoid a potential disorderly member
default. Defaults in bilaterally settled transactions are likely

[[Page 2718]]

to be less orderly and subject to variable default management
techniques because bilaterally settled transactions are not subject to
the default management processes that are required to be in place and
publicly disclosed at a CCP.\23\ Centralized default management is a
key feature of central clearing.\24\ Because the CCP has novated and
guaranteed the transactions, it is uniquely positioned to coordinate
the default of a member for trades that it has centrally cleared, and
the non-defaulting members can rely on the CCP to complete the
transactions of the defaulting member and cover any resulting losses
using the defaulting member's resources and/or its default management
tools. Even in a situation where two CCPs have to coordinate the
default of a joint member, that coordination should result in more
efficiency and market confidence than multiple bilateral settlements.
---------------------------------------------------------------------------

\23\ A covered clearing agency, including a U.S. Treasury
securities CCA, is required to establish, implement, maintain and
enforce written policies and procedures reasonably designed to, as
applicable, ensure the CCA has the authority and operational
capacity to contain losses and liquidity demands and continue to
meet its obligations, which must be tested annually, and publicly
disclose all relevant rules and material procedures, including key
aspects of its default rules and procedures. See Rule 17ad-22(e)(13)
and (e)(23)(i).
\24\ CCA Standards Proposing Release, supra note 8, 79 FR 29545
(a CCP's default management procedures would provide certainty and
predictability about the measures available to a covered clearing
agency in the event of a default which would, in turn facilitate the
orderly handling of member defaults and would enable members to
understand their obligations to the covered clearing agency in
extreme circumstances).
---------------------------------------------------------------------------

Third, the Commission stated that it believes that the requirement
to clear eligible secondary market transactions will further the prompt
and accurate clearance and settlement of U.S. Treasury securities by
increasing the multilateral netting of transactions in these
instruments, thereby reducing operational and liquidity risks, among
others. Central clearing of transactions nets down gross exposures
across participants, which reduces firms' exposures while positions are
open and reduces the magnitude of cash and securities flows required at
settlement.\25\ As the Commission stated in the Proposing Release,
FICC's failure to receive all eligible trading activity of an active
market participant reduces the value of its vital multilateral netting
process and causes FICC to be less well-situated to prevent future
market crises.\26\
---------------------------------------------------------------------------

\25\ 2021 IAWG Report, supra note 4, at 30.
\26\ Proposing Release, supra note 14, 87 FR 64628 & n. 182
(citing Self-Regulatory Organizations; Fixed Income Clearing
Corporation; Order Granting Approval of a Proposed Rule Change
Relating to Trade Submission Requirements and Pre-Netting, Exchange
Act Release No. 51908 (June 22, 2005), 70 FR 37450 (June 29, 2005)
(describing a rule designed to bring additional transactions into
FICC's netting system as ``clearly designed to promote the prompt
and accurate clearance and settlement of those transactions and to
preserve the safety and soundness of the national clearance and
settlement system.'')).
---------------------------------------------------------------------------

The benefits of multilateral netting flowing from central clearing
can improve market safety by lowering exposure to settlement failures,
which would also tend to promote the prompt and accurate clearance and
settlement of U.S. Treasury securities transactions.\27\ Multilateral
netting can also reduce the amount of balance sheet required for
intermediation and could also enhance dealer capacity to make markets
during normal times and stress events because existing bank capital and
leverage requirements recognize the risk-reducing effects of
multilateral netting of trades that CCP clearing accomplishes.\28\
---------------------------------------------------------------------------

\27\ Darrell Duffie, Still the World's Safe Haven Redesigning
the U.S. Treasury Market After the COVID-19 Crisis, Hutchins Center
Working Paper # 62 (Brookings Inst.) at 15 (June 2020), available at
https://www.brookings.edu/wp-content/uploads/2020/05/WP62_Duffie_v2.pdf (``Duffie'').
\28\ 2021 IAWG Report, supra note 4, at 30; Nellie Liang &
Patrick Parkinson, Enhancing Liquidity of the U.S. Treasury Market
Under Stress, at 9 (Dec. 16, 2020), available at https://www.brookings.edu/wp-content/uploads/2020/12/WP72_Liang-Parkinson.pdf (``Liang & Parkinson''); Duffie, supra note 27, at 16-
17.
---------------------------------------------------------------------------

Fourth, the Commission stated that the potential benefits
associated with the multilateral netting of transactions at a CCP that
the requirement to clear eligible secondary market transactions is
designed to bring about could, in turn, help to unlock further
improvements in U.S. Treasury market structure. For example, the
increase in clearing and consequent reduction in counterparty credit
risk could ``enhance the ability of smaller bank and independent
dealers to compete with the incumbent bank dealers.'' \29\ Similarly,
decreased counterparty credit risk--and potentially lower costs for
intermediation--could result in narrower spreads, thereby enhancing
market quality.\30\ The Commission also stated that increased
accessibility of central clearing in U.S. Treasury markets could
support movement toward all-to-all trading, even potentially in the
repo market, which would further improve market structure and
resiliency, although a movement in that direction is not assured.\31\
This potential movement would stem from the fact that increased central
clearing of U.S. Treasury securities transactions would, in turn,
result in decreased counterparty risk, making all-to-all trading more
attractive, that is, a market participant would be more willing to
trade with any counterparty if a CCP were to serve as its ultimate
counterparty.
---------------------------------------------------------------------------

\29\ Liang & Parkinson, supra note 28, at 9.
\30\ G-30 Report, supra note 5, at 13.
\31\ 2021 IAWG Report, supra note 4, at 30; Duffie, supra note
27, at 16; G-30 Report, supra note 5, at 13. All-to-all trading
would be characterized by the ability for a bid or offer submitted
by one market participant to be accepted by any other market
participant, with trades executed at the best bid or offer. See,
e.g., Liang & Parkinson, supra note 28, at 9. All-to-all trading
could improve the quality of trade execution in normal market
conditions and broaden and stabilize the supply of market liquidity
under stress. See, e.g., G-30 Report, supra note 5, at 10.
---------------------------------------------------------------------------

Finally, the Commission stated that increased central clearing
should enhance regulatory visibility in the critically important U.S.
Treasury market. Specifically, central clearing increases the
transparency of settlement risk to regulators and market participants,
and in particular allows a CCP to identify concentrated positions and
crowded trades, adjusting margin requirements accordingly, which should
help reduce significant risk to the CCP and to the system as a
whole.\32\ In light of the role of U.S. Treasury securities in
financing the Federal Government, it is important that regulators
improve their visibility into this market. Increased central clearing
would also allow for a more aggregated view of market activity in one
place.
---------------------------------------------------------------------------

\32\ Duffie, supra note 27, at 15;2021 IAWG Report, supra note
4, at 30 (centralization of transactions at a CCP ``can simplify
data collection and improve visibility into market conditions for
the authorities and, to some degree, for market participants'').
---------------------------------------------------------------------------

a. Comments Regarding the Requirement To Clear Eligible Secondary
Market Transactions
Some commenters generally supported the proposal and its approach
to requiring additional central clearing of transactions in U.S.
Treasury securities.\33\ However, other commenters generally opposed
the proposed requirement to clear eligible

[[Page 2719]]

secondary market transactions, arguing that there was not sufficient
information on the costs and benefits of such a requirement, that the
Commission should do further study, and/or that the Commission should
incentivize additional clearing instead of requiring it.\34\
---------------------------------------------------------------------------

\33\ See generally Letter from Americans for Financial Reform
Education Fund (Dec. 27, 2022) (``AFREF Letter''); Letter from
Stephen W. Hall, Legal Director and Securities Specialist, and Scott
Farnin, Legal Counsel, Better Markets, Inc. (Dec. 23, 2022)
(``Better Markets Letter''); Letter from Murray Pozmanter, Managing
Director, President of DTCC Clearing Agency Services, Head of Global
Business Operations, and Laura Klimpel, General Manager of FICC,
Head of SIFMU Business Development, Depository Trust and Clearing
Corporation and Fixed Income Clearing Corporation (Dec. 27, 2022)
(``DTCC/FICC Letter''); Letter from Robin Vince, President and Chief
Executive Officer, The Bank of New York Mellon Corporation (Dec. 22,
2022) (``BNY Mellon Letter''); Letter from Rachel Goldberg, Head of
Government Relations and Regulatory Strategy, Americas, London Stock
Exchange Group (Dec. 27, 2022) (``LSEG Letter''); Letter from Chris
Edmonds, Chief Development Officer, Intercontinental Exchange, Inc.
(Jan. 12, 2023) (``ICE Letter'').
\34\ The Commission discusses the comments on incentives in its
discussion of alternative approaches to a clearing requirement in
part II.A.5 infra.
---------------------------------------------------------------------------

One commenter also referenced the need to assess the potential
impact of an increased volume of cleared repo transactions on the
Secured Overnight Financing Rate (``SOFR''), given its importance as a
reference rate replacing LIBOR and because SOFR is calculated largely
based on implied financing rates of repo transactions cleared at
FICC.\35\ SOFR is calculated as a volume-weighted median, which is the
rate associated with transactions at the 50th percentile of transaction
volume.\36\ Specifically, the volume-weighted median rate is calculated
by ordering the transactions from lowest to highest rate, taking the
cumulative sum of volumes of these transactions, and identifying the
rate associated with the trades at the 50th percentile of dollar
volume. Such volume weighting should allow preparation of the rate to
take into account any increased transaction volume arising from
additional central clearing in response to a requirement to clear
eligible secondary market transactions, thereby making further study
unnecessary.
---------------------------------------------------------------------------

\35\ Letter from William C. Thum, Managing Director and
Assistant General Counsel, Securities Industry and Financial Markets
Association (``SIFMA'') Asset Management Group, at 7 (Dec. 23, 2022)
(``SIFMA AMG Letter'').
\36\ Additional Information about Reference Rates Administered
by the New York Fed, available at https://www.newyorkfed.org/markets/reference-rates/additional-information-about-reference-rates#tgcr_bgcr_sofr_calculation_methodology.
---------------------------------------------------------------------------

With respect to costs and benefits, one commenter stated that the
increased costs of centrally clearing U.S. Treasury security
transactions may reduce liquidity and diversity in the Treasury market
if firms reduce activity, leave the market, or if barriers to entry are
too high, given the significant costs of clearing for market
participants.\37\ The commenter identified several types of costs,
including initial margin requirements, clearing fees, obligations with
respect to FICC's Capped Contingent Liquidity Facility (``CCLF''), the
operational build necessary to access central clearing either as a
direct or indirect participant, and legal costs and time associated
with onboarding customers for indirect central clearing, including,
e.g., the need for Sponsoring Members to file UCC financing statements
with respect to Sponsored Members under the Sponsored Member program.
The commenter stated that the impact of these costs would be
disproportionately felt by small and mid-sized participants in the U.S.
Treasury market, and that these costs would reduce diversity in the
market and further increase concentration among market participants
(which may increase systemic risk) if such participants leave the
market.\38\
---------------------------------------------------------------------------

\37\ Letter from Robert Toomey, Managing Director and Associate
General Counsel, Securities Industry and Financial Markets
Association, and Michelle Meertens, Deputy General Counsel,
Institute of International Bankers, at 8 (Dec. 22, 2022) (``SIFMA/
IIB Letter'').
\38\ SIFMA/IIB Letter, supra note 37, at 8.
---------------------------------------------------------------------------

As discussed in more detail in part IV.C.2, increased transaction
costs will generally reduce the expected return of a particular
investment. If the amendments regarding eligible secondary market
transactions resulted only in such increased costs, then the potential
risk/return tradeoff would worsen, resulting in decreased transaction
volumes and decreased liquidity. However, central clearing provides
other benefits, including those described in part IV.C.1, many of which
could accrue to small and mid-sized market participants. Moreover,
increased cost does not necessarily mean that firms will reduce
activity or leave the market.
The commenter also stated that these costs may incentivize non-
direct participants of a U.S. Treasury securities CCA to look for ways
to trade away from direct participants in order to not have to
centrally clear U.S. Treasury transactions, undermining the policy
goals of the proposal.\39\ The Commission acknowledges that the
proposed requirement for U.S. Treasury securities CCAs to require their
members to submit eligible secondary market transactions for clearing
and settlement does not limit the ability of market participants to
transact in U.S. Treasury securities transactions away from CCAs. This
requirement is not a mandate to clear all transactions in U.S. Treasury
securities, regardless of who executes the transaction, and differs
from the swaps mandate imposed by Congress in the Dodd-Frank Act in
2010.\40\ However, given current market structure and requirements
applicable to certain market participants, it would be challenging for
market participants to simply shift all their activity to transact away
from CCAs. For example, primary dealers, which serve as trading
counterparties of the New York Fed in its implementation of monetary
policy, are required to maintain a substantial presence as a market
maker that provides two-way liquidity in U.S. government securities,
particularly Treasury cash and repo operations.\41\ These primary
dealers must be participants in FICC, as the CCP for the government
securities market, to support clearing of primary market
transactions.\42\ Therefore, if a market participant wants to transact
with a primary dealer which is required to be a direct participant of
FICC, it would have to determine an appropriate way to submit such
transactions for clearing and settlement. Primary dealers are
responsible for a significant portion of market activity in the U.S.
Treasury market (see part IV.B infra), and therefore, market
participants likely would continue to transact with such primary
dealers.
---------------------------------------------------------------------------

\39\ SIFMA/IIB Letter, supra note 37, at 8.
\40\ Dodd-Frank Act section 723; 15 U.S.C. 3C(a).
\41\ See Primary Dealers, available at https://www.newyorkfed.org/markets/primarydealers (``In order to be eligible
as a primary dealer, a firm must . . . Be a participant in the
central counterparty service for the government securities market--
DTCC's FICC-GSD--to support clearing of primary market
transactions.'').
\42\ Id.
---------------------------------------------------------------------------

In addition, the commenter stated that central clearing can have
procyclical effects in times of market stress due to the margin
requirements of clearing agencies, further reducing liquidity when it
is most needed.\43\ The commenter stated that, depending on the
applicable margin models, clearing can be procyclical in times of
market turmoil, as increased margin requirements (including intraday
and ad hoc calls) drive demand for liquid assets, which, in turn,
increases the scarcity of those assets and further drives market
stress. The commenter described FICC's rules as allowing FICC to
demand, at any time in its discretion, additional margin from its
members in times of market volatility, including through intraday
calls, to safeguard the clearing infrastructure.\44\ The commenter
suggested that the Commission should engage in additional study on the
procyclical effects of central clearing before implementing a central
clearing requirement, focusing on the appropriate balance from a
systemic risk perspective of rigorously managing the risk of positions
cleared through a CCP as compared to minimizing liquidity strains on
the U.S. Treasury market.\45\
---------------------------------------------------------------------------

\43\ SIFMA/IIB Letter, supra note 37, at 9.
\44\ SIFMA/IIB Letter, supra note 37, at 9.
\45\ SIFMA/IIB Letter, supra note 37, at 9.
---------------------------------------------------------------------------

The Commission acknowledges that, in times of market stress, margin
calls

[[Page 2720]]

may increase to address the ongoing market volatility. This is by
design, as margin models are built to be responsive to current market
conditions. The Commission has specifically required that CCAs have the
authority and operational capacity to make intraday margin calls in
defined circumstances.\46\ This ability is important to the CCA's
ability to manage the risk and cover the credit exposures that its
participants may bring to the CCA. When considering a CCA's authority
with respect to intraday margin, the Commission may consider its
potential procyclicality.\47\ In addition, the Commission may consider
the transparency of the margin model, such that market participants can
understand when the CCA may make margin calls.\48\ In addition to the
FICC rules cited by the commenter, FICC has provided additional
transparency regarding how it determines the need for intraday margin
calls, including the specific criteria that it uses to assess the
need.\49\ FICC is also subject to Rule 17ad-22(e)(23), which requires
certain levels of public disclosure regarding FICC's margin methodology
and the costs of participating in FICC, as discussed further in part
II.B.2 infra. The Commission's ongoing consideration of the role and
function of intraday margin calls, as well as market participants'
ability to understand such calls, obviates the need for separate study
in connection with this proposal.\50\
---------------------------------------------------------------------------

\46\ 17 CFR 240.17ad-22(e)(6)(ii).
\47\ See, e.g., Self-Regulatory Organizations; Fixed Income
Clearing Corporation; Order Approving a Proposed Rule Change to
Modify the Calculation of the MBSD VaR Floor to Incorporate a
Minimum Margin Amount, Exchange Act Release No. 92303, at 32 (June
30, 2021) (discussing commenter's concern regarding potential
procyclical nature of a margin methodology change); Self-Regulatory
Organizations; The Options Clearing Corporation; Order Granting
Approval of Proposed Rule Change Concerning The Options Clearing
Corporation's Margin Methodology for Incorporating Variations in
Implied Volatility, Exchange Act Release No. 95319, at 3 (July 19,
2022) (referencing the impact of a change to margin methodology on
procyclicality of margin).
\48\ See, e.g., Self-Regulatory Organizations; National
Securities Clearing Corporation; Order Approving a Proposed Rule
Change to Enhance National Securities Clearing Corporation's
Haircut-Based Volatility Charge Applicable to Illiquid Securities
and UITs and Make Certain Other Changes to Procedure XV, Exchange
Act Release No. 34-90502, at 56-59 (Nov. 24, 2020) (discussing
commenter's concerns regarding transparency of change to margin
methodology).
\49\ See Self-Regulatory Organizations; Fixed Income Clearing
Corporation; Notice of Filing of Proposed Rule Changes to the
Required Fund Deposit Calculation in the Government Securities
Division Rulebook, Exchange Act Release No. 82588 (Jan. 26, 2018)
(identifying the following specific parameter breaks: (i) a dollar
threshold that evaluates whether a Netting Member's Intraday VaR
Charge equals or exceeds a set dollar amount (then set at
$1,000,000) when compared to the VaR Charge that was included in the
most recently collected Required Fund Deposit including, any
subsequently collected Intraday Supplemental Fund Deposit; (ii) a
percentage threshold, that evaluates whether the Intraday VaR Charge
equals or exceeds a percentage increase (then set at 100%) of the
VaR Charge that was included in the most recently collected Required
Fund Deposit including, if applicable, any subsequently collected
Intraday Supplemental Fund Deposit; (iii) the coverage target, that
evaluates whether a Netting Member is experiencing backtesting
results below the 99% confidence level). FICC has updated this
information via Important Notices to its participants. See, e.g.,
Important Notice GOV1244-22, GSD Intraday Supplemental Fund Deposit
Parameter Change (Apr. 11, 2022), available at https://www.dtcc.com/-/media/Files/pdf/2022/4/11/GOV1244-22.pdf (raising the coverage
target).
\50\ See also Proposed Rule, Covered Clearing Agency Resilience
and Recovery and Wind-Down Plans, Exchange Act Release No. 97516
(May 17, 2023), 88 FR 34708 (May 30, 2023) (proposing additional
requirements with respect to intraday margin that CCAs require
intraday monitoring of their exposures and specifying particular
circumstances in which the CCA should make intraday margin calls).
---------------------------------------------------------------------------

b. Comments Regarding the Concentration of Risk in One Covered Clearing
Agency
Commenters also mentioned the potential concentration risk that
would arise as a result of the requirement to clear eligible secondary
market transactions, specifically because only one covered clearing
agency currently provides such services. One commenter stated that
concentrating such significant levels of settlement, operational,
liquidity and credit risk in one institution means that were there
operational or liquidity stress at FICC, widespread dysfunction in the
Treasury markets could result.\51\ Another commenter which analyzed
market views of the proposal identified increased concentration risk as
a primary concern for market participants, who cited potential
technical issues at FICC that would result in a ``pause [of]
counterparty trade transactions and lead to substantial losses for
market participants.'' However, the commenter also acknowledged that a
smaller group of market participants explained that they were not
opposed to a single clearinghouse model through FICC, stating that FICC
has adequate risk models and that the concentration in one CCP is not
of concern in the futures or derivatives markets, which, like FICC,
also only have one CCP to serve their respective markets.\52\
---------------------------------------------------------------------------

\51\ SIFMA/IIB Letter, supra note 37, at 10.
\52\ Comment Submission from SIA Partners, entitled CENTRAL
CLEARING OF U.S. TREASURIES & REPO, A Study on the Impact to the
Market and Market Participants, at 79-80 (Mar. 2023) (``SIA Partners
Comment''); see also id. at 8.
---------------------------------------------------------------------------

In addition, one commenter stated that the Commission should only
impose a clearing mandate once FICC and at least a second covered
clearing agency are able to offer access to clearing solutions that
will fulfill the enhanced rule requirements and meet the needs of
market participants.\53\ The commenter noted that the existence of one
covered clearing agency serving the U.S. Treasury market is highly
problematic as it creates enormous concentration risk for market
participants, and highlighted that, given the importance of the U.S.
Treasury market to the overall global economy, there needs to be a
compelling reason for increasing the concentration of cleared trading
activity in a single clearing house that is member owned and operated
on a for-profit basis, particularly when there is no alternative or
fallback venue should the clearing house experience a disruption to its
operations or more significantly were it to fail.\54\
---------------------------------------------------------------------------

\53\ SIFMA/AMG Letter, supra note 37, at 3, 9.
\54\ SIFMA/AMG Letter, supra note 37, at 9.
---------------------------------------------------------------------------

The Commission acknowledges that, currently, there is only one U.S.
Treasury securities CCA, FICC, and that this does create concentration
risk for the clearing of U.S. Treasury securities transactions.
However, this concentration risk is mitigated by the existence of a
supervisory framework for the existing U.S. Treasury securities CCA,
and it is not uncommon for one CCA to serve a particular market.\55\
The Commission therefore disagrees with the commenter that the
existence of two CCAs is necessary for this requirement to be
implemented. Moreover, the Commission is not requiring that the
additional central clearing of U.S. Treasury securities transactions be
concentrated in one clearing house. But, if that remains the case going
forward, the benefits expected to arise from this additional clearing,
as discussed further in part IV.C.1 infra, constitute a sufficient
compelling reason to adopt the final rule, even if such concentration
is present, which, as discussed, is subject to the appropriate
mitigation of risk arising from the regulatory framework applicable to
CCAs as discussed in this section.
---------------------------------------------------------------------------

\55\ For example, there is only one CCA in the U.S. equities
market and in the U.S. listed derivatives market.
---------------------------------------------------------------------------

FICC has been designated by the Financial Stability Oversight
Council as systemically important under Title VIII of the Dodd-Frank
Act. This designation means that FICC is subject to heightened
supervision and examination by the Commission, in consultation with the
Board of Governors of the Federal Reserve System (``Board of
Governors''.

[[Page 2721]]

FICC is subject to the Covered Clearing Agency Standards, which address
the various types of risk that FICC faces as a CCP, including
settlement, operational, liquidity, and credit risk.
A CCA must be able to meet the requirements of the Covered Clearing
Agency Standards regardless of the presence or absence of other CCAs.
The Covered Clearing Agency Standards specifically address a CCA's
obligations in 23 specific areas, many of which directly relate to the
CCA's ability to manage the risks presented to it as a CCA. For
example, a CCA must have policies and procedures in place to
effectively identify, measure, monitor, and manage its credit exposures
to participants and those arising from its payment, clearing, and
settlement processes, including by, among other things, maintaining
sufficient financial resources to cover its credit exposure to each
participant fully with a high degree of confidence and maintain
additional financial resources to enable it to cover a wide range of
foreseeable stress scenarios, including the default of the largest or
two largest participant families (depending on the nature of the CCA's
activities). A CCA also must have policies and procedures in place to
effectively measure, monitor, and manage the liquidity risk that arises
in or is borne by the CCA, including measuring, monitoring, and
managing its settlement and funding flows on an ongoing and timely
basis, and its use of intraday liquidity, by, among other things,
holding qualifying liquid resources in an amount sufficient to effect
same-day and, where appropriate, intraday and multiday settlement of
payment obligations with a high degree of confidence under a wide range
of foreseeable stress scenarios that includes, but is not limited to,
the default of the largest participant family in extreme but plausible
market conditions. With respect to both its credit and liquidity
resources, the CCA is required to, among other things, test the
sufficiency of such resources at least once each day using standard and
predetermined parameters and assumptions, conduct a comprehensive
analysis on at least a monthly basis of the existing scenarios, models,
and underlying parameters and assumptions used to ensure that they are
appropriate for determining the CCA's needs and resources in light of
current and evolving market conditions, and to perform a model
validation of the models used for such testing at least annually.\56\
---------------------------------------------------------------------------

\56\ 17 CFR 240.17ad-22(e)(4)(vi) and (vii) and (e)(7)(vi) and
(vii).
---------------------------------------------------------------------------

In addition, a CCA is required 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 and among other things,
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, and is
monitored by management on an ongoing basis and is regularly reviewed,
tested, and verified by conducting backtests of its margin model at
least once each day using standard predetermined parameters and
assumptions and conducting a sensitivity analysis of its margin model
and a review of its parameters and assumptions for backtesting on at
least a monthly basis, among other things.\57\ A CCA also is required
to have policies and procedures reasonably designed to establish
objective, risk-based, and publicly disclosed criteria for
participation, which permit fair and open access by direct and, where
relevant, indirect participants and other financial market utilities,
require participants to have sufficient financial resources and robust
operational capacity to meet obligations arising from participation in
the clearing agency, and monitor compliance with such participation
requirements on an ongoing basis; and identify, monitor, and manage the
material risks to the CCA arising from arrangements in which firms that
are indirect participants in the CCA rely on the services provided by
direct participants to access the CCA's payment, clearing, or
settlement facilities.\58\
---------------------------------------------------------------------------

\57\ 17 CFR 240.17ad-22(e)(6).
\58\ 17 CFR 240.17ad-22(e)(18) and (19).
---------------------------------------------------------------------------

These requirements should ensure that a CCA is able to accommodate
the market needs for its clearance and settlement activity and that a
CCA can appropriately risk manage the activity that its participants
submit for clearing and settlement, which should, in turn, mitigate the
potential concentration risk arising from the existence of only one CCA
for a particular asset class.
Further, regarding the comments raising concerns about potential
operational or technical issues at a single CCA, the Covered Clearing
Agency Standards include Rule 17ad-22(e)(17), which requires written
policies and procedures reasonably designed to manage the covered
clearing agency's operational risks by (i) identifying the plausible
sources of operational risk, both internal and external, and mitigating
their impact through the use of appropriate systems, policies,
procedures, and controls; (ii) ensuring that systems have a high degree
of security, resiliency, operational reliability, and adequate,
scalable capacity; and (iii) establishing and maintaining a business
continuity plan that addresses events posing a significant risk of
disrupting operations.\59\ In addition, CCAs, as registered clearing
agencies, are subject to the requirements of Regulation Systems
Compliance Integrity (``Regulation SCI''). Regulation SCI is designed
to strengthen the infrastructure of the U.S. securities markets, reduce
the occurrence of systems issues in those markets, improve their
resiliency when technological issues arise, and implement an updated
and formalized regulatory framework, thereby helping to ensure more
effective Commission oversight of such systems.\60\ As entities subject
to Regulation SCI, CCAs are required to have written policies and
procedures reasonably designed to ensure that their key automated
systems have levels of capacity, integrity, resiliency, availability,
and security adequate to maintain their operational capability and
promote the maintenance of fair and orderly markets, and that such
systems operate in accordance with the Exchange Act and the rules and
regulations thereunder and the entities' rules and governing documents,
as applicable.\61\ These requirements should work to mitigate the
possibility that a CCA would experience an interruption to its
operations. In the event that a CCA were to fail, it is required to
have policies and procedures to establish a recovery and wind-down plan
to address that situation.\62\
---------------------------------------------------------------------------

\59\ 17 CFR 240.17ad-22(e)(17).
\60\ Securities Exchange Act Release No. 73639 (Nov. 19, 2014),
79 FR 72252, 72253, 72256 (Dec. 5, 2014).
\61\ See 17 CFR 242.1001.
\62\ 17 CFR 240.17ad-22(e)(3)(ii). In the event of a wind-down
in which the result is that the U.S. Treasury securities CCA no
longer exists, Rule 17ad-22(e)(18)(iv) would not apply, as there
would be no CCA to impose such membership requirements. The
requirement to clear eligible secondary market transactions arises
under the CCA's rules and is not a mandate to clear based on the
nature of the security.
---------------------------------------------------------------------------

FICC also must meet its obligations under both Section 19(b) of the
Exchange Act, as a self-regulatory organization, and Title VIII of the
Dodd-Frank Act. This means that the Commission has the opportunity to
review any proposed rule changes and imposes specific additional filing
obligations for an entity designated as systemically important under
Title VIII

[[Page 2722]]

of the Dodd-Frank Act to provide advance notice to the Commission,
which must consult with the Board of Governors, of any change to the
entity's procedures that may materially alter the nature or level of
risk presented.\63\ This overall supervisory framework, including the
Covered Clearing Agency Standards, should help ensure that FICC
continues to be subject to robust supervision and oversight and to be
able to manage the risks presented to it, even those arising from
increased Treasury clearing. In light of the robust regulatory
framework applicable to CCAs, the fact that only one CCA serves the
market should not preclude the imposition of a requirement to clear
eligible secondary market transactions.
---------------------------------------------------------------------------

\63\ 12 U.S.C. 5465(e); 17 CFR 240.19b-4.
---------------------------------------------------------------------------

Further, the Commission is not persuaded that the ownership or
organizational structure of the present U.S. Treasury securities CCA
has an effect on its ability to serve the market. The Commission has
not imposed particular requirements for the ownership or corporate
structure of CCAs, and CCAs currently exhibit a variety of ownership
and corporate structures. For example, FICC is wholly owned by the
Depository Trust & Clearing Corporation (``DTCC''), which is, in turn,
owned by the members of the clearing agencies owned by the DTCC.\64\
FICC operates on a cost plus low-margin model, meaning that its fees
are cost-based plus a markup as approved by the Board or management and
that this markup or ``low margin'' is applied to recover development
costs and operating expenses and to accumulate capital sufficient to
meet regulatory and economic requirements.\65\ Nevertheless, a CCA's
status as a for-profit organization does not preclude its ability to
meet its requirements under the Covered Clearing Agency Standards.
---------------------------------------------------------------------------

\64\ The members of such clearing agencies are required to
purchase common shares under DTCC's Shareholders Agreement as a
condition to use the clearing agencies' services and facilities.
See, e.g., FICC Rule 49, section 2, supra note 19. This differs from
other clearing agencies or clearing organizations in which the
shareholders are not limited to the participants of the clearing
agency and the clearing agency may be owned by a publicly traded
company.
\65\ See, e.g., Self-Regulatory Organizations; Fixed Income
Clearing Corporation; Notice of Filing and Immediate Effectiveness
of Proposed Rule Change to Amend Certain MBSD Fees, Exchange Act
Release No. 96575 (Dec. 22, 2022). In addition, because FICC is
member-owned, members may receive rebates when FICC collects excess
net income, which is defined as either income of FICC or one
business line of FICC after application of expenses, capitalization
costs, and applicable regulatory requirements. See FICC Rules, Fee
Structure, Section XII, supra note 19.
---------------------------------------------------------------------------

An additional commenter stated its belief that relinquishing
control of credit approval to a single entity poses a significant
problem, particularly, with all transactions going through FICC and
where margin requirements can be changed at any time. The commenter
stated that every firm has a different risk appetite and quantitative
and qualitative perspectives as it relates to credit analysis, which
are part of the professional services and expertise that well-run firms
offer, and that by inserting FICC into the center of the credit
approval process, firms lose their ability to apply their deeply
informed market views and differentiate themselves from
competitors.\66\
---------------------------------------------------------------------------

\66\ Letter from the Independent Dealer & Trader Association, at
9 (Dec. 27, 2022) (``IDTA Letter'').
---------------------------------------------------------------------------

The Commission disagrees that the requirement to clear eligible
secondary market transactions, which currently can be done only at
FICC, will remove firms' ability to differentiate themselves from their
competitors. FICC has no role in the relationship between a direct
participant and the direct participant's customers, and, indeed, the
Exchange Act provides that its rules cannot impose any schedule of
prices, or fix rates or other fees, for its participants' services.\67\
FICC's direct participants will remain free to determine what services
they will offer to their customers, and at what price, thereby
providing the ability for the direct participants to differentiate
themselves from their competitors.
---------------------------------------------------------------------------

\67\ 15 U.S.C. 78q-1(b)(3)(E).
---------------------------------------------------------------------------

The Commission also disagrees that margin requirements at FICC can
change at any time. FICC's margin methodology is part of its rules that
have been approved by the Commission, and changes to that methodology
must be filed with and reviewed by the Commission because of FICC's
status as a self-regulatory organization. The margin methodology, which
is part of FICC's approved rules, does provide some flexibility to FICC
to manage risk, and potentially increase margin requirements, in times
of market volatility and to guard against exposure to the CCP, but this
flexibility is not equivalent to FICC being able to alter its margin
requirements at any time. Pursuant to the Commission's rules, FICC
would be obligated to file for Commission review any proposed change to
its margin methodology and to file an advance notice of any proposed
change to its rules in the event that the change would materially alter
the nature or level of risk presented by the CCA, with both of these
processes involving notice and the opportunity for public comment.\68\
---------------------------------------------------------------------------

\68\ 15 U.S.C. 78s(b); Dodd-Frank Act Section 806(e); 17 CFR
240.19b-4.
---------------------------------------------------------------------------

Finally, one commenter also stated that any final rule should
expressly acknowledge the potential for multiple U.S. Treasury
securities CCAs and prohibit a clearing agency's rules from restricting
or impeding in any way their members' ability to clear U.S. Treasury
securities cash or repo transactions at another CCA.\69\ Such
clarification is unnecessary. The requirements being adopted apply to
any U.S. Treasury securities CCA and do not rely on the existence of
only one U.S. Treasury securities CCA. The Commission acknowledges that
there is the potential for multiple clearing agencies serving the U.S.
Treasury market under its regulatory framework, and that the existence
of additional U.S. Treasury securities CCAs would lower the
concentration risk that currently exists due to having a single CCA for
that market. Moreover, a rule prohibiting a clearing agency from
restricting or impeding in any way its member's ability to clear at
another CCA is also unnecessary because to be registered under Section
17A of the Exchange Act, a clearing agency's rules must not impose any
burden on competition not necessary or appropriate in furtherance of
the purposes of Section 17A.\70\
---------------------------------------------------------------------------

\69\ ICE Letter, supra note 33, at 2-3.
\70\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

c. Final Rule
For the reasons discussed in parts II.A.1.a and b supra, the
Commission is adopting Rule 17ad-22(e)(18)(iv) as proposed.\71\ This
requirement applies to all types of transactions that are of a type
currently accepted for clearing at a U.S. Treasury securities CCA; it
does not impose a requirement on a U.S. Treasury securities CCA to
offer additional products for clearing.
---------------------------------------------------------------------------

\71\ The Commission also amends the CFR designation of Rule
17Ad-22 in order to ensure the regulatory text conforms more
consistently with section 2.13 of the Document Drafting Handbook.
See Office of the Federal Register, Document Drafting Handbook (Aug.
2018 Edition, Revision 2.1, dated Oct. 2023), available at https://www.archives.gov/files/federal-register/write/handbook/ddh.pdf. In
particular, the Commission amends the CFR section designation for 17
CFR 240.17Ad-22 (Rule 17Ad-22) to replace the uppercase letter with
the corresponding lowercase letter, such that the rule is
redesignated as 17 CFR 240.17ad-22 (Rule 17ad-22).
---------------------------------------------------------------------------

2. Definition of Eligible Secondary Market Transactions
As part of Rule 17ad-22(a), the Proposing Release set forth a
definition of an eligible secondary market

[[Page 2723]]

transaction in U.S. Treasury securities \72\ subject to the requirement
to submit for clearance and settlement discussed in part II.A.1 above.
Specifically, the definition of an eligible secondary market
transaction \73\ would include:
---------------------------------------------------------------------------

\72\ The Commission did not receive any comments on its proposed
definition of ``U.S. Treasury security'' and is adopting that
definition as proposed.
\73\ As the Commission stated in the Proposing Release, the
amendment does not apply to the primary market, i.e., the issuance
and sale of a U.S. Treasury security to a primary dealer or other
bidder in a U.S. Treasury auction. Proposing Release, supra note 14,
87 FR 64621. Further, as the Commission also stated in the Proposing
Release, because trading in when-issued securities occurring the day
after the auction shares similar characteristics to secondary market
transactions and because such trading is already reported as a
secondary market transaction, the definition of an eligible
secondary market transaction would apply to when-issued trades that
occur the day after the auction and are considered on-the-run on
some IDBs, to the extent that such when-issued trades otherwise meet
the definition of an eligible secondary market transaction, as
discussed further in part II.A.2.ii infra. Id. However, because
when-issued trading occurring before and on the day of the auction
does not share these characteristics and is primarily used as a tool
for price discovery leading to the auction, such transactions would
not be encompassed by the definition. Id.
---------------------------------------------------------------------------

Repurchase agreements and reverse repurchase agreements in
which one of the counterparties is a direct participant;
Any purchases and sales entered into by a direct
participant if the direct participant (A) brings together multiple
buyers and sellers using a trading facility (such as a limit order
book) and (B) is a counterparty to both the buyer and seller in two
separate transactions; and
Any purchases and sales of U.S. Treasury securities
between a direct participant and a counterparty that is a registered
broker-dealer, government securities dealer, or government securities
broker, a hedge fund, or an account at a registered broker-dealer,
government securities dealer, or government securities broker where
such account may borrow an amount in excess of one-half of the value of
the account or may have gross notional exposure of the transactions in
the account that is more than twice the value of the account.
The Commission is adopting this rule, with modifications related to
repos by other clearing organizations (see part II.A.2.a.iii), inter-
affiliate repo transactions (see part II.A.2.a.vi), and state and local
government repo transactions (see part II.A.2.a.vii) and related to
cash transactions by hedge funds and leveraged accounts (see part
II.A.2.b.iii). The Commission discusses the proposed definitions and
the comments received thereupon in the following sections.
a. Repo Transactions
The proposed definition of an eligible secondary market transaction
would include, among other things, all U.S. Treasury repurchase and
reverse repurchase agreements entered into by a direct participant of a
U.S. Treasury securities CCA, subject to the exclusions discussed in
part XX infra. As explained in the Proposing Release, in a U.S.
Treasury repo transaction, one party sells a U.S. Treasury security to
another party (often referred to as the ``start leg'') and commits to
repurchase the security at a specified price on a specified later date
(often referred to as the ``end leg''), and a reverse repo transaction
is the same transaction from the buyer's perspective.\74\
---------------------------------------------------------------------------

\74\ Proposing Release, supra note 14, 87 FR 64616. The effect
of a repo transaction is similar to a cash loan, using U.S. Treasury
securities as collateral. Id. However, standard industry
documentation classifies the start and end legs of the repo
transaction as purchases and sales of securities. See, e.g., SIFMA,
Master Repurchase Agreement (September 1996 Version), available at
https://www.sifma.org/wp-content/uploads/2017/08/MRA_Agreement.pdf.
In this release, the term ``seller'' refers to the party selling
U.S. Treasury securities on the start leg of the transaction and
repurchasing them on the end leg of the transaction. The term
``buyer'' refers to the party purchasing the U.S. Treasury
securities on the start leg of the transaction and selling them on
the end leg of the transaction.
---------------------------------------------------------------------------

In the Proposing Release, the Commission stated that the available
data indicates that the volume of repo transactions that are
bilaterally cleared and settled remains substantial.\75\ Because of
this, FICC lacks visibility into its members' non-centrally cleared
repo trades, and the default of one counterparty can have cascading
effects on multiple other market participants, including members of
FICC, thereby risking contagion to the CCP.
---------------------------------------------------------------------------

\75\ Proposing Release, supra note 14, 87 FR 64616 (citing 2021
IAWG Report, supra note 4, at 29 (stating that non-centrally cleared
bilateral repo represents a significant portion of the market,
roughly equal in size to centrally cleared repo) (citing a 2015
pilot program by the Treasury Department); TMPG, Clearing and
Settlement Practices for Treasury Secured Financing Transactions
Working Group Update (``TMPG Repo White Paper''), at 1 (Nov. 5,
2021), available at https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/CSP_SFT_Note.pdf; Katy Burne, ``Future
Proofing the Treasury Market,'' BNY Mellon Aerial View, at 7 (Nov.
2021), available at https://www.bnymellon.com/content/dam/bnymellon/documents/pdf/aerial-view/future-proofing-the-us-treasury-market.pdf.coredownload.pdf (noting that 63% of repo transactions
remain non-centrally cleared according to Office of Financial
Research data as of Sept. 10, 2021); Sebastian Infante et al.,
Insights from revised Form FR2004 into primary dealer securities
financing and MBS activity (Aug. 5, 2022), available at https://www.federalreserve.gov/econres/notes/feds-notes/insights-from-revised-form-fr2004-into-primary-dealer-securities-financing-and-mbs-activity-20220805.htm (recent research with respect to primary
dealers indicates that 38% of their repo and 60% of their reverse
repo activity is not centrally cleared, and, overall, that 20% of
all their repo and 30% of their reverse repo activity is centrally
cleared through FICC)).
---------------------------------------------------------------------------

The Commission also stated its belief that, particularly with
respect to banks and dealers, an important potential benefit of repo
central clearing stems from mitigating the constraints on
intermediaries' balance sheets under the existing accounting and
regulatory capital rules.\76\ The Commission further stated that it
believes that the benefit of this resulting additional balance sheet
capacity could be shared by all market participants through improved
market liquidity and smooth market functioning.\77\
---------------------------------------------------------------------------

\76\ In effect, accounting rules allow purchases and sales of
the same security to be netted but do not allow repos of the same
security to be netted, unless the repos are with the same
counterparty and the trades have been documented under a master
netting agreement. See, e.g., Proposing Release, supra note 14, 87
FR 64621 (citing G-30 Report, supra note 5, at 13; Program on
International Financial Systems, Mandatory Central Clearing for U.S.
Treasuries and U.S. Treasury Repos, at 25-27 (Nov. 2021), available
at https://www.pifsinternational.org/wp-content/uploads/2021/11/PIFS-Mandatory-Central-Clearing-for-U.S.-Treasury-Markets-11.11.2021.pdf (``PIFS Paper'')). Thus, if a dealer's repos are all
with a U.S. Treasury securities CCA, greater netting is allowed.
\77\ See Committee on the Global Financial System, Repo Market
Functioning, at 24 (Apr. 2017), available at https://www.bis.org/publ/cgfs59.pdf.
---------------------------------------------------------------------------

The Commission also referenced that, as with cash markets, risk
management practices in the bilateral clearance and settlement of repos
are not uniform across market participants and are not transparent.\78\
Indeed, a recent publication stated that competitive pressures in the
bilaterally settled market for repo transactions have exerted downward
pressure on haircuts, sometimes to zero.\79\ The reduction of haircuts,
which serve as a counterparty credit risk mitigant in bilateral repos,
could result in greater exposure to potential counterparty default risk
in non-centrally cleared repos. The Commission stated that by contrast,
a U.S. Treasury securities CCA is subject to the Commission's risk
management requirements addressing financial, operational, and legal
risk management, which include, among other things, margin requirements
commensurate with the risks and particular attributes of each relevant
product, portfolio, and market.\80\ Therefore, repos cleared at a U.S.
Treasury securities CCA would be subject to transparent risk management
standards that are publicly available and

[[Page 2724]]

applied uniformly and objectively to all participants in the CCA.
---------------------------------------------------------------------------

\78\ TMPG Repo White Paper, supra note 75, at 1.
\79\ G-30 Report, supra note 5, at 13.
\80\ 17 CFR 240.17ad-22(e)(6).
---------------------------------------------------------------------------

Many commenters supported the definition of an eligible secondary
market transaction as it relates to repo and reverse repo
transactions.\81\ These commenters encouraged a broad and comprehensive
definition to limit market fragmentation and avoidance of central
clearing. Several other commenters that did not support a requirement
to clear eligible secondary market transactions still acknowledged that
repos were the most appropriate scope for such a requirement if one
were to be adopted. For example, one commenter agreed that a clearing
mandate applied to bilateral repo transactions would be beneficial,
pointing to the balance sheet efficiency resulting from repo clearing,
but stressing that this requirement be put in place only after the
Commission has strengthened the ability for market participants to
access central clearing.\82\ Another commenter stated that while the
case for clearing repos is ``marginally stronger'' than the case for
clearing cash transactions, it is ``far from convincing.'' \83\
---------------------------------------------------------------------------

\81\ See Letter from Jir[iacute] Kr[oacute]l, Deputy CEO, Global
Head of Government Affairs, Alternative Investment Management
Association, at 6-7 (Dec. 22, 2022) (``AIMA Letter''); AFREF Letter,
supra note 33, at 3; see generally Better Markets Letter, supra note
33; DTCC/FICC Letter, note 33; Letter from Ryan Sheftel, Global Head
of Fixed Income, GTS Securities, LLC (Jan. 6, 2023) (``GTS
Securities Letter''); LSEG Letter, supra note 33; Letter from ARB
Trading Group LP, Citadel Securities, DRW Holdings, LLC, Eagle Seven
LLC, Geneva Trading USA, LLC, Hard Eight Futures, LLC, Hudson River
Trading LLC, IMC Trading, Jump Trading Group, Kore Trading LLC,
Optiver, Quantlab Financial, LLC, WH Trading LLC, and XR Trading
LLC, at 4 (Dec. 27, 2022) (``ARB et al. Letter''); Letter from
Manfred E. Will, Founder & CEO, MEW Consul (Oct. 24, 2022); Letter
from Shiv Rao, Chairman, Sunthay Holdings LLC, at 2 (Dec. 27, 2022);
and Letter from Elisabeth Kirby, Head of U.S. Market Structure,
Tradeweb Markets Inc. (Dec. 27, 2022). One commenter, while broadly
supporting the definition of an eligible secondary market repo and
reverse repo transaction, recommended excluding Derivatives Clearing
Organizations (``DCO'') registered with the CFTC. See Letter from
Jonathan Marcus, Senior Managing Director and General Counsel, CME
Group Inc., at 6-7 (Dec. 27, 2022) (``CME Letter'') and part
II.A.2.iii infra. Other commenters, while broadly supporting the
definition, recommended excluding transactions executed on the
triparty repo platform. See Letter from Stephen John Berger,
Managing Director, Global Head of Government & Regulatory Policy,
Citadel and Citadel Securities (Dec. 27, 2022) (``Citadel Letter''),
Letter from Jennifer W. Han, Executive Vice President, Chief Counsel
& Head of Global Regulatory Affairs, Managed Funds Association at 6,
14 (Dec. 21, 2022) (``MFA Letter''), and part II.A.2.i infra.
\82\ MFA Letter, supra note 81, at 13 (supporting inclusion of
bilateral repo and reverse repo).
\83\ SIFMA AMG Letter, supra note 35, at 11.
---------------------------------------------------------------------------

Other commenters questioned the need for a requirement with respect
to repo, noting that the balance sheet netting efficiencies already
exist, providing a natural incentive to centrally clear such
transactions.\84\ The Commission agrees that centrally cleared repo
already benefits from favorable treatment on balance sheet, but also
recognizes that, by definition, a requirement to clear repo
transactions should result in more transactions being centrally
cleared. Thus, there would still be benefits from the requirement,
despite the currently existing balance sheet treatment, as discussed
further in part IV.C.1.a.ii.
---------------------------------------------------------------------------

\84\ See, e.g., SIFMA AMG Letter, supra note 35, at 4; SIFMA-IIB
Letter, supra note 37, at 4.
---------------------------------------------------------------------------

In addition, some commenters supported excluding particular types
of repos from the definition, and other commenters supported excluding
particular types of market participants engaging in repos from the
definition. The Commission discusses these comments in the following
parts.
i. Triparty Repo
Several commenters supported excluding triparty repos from the
definition of an eligible secondary market transaction.\85\ One
commenter suggested that the cost of including triparty repos would
outweigh the benefits, and other commenters raised similar
concerns.\86\ The discussion of additional costs and benefits arising
from the inclusion of triparty repos within the definition of an
eligible secondary market transaction is provided in part IV.C.2 infra.
Several commenters argued that including triparty repos would not
significantly reduce the risks that the proposal seeks to address
because the current triparty market infrastructure inherently mitigates
the associated risks.\87\ Specifically, these commenters argue that
credit risk in the triparty market is mitigated by the triparty agent's
provision of custodial, collateral management, and settlement
services.\88\
---------------------------------------------------------------------------

\85\ See MFA Letter, supra note 81, at 6, 14; SIFMA-IIB Letter,
supra note 37, at 20-21; SIFMA AMG Letter, supra note 35, at 6, 11;
Letter from Sarah A. Bessin, Deputy General Counsel, and Nhan
Nguyen, Assistant General Counsel, Investment Company Institute at
22-23 (Dec. 23, 2022) (``ICI Letter''); Citadel Letter, supra note
81, at 6; Letter from Deborah A. Cunningham, Executive Vice
President, Chief Investment Officer of Global Liquidity Markets, and
Senior Portfolio Manager, Susan R. Hill, Senior Vice President,
Senior Portfolio Manager and Head of Government Liquidity, and David
R. McCandless, Corporate Counsel, Federated Hermes at 5 (Dec. 28,
2022) (``Federated Letter''); Letter from Sebastian Crapanzano,
Managing Director, Morgan Stanley, at 2 (Nov. 15, 2023) (``Morgan
Stanley Letter'').
\86\ See MFA Letter, supra note 81, at 6, 14; see also SIFMA/IIB
Letter, supra note 37, at 20; ICI Letter, supra note 85, at 11;
Federated Letter, supra note 85, at 5.
\87\ See MFA Letter, supra note 81, at 14; SIFMA/AMG Letter,
supra note 35, at 11; ICI Letter, supra note 85, at 12, 22; Citadel
Letter, supra note 81, at 6; Federated Letter, supra note 85, at 5.
\88\ See id.
---------------------------------------------------------------------------

Moreover, one commenter stated that the infrastructure underlying
the triparty repo market is robust and provides credit protections,
operational safeguards, and strict internal controls akin to central
clearing.\89\ One commenter stated that the triparty agent's ability to
handle the settlement of triparty repos through its collateral
allocation system has resulted in a well-functioning process that
operates under severe time constraints.\90\ One commenter added that
the triparty market is relatively safe from credit risk because the
triparty agent is subject to prudential regulation.\91\ One commenter
added that settlement risk in the triparty market is nearly eliminated
because collateral posted to the triparty platform cannot generally be
repledged outside the platform.\92\ The commenter stated, therefore,
that the only significant source of settlement risk is the rare
occurrence of a counterparty's nonpayment of the repurchase price,
which is generally attributable to operational risk as opposed to
credit risk.\93\ Another commenter stated that these types of triparty
repos, described as secured funding transactions where the funding
counterparty has no rehypothecation rights, do not appear to raise
concerns discussed in the proposal regarding the use of transactions to
generate leverage that would warrant imposition of the requirement to
clear eligible secondary market transactions.\94\
---------------------------------------------------------------------------

\89\ See ICI Letter, supra note 85, at 22.
\90\ See Federated Letter, supra note 85, at 3.
\91\ See MFA Letter, supra note 81, at 14.
\92\ See Federated Letter, supra note 85, at 5.
\93\ See Federated Letter, supra note 85, at 5.
\94\ Morgan Stanley Letter, supra note 85, at 2.
---------------------------------------------------------------------------

Despite supporting the exclusion of triparty repos from the
definition of an eligible secondary market transaction, one commenter
acknowledged that the triparty agent ``does not fulfill a CCP role--it
does not guarantee either counterparty's performance through novation
or otherwise and does not assume counterparty risk.'' \95\ For this
reason, triparty repos will not be excluded from the definition of an
eligible secondary market transaction.
---------------------------------------------------------------------------

\95\ ICI Letter, supra note 85, at 33.
---------------------------------------------------------------------------

The Commission recognizes that the current triparty market
infrastructure incorporates credit protections, operational safeguards,
and strict internal controls. The Commission also recognizes that the
triparty agent's current processes for handling the settlement of
triparty repos generally

[[Page 2725]]

function well. However, the triparty agent does not serve as a central
counterparty, meaning that it does not guarantee either counterparty's
performance through novation or assume counterparty risk, and
therefore, the Commission disagrees with the contention that the
current market infrastructure incorporates controls equivalent to those
available through central clearing. The Commission recognizes that the
triparty agent is subject to heightened prudential regulation.\96\
However, the triparty agent is not subject to regulatory supervision as
a CCP, which entails additional protections against the risk of many
market participants acting to liquidate similar collateral in the event
of a default in a non-centrally cleared environment. A U.S. Treasury
securities CCA is subject to the Commission's risk management
requirements addressing financial, operational, and legal risk
management, which include, among other things, margin requirements
commensurate with the risks and particular attributes of each relevant
product, portfolio, and market and also include certain requirements
applicable only to covered clearing agencies that are serving as
central counterparties.\97\ In contrast, a triparty agent is not
equipped with a mechanism to manage the risk of collateral fire-sale in
the aftermath of a counterparty default.\98\ As a result, a U.S.
Treasury securities CCA is better positioned to handle a large,
unexpected default than a triparty agent. The possibility that a direct
participant in a U.S. Treasury securities CCA with large, unsettled
trading volumes (bilateral or triparty) could fail creates contagion
risk to the CCA, as well as to the market as a whole. This rulemaking
is designed to ameliorate that contagion risk, at least in part.
Accordingly, the Commission does not believe that the current triparty
market infrastructure alone mitigates the aforementioned contagion risk
sufficiently to warrant excluding triparty repos from the definition of
an eligible secondary market transaction. In response to the commenter
who stated that most risks are eliminated because collateral cannot be
posted outside the triparty platform, the Commission disagrees.
Significant risks exist if concerns emerge regarding the financial
condition of sellers in the triparty market.\99\ In such scenarios,
even though collateral stays within the triparty platform, the buyer
could still experience distress following a sudden default of a
triparty repo counterparty.\100\ For example, a triparty repo default
may leave a money market fund holding long-dated Treasury securities
collateral, which may cause the money market fund to no longer meet
requirements under rule 2a-7 relating to the weighted average life to
maturity of the fund's portfolio.\101\ A spike in market volatility
accompanying an event of default and potential collateral liquidation
activity by buyers could cause liquidity stress for the financial
system leading to decline in collateral value even for the most
creditworthy assets such as U.S. Treasury securities. A U.S. Treasury
securities CCA is better positioned to manage a repo counterparty
default by employing a range of available pre-funded resources without
reliance on repo collateral liquidation.\102\ In contrast, the triparty
platform is not designed to manage risks associated with a repo
counterparty default and a potential collateral liquidation following
the default. In a triparty repo transaction, the triparty custodian
bank holds the collateral on behalf of the buyer. However, the buyer is
responsible for initiating and managing the collateral liquidation
process, including Treasury securities, if the liquidation is
necessary.\103\
---------------------------------------------------------------------------

\96\ The triparty agent is supervised and/or regulated by, among
others, New York State Department of Financial Services, and the
Federal Reserve Bank of New York. See https://www.bnymellon.com/us/en/disclaimers/business-disclaimers. Additionally, the triparty
agent is designated as a Global Systemically Important Bank by the
Financial Stability Board. See https://www.fsb.org/wp-content/uploads/P211122.pdf.
\97\ 17 CFR 240.17ad-22(e)(6).
\98\ See, e.g, Brian Begalle et al., The Risk of Fire Sales in
the Tri-Party Repo Market, N.Y. Fed Staff Report No. 616 (``Begalle
et al.''), at 9-14, available at, https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr616.pdf.
\99\ See 2013 Annual Report of the Financial Stability Oversight
Council, at 4, 12-13, 133-134, available at https://home.treasury.gov/system/files/261/FSOC-2013-Annual-Report.pdf
(``FSOC 2013 Annual Report''); Begalle et al., supra note 98
(discussing concern that stress caused by a potential default of a
triparty repo counterparty can lead to either pre-default fire sales
of assets by the counterparty or post-default fire sales of
collateral by the triparty repo investor and the related financial
stability concerns). See also 2019 Annual Report of the Financial
Stability Oversight Council, at 11, available at https://home.treasury.gov/system/files/261/FSOC2019AnnualReport.pdf
(highlighting that the possibility of fire sales of collateral by
creditors of a defaulted counterparty in the triparty repo market
remains a financial system vulnerability despite the triparty repo
infrastructure reform).
\100\ See FSOC 2013 Annual Report, supra note 99, at 12-13
(recognizing that a major broker-dealer's default could threaten
financial stability as the broker-dealers' creditors liquidate the
collateral pledged against their tri-party repo lending, with the
fire sales of this collateral potentially destabilizing financial
markets and amplifying the negative consequences of such a default).
\101\ See 17 CFR 270.2a-7(d)(1). In addition, the money market
fund holding the collateral may cause liquidity concerns under rule
2a-7. See 17 CFR 270.2a-7(d)(4).
\102\ 17 CFR 240.17ad-22(e)(13).
\103\ Baklanova, et al., Reference Guide to U.S. Repo and
Securities Lending Markets, OFR Working Paper No15-17 (Sept. 2015),
available at: https://www.financialresearch.gov/working-papers/files/OFRwp-2015-17_Reference-Guide-to-U.S.-Repo-and-Securities-Lending-Markets.pdf.
---------------------------------------------------------------------------

One commenter argued that including triparty repos in the
definition of an eligible secondary market transaction would likely
impair the cash and collateral management processes of hedge funds and
alternative asset managers.\104\ Specifically, the commenter suggested
that such firms currently conduct same-day bilateral transactions that
they would not be able to conduct with a direct participant of a U.S.
Treasury securities CCA required to centrally clear its repo
transactions.\105\ Similarly, another commenter argued that including
triparty repos would prevent participants, such as money market funds,
from conducting transactions on a short term (i.e., overnight) basis
when U.S. Treasury securities CCAs are at full capacity.\106\
---------------------------------------------------------------------------

\104\ See MFA Letter, supra note 81, at 17.
\105\ See id.
\106\ See ICI Letter, supra note 85, at 12, 22.
---------------------------------------------------------------------------

The Commission disagrees with these commenters. In its supervisory
capacity, the Commission is aware that registered funds, hedge funds,
and alternative asset managers currently conduct centrally cleared
triparty repo transactions. For example, the Commission is aware that
numerous hedge funds conduct such same-day transactions as sponsored
members of FICC. Therefore, the existing operational infrastructure
supports centrally cleared triparty repo transactions. The FICC
novation window for all delivery-versus-payment trades, including the
sponsored repo service, remains open until 8 p.m. (ET) and therefore is
available for a later-day trading.\107\ Additionally, the Commission
disagrees that there is a finite ``full capacity'' at a U.S. Treasury
securities CCA. The Commission understands that increased demand for a
CCA service may lead to a higher volume of trading activity by existing
members and, in certain circumstances, reduce members' ability or
willingness to facilitate their clients' access to central clearing, if
such members do not wish to grow this line of business. However, higher
demand for access to central clearing could also present an opportunity
for dealers that

[[Page 2726]]

do not currently offer such services to enter the market, resulting in
growing CCA capacity, more competition among its members, and a wider
range of available repo counterparties. The Commission also understands
that the existing U.S. Treasury securities CCA may consider, as
appropriate, additional changes to their operational infrastructure and
trading capacity, including revisions to the eligibility criteria for
sponsored membership and an extension of the trade submission and
novation windows later in the day,\108\ to enhance their ability to
accommodate any increase in the volume of centrally cleared triparty
repo transactions resulting from this rulemaking.
---------------------------------------------------------------------------

\107\ See DTCC, Looking to the Horizon: Assessing a Potential
Expansion of U.S. Treasury Central Clearing, Sept. 2023 (``DTCC 2023
White Paper''), available at https://www.dtcc.com/-/media/Files/Downloads/WhitePapers/Accessing-Potential-Expansion-US-Treasury-Clearing-White-Paper.pdf.
\108\ Id.
---------------------------------------------------------------------------

One commenter expressed concern that the centrally cleared triparty
repo market has only been available since 2021 and is therefore,
relatively untested.\109\ Therefore, the commenter suggested that the
Commission should delay its decision whether to include triparty repos
in the definition of an eligible secondary market transaction until
after the Commission has had an opportunity to evaluate the
effectiveness of the centrally cleared triparty repo
infrastructure.\110\ The Commission disagrees. While FICC expanded its
Sponsored Service in 2021 to enable sponsored members (e.g., registered
funds) to conduct centrally cleared triparty repo transactions,\111\
FICC has been facilitating such transactions for its direct
participants via the General Collateral Finance (``GCF'') Repo Service
since 1998.\112\ Additionally, although the expanded Sponsored Service
is relatively new, the infrastructure is operational, and its usage
appears to be increasing. Data provided by the Federal Reserve show a
significant increase in the gross value of Treasury securities traded
in GCF Repo since March 2020.\113\ Additionally, as stated above, the
Commission understands that the U.S. Treasury securities CCA is
consulting with market participants and is considering steps to further
enhance its operational infrastructure to support any increase in the
volume of centrally cleared triparty repo transactions resulting from
this rulemaking.\114\
---------------------------------------------------------------------------

\109\ See MFA Letter, supra note 81, at 12, 14.
\110\ See id.
\111\ Securities Exchange Act Release No. 92799 (Aug. 27, 2021),
86 FR 49387 (Sept. 2, 2021) (SR-FICC-2021-801); Securities Exchange
Act Release No. 92014 (May 25, 2021), 86 FR 29334 (June 1, 2021)
(SR-FICC-2021-003).
\112\ Securities Exchange Act Release No. 40623 (Oct. 30, 1998),
63 FR 59831 (Nov. 5, 1998) (SR-GSCC-98-02).
\113\ Federal Reserve, GCF Repo (showing that the daily snapshot
of the Treasury securities value traded in the GCF repo segment was
under $120 billion on Mar. 10, 2020. The value reported on June 9,
2023 was over $320 billion, which includes sponsored activity),
available at https://www.newyorkfed.org/data-and-statistics/data-visualization/tri-party-repo#interactive/tripartygcf.
\114\ See DTCC 2023 White Paper, supra note 107.
---------------------------------------------------------------------------

Finally, commenters argued for the exclusion from the definition of
an eligible secondary market transaction of triparty repos involving
purchased securities that include both Treasury CUSIPs and securities
with other CUSIPs or where permitted substitution may be made in CUSIPs
other than Treasury CUSIPs. According to the commenters, the fact that
some CUSIPs in a mixed triparty repo are U.S. Treasury security CUSIPs
should not bring that transaction into the definition of an eligible
secondary market transaction if it were of a type that is entered into
in the ordinary course of business or otherwise in connection with a
legitimate business purpose. The commenters stated that without such an
exemption, the definition of an eligible secondary market transaction
could scope in transactions of which U.S. Treasury securities only
represent a small component, which would exceed the regulatory
objective behind the proposal, and stated that such transactions do
have margin collected.\115\
---------------------------------------------------------------------------

\115\ See SIFMA/IIB Letter, supra note 37, at 20-21; Letter from
Jiri Krol, Deputy CEO, Global Head of Government Affairs,
Alternative Investment Management Association (Oct. 20, 2023) at 3
(``AIMA Letter II''); see also Citadel Letter, supra note 81, at 6
(supporting that the Commission exclude triparty repos at this
stage, noting that they may include both Treasury and non-Treasury
securities as collateral).
---------------------------------------------------------------------------

The Commission understands that market participants may use U.S.
Treasury securities as permissible substitutions for other types of
collateral and generally should not consider mixed CUSIP triparty repos
resulting from such a permissible substitution as within the scope of
part (i) of the definition of an eligible secondary market transaction.
Collateral substitution allows a repo seller to complete trade
settlement even if the type of collateral securities agreed upon at the
time of trade initiation is no longer available. Typically, Treasury
securities or cash can be permissible substitution.\116\ However, to
the extent that a mixed CUSIP triparty repo contains U.S. Treasury
CUSIPs from the outset of the transaction, such a transaction would be
included in the scope of part (i) of the definition of an eligible
secondary market transaction. An exclusion for such transactions is not
necessary because the counterparties specifically structured the
transaction to include U.S. Treasury securities; therefore, such a
transaction is within the scope of the definition. Data submitted by
money market funds on Form N-MFP shows that the holdings reported as
U.S. Government Agency Repurchase Agreements are typically
collateralized by U.S. government agency securities and are also
partially collateralized by Treasury securities.\117\ Collateral
management practices may evolve to better delineate collateral types in
light of the definition of an eligible secondary market transaction.
---------------------------------------------------------------------------

\116\ For example, money market fund filings of portfolio data
show that, on average, Treasury securities account for around 3% of
collateral backing investments in non-government repos.
\117\ Money market fund filings of portfolio data show that, on
average, Treasury securities account for around 20% of collateral
backing investments in U.S. government agency repos.
---------------------------------------------------------------------------

ii. Repos by Registered Funds
Registered investment companies, or registered funds, that is,
those entities that are registered under the Investment Company Act of
1940 (``1940 Act''), including money market funds and exchange-traded
funds, are important participants in the U.S. Treasury repo market.
Filings of Form N-MFP by money market funds show that, as of September
30, 2023, these funds invested approximately $2.2 trillion in Treasury
repos.\118\ In addition, mutual funds invested $37 billion in
repurchase agreements, including those backed by Treasury
securities.\119\ Generally, commenters acknowledged that central
clearing of Treasury repos and reverse repos through the FICC Sponsored
Service, which has been available to registered funds since 2005,
provides additional collateral supply.\120\ FICC data shows that at the
end of November 2023, the daily volume of sponsored ``delivery-versus-
payment'' Treasury repo activity was approximately $820 billion, while
the daily volume of sponsored activity in the triparty GCF repo was
close to $130 billion.\121\
---------------------------------------------------------------------------

\118\ Of this amount, approximately $1.5 trillion was invested
in the Federal Reserve's overnight reverse repo facility. See U.S.
Securities and Exchange Commission, Money Market Fund Statistics
(Sept. 2023), available at https://www.sec.gov/divisions/investment/mmf-statistics. Repo transactions with the central bank are excluded
from the scope of Eligible Secondary Market Transactions.
\119\ Federal Reserve, Financial Accounts of the United States,
Table L.207 Federal Funds and Security Repurchase Agreements (2023
Q2).
\120\ ICI Letter, supra note 85, at 13; Federated Letter, supra
note 85, at 2; DTCC/FICC Letter, supra note 33, at 17.
\121\ See DTCC, Sponsored DVP and Sponsored GC Activity,
available at https://www.dtcc.com/charts/membership, which also
shows data over a longer timeframe for reference.

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

[[Page 2727]]

Several commenters stated that they did not support including repo
transactions with registered funds as a counterparty in the definition
of an eligible secondary market transaction, which, as proposed, would
include repo transactions with all counterparties.\122\ One commenter
stated that the Commission should not, at this time, require that repos
between a fund and a direct participant of a U.S. Treasury securities
CCA be subject to a clearing requirement because the current clearing
framework is not sufficiently developed to support such a mandate.\123\
The commenter identified several issues to be addressed prior to
adopting such a requirement, which are discussed in the following
paragraphs.
---------------------------------------------------------------------------

\122\ ICI Letter, supra note 85, at 12-28; Federated Letter,
supra note 85, at 2-6.
\123\ ICI Letter, supra note 85, at 12.
---------------------------------------------------------------------------

First, the commenter stated that the Commission should encourage
FICC to enhance its Sponsored Service in several ways, to address
regulatory, structural, and operational issues raised by the proposal.
The commenter stated that the Commission should encourage FICC to
further develop a ``give up'' structure to facilitate best execution.
The commenter described this as a ``critically important step'' to
incentivize voluntary clearing, because it would generate increased
competition among market participants, which may result in more
efficient pricing. The commenter also stated that a ``give up''
structure would be essential under a requirement to centrally clear
eligible secondary market transactions because the Sponsored Service
may not be able to meet the increased capacity requirements due to the
limited number of sponsoring members and the increased demand for
sponsored clearing under such a requirement. The commenter suggested
that the infrastructure currently used by FICC for prime brokerage
clearing could be leveraged to develop a give up model, stating that
any such model will need to provide for standardized documentation that
facilitates additions and deletions of approved brokers, agreed-upon
terms for rejection of trades by a sponsoring member, and centralized
storage of delegation.\124\
---------------------------------------------------------------------------

\124\ ICI Letter, supra note 85, at 13-14.
---------------------------------------------------------------------------

The commenter requested that the SEC encourage FICC to establish a
feature allowing (but not requiring) registered fund sponsored members
to support their obligations by having margin posted with FICC (``FICC
registered fund margin arrangement'') rather than by paying fees to the
sponsoring member.\125\ FICC's rules currently provide that each
sponsoring member must make a deposit to FICC's Clearing Fund based on
the activity of its sponsored members.\126\ The contributions of all
Netting Members, including those that are sponsoring members, are
commingled in the Clearing Fund and are available to FICC for, among
other things, securing members' obligations and providing liquidity to
meet its settlement obligations.\127\ While the commenter stated that
the Sponsored Service under current FICC rules does not raise custody
issues for registered funds under the 1940 Act because registered funds
are not required to post margin to FICC, if a fund's margin were
permitted to be posted with FICC, that could raise custody issues for
funds unless such funds receive relief from certain provisions of the
1940 Act.\128\ The commenter stated that permitting registered funds'
margin to be posted with FICC could reduce costs for registered funds
and facilitate their use of cleared reverse repos and term repos.\129\
The commenter also stated that the final rule should require FICC to
establish margin rules that ensure that margin is held in a segregated
manner, not commingled with any direct participant's house margin, and
not be subject to loss mutualization associated with other direct
participants.\130\ Finally, the commenter stated that in order to
address concerns regarding the security of registered fund assets under
a Treasury repo clearing mandate, FICC rules addressing margin posting
would need to be amended to provide for enhanced recordkeeping,
internal controls, and transparency around the positions and related
margin.\131\
---------------------------------------------------------------------------

\125\ ICI Letter, supra note 85, at 14; Letter from Jennifer W.
Han, Executive Vice President, Chief Counsel & Head of Global
Regulatory Affairs, Managed Funds Association (Dec. 4, 2023), at 4
(``MFA Letter II''). See also MFA Letter, supra note 81, at 7
(noting that ``an indirect participant should have the ability
(although not the obligation) to fund the margin obligations of the
direct participant clearing on its behalf which are attributable to
the indirect participant. In such case, the margin posted by the
indirect participant should be segregated from the direct
participant's house margin, and it should not be subject to loss
mutualization vis-[agrave]-vis other direct participants. Given that
many indirect participants have fiduciary obligations to their own
clients, it is crucial that indirect participants are able to post
margin on a segregated basis such that their clients are not subject
to the credit risk of others (and, likewise, that their funds are
not subject to loss mutualization).''); SIFMA/IIB Letter, supra note
37, at 12-13 (noting that ``it will be difficult to support
expanding cleared trading in U.S. Treasury securities until we have
a framework which ensures customers can access clearing solutions
where their margin and collateral will be adequately protected,
including from loss mutualization by the clearing agency'').
\126\ FICC Rule 3A, section 10, supra note 19.
\127\ FICC Rule 4, supra note 19.
\128\ Section 17(f) of the 1940 Act (providing that ``[e]very
registered management company shall place and maintain its
securities and similar investments in the custody of (A) a bank or
banks having the qualifications prescribed in paragraph (1) of
section 26(a) of this title for the trustees of unit investment
trusts; or (B) a company which is a member of a national securities
exchange as defined in the Securities Exchange Act of 1934, subject
to such rules and regulations as the Commission may from time to
time prescribe for the protection of investors; or (C) such
registered company, but only in accordance with such rules and
regulations or orders as the Commission may from time to time
prescribe for the protection of investors.''). See also rule 17f-1
under the 1940 Act (permitting registered funds to custody assets
with a member of a national securities exchange as defined in the
1934 Act pursuant to certain conditions).
\129\ ICI Letter, supra note 85, at 14.
\130\ Id.
\131\ See id. (``Enhanced recordkeeping and related controls are
critical to appropriately identifying ownership of assets during a
Treasury repo or reverse repo transaction particularly since, unlike
a typical derivates or cash transaction, ownership of the Treasury
securities underlying a repo or reverse repo change owners during
the transaction.'').
---------------------------------------------------------------------------

In order to support a clearing requirement for eligible secondary
market transactions, the Commission is taking the position that, for a
period of five years, registered funds utilizing such an arrangement in
a manner consistent with the circumstances described below would not
provide a basis for enforcement action under Section 17(f) of the 1940
Act. The Commission takes this position to recognize the unique
circumstances facing registered funds in the context of entering into
eligible secondary market transactions using FICC's Sponsored Program.
Our staff has previously stated that it would not recommend
enforcement action under the custody provisions of the 1940 Act in the
context of certain registered fund trading activities.\132\ For
example, the staff issued the Delta Letter in connection with Delta's
options clearing service, which provided assurances that the staff
would not recommend enforcement action under

[[Page 2728]]

Section 17(f) of the 1940 Act if registered investment companies
deposited margin with Delta.\133\ One representation in the Delta
Letter was that Delta was permitted to withdraw the margin provided
``only upon the investment company's default on the option contract.''
\134\ Other previous staff no-action positions have been provided in
different contexts. In one such no-action position, FICC represented
that a registered fund's margin would not be used to cover another
client's default and segregating fund assets from the custodian's
proprietary assets and other customers' assets.\135\ These types of
features would help protect fund client assets consistent with the 1940
Act under the FICC registered fund margin arrangement, and we have
included similar types of features for purposes of our position that
follows below.
---------------------------------------------------------------------------

\132\ See e.g., Delta Government Options Corp. No-Action Letter
(pub. avail. Sept. 27, 1990) (``Delta Letter''); cf. CME Group, Inc.
No-Action Letter (pub. avail. Dec. 19, 2017); FICC No-Action Letter
(pub. avail. Mar. 13, 2003) (``FICC 2003 Letter''). In the FICC
Letter, the staff observed certain operational features of FICC's
Mortgage-Backed Securities Division (``MBSD''), which differ from
the current circumstances of FICC's Government Securities Division,
such as registered funds being direct participants in MBSD's
clearing scheme and participant trades not being novated to MBSD.
Any staff statements cited represent the views of the staff. They
are not a rule, regulation, or statement of the Commission.
Furthermore, the Commission has neither approved nor disapproved
their content. These staff statements, like all staff statements,
have no legal force or effect: they do not alter or amend applicable
law; and they create no new or additional obligations for any
person.
\133\ Delta Letter.
\134\ Id.
\135\ See FICC 2003 Letter.
---------------------------------------------------------------------------

While the final rules do not require registered funds' margin to be
posted with FICC, and no current U.S. Treasury securities CCA has rules
imposing such a requirement, as discussed above, a commenter requested
that the Commission encourage FICC to establish a FICC registered fund
margin arrangement.\136\ The Commission agrees that facilitating the
ability for a registered fund's margin to be posted at FICC as an
alternative to the sponsoring member posting the margin and passing the
cost of doing so through to the registered fund may lower the cost of
trading for the fund, and the Commission position below will help
facilitate the posting of registered fund margin \137\ to satisfy a
U.S. Treasury securities CCA's margin deposit requirements.
---------------------------------------------------------------------------

\136\ See ICI Letter, supra note 85, at 14.
\137\ The Commission position is intended to address certain
considerations under the 1940 Act specific to registered funds.
Other types of buy-side participants may have different
considerations to address in connection with their participation in
the Sponsored Program beyond the scope of the 1940 Act.
---------------------------------------------------------------------------

Specifically, the Commission takes the position that, for a period
of five years beginning on the effective date of this adopting release,
if a registered investment fund's cash and/or securities are placed and
maintained in the custody of FICC for purposes of meeting FICC's margin
deposit requirements that may be imposed for eligible secondary market
transactions in connection with the fund's participation in the
Sponsored Program, it would not provide a basis for enforcement action
under Section 17(f) of the 1940 Act so long as: \138\
---------------------------------------------------------------------------

\138\ To the extent a registered fund becomes aware that its
custodial arrangement is no longer consistent with the FICC
registered fund margin framework, the registered fund may not
utilize the FICC registered fund margin framework to enter into
eligible secondary market transactions.
---------------------------------------------------------------------------

FICC withdraws the margin provided by a sponsored member
registered fund only upon that registered fund's default; \139\
---------------------------------------------------------------------------

\139\ For the avoidance of doubt, FICC may only withdraw margin
provided by a registered fund in the event that the registered fund
defaults on a transaction that has been novated to FICC.
---------------------------------------------------------------------------

The margin provided by a registered fund is not commingled
with, and is kept separate from, FICC's assets; \140\
---------------------------------------------------------------------------

\140\ See FICC Letter; see also Institutional Equity Fund No-
Action Letter (pub. avail. Feb. 27, 1984) (stating that the staff
would not recommend enforcement action under Section 17(f) of the
1940 Act if, among other things, the assets of a registered fund
participating in the Options Clearing Corporation's program were
held in a ``non-proprietary account at OCC which does not include
any assets held by the Clearing Member agent other than as a
fiduciary, custodian or otherwise for customers'').
---------------------------------------------------------------------------

FICC segregates on its books and records the margin
provided by a registered fund (or series thereof, as applicable), and
identifies a value of margin in its books and records as being
attributable to the registered fund;
The entity that FICC uses to custody such margin is an
eligible fund custodian under the 1940 Act and the applicable rules
thereunder; \141\
---------------------------------------------------------------------------

\141\ See Section 17(f) of the 1940 Act and the rules
thereunder.
---------------------------------------------------------------------------

The margin provided by a registered fund is not subject to
loss mutualization \142\ or allocation; \143\
---------------------------------------------------------------------------

\142\ See FICC 2003 Letter at n. 18.
\143\ See e.g., FICC Rule 4, supra note 19.
---------------------------------------------------------------------------

The margin provided by a registered fund is not used by
FICC for any purpose other than in connection with that registered
fund's default as a sponsored member; \144\
---------------------------------------------------------------------------

\144\ For purposes of this Commission position, FICC is not
permitted to use registered fund margin for default liquidity
purposes.
---------------------------------------------------------------------------

Registered funds receive quarterly statements of accounts
concerning the margin provided in connection with eligible secondary
market transactions showing, at a minimum, the name of the account,
asset movements during the quarter, and quarter-end positions; and
The account into which a registered fund's margin is
deposited is governed by a contract by and among the registered fund,
its sponsoring member, and FICC providing for an arrangement consistent
with this Commission position, (together, the ``FICC registered fund
margin framework'').\145\
---------------------------------------------------------------------------

\145\ The Commission notes that this position only applies with
respect to the custody of registered fund margin, and does not apply
to cash or collateral received under a sponsored repo or reverse
repo trade. Further, this position does not impact any other
obligation that a registered fund has in connection with its
participation in the Sponsored Program or under the 1940 Act and
rules thereunder.
---------------------------------------------------------------------------

In general, Section 17(f) of the 1940 Act and the rules thereunder
govern the safekeeping of investment company assets.\146\ The FICC
registered fund margin framework is designed to protect fund investor
assets, consistent with the principles of the 1940 Act.\147\ The
framework would seek to adequately protect registered fund assets by
isolating them from FICC's proprietary assets and segregating them on
FICC's books and records from the sponsoring member's other customers,
preventing registered fund assets from being used to cover any
obligation other than an obligation of that registered fund, limiting
FICC's ability to use registered fund margin for any purpose other than
an obligation of the registered fund as a sponsored member, and
prohibiting registered fund assets from being subject to loss
mutualization or allocation.\148\ Five years is intended to provide
sufficient time for FICC to develop and file any proposed rule changes
under Section 19(b) of the Exchange Act that may be relevant to
facilitate a registered fund's ability to have its margin posted at
FICC consistent with the FICC registered fund margin framework. The
Commission will consider any proposed rule changes consistent with its
obligations under Section 19(b) of the Exchange Act in the event that
FICC submits any proposal to facilitate a registered fund's ability to
have its margin posted at FICC consistent with the FICC registered fund
margin framework in the future, and providing this position for five
years will also provide sufficient time for the Commission to determine
if extending or revising this position is appropriate. Five years is
intended to provide sufficient time for market participants to consider
other potential frameworks for the posting of registered fund margin to
satisfy FICC's margin deposit requirements and to gain insight into the
merits of such frameworks.\149\
---------------------------------------------------------------------------

\146\ The legislative history of section 17(f) indicates that
Congress intended the assets of investment companies to be kept by a
financially secure entity that has sufficient safeguards against
misappropriation. See Investment Trusts and Investment Companies:
Hearings on S. 3580 Before a Subcomm. of the Senate Comm. on Banking
and Currency, 76th Cong., 3d Sess. 264 (1940).
\147\ See e.g., ICI Letter, supra note 85, at 14.
\148\ Cf. infra part II.C.2.
\149\ We note that a U.S. Treasury securities CCA could develop
a different mechanism for a registered fund to post margin. For
example, the Options Clearing Corporation has a ``deposits in lieu
of margin'' framework whereby a customer of a clearing member makes
a deposit in lieu of margin through OCC's escrow deposit program,
and the relevant positions are excluded from the clearing member's
margin requirement to OCC. See OCC Rules 610, 610A, 610B, and 610C;
see also Self-Regulatory Organization: The Options Clearing
Corporation: Notice of Filing of Advance Notice Concerning the
Options Clearing Corporation's Escrow Deposit Program, Securities
Exchange Act Rel. No. 34-78334 (Sept. 14, 2016), 81 FR 64537-38
(Sept. 20, 2016). Although there are fundamental differences in the
purpose and use of margin in the OCC's deposit in lieu of margin
framework, a U.S. Treasury securities CCA could use the principles
underlying the OCC's program by analogy in developing its own margin
posting framework.

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

[[Page 2729]]

A registered fund may wish to use a member of a national securities
exchange as a sponsoring member. Such a sponsoring member that receives
and posts margin to a U.S. Treasury securities CCA on behalf of
registered funds may be deemed to have custody of fund assets and
implicate Rule 17f-1 under the 1940 Act. Therefore, the Commission
takes the position, for a period of five years from the effective date
of this adopting release, that if a registered fund's cash and/or
securities are placed and maintained with a sponsoring member that is a
member of a national securities exchange, solely in connection with
facilitating the posting of margin to FICC on behalf of a registered
fund in connection with the registered fund's participation in the
Sponsored Program, it would not provide the basis for an enforcement
action against a registered fund under Section 17(f) of the 1940 Act so
long as: (i) the fund complies with Rule 17f-1(a), (b)(5), and (d), and
(ii) the contract between the registered fund and the member of the
national securities exchange provides for the following:
The margin provided by a registered fund is not commingled
with, and is kept separate from, the sponsoring member's assets; \150\
---------------------------------------------------------------------------

\150\ See note 140 supra.
---------------------------------------------------------------------------

The sponsoring member segregates on its books and records
the margin provided by a registered fund (or series thereof, as
applicable), and identifies a value of margin in its books and records
as being attributable to the registered fund;
The registered fund's provision of margin is consistent
with the FICC registered fund margin framework; and
The sponsoring member does not hold registered fund assets
that exceed the amount that is required to be deposited as margin to
FICC with respect to the registered fund's outstanding eligible
secondary market transactions.\151\
---------------------------------------------------------------------------

\151\ This Commission position would not apply to the extent
that the sponsoring member holds an amount of registered fund assets
that exceeds the registered fund's margin obligations. If a
sponsoring member were to hold registered fund assets in an amount
that exceeds the registered fund's margin obligations, then the
sponsoring member would need to return such excess to the registered
fund as promptly as possible or promptly comply with all
requirements of Rule 17f-1 under the 1940 Act.
---------------------------------------------------------------------------

As above, such an approach is intended to accomplish a similar
purpose as the FICC registered fund margin framework and additionally
limit the amount of assets held in custody at a sponsoring member that
is a member of a national securities exchange to an amount of margin
that is required by FICC.
More generally, the Commission understands that the commenter which
raised issues regarding the ability of registered funds to post margin
to the CCA is referring to clearing models whereby an indirect
participant in a U.S. Treasury securities CCA executes a transaction
with a counterparty and then ``gives up'' the transaction to another
party to submit for clearance and settlement. The Commission agrees
with the commenter that the use of a ``give up'' model could be helpful
in further facilitating the increased demand for central clearing under
a potential clearing requirement. The Commission understands that FICC
currently has certain models that facilitate ``give up'' style
clearing, and, consistent with the requirement discussed in part II.B.2
infra, encourages U.S. Treasury securities CCAs to consider how best to
facilitate ``give up'' clearing.
The Commission's ability to ``encourage'' FICC, a covered clearing
agency, must be considered in context of the relevant regulatory
framework. Covered clearing agencies are SROs for purposes of the
Exchange Act,\152\ meaning that, as an SRO, a covered clearing agency
is required to file with the Commission any proposed rule or proposed
change in its rules, including additions or deletions from its
rules.\153\ The Commission publishes all proposed rule changes for
comment.\154\ When considering whether to approve or disapprove a
proposed rule change, the Commission shall approve the proposed rule
change if it finds that such proposed rule change is consistent with
the requirements of the Exchange Act and the rules and regulations
thereunder applicable to the particular type of SRO.\155\
---------------------------------------------------------------------------

\152\ 17 CFR 240.17ad-22(a)(5) (defining a covered clearing
agency); 15 U.S.C. 78c(a)(26) (defining an SRO to include a
registered clearing agency).
\153\ An SRO must submit proposed rule changes to the Commission
for review and approval pursuant to Rule 19b-4 under the Exchange
Act. A stated policy, practice, or interpretation of an SRO, such as
its written policies and procedures, would generally be deemed to be
a proposed rule change. See 15 U.S.C. 78s(b)(1); 17 CFR 240.19b-4.
See 15 U.S.C. 78s(b)(3)(A) (setting forth the types of proposed rule
changes that take effect upon filing with the Commission). The
Commission may temporarily suspend those rule changes within 60 days
of filing and institute proceedings to determine whether to approve
or disapprove the rule changes. 15 U.S.C. 78s(b)(3)(C).
\154\ See 15 U.S.C. 78s(b)(1). Proposed rule changes are
generally required to be approved by the Commission prior to going
into effect; however, certain types of proposed rule changes take
effect upon filing with the Commission.
\155\ 15 U.S.C. 78s(b)(1)(C)(i). On the other hand, the
Commission shall disapprove a proposed rule change if it cannot make
such a finding. 15 U.S.C. 78s(b)(1)(C)(ii).
---------------------------------------------------------------------------

In addition, clearing agencies registered with the Commission are
financial market utilities, as defined in section 803(6) of the Dodd-
Frank Act.\156\ A clearing agency that has been designated by the
Financial Stability Oversight Council as systemically important or
likely to become systemically important, and for which the Commission
is the Supervisory Authority (``designated clearing agency''), is
required to file 60-days advance notice with the Commission of changes
to rules, procedures, and operations that could materially affect the
nature or level of risk presented by the designated clearing agency
(``advance notice'').\157\ Such an advance notice also requires
consultation with the Board of Governors.\158\ The Clearing Supervision
Act authorizes the Commission to object to changes proposed in such an
advance notice, which would prevent the clearing agency from
implementing its proposed change(s).\159\
---------------------------------------------------------------------------

\156\ See 12 U.S.C. 5462(6).
\157\ The Dodd-Frank Act defines a ``designated clearing
entity'' as a designated financial market utility that is either a
derivatives clearing organization registered under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a-1) or a clearing agency
registered with the Securities and Exchange Commission under section
17A of the Securities Exchange Act of 1934 (15 U.S.C. 78q-1). See 12
U.S.C. 5462(3). The Commission is the Supervisory Agency, as defined
in 12 U.S.C. 5462(8), for four designated clearing agencies (the
Depository Trust Company, the National Securities Clearing
Corporation, the Fixed Income Clearing Corporation, and the Options
Clearing Corporation). See 12 U.S.C. 5465(e)(1)(A). The Commission
published a final rule concerning the filing of advance notices for
designated clearing agencies in 2012. See 17 CFR 240.19b-4(n);
Exchange Act Release No. 34-67286 (June 28, 2012), 77 FR 41602 (July
13, 2012).
\158\ See 12 U.S.C. 5465(e)(1)(B).
\159\ See 12 U.S.C. 5465(e)(1)(E) and (F).
---------------------------------------------------------------------------

These statutory requirements applicable to covered clearing
agencies mean that the Commission must consider proposed rule changes
as they are filed. The Commission does not dictate particular proposed
rule changes that a CCA should adopt, although a CCA may determine that
it should propose certain rule changes in response to a new or amended
Commission rule. In response to this

[[Page 2730]]

commenter, and as discussed in part II.B.2 infra, the Commission will
consider any proposed rule changes filed by FICC, or any other U.S.
Treasury securities CCA, in due course, consistent with its obligations
under Section 19(b) of the Exchange Act. The Commission does not have
the ability to revise particular aspects of the rules of an SRO that is
a registered clearing agency, like a CCA.\160\
---------------------------------------------------------------------------

\160\ 15 U.S.C. 78s(c) (establishing the Commission's authority
to, by rule, abrogate, add to, and delete from the rules of an SRO
other than a registered clearing agency).
---------------------------------------------------------------------------

Second, the commenter discussed potential custody issues for
registered funds under Section 17(f) of the 1940 Act and Rule 17f-4
thereunder. Section 17(f) requires that a registered fund maintain its
securities and similar investments in a bank, a company which is a
member of a national securities exchange, or its own custody.\161\ The
commenter stated that substantially all funds use a bank custodian, and
that a bank custodian is particularly beneficial to funds in the
context of repo and reverse repo transactions with respect to
custodying both securities and cash.\162\
---------------------------------------------------------------------------

\161\ 15 U.S.C. 80a-17(f)(1).
\162\ ICI Letter, supra note 85, at 15.
---------------------------------------------------------------------------

The Commission has adopted rules that specify required
qualifications for entities other than those named in Section 17(f) to
act as custodians of fund assets, including Rule 17f-4 which permits a
registered fund to deposit the securities it owns in a securities
depository, under certain conditions.\163\ A ``securities depository''
is defined to include a clearing corporation that is registered with
the Commission under Section 17A of the Exchange Act.\164\ The
commenter observed that FICC is registered as a clearing agency, but
that FICC has stated that it is not a securities depository and does
not provide securities depository services.\165\ The commenter asserted
that, because FICC is not deemed to be a securities depository eligible
to custody fund assets, expanding the Sponsored Service for funds would
require addressing Section 17(f) ``if the offering would require margin
posting by funds,'' and stated that one way to do this would be for
FICC to obtain Commission relief to hold fund margin as an eligible
securities depository within the meaning of Rule 17f-4.\166\
---------------------------------------------------------------------------

\163\ 17 CFR 270.17f-4.
\164\ 17 CFR 270.17f-4.
\165\ ICI Letter, supra note 85, at 15.
\166\ ICI Letter, supra note 85, at 15-16.
---------------------------------------------------------------------------

The Commission is not opining on whether FICC's Government
Securities Division could currently be considered a ``securities
depository'' for purposes of Rule 17f-4.\167\ However, the amendments
to Rule 17ad-22(e) do not require that registered funds post margin
directly to a U.S. Treasury securities CCA, meaning that this issue is
not implicated at this time. Therefore, the Commission does not believe
that such concerns are ripe for consideration, as no U.S. Treasury
securities CCA has proposed particular rules that would require the
posting of registered funds' securities at the CCA and such an
arrangement is not specifically required by the requirement to clear
eligible secondary market transactions. Moreover, as discussed in this
part above, the Commission has taken the position regarding the FICC
registered fund margin framework in light of the commenter's concern.
---------------------------------------------------------------------------

\167\ The commenter's assertion that FICC has stated that it is
not a securities depository and does not provide securities
depository services comes from a statement in FICC's Disclosure
Framework concerning a different regulatory regime. Specifically,
the statement concerns whether FICC is a ``central securities
depository'' or provides ``central securities depository'' services,
for purposes of discussing FICC's obligation to comply with Rule
17ad-22(e)(10), which applies to CCAs that provide central
securities depository services. ``Central securities depository'' is
a defined term in the Covered Clearing Agency Standards, meaning a
clearing agency that is a securities depository as described in
Section 3(a)(23)(A) of the Act (15 U.S.C. 78c(a)(23)(A). Section
3(a)(23)(A) defines a securities depository, in turn, as who (i)
acts as a custodian of securities in connection with a system for
the central handling of securities whereby all securities of a
particular class or series of any issuer deposited within the system
are treated as fungible and may be transferred, loaned, or pledged
by bookkeeping entry without physical delivery of securities
certificates, or (ii) otherwise permits or facilitates the
settlement of securities transactions or the hypothecation or
lending of securities without physical delivery of securities
certificates.
---------------------------------------------------------------------------

The Commission's definition of an eligible secondary market
transaction and the requirement to clear such transactions does not, on
its own, mandate particular changes to FICC's membership models,
including the Sponsored Service. FICC has not proposed any rule changes
with respect to the Sponsored Service in this regard at this time. The
Commission will consider any proposed rule changes consistent with its
obligations under Section 19(b) of the Exchange Act in the event that
FICC submits any such proposal in the future.
Third, the commenter stated that FICC's rules addressing margin
posting will need to be amended to provide for enhanced recordkeeping,
internal controls, and transparency around the positions and related
margin, to address fund concerns regarding the security of fund assets
under a requirement to clear certain transactions. The commenter stated
that enhanced recordkeeping and related controls are critical to
appropriately identifying ownership of assets during a repo transaction
particularly since, unlike a typical derivatives or cash transaction,
ownership of the U.S. Treasury securities underlying a repo transaction
changes during the transaction. The commenter asserted that FICC
currently relies on its broker-dealer members and, in certain cases,
designated agency banks to maintain records regarding margin positions,
and that FICC has indicated that it is not able to identify positions
or possess the assets of its members' customers. The commenter states
that notwithstanding FICC's current lack of infrastructure, ``the
Proposal relies heavily on FICC to intermediate transactions under a
clearing mandate and contemplates that this approach will provide a
higher level of safety to the market than the current bilateral market,
which relies on a well-diversified group of credit-worthy banks to hold
collateral, including through robust tri-party arrangements, and
utilizes an industry standard agreement that is well understood by
market participants.'' \168\
---------------------------------------------------------------------------

\168\ ICI Letter, supra note 85, at 16-17.
---------------------------------------------------------------------------

However, no U.S. Treasury securities CCA has proposed particular
rules that would require the posting of registered funds' securities at
the CCA. The Commission's definition of an eligible secondary market
transaction and the requirement to clear such transactions does not, on
its own, mandate particular changes to FICC's membership models,
including the Sponsored Service. The Commission will consider any
proposed rule changes consistent with its obligations under Section
19(b) of the Exchange Act in the event that FICC submits any such
proposal in the future.
The Commission disagrees with the commenter's assertion that FICC
has indicated that it is not able to identify positions or possess the
assets of its members' customers. FICC currently is able to maintain
position data for customer positions in all its indirect access
models.\169\ In addition, under the amendments being adopted in this
release, FICC will, as discussed in section II.B.1 infra, be required
to separately calculate and hold customer margin (which it currently
does for the Sponsored Service), which addresses

[[Page 2731]]

the commenter's concern that FICC calculate and hold customer margin
separately.
---------------------------------------------------------------------------

\169\ FICC Buyside FAQ at 4, available at https://www.dtcc.com/ustclearing/-/media/Files/Downloads/Microsites/Treasury-Clearing/FICC-GSD-FAQ.pdf (``FICC records positions of Sponsored Members and
positions of Executing Firms of a Prime Broker as long as the Prime
Broker submits the trades to FICC using a unique client identifier
called the ``Executing Firm symbol.'') (``FICC Buyside FAQ'').
---------------------------------------------------------------------------

Fourth, the commenter highlighted its support for strong
protections for fund assets, including ``legally segregated,
operationally commingled'' (``LSOC'') protections. In addition, another
commenter asserted that, without an exclusion from the definition of an
eligible secondary market transaction for repos with registered funds,
such funds could be subject to greater counterparty credit risk because
the existing Sponsored Member clearing model at FICC has no requirement
to segregate customer assets, while at present most registered funds
use third-party custodians to hold securities and cash.\170\ The
Commission addresses these comments in more detail in part II.B.1
below.
---------------------------------------------------------------------------

\170\ SIFMA AMG Letter, supra note 35, at 5.
---------------------------------------------------------------------------

Fifth, the commenter stated that the Commission and FICC must
address the bankruptcy treatment of certain fund assets. Specifically,
the commenter stated that FICC's rules should confirm that agreements
entered into by repo counterparties will be enforceable against both
parties, notwithstanding that the transactions are cleared, and provide
a clear process for closeout of transactions by FICC, including both
the start and end legs of the transaction. The commenter also stated
that FICC's rules need to address what happens upon the insolvency of a
sponsoring member in a variety of factual circumstances, including
providing for prompt replacement of the sponsoring member by its
sponsored members and handling of other functions typically performed
by the sponsoring member to ensure that transactions by the sponsored
member are maintained and allowing the sponsored member the authority
to receive certain reports directly and to post to the clearing fund to
preserve pending trades. The commenter also stated that FICC's rules
should provide clarity regarding how non-defaulting parties, such as
funds, can exercise closeout rights, including those available under
Sections 555, 559, 561, and similar sections of the U.S. Bankruptcy
Code. The commenter stated that if, in the future, FICC decides to
expand the Sponsored Service to permit (but not require) sponsored
members to post margin, then the Commission and FICC should clarify
that the margin posted by a sponsored member with its sponsoring member
for on-posting with FICC would be eligible for customer treatment under
the Securities Investor Protection Act (``SIPA''). The commenter also
argues that clarification of FICC's rules regarding closeout rights--
particularly in respect to ``done away'' trades--is important to
clarify a repo counterparty's rights under different insolvency regimes
applicable to cleared transactions.\171\
---------------------------------------------------------------------------

\171\ ICI Letter, supra note 85, at 20-21.
---------------------------------------------------------------------------

Regarding these bankruptcy-related comments, FICC's rules already
address the issues raised by the commenter. For example, with respect
to the enforceability of the agreements entered into by repo
counterparties, FICC requires applicants for membership to execute a
Membership Agreement, in which the applicant agrees to be bound by
FICC's Rules, and FICC further requires applicants for membership to
provide a legal opinion regarding the membership agreement, which
incorporates FICC's Rules.\172\ Novation consists of the termination of
the deliver, receive, and related payment obligations between the
parties to a trade, and their replacement with identical obligations to
and from FICC in accordance with the Rules. Once it novates a
transaction, FICC contractually replaces the original counterparties'
obligations to each other with two sets of obligations, both of which
include FICC and one of the original counterparties.\173\ FICC is not a
party to the pre-novation bilateral agreements between a Sponsoring
Member and its Sponsored Members, and therefore, it cannot guarantee
performance of those contracts.
---------------------------------------------------------------------------

\172\ FICC Rule 2A, Section 7, supra note 19; FICC Disclosure
Framework, Principle 1, available at https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/FICC_Disclosure_Framework.pdf.
\173\ FICC Rule 5, section 8 (regarding novation generally) and
Rule 3A, section 7(a) (regarding novation in the Sponsored Service),
supra note 19.
---------------------------------------------------------------------------

In addition, with respect to FICC's need to establish a process for
closeout, FICC's Rules contain these processes. Upon ceasing to act for
an insolvent member, FICC may promptly close out and manage the
member's positions, including with respect to the member's pending
transactions with non-defaulting members.\174\ Specifically, FICC would
terminate and net all of the insolvent member's positions, after which
FICC would liquidate the net positions through market action and
determine a single net amount owed to or from the insolvent member from
or to FICC.\175\ After closing out the insolvent member's final net
positions, FICC's Rules provide for the timely settlement of all
deliver, receive, and related payment obligations that would have
arisen had FICC not ceased to act for the insolvent member (i.e., FICC
would seek to fulfill its settlement obligations with respect to the
insolvent member's pending transactions with non-defaulting members.)
\176\ Similarly, in the event that FICC determines to treat a
Sponsoring Member as insolvent, FICC would cease to act for the
Sponsoring Member.\177\ FICC would determine whether to close-out the
affected Sponsored Member Trades and/or permit the Sponsored Members to
complete their settlement.\178\ In the event that it closes out the
Sponsored Member's transactions, it would follow the same closeout
process.\179\
---------------------------------------------------------------------------

\174\ FICC Rule 22A, Section 2, supra note 19.
\175\ See id.
\176\ See id.
\177\ FICC Rule 3A, Section 16(b), supra note 19.
\178\ Id.
\179\ Id.
---------------------------------------------------------------------------

Moreover, these comments generally relate to particular features of
FICC's Sponsored Service, including how the sponsored member is able to
interact with FICC, FICC's ability to settle the transactions in the
event of a Sponsoring Member default, and the operation of certain
bankruptcy provisions. For the reasons discussed in more detail in part
II.B.2 infra, the Commission cannot change the rules governing the
Sponsored Service.
Sixth, the commenter identified issues for registered funds that
would arise if additional clearing were to require funds to contribute
to FICC's CCLF. The commenter explained that contribution by a
registered fund to the CCLF could result in a prohibited joint
transaction in violation of: Section 17(d) of the 1940 Act if
affiliates of the fund (e.g., other funds managed by the same
investment adviser) also contribute to the fund; Section 18 of the 1940
Act, which prohibits a registered fund from issuing ``senior
securities;'' Section 17(f) of the 1940 Act; the fund's investment
purpose, policies, and organization documents; or the fiduciary duties
of the fund's board and its investment adviser. The commenter asserts
that the Commission would need to carefully evaluate the ability of a
registered fund to become a FICC netting member and contribute to the
CCLF, as well as amending its rules to confirm that view, or that, in
the alternative, FICC could create a special category of netting member
that would not require a fund to contribute to the CCLF.\180\
---------------------------------------------------------------------------

\180\ ICI Letter, supra note 85, at 22.
---------------------------------------------------------------------------

In response to this commenter, any requirement for a U.S. Treasury
securities CCA to have policies and procedures requiring its direct
participants to clear eligible secondary market transactions does not,
on its

[[Page 2732]]

own, require any particular market participant to become a direct
participant of a U.S. Treasury securities CCA, thereby taking on the
membership obligations of such participation, including contribution to
the CCLF. The Commission acknowledges the commenter's view that certain
regulatory provisions applicable to registered funds could effect a
registered fund's ability to join a U.S. Treasury securities CCA
directly, but the Commission does not believe that these concerns
should impact its consideration of the proposal as the proposal would
not impose such requirements. Consistent with its obligations under
Section 19 of the Exchange Act, in its review of any rule filings, the
Commission would consider issues related to the ability of market
participants, including registered funds, to participate in FICC.
Seventh, the commenter stated that bilateral tri-party repo should
be exempted from the definition of an eligible secondary market
transaction. The Commission has considered this comment in part
II.A.2.a.i supra.
In addition, certain commenters also provided specific arguments
regarding money market funds subject to Rule 2a-7 under the 1940
Act.\181\ One commenter stated that the Commission should not include
repos with money market funds subject to Rule 2a-7 within the
definition of an eligible secondary market transaction, noting that the
current ability to transact in Treasury repurchase agreements across a
variety of clearance and settlement platforms allows these funds to be
invested in a manner that is in the best interest of their
shareholders. The commenter also referred to the planning and tools
that have been developed that seek to avoid a disorderly default in
repurchase agreement markets. The commenter also stated that the likely
insolvency regimes for the major repurchase agreement participants that
would be facilitated by a receiver (either the Federal Deposit
Insurance Corporation or the Securities Investor Protection
Corporation) allow the receiver to transfer or wind down repurchase
agreements in an orderly manner.\182\
---------------------------------------------------------------------------

\181\ Federated Letter, supra note 85, at 3; ICI Letter, supra
note 85, at 5-8.
\182\ Federated Letter, supra note 85, at 3 (citing SEC. & EXCH.
COMM'N, DIV. OF INV. MGMT GUIDANCE UPDATE: COUNTERPARTY RISK
MANAGEMENT PRACTICES WITH RESPECT TO TRI-PARTY REPURCHASE AGREEMENTS
(July 2013), available at https://www.sec.gov/divisions/investment/guidance/im-guidance-2013-03.pdf).
---------------------------------------------------------------------------

Two commenters raised questions with respect to regulatory
diversification requirements, that is, whether registered funds,
including money market funds, will continue to meet the definition of a
``collateralized fully'' repurchase agreement under Rule 5b-3 under the
Investment Company Act of 1940 if Treasury repo investments through the
Sponsored Service grow significantly.\183\ Commenters explained that
meeting the definition of a ``collateralized fully'' repurchase
agreement under Rule 5b-3 is necessary for Treasury repurchase
agreements to remain permissible investments for a government money
market fund and for achieving ``look through'' treatment for certain
diversification requirements imposed under the 1940 Act and Internal
Revenue Code.\184\ One commenter asked that the Commission confirm
through rulemaking or guidance that repo clearing offerings made
available by FICC to registered funds ``would continue to satisfy'' the
``collateralized fully'' standard set forth in Rules 5b-3 and 2a-7
under the 1940 Act and would allow funds to achieve ``look through
treatment'' for diversification purposes.\185\
---------------------------------------------------------------------------

\183\ 17 CFR 270.5b-3(c)(1). Federated Letter, supra note 85, at
6; ICI Letter, supra note 85, at 23-24.
\184\ Federated Letter, supra note 85, at 6; ICI Letter, supra
note 85, at 23-24.
\185\ ICI Letter, supra note 85, at 23-24.
---------------------------------------------------------------------------

One commenter also referenced the need for relief for reverse repo
transactions. The commenter stated that, unlike Treasury repo
agreements that are ``collateralized fully,'' Treasury reverse repo
transactions entered into by funds (i.e., where a fund is the seller)
currently are not eligible for look-through treatment. The commenter
concludes that this means that, under the proposal, absent additional
rulemaking or relief, most money market funds would be limited to
investing no more than 5% of their total assets in reverse repo
agreements because funds would face FICC as the counterparty, and that
diversified non-money market funds would be limited to investing either
no more than 25% of their total assets in reverse repo agreements or no
more than 5%, with respect to 75% of their total assets, in reverse
repo agreements. The commenter stated that registered funds may use
Treasury reverse repo agreements as a form of short-term financing to
facilitate shareholder redemption requests.\186\
---------------------------------------------------------------------------

\186\ ICI Letter, supra note 85, at 25.
---------------------------------------------------------------------------

The Commission acknowledges that the final rule could limit the
extent to which some registered funds enter into Treasury reverse repo
agreements. However, the Commission believes that this effect will be
limited because a relatively small number of funds report Treasury
reverse repo agreements on Form N-PORT, and funds generally have other
available means to generate cash to meet shareholder redemption
requests, such as lines of credit, securities lending, interfund
lending, or selling portfolio investments, as applicable. The combined
effect of the final rule and the diversification requirements in
section 5(b) of the 1940 Act could practically limit the amount some
funds may invest in Treasury reverse repo.\187\
---------------------------------------------------------------------------

\187\ Section 5(b) divides management investment companies into
``diversified companies'' and ``non-diversified companies.'' Under
this section, (i) a ``diversified company'' means a management
company which meets the following requirements: At least 75 per
centum of the value of its total assets is represented by cash and
cash items (including receivables), Government securities,
securities of other investment companies, and other securities for
the purposes of this calculation limited in respect of any one
issuer to an amount not greater in value than 5 per centum of the
value of the total assets of such management company and to not more
than 10 per centum of the outstanding voting securities of such
issuer and (ii) a ``non-diversified company'' means any management
company other than a diversified company. See section 5 of the 1940
Act.
---------------------------------------------------------------------------

The commenter separately suggested that the final rule would affect
money market funds' use of Treasury reverse repo agreements, in light
of additional diversification requirements for those funds. However,
money market funds are not permitted to rely on rule 18f-4 under the
1940 Act to enter into reverse repo transactions.\188\ Moreover, money
market funds historically have not reported holdings of reverse repo
agreements in their portfolio reports filed with the Commission.
---------------------------------------------------------------------------

\188\ See Use of Derivatives by Registered Investment Companies
and Business Development Companies, Investment Company Act Release
No. 34084 (Nov. 2, 2020), 85 FR 83162 (Dec. 21, 2020); 17 CFR
270.18f-4. Rule 18f-4 establishes a framework for funds' use of
derivatives and certain other transactions, including reverse
repurchase agreements. Money market funds are not permitted to rely
on rule 18f-4 for these transactions.
---------------------------------------------------------------------------

The Commission's definition of an eligible secondary market
transaction and the requirement to clear such transactions does not
mandate particular changes to FICC's membership models, including the
Sponsored Service. FICC has not proposed any rule changes with respect
to the Sponsored Service in this regard at this time. The Commission
will consider any proposed rule changes consistent with its obligations
under Section 19(b) of the Exchange Act in the event that FICC submits
any such proposal in the future. In the event that any U.S. Treasury
securities CCA proposes a clearing model in which

[[Page 2733]]

registered funds would be required to place and maintain assets to
effect eligible secondary market transactions at the CCA, the
Commission would consider the applicability of Section 17(f) of the
1940 Act.
One commenter explained that registered funds' access to the
Treasury repo market could be restricted by the number or willingness
of the FICC netting members to provide sponsoring services with
attending negative effect on the market liquidity.\189\ Although
increases in demand for the Sponsored Service may put pressure on
existing sponsoring members and reduce their ability or willingness to
onboard additional clients, this could also present an opportunity for
dealers that currently do not offer the Sponsored Service to enter the
market, resulting in more competition and a wider range of
counterparties. This is supported by an observation of a growing number
of dealers offering the Sponsored Service and the growing volume of
sponsored repo indicating increased adoption of this service by a wider
range of market participants.\190\
---------------------------------------------------------------------------

\189\ ICI Letter, supra note 85, at 30-31.
\190\ See Sponsored DVP and GC Repo Activity, available at
https://www.dtcc.com/charts/membership.
---------------------------------------------------------------------------

Several commenters raised concerns about the potential effect of
the proposal and a potential resultant high level of exposure to the
U.S. Treasury securities CCA on ratings assigned to certain money
market funds by Nationally Recognized Statistical Rating Organizations
(NRSROs).\191\ The commentators explained that NRSROs typically
establish exposure limits that a rated money market fund may have to
any particular CCA and, if these limits are breached, a fund may not be
able to maintain the currently assigned rating.\192\ The Commission
does not have the authority to adjust the NRSROs' rating criteria and
methodologies, and it cannot anticipate how NRSROs may adjust their
rating criteria and methodologies in response to the U.S. Treasury
market infrastructure changes resulting from the adoption of the
Membership Definition.
---------------------------------------------------------------------------

\191\ Federated Letter, supra note 85, at 6-7; ICI Letter, supra
note 85, at 25-26; SIFMA AMG Letter, supra note 35, at 14.
\192\ Id.
---------------------------------------------------------------------------

iii. Repos by Other Clearing Organizations
Several commenters supported a limited exclusion from the
definition of an eligible secondary market transaction for U.S.
securities transactions entered into by a derivatives clearing
organization (``DCO''). A DCO is an entity that is regulated by the
CFTC and is defined as a clearinghouse, clearing association, clearing
corporation, or similar entity, facility, system, or organization that,
with respect to an agreement, contract, or transaction (i) enables each
party to the agreement, contract, or transaction to substitute, through
novation or otherwise, the DCO's credit for the credit of the parties;
(ii) arranges or provides, on a multilateral basis, for the settlement
or netting of obligations resulting from such agreements, contracts, or
transactions executed by the DCO's participants; or (iii) otherwise
provides clearing services or arrangements that mutualize or transfer
among the DCO's participants the credit risk arising from such
agreements, contracts, or transactions executed by the
participants.\193\ Generally, DCOs perform similar functions as CCAs,
but for commodities as opposed to securities.
---------------------------------------------------------------------------

\193\ 7 U.S.C. 1a(15) (defining DCO) and 7a-1(a) (establishing
DCO registration requirement).
---------------------------------------------------------------------------

One commenter recognized that DCOs are not specifically enumerated
as an entity type subject to the expanded clearing requirement, but
stated that, in practice, it would be impractical for DCOs to avoid
entering into repos with direct participants of U.S. Treasury CCAs,
which would therefore be included in the definition of an eligible
secondary market transaction.\194\ First, the commenter stated that an
exclusion for DCOs was necessary to allow DCOs to retain the
flexibility necessary to effectively manage risk when managing the
default of a participant of the DCO, with respect both to access to the
appropriate counterparties and to pressing time considerations. The
commenter stated that requiring the central clearing of repos entered
into for default management by a DCO could undermine the effectiveness
of the DCO's default management practices. Second, the commenter
asserted that including transactions with a DCO within the definition
of an eligible secondary market transaction would threaten DCOs'
effective cash management. The commenter stated that DCOs regularly
receive U.S. dollar cash as margin from their clearing members and then
enter into reverse repos, as permitted under the applicable CFTC
regulations. However, the commenter expressed concern that the
permissible counterparties and counterparty concentration limits
included in CFTC Rule 1.25 would appear to be in tension with the
requirement to clear eligible secondary market transactions because a
clearing agency, which would become the counterparty to any transaction
that is centrally cleared, is not a permissible counterparty. Finally,
the commenter stated that allowing transactions with DCOs to be scoped
into the definition of an eligible secondary market transaction would
be inconsistent with the spirit, and the letter, of Section 5b(f)(1) of
the Commodity Exchange Act, which states that ``under no circumstances
shall a [DCO] be compelled to accept the counterparty credit risk of
another clearing organization.'' \195\
---------------------------------------------------------------------------

\194\ CME Letter, supra note 81, at 6.
\195\ CME Letter, supra note 81, at 6-7.
---------------------------------------------------------------------------

An additional commenter made similar arguments. This commenter
stated that the rule as proposed could create contagion risk by
increasing linkages between CCPs, stating that this risk would
crystallize if a CCP clearing its investment trades contributed to the
mutualized financial resources of another CCP via its default fund or
was otherwise exposed to loss in the event of a member default of the
other CCP. The commenter further stated that existing regulations under
both U.S. and European regulatory frameworks recognize the potential
financial stability risks of inter-CCP linkages and prohibit them from
accepting the counterparty credit risk of another CCP. According to the
commenter, one such conflict arises under the Commodity Exchange Act
where, to minimize systemic risk, there is a requirement that ``[. . .]
under no circumstances shall a derivatives clearing organization be
compelled to accept the counterparty credit risk of another clearing
organization.'' Finally, the commenter states that a clearing model
tailored to meet CCPs' bespoke collateral management requirements would
need to be developed before they could operationally clear investment
trades.\196\
---------------------------------------------------------------------------

\196\ Letter from Rachel Goldberg, Head of Government Relations
and Regulatory Strategy, Americas, London Stock Exchange Group, at
2-3 (June 15, 2023).
---------------------------------------------------------------------------

The Commission understands that reverse repos are used heavily by
central counterparties as a means of investing their cash.\197\ The
Commission also agrees that entities that provide central counterparty
services, like DCOs and clearing agencies, must be able to effectively
manage the default of a participant.\198\ In the event of a participant
default, the need for such entities to be able to react within
potentially compressed timeframes, including by engaging in repos of
U.S.

[[Page 2734]]

Treasury securities held as margin to create liquidity, may be
essential to their default management processes. The Commission agrees
that including such transactions within the scope of an eligible
secondary market transaction might have systemic risk implications and
counteract the goals of effective and efficient default management by
CCPs in such scenarios. Accordingly, it is appropriate to exclude repos
entered into by an entity acting as a central counterparty from the
definition of an eligible secondary market transaction.\199\
---------------------------------------------------------------------------

\197\ See BIS, Committee on the Global Financial System, Repo
Market Functioning, Apr. 2017.
\198\ Proposing Release, supra note 14, 87 FR at 64627.
\199\ The Commission is not opining on the proposal's
consistency with the Commodity Exchange Act or other regulatory
regimes, but the commenter's concern is moot in light of the
modification to the definition of an eligible secondary market
transaction that the Commission is adopting.
---------------------------------------------------------------------------

To do so, the Commission is modifying the definition of an eligible
secondary market transaction in Rule 17ad-22(a) to exclude any
repurchase or reverse repurchase agreement collateralized by U.S.
Treasury securities in which one counterparty is a covered clearing
agency providing central counterparty services, a derivatives clearing
organization (see 7 U.S.C. 7a-1 and 17 CFR 39.3), or is regulated as a
central counterparty in its home jurisdiction. With respect to a
counterparty that is regulated as a central counterparty in its home
jurisdiction, this portion of the exclusion encompasses entities that
may serve as central counterparties in their home jurisdiction and may
transact in repos with direct participants of a U.S. Treasury
securities CCA. Although commenters did not specifically suggest this
exclusion for a counterparty that is regulated as a CCP in its home
jurisdiction, this aspect of the exclusion is appropriate to ensure
that entities serving as central counterparties in other jurisdictions
are similarly excepted from the definition of an eligible secondary
market transaction as repo counterparties.
iv. Repos by FCMs
Two commenters asked the Commission to adopt an exemption that
would allow Futures Commission Merchants (``FCMs'') to continue to
engage in eligible secondary market transactions in U.S. Treasury
securities outside of central clearing, and another commenter
acknowledged the potential interaction between the proposal and the
regulatory framework governing FCMs.\200\ An FCM is an entity engaged
in soliciting or accepting orders for the purchase or sale of
commodities, futures, swaps, or other instruments regulated by the
CFTC.\201\ FCMs can also be registered with the Commission as broker-
dealers.\202\ In their role as market intermediaries, FCMs hold
customer funds and securities. The commenter explained that as of
October 31, 2022, FCMs held an aggregate amount of more than $500
billion in segregated customer accounts, a substantial percentage of
which is held in the form of U.S. Treasury securities.\203\
---------------------------------------------------------------------------

\200\ See comments from Walt L. Lukken, President and Chief
Executive Officer, Futures Industry Association, at 2-7 (Dec. 23,
2022) (``FIA Letter''). See also SIFMA/IIB Letter, supra note 37, at
30-31 (recognizing that the absent an exemption for FCMs from the
central clearing requirement, FCMs engaging in repo transactions
would be placed in the untenable position of violating either the
SEC's proposal or existing CFTC regulations). See also DTCC/FICC
Letter, supra note 33, at 25 (recognizing that CFTC regulations
currently limit FCM access to central clearing by preventing FCMs
from entering into FICC-cleared repo transactions using customer
property).
\201\ See 7 U.S.C. 1a(28)(A).
\202\ One commenter states that the majority of FCMs are dually
registered as FCMs and broker-dealers. See FIA Letter, supra note
200, at 2.
\203\ See FIA Letter, supra note 200, at 4.
---------------------------------------------------------------------------

As the commenter noted, FCMs are required under the Commodity
Exchange Act \204\ and the regulations promulgated thereunder \205\ to
assure the protection of customer funds. Specifically, as the commenter
explained, FCMs are required to hold customer funds and securities in
segregated accounts with a bank or other permitted depository that
acknowledges such customer assets ``will be separately accounted for
and segregated'' from the FCM's own funds and ``must otherwise be
treated in accordance with the provisions of the [CEA]'' and CFTC
rules.\206\ The commenter highlighted that neither the bank/depository
nor the FCM may use the FCM's customer funds to ``secure or guarantee
any obligations'' that the FCM might owe to the bank/depository or make
the funds ``subject to any right of offset or lien for or on account of
any indebtedness, obligations, or liabilities'' the FCM may owe the
bank/depository.\207\ The commenter expressed concern as to whether the
account structure provided by FICC would be consistent with these
rules.
---------------------------------------------------------------------------

\204\ 7 U.S.C. 1-26.
\205\ 17 CFR 1.1-190.19.
\206\ See FIA Letter, supra note 200, at 3 (discussing 17 CFR
1.20 (regarding futures traded on U.S. futures exchanges) and 17 CFR
22.4 (regarding cleared swaps)).
\207\ FIA Letter, supra note 200, at 3-4 (discussing 17 CFR
1.20, 22.2, and 30.7).
---------------------------------------------------------------------------

As an initial matter, the requirement for direct participants of a
U.S. Treasury securities CCA to clear eligible secondary market
transactions does not require that an FCM post customer assets directly
to the U.S. Treasury securities CCA. An FCM could access central
clearing through a customer model, such as the Sponsored Service or the
Prime Broker/Correspondent clearing models, that allows the customer/
FCM to hold customer assets elsewhere (such as at the Sponsoring
Member) and does not require that the FCM post customer assets to the
U.S. Treasury securities CCA. Therefore, the ability of the CCA to
provide an account structure consistent with the CFTC Rules should not
prevent an FCM's transactions from being submitted to central clearing.
Moreover, in light of the requirements regarding the segregation of
house and customer margin, as discussed in part II.B.1 infra, and the
amendments to Rule 15c3-3, as discussed in part II.C infra, U.S.
Treasury securities CCAs will have to ensure that they have adopted
policies and procedures to separate house and customer margin and to
establish certain types of segregated accounts. The Commission
encourages FCMs seeking the ability to post customer funds directly to
the CCP to engage with the CCAs to consider whether such new account
structures may be sufficient to comply with the provisions of the CFTC
regulations that the commenter has identified or whether such
structures could be leveraged to meet the commenter's needs. For
example, the Commission understands that the existing U.S. Treasury
securities CCA recently has indicated that it would develop customer
clearing account structures in which each customer's margin would be
calculated on a gross basis and held physically segregated from all
other FICC margin and would also be legally segregated from FICC member
as well as fellow customer exposures.\208\
---------------------------------------------------------------------------

\208\ DTCC 2023 White Paper, supra note 107, at 22-23.
---------------------------------------------------------------------------

One of the commenters also explained that FCMs are permitted to
invest customer funds in certain securities determined by the CFTC to
be ``consistent with the objectives of preserving capital and
maintaining liquidity.'' \209\ The commenter stated that permitted
investments include, among other things, U.S. Treasury securities, and
investments with U.S. Treasury securities may be made by either direct
purchase or sale or by entering into repo transactions.\210\ The
commenter further explained that, for repo transactions, an FCM's
``permitted

[[Page 2735]]

counterparties are limited to a bank . . . , securities broker-dealer,
or government securities dealer registered with the [Commission],'' and
a clearing agency is not a permitted counterparty.\211\
---------------------------------------------------------------------------

\209\ FIA Letter, supra note 200, at 4-5 (discussing 17 CFR
1.25(b)).
\210\ FIA Letter, supra note 200, at 4-5 (discussing 17 CFR
1.25(a)).
\211\ FIA Letter, supra note 200, at 5 (discussing 17 CFR
1.25(d)(2)).
---------------------------------------------------------------------------

The commenter stated that, absent relief, conflict between the CFTC
rules and the proposal would effectively prohibit FCMs from entering
into U.S. Treasury security transactions pursuant to CFTC Rule
1.25.\212\ The commenter explained that a U.S. Treasury securities CCA
interposes itself between the counterparties to a securities
transaction through novation, acting functionally as the buyer to every
seller and seller to every buyer.\213\ Therefore, according to the
commenter, if an FCM were to conduct a cleared transaction, the CCA
would become the FCM's counterparty. Since a CCA is not a permitted FCM
counterparty under the CFTC rules, the commenter states that FCMs are
prohibited from conducting such cleared transactions.\214\ The
commenter contended that if the Commission adopts the requirement to
clear eligible secondary transactions as proposed, an FCM would lose
its current ability to conduct transactions in U.S. Treasury securities
with a direct participant of a U.S. Treasury securities CCA in
compliance with CFTC rules.\215\
---------------------------------------------------------------------------

\212\ FIA Letter, supra note 200, at 6.
\213\ FIA Letter, supra note 200, at 6; see also Proposing
Release, supra note 14, 87 FR at 64612.
\214\ FIA Letter, supra note 200, at 6 (citing 17 CFR
1.25(d)(2)).
\215\ See FIA Letter, supra note 200, at 6.
---------------------------------------------------------------------------

The Commission recognizes that if the FCM were to access a U.S.
Treasury securities CCA through a model like FICC's Sponsored Service,
the CCA would novate the transaction and become the counterparty to the
FCM, which, as the commenter has described it, would not be consistent
with Rule 1.25(d)(2) with respect to permitted counterparties. However,
the requirement to clear eligible secondary market transactions does
not require that the FCM use a particular type of model that would make
the FCM a counterparty to a CCA. The FCM could access central clearing
through an agent clearing model like FICC's Prime Broker or
Correspondent Clearing models, in which it would essentially ``give
up'' its transaction to a direct participant for submission without
becoming a counterparty to the CCA, which should be consistent with the
FCM's obligations under Rule 1.25(d)(2). Therefore, this requirement to
clear eligible secondary market transactions does not obligate the FCM
to use a model that would necessarily result in a transaction with a
clearing agency as the counterparty to the FCM.
The Commission recognizes this apparent tension between the
application of Rule 1.25(d)(2), as described by the commenter, and the
requirement to clear repos as part of the definition of eligible
secondary market transactions.\216\ However, as discussed in the
Proposing Release, when Congress added section 17A to the Exchange Act
as part of the Securities Acts Amendments of 1975, it directed the
Commission to facilitate the establishment of (i) a national system for
the prompt and accurate clearance and settlement of securities
transactions (other than exempt securities) and (ii) linked or
coordinated facilities for clearance and settlement of securities
transactions, and the Government Securities Act of 1986 specifically
included government securities within the scope of section 17A.\217\
The Commission therefore has the ability to make rules governing
central clearing in the U.S. Treasury market, which may affect a
diverse group of market participants, including FCMs. The Commission
encourages interested parties to work with the CCA to identify any
modifications to its client clearing models to better allow FCMs to
access central clearing in the U.S. Treasury market. In addition, FCMs
could enter into repos with market participants that are not direct
participants of a U.S. Treasury securities CCA.\218\
---------------------------------------------------------------------------

\216\ See CFTC Global Market Advisory Committee (``GMAC''),
Global Market Structure Subcommittee, CFTC Rule1.25(d)(2)
Recommendation (discussing the impact of Rule 1.25(d)(2) on FCMs'
ability to participate in cleared repo), available at https://www.cftc.gov/PressRoom/Events/opaeventgmac110623. The CFTC's GMAC
voted in favor of this recommendation to amend Rule 1.25(d)(2) to
include CCAs as permitted counterparties.
\217\ Proposing Release, supra note 14, 88 FR at 64617.
\218\ CFTC Rule 1.25(a)(1) also identifies additional types of
permitted investments available to an FCM for its customer funds,
including municipal bonds, corporate bonds, and interests in money
market mutual funds.
---------------------------------------------------------------------------

The commenter also notes that CFTC rules require that securities
transferred to an FCM's customer segregated custodial account must be
``made on a delivery versus payment [(DVP)] basis in immediately
available funds.'' \219\ Even if a U.S. Treasury securities CCA would
be a permitted FCM counterparty under the CFTC rules, the commenter
expressed concern that upon the sale or resale of securities in a repo
transaction, the FCM's customer segregated cash account may not receive
same-day funds credited simultaneously with the delivery or transfer of
securities.\220\ The Commission does not believe that such concerns are
warranted. FICC clears all transactions DVP meaning that payment of
cash is made at the same time as delivery of securities.
---------------------------------------------------------------------------

\219\ FIA Letter, supra note 200, at 5 (discussing 17 CFR
1.25(d)(9)).
\220\ See id.
---------------------------------------------------------------------------

Finally, the commenter also explained that CFTC rules require that
the agreement between an FCM and a repo counterparty must ``make[ ]
clear that, in the event of the [FCM's] . . . bankruptcy, any
securities purchased with customer funds that are subject to an
agreement may be immediately transferred. The agreement [must] also
make[ ] clear that, in the event of an [FCM's] . . . bankruptcy, the
counterparty has no right to compel liquidation of securities subject
to an agreement or to make a priority claim for the difference between
current market value of the securities and the price agreed upon for
resale of the securities to the counterparty, if the former exceeds the
latter.'' \221\ The commenter also expressed concern that there is no
assurance that a U.S. Treasury securities CCA would agree to the
bankruptcy provisions in the CFTC rules applicable to FCMs described
above.\222\ However, as stated in the discussion above, the requirement
to clear eligible secondary market transactions does not require that
the FCM enter into a repo agreement with the CCA.
---------------------------------------------------------------------------

\221\ FIA Letter, supra note 200, at 5 (discussing 17 CFR
1.25(d)(13)).
\222\ See id. The commenter also noted that the CFTC has advised
that ``in-house transactions'' in which an FCM receiving customer
collateral that is not acceptable at a Derivatives Clearing
Organization (``DCO'') or foreign board of trade may, independent of
CFTC Rule 1.25 requirements, exchange that collateral for acceptable
collateral to the extent necessary to meet margin requirements. The
commenter requested confirmation from the Commission that such ``in-
house transactions'' would similarly not be subject to the proposed
clearing requirement were an FCM to conduct transactions with a
participant of a U.S. Treasury securities CCA. If such transactions
are with a participant of a U.S. Treasury securities CCA and
otherwise meet the definition of an eligible secondary market
transaction, then they would be subject to the requirement.
---------------------------------------------------------------------------

For the reasons discussed above, the Commission does not believe
that an exclusion for FCMs is necessary to accommodate the relevant
provisions of the CFTC Rules. Moreover, an exclusion for FCMs would be
inconsistent with the purpose of the rule which is to help reduce
contagion risk to the CCA and bring the benefits of central clearing to
more transactions involving U.S. Treasury securities, particularly in
light of their significance to the Treasury market.

[[Page 2736]]

v. Repos Involving ``End Users''
One commenter argued that transactions by commercial entities
participating in the Treasury repo market solely for investing their
extra cash balances should be excluded from the definition of an
eligible secondary market transaction. The commenter stated that
corporations are often required under their credit agreements to invest
cash in specified cash equivalents, which typically include Treasury
repos, and that these transactions are likely to be quite limited in
size.\223\ The commenter suggested that the Commission could leverage
the definition of commercial end user in the uncleared security-based
swap margin rules or non-financial end user in the uncleared swap
margin rules (which both similarly contain exemptions for such
entities).\224\
---------------------------------------------------------------------------

\223\ SIFMA/IIB Letter, supra note 37, at 22.
\224\ Id. (citing 17 CFR 240.18a-3(b)(2), and 23.151; 12 CFR
45.2).
---------------------------------------------------------------------------

Another commenter requested a similar exclusion, stating that
commercial entities that enter into cash or repo transactions do so for
various, legitimate purposes, but that these entities' trading is
rarely large in size and the costs of these transactions being cleared
would ultimately outweigh the benefits. The commenter also stated that
such an exclusion would be consistent with the exemption in the
Commission's uncleared swap margin rules.\225\ An additional commenter
requested the same exclusion for non-financial commercial end users,
such as corporations and municipalities. The commenter stated that
these types of entities typically transact in U.S. Treasury repos for
funding and liquidity management purposes, and that the increased costs
of centrally clearing such transactions may outweigh the willingness of
these types of entities to continue to use U.S. Treasury securities for
funding and liquidity management purposes, thus eliminating an
effective corporate management tool without advancing the Commission's
stated policy objectives.\226\
---------------------------------------------------------------------------

\225\ AIMA Letter II, supra note 115, at 3.
\226\ See Morgan Stanley Letter, supra note 85, at 2.
---------------------------------------------------------------------------

The Commission understands that in addition to cash assets obtained
through credit agreements, other sources of corporate cash exist that
do not typically have accompanying investment limitations, such as
equity capital, retained earnings, sales of assets, and legal
settlements, among others. Investments of the combined surplus cash by
corporate treasurers are typically aligned with the firm's projected
cash needs and may include a range of investment options in addition to
Treasury repos.\227\ As of June 30, 2023, balances of liquid assets
held by nonfinancial corporations are estimated at approximately $6.9
trillion.\228\ While the commenter stated that such an exclusion may be
warranted because the Treasury repo investments are likely to be
limited in size, commercial end-users could change the size of their
Treasury repo investments, including by entering into large Treasury
repo investments, or by using alternative options for the short-term
investment of cash that share a similar risk profile, such as a money
market fund, depending on many firm-specific and market factors. For
example, commercial end-users may increase allocations to U.S. Treasury
repos for credit diversification, particularly at times of market
stress. U.S. Treasury repos may offer higher yields, particularly at
times when issuance of Treasury securities increases and dealers seek
financing to complete settlement by borrowing more cash in the repo
market. The high liquidity of Treasury repos could also be attractive
to commercial end-users, especially if a significant amount of
liquidity needs to be accumulated to complete a corporate transaction
such as a merger or an acquisition.
---------------------------------------------------------------------------

\227\ Association of Finance Professionals, 2023 AFP Liquidity
Survey, available at https://www.afponline.org/publications-data-tools/reports/survey-research-economic-data/Details/liquidity-survey.
\228\ Federal Reserve, Financial Accounts of the United States,
L.103 Nonfinancial Corporate Business (the broad measure of liquid
assets includes cash held in banks' accounts and deposits, and cash
invested in various liquid financial assets), available at https://www.federalreserve.gov/releases/z1/20230908/html/l103.htm.
---------------------------------------------------------------------------

An exemption for end users could permit commercial entities to
enter into Treasury repo investments without the risk-reducing benefits
of central clearing. In addition, due to the variety of sources of cash
available to commercial entities besides those obtained through credit
agreements and the size of corporate liquid assets held by commercial
entities, excluding commercial entities from the scope of the
definition of an eligible secondary market transaction would not be
consistent with the intent to reduce risk and enhance efficiency of the
U.S. Treasury market.\229\ The Commission also disagrees with the
contention that the increased costs arising from the clearing mandate
would impede the willingness of commercial entities to continue to use
the Treasury repo market for funding and liquidity management purposes.
As discussed in part I supra, central clearing allows market
participants to reduce costs and increase operational efficiency, among
other benefits, which would, in turn, lead to lower funding costs in
the repo market and greater availability of liquidity for all market
participants, including commercial end-users.
---------------------------------------------------------------------------

\229\ Association of Finance Professionals, 2023 AFP Liquidity
Survey, available at https://www.afponline.org/publications-data-tools/reports/survey-research-economic-data/Details/liquidity-survey.
---------------------------------------------------------------------------

Moreover, the Commission disagrees with the commenter's suggestion
that it could leverage the definitions used in exempting certain end
users from swap clearing requirements. The commercial end user in the
uncleared security-based swap margin rules is defined as a counterparty
to the swap that is (i) is not a financial entity; (ii) is using swaps
to hedge or mitigate commercial risk; and (iii) meets certain reporting
obligations associated with entering into non-cleared swaps.\230\ The
exemption is intended to ensure that certain types of commercial
entities are able to continue to use swaps to manage their specific
commercial risks and are not unduly burdened by the need to post
margin. The end-user exemption from clearing for swaps may not be
available to all commercial entities entering swaps. When implementing
the exemption, the CFTC specifically required, among other things, that
the end user must be using the swap to hedge or mitigate commercial
risk, and that the swap that is hedging or mitigating commercial risk
cannot be used for a purpose that is in the nature of speculation,
investing, or trading.\231\ In addition, the counterparty that elected
the end-user exception must provide reports relating to its ability to
meet financial obligations associated with entering into non-cleared
swaps.\232\
---------------------------------------------------------------------------

\230\ Commodity Exchange Act section 2(h)(7); Exchange Act
section 3C(g).
\231\ 17 CFR 50.50(a)(1)(ii) and (c)(2)(i).
\232\ 17 CFR 50.50(b).
---------------------------------------------------------------------------

In contrast, the commercial end user activity in the U.S. Treasury
repo market is unrelated to the commercial activity of these users.
Investment of surplus cash is an activity similar to that of
institutional asset managers such as registered funds or other managed
investments. As discussed above, investing is a type of activity that
would not qualify the end-user exemption in the swap market. For the
reasons here and above, the Commission does not believe that an
exception for commercial end users is appropriate in the Treasury repo
market.
vi. Interaffiliate Repos
One commenter recommended that the Commission exempt transactions
in

[[Page 2737]]

U.S. Treasury securities between affiliates from any central clearing
requirement. The commenter stated that inter-affiliate transactions are
important to corporate groups, which may use them to achieve efficient
risk and capital allocation and obtain flexibility for addressing
customer demands.\233\
---------------------------------------------------------------------------

\233\ SIFMA/IIB Letter, supra note 37, at 21-22.
---------------------------------------------------------------------------

The commenter further stated that requiring inter-affiliate
transactions to be centrally cleared would impose additional costs with
limited benefits, for two reasons. First, if an inter-affiliate
transaction is part of a ``back-to-back arrangement,'' meaning that the
related external transaction between the affiliated counterparty and a
non-affiliated counterparty is not centrally cleared, then subjecting
the inter-affiliate transaction to a central clearing requirement does
nothing to reduce the contagion risk presented by the non-affiliated
counterparty. The commenter further asserted that if that external
transaction is already centrally cleared, the contagion risk would
already be addressed and requiring the inter-affiliate transaction to
be cleared would not create additional benefits. Second, a direct
participant's affiliate's credit risk is already part of the group-wide
financial risks to which the Treasury CCP is exposed, and central
clearing of inter-affiliate transactions is unlikely to meaningfully
impact the risk profile.\234\ The commenter stated that, for similar
reasons, the CFTC has exempted inter-affiliate swaps from the swap
mandatory clearing rules.\235\
---------------------------------------------------------------------------

\234\ SIFMA/IIB Letter, supra note 37, at 21-22.
\235\ See id. at 22 n. 66 (citing generally 17 CFR 50.52).
---------------------------------------------------------------------------

Additional commenters made similar arguments. For example, one
commenter stated that the definition of an eligible secondary market
transaction should not apply to transactions between a direct
participant of a U.S. Treasury securities CCA and its affiliates. The
commenter explained that a CCA's direct participants provide a range of
risk management, collateral management, asset-liability management, and
funding and liquidity services to their affiliates, including
affiliated U.S. broker-dealers, and that imposing the definition of
those direct participants' transactions with affiliates would be
potentially disruptive and unnecessary to advance the Commission's
stated policy objectives.\236\ Another commenter stated that a
requirement to clear transactions between affiliates would create new,
unnecessary costs without any benefits.\237\
---------------------------------------------------------------------------

\236\ See Morgan Stanley Letter, supra note 85, at 1-2.
\237\ AIMA Letter II, supra note 115, at 3.
---------------------------------------------------------------------------

As discussed in more detail in part IV.B, the Commission
understands that inter-affiliate transactions represent an important
tool to transfer liquidity and risk within an affiliated group. These
transactions may serve different purposes, including, but not limited
to, providing U.S. Treasury securities for delivery when an affiliate
has taken a long or short position in U.S. Treasury securities as a
hedge against other exposures, allowing the movement of U.S. Treasury
securities to allow them to be posted as margin on an affiliate's
transaction, ensuring that U.S. Treasury securities can serve as a
liquidity buffer for an affiliated bank,\238\ or to meet liquidity
composition targets. To get the U.S. Treasury securities to the
appropriate entity within an affiliated group, the affiliate often
enters into repos or reverse repos with a direct participant of a U.S.
Treasury securities CCA.
---------------------------------------------------------------------------

\238\ A liquidity buffer generally refers to liquid assets that
a banking organization manages to enable it to meet expected and
unexpected cash flows and collateral needs without adversely
affecting the banking organization's daily operations. See generally
FRB, FDIC, & OCC, Q&As on Statement Regarding the Use of Capital and
Liquidity Buffers (Mar. 17, 2020), available at https://www.fdic.gov/news/financial-institution-letters/2020/fil20020a.pdf.
---------------------------------------------------------------------------

In certain circumstances, the counterparty credit risk posed by
inter-affiliate transactions may be less than other transactions.\239\
However, affiliated entities are separate legal entities and,
generally, are not legally responsible for each other's contractual
obligations. In the event that one or more affiliated entities becomes
insolvent, the affiliates, as separate legal entities, would be managed
as separate estates in a bankruptcy, with the trustee having a duty to
the creditors of the affiliate, not the affiliated family. Thus, the
Commission does not agree that a U.S. Treasury securities CCA is
exposed to the group-wide financial risks of a direct participant's
affiliated group.
---------------------------------------------------------------------------

\239\ See, e.g., Clearing Exemption for Swaps Between Certain
Affiliated Entities, 77 FR 50425, 50427 (Mar. 2012) (discussing the
internalization of counterparty risk on inter-affiliate swap
transactions as wholly owned members of the same corporate group,
but also discussing that similar benefits may not accrue for other
inter-affiliate swaps when the counterparties are not members of the
same group).
---------------------------------------------------------------------------

In response to the comments received, the Commission is modifying
the definition of an eligible secondary market transaction in Rule
17ad-22(a) to conditionally exclude inter-affiliate repurchase and
reverse repurchase transactions. Specifically, the Commission is
excluding from that definition any repurchase or reverse repurchase
agreement collateralized by U.S. Treasury securities entered into
between a direct participant and an affiliated counterparty, provided
that the affiliated counterparty submits for clearance and settlement
all other repurchase or reverse repurchase agreements collateralized by
U.S. Treasury securities to which the affiliated counterparty is a
party. By referring to all other repos or reverse repos, the exemption
clarifies that the requirement does not encompass transactions between
the direct participant and the affiliate, i.e., the transactions that
are excluded, and also does not encompass the affiliate's transactions
that would otherwise be excluded under sections (iii), (iv), or (v) of
the definition of an eligible secondary market transaction. This
exclusion is appropriate to ensure that affiliated groups can continue
to use inter-affiliate repo transactions to transfer liquidity or risk,
while also conditioning that ability on the affiliated counterparty's
submission of its eligible secondary market repo transactions for
clearance and settlement.\240\
---------------------------------------------------------------------------

\240\ Although the commenter referred generally to inter-
affiliate transactions, without specifying cash versus repo, the
Commission is limiting the exclusion to repo transactions only for
two reasons. First, inter-affiliate cash transactions would only be
included in the definition of an eligible secondary market
transaction if they met the definition of such transaction, as
discussed further in part II.A.2.b. Second, as discussed in this
section and in part IV.B.3.b.v, the Commission understands that the
inter-affiliate transactions referenced by the commenter typically
take the form of repo or reverse repo transactions.
---------------------------------------------------------------------------

Regarding the conditional nature of the exclusion, the Commission
agreed with the commenter that if the external transaction of a ``back-
to-back'' arrangement in which the related external transaction between
the affiliated counterparty and a non-affiliated counterparty is
centrally cleared, the contagion risk would already be addressed and
requiring the inter-affiliate transaction to be cleared would not
create additional benefits. To ensure that this is the case, the
Commission is conditioning the availability of the exclusion for inter-
affiliate transactions on an obligation for the affiliated counterparty
to submit its repo transactions, other than those with its direct
participant counterparty, for clearance and settlement. This condition
should also help ensure that a direct participant cannot rely upon an
inter-affiliate transaction to avoid the requirement to clear eligible
secondary market transactions. If there were no such condition, a
direct participant

[[Page 2738]]

could simply use inter-affiliate transactions to move securities and
funds to affiliates, and the affiliated counterparty could then enter
into external transactions with counterparties which, if entered into
as a direct participant of a U.S. Treasury securities CCA, would be
eligible secondary market transactions.\241\ The Commission did not
limit this condition to only the ``back-to-back'' transactions because
such transactions may not serve as the only potential means by which
inter-affiliate transactions can be used to evade the requirement to
clear eligible secondary market transactions, and for that matter, may
not serve as the only potential means by which such transactions can
transfer risk.\242\ This condition should lessen the potential for any
impacts arising from the default of an inter-affiliate transaction to
spread throughout an affiliated group because it would ensure that the
external facing transactions of an affiliated counterparty would be
centrally cleared, if the direct participant wanted to exclude its
inter-affiliate transactions.\243\
---------------------------------------------------------------------------

\241\ The Commission acknowledges that the affiliated
counterparty's transactions may encompass transactions to which the
requirement to clear eligible secondary market transactions already
applies, either because the affiliated counterparty is transacting
with another direct participant of a U.S. Treasury securities CCA or
because the affiliated counterparty is itself a direct participant
of a U.S. Treasury securities CCA. The condition for the affiliate
to clear its repo or reverse repo transactions would also apply,
however, even if the affiliate is not a direct participant of a U.S.
Treasury securities CCA.
\242\ See, e.g., Final Rule, Clearing Exemption for Swaps
Between Certain Affiliated Entities, 78 FR 21750, 21761-62 (Apr. 11,
2013).
\243\ Moreover, the condition is consistent with the commenters'
views noting that in the event that the external transaction is
centrally cleared, the benefits of central clearing would be
realized. See AIMA Letter II, supra note 115, at 3.
---------------------------------------------------------------------------

This approach to an inter-affiliate exclusion for repos is
consistent with the CFTC's treatment of this issue in the swaps market,
as the commenter suggested. As part of its inter-affiliate swap
exemption, the CFTC also included a requirement that that the swaps
entered into by the affiliated counterparties with unaffiliated
counterparties must be cleared.\244\ This approach to an inter-
affiliate exclusion for repos is also similar to the existing rules
with respect to inter-affiliate transactions in place at FICC, as the
only U.S. Treasury securities CCA. FICC's rules require that its direct
participants submit the transactions of particular affiliated
counterparties (referred to as a Covered Affiliate), i.e., those that
are not also direct participants, that are not foreign entities, and
that are either broker-dealers, banks, trust companies, and/or FCMs, if
that transaction is with another direct participant or another direct
participant's Covered Affiliate.
---------------------------------------------------------------------------

\244\ See 17 CFR 50.52(a)(4)(i)(E).
---------------------------------------------------------------------------

To accommodate this exclusion, the Commission is also adopting in
Rule 17ad-22(a) a definition of an affiliated counterparty for purposes
of the definition of an eligible secondary market transaction.
Specifically, an affiliated counterparty would be defined as any
counterparty which meets the following criteria: (i) the counterparty
is either a bank (as defined in 15 U.S.C. 78c(6)), broker (as defined
in 15 U.S.C. 78c(4)), dealer (as defined in 15 U.S.C. 78c(5)), or
futures commission merchant (as defined in 7 U.S.C. 1a(28)), or any
entity regulated as a bank, broker, dealer, or futures commission
merchant in its home jurisdiction; (ii) the counterparty holds,
directly or indirectly, a majority ownership interest in the direct
participant, or the direct participant, directly or indirectly, holds a
majority ownership interest in the counterparty, or a third party,
directly or indirectly, holds a majority ownership interest in both the
direct participant and the counterparty; and (iii) the counterparty,
direct participant, or third party referenced in (ii) as holding the
majority ownership interest would be required to report its financial
statements on a consolidated basis under U.S. Generally Accepted
Accounting Principles or International Financial Reporting Standards,
and such consolidated financial statements include the financial
results of the majority-owned party or of both majority-owned parties.
With respect to the types of entities that can be considered an
affiliated counterparty, this definition is consistent with how the
current U.S. Treasury securities CCA defines the terms for purposes of
its rule regarding its participants' obligation to clear transactions
with certain affiliates, and this consistency should be helpful to
direct participants when considering compliance with this conditional
exemption. The reference to entities that are regulated as banks,
brokers, dealers, or futures commission merchants in their home
jurisdictions encompasses foreign affiliates of direct participants of
a U.S. Treasury securities CCA. This aspect of the definition of an
affiliated counterparty is meant to ensure that, to take advantage of
the conditional inter-affiliate exemption, a direct participant of a
U.S. Treasury securities CCA would have to ensure that the transactions
of both domestic and foreign affiliates are submitted for clearing.
Similarly, with respect to what constitutes affiliated, that is, the
specific identification of ownership interest to describe the requisite
custody or control to be considered affiliated, this definition is
consistent with the definition used by the CFTC for purposes of the
inter-affiliate swap exemption. This consistency, and additional
specificity about the requisite custody or control, should be helpful
to the direct participants of a U.S. Treasury securities CCA when
determining compliance with this conditional exemption.\245\
---------------------------------------------------------------------------

\245\ Rule 17ad-22(a) currently contains a definition of a
``participant family'' for purposes of Rule 17ad-22(b)(3), (d)(14),
(e)(4), and (e)(7). 17 CFR 240.17ad-22(a)(12). This term is defined
to mean that if a participant directly, or indirectly through one or
more intermediaries, controls, is controlled by, or is under common
control with, another participant then the affiliated participants
shall be collectively deemed to be a single participant family for
purposes of the specified portions of Rule 17ad-22. The Commission
believes that a more specific and granular definition of an
affiliated counterparty would be helpful for the purposes of the
inter-affiliate exclusion because it would address any potential
uncertainty about whether an entity controls, is controlled by, or
is under common control with, another entity.
---------------------------------------------------------------------------

This exemption is conditional, and a direct participant of a U.S.
Treasury securities CCA may choose not to use the exemption, meaning
that its affiliated counterparty would not be required to submit its
repo transactions, other than those with its direct participant
counterparty, for clearance and settlement. If a direct participant
chooses to use the exemption, its affiliated counterparty could submit
its transactions in several ways, including through an indirect
clearing model (e.g., at FICC, the affiliated counterparty could be a
Sponsored Member or use the Prime Broker or Correspondent Clearing
models to submit its transactions for clearance and settlement) or by
becoming a direct participant of the CCA.\246\
---------------------------------------------------------------------------

\246\ See notes 680 and 681 infra and accompanying text
regarding these models.
---------------------------------------------------------------------------

vii. Repos by State and Local Governments
Several commenters argued that regulatory and practical constraints
on the state and local government level could limit their ability to
centrally clear their Treasury repo and reverse repo transactions.\247\
The commenters stated that authorizing statutes and local ordinances in
several states only permit repo transactions with a bank or a
government securities dealer counterparty.\248\ As such, a centrally
cleared repo, which is novated to a CCA may not comply with these
statutes or ordinances, because the CCA would be

[[Page 2739]]

the counterparty. One commenter also highlighted specific
collateralization requirements (e.g., 102%) by several states to their
repo counterparties and raised concerns that varying levels of
margining in central clearing of such trades could create a conflict
with state laws.\249\ The commenters argued that amending state and
local governments' authorizing statutes through the legislative actions
of an applicable body would take a substantial amount of time and would
disrupt investments of public funds in the Treasury repo market with a
negative effect on market liquidity.\250\ Considering these challenges,
the commentors suggested exempting state and local governments from the
scope of the definition of an eligible secondary market transaction.
---------------------------------------------------------------------------

\247\ SIFMA AMG Letter, supra note 35, at 14; Federated Letter,
supra note 81, at 7; IDTA Letter, supra note 66, at 10.
\248\ Id.
\249\ IDTA Letter, supra note 66, at 10.
\250\ SIFMA AMG Letter, supra note 35, at 14; Federated Letter,
supra note 81, at 7; IDTA Letter, supra note 66, at 10; see also
Letter from James Tabacchi, Chairman, Independent Dealer and Trader
Association and attached whitepaper at 5 (Sept. 1, 2023) (discussing
the fact that most states and municipalities use Master Repo
Agreements based on local law and would by statute be unable to sign
a New York law-based agreement to clear through a U.S. Treasury
securities CCA).
---------------------------------------------------------------------------

The Commission agrees with the commenters that it would be
appropriate to adopt an exclusion for any repurchase or reverse
repurchase transaction collateralized by U.S. Treasury securities
between a direct participant and a state or local government, in light
of both the potential conflicts with state and local government
authorities related to their investments and because of the nature and
size of U.S. Treasury market activity by such entities.
According to the United States Census Bureau's 2017 Census of
Governments data, there were over 90,000 local governments in the
United States, including county, city, municipality, township, and
special purpose governments as well as nearly 13,000 independent school
district governments.\251\ Many of these local governments operate only
small budgets and access the Treasury repo market infrequently and on a
small scale for secured investment of their surplus cash balances.
While comprehensive data about investment activity of state and local
governments are lacking, the costs of building legal and operational
infrastructure to access central clearing by most of these governments
may prevent them from accessing the Treasury repo market.
---------------------------------------------------------------------------

\251\ United States Census Bureau, ``2017 Census of
Governments--Organization,'' Table 2: Local Governments by Type and
States and Table 9: Public School System by Types of Organization
and State, available at https://www.census.gov/data/tables/2017/econ/gus/2017-governments.html.
---------------------------------------------------------------------------

The Commission does not believe that such an exclusion should apply
to any pension or retirement plan established or maintained by a state,
any of its political subdivisions, or any agency or instrumentality of
a state or any of its political subdivisions, for the benefit of its
employees (or any beneficiaries of its employees). Such state pension
and retirement plans generally do not face the same statutory
restrictions as state and local governments regarding their
investments,\252\ and indeed, several such plans are currently
Sponsored Members of FICC.\253\
---------------------------------------------------------------------------

\252\ See, e.g., California Government Code section 20190
(providing that Board of Advisors of Public Employee Retirement
System may, in its discretion, invest the assets of the fund through
the purchase, holding, or sale thereof of any investment, financial
instrument, or financial transaction when the investment, financial
instrument, or financial transaction is prudent in the Board's
informed opinion); N.Y. Retire. & Soc. Sec. Law 177 (identifying
eligible investments of NY state public pension funds, without
limiting the counterparties to a repo); Wis. Stat. 325.17
(identifying eligible investments for Wisconsin state public pension
funds to various instruments, without limiting the counterparties to
a repo).
\253\ DTCC, FICC-GSD Member Directories, Sponsored Member
Listings, available at https://www.dtcc.com/client-center/ficc-gov-directories (showing five state and local pension plans as Sponsored
Members).
---------------------------------------------------------------------------

Moreover, state pension and retirement plans manage a substantial
amount of assets and are important participants in the Treasury repo
market. In contrast to surplus cash balances of state and local
governments that are expected to be managed with the principal
preservation objective, public pension and retirement plans typically
have more sizable assets under management and pursue a long-term return
objective employing a variety of return-enhancing strategies, including
the use of leverage.\254\ As of March 31, 2023, total funded assets
under management of these plans were approximately $5.3 trillion.\255\
A survey conducted by the National Association of State Retirement
Administrators found that the average public pension fund allocates
around 2.5% of its assets to cash investments, which would include
investments in the Treasury repo market.\256\ Given the total asset
size of the state pension and retirement plans and the variety of
investment strategies that they can pursue as well as their ability to
participate in central clearing under their governing statutes,
excluding these plans from the scope of the definition of an eligible
secondary market transaction would be inconsistent with the intent to
reduce risk and enhance efficiency of the U.S. Treasury market.
---------------------------------------------------------------------------

\254\ See, e.g., California Public Employees' Retirement System
Total Fund Investment Policy, available at https://www.calpers.ca.gov/docs/total-fund-investment-policy.pdf; State of
Wisconsin Investment Board, Investment Strategy, available at
https://www.swib.state.wi.us/investmentstrategy; Teachers Retirement
System of Texas, Investment Strategy, available at https://www.trs.texas.gov/Pages/investment_strategy.aspx.
\255\ Federal Reserve, Financial Accounts of the United States,
L.120 State and Local Government Employee Retirement Funds (total
funded assets are considered), available at https://www.federalreserve.gov/releases/z1/20230608/html/l120.htm. This data
set consists of retirement systems that are administered by a
recognized unit of a state or local government as defined by the
Bureau of the Census and whose members are public employees
compensated with public funds. It includes the defined benefit (DB)
and defined contribution (DC) retirement funds of both state
governments and local government entities such as counties,
municipalities, townships, school districts, and special districts.
\256\ National Association of State Retirement Administrators,
Investments, available at https://www.nasra.org/investment.
---------------------------------------------------------------------------

The Commission is therefore excluding from the definition of an
eligible secondary market transaction any repurchase or reverse
repurchase agreement collateralized by U.S. Treasury securities in
which one counterparty is a state or local government. In addition, the
Commission would add a definition of state and local government to Rule
17ad-22(a) to mean a state or any political subdivision thereof, or an
agency or instrumentality of a State or any political subdivision
thereof, but not to include any pension or retirement plan established
or maintained by a state, any of its political subdivisions, or any
agency or instrumentality of a state or any of its political
subdivisions, for the benefit of its employees (or any beneficiaries of
its employees).\257\
---------------------------------------------------------------------------

\257\ ``State'' is defined in Exchange Act section 3(a)(16) as
any State of the United States, the District of Columbia, Puerto
Rico, the Virgin Islands, or any other possession of the United
States.
---------------------------------------------------------------------------

viii. Other Repo Comments
One commenter suggested that the Commission should provide further
specificity around the definition of a repurchase or reverse repurchase
agreement, suggesting that it may be advisable for the Commission to
adopt the definition used by the current U.S. Treasury securities
CCA.\258\ The

[[Page 2740]]

commenter suggested that this definition is indifferent to the method
of documentation, making it clear that inclusion in the definition does
not depend on the particular documentation the parties elect to use,
such as a Master Securities Lending Agreement or Master Securities Loan
Agreement.\259\ The Commission does not believe that further revision
of the definition is necessary.
---------------------------------------------------------------------------

\258\ DTCC/FICC Letter, supra note 33, at 11-12 (citing the FICC
definition of a Repo Transaction, which covers ``(1) an agreement of
a party to transfer Eligible Securities to another party in exchange
for the receipt of cash, and the simultaneous agreement of the
former party to later take back the same Eligible Securities (or any
subsequently substituted Eligible Securities) from the latter party
in exchange for the payment of cash, or (2) an agreement of a party
to take in Eligible Securities from another party in exchange for
the payment of cash, and the simultaneous agreement of the former
party to later transfer back the same Eligible Securities (or any
subsequently substituted Eligible Securities) to the latter party in
exchange for the receipt of cash'').
\259\ DTCC/FICC Letter, supra note 33, at 11-12.
---------------------------------------------------------------------------

The definition of an eligible secondary market transaction, both as
proposed and as adopted, applies to all types of transactions that are
of a type currently accepted for clearing at a U.S. Treasury securities
CCA. It does not impose a requirement on a U.S. Treasury securities CCA
to offer additional products for clearing. One commenter specifically
agreed that the proposal should apply to the types of transactions that
are eligible for clearing at a U.S. Treasury securities CCA, as those
eligibility criteria evolve over time. The commenter stated that such
an approach would ensure that the requirement would not inadvertently
give rise to risk or undue costs by forcing into central clearing
transaction types that have not gone through a methodical risk analysis
or for which the costs may outweigh the benefits, while at the same
time, it would allow the requirement to evolve as U.S. Treasury
securities CCAs, their direct participants, and regulators identify
transaction types that would benefit from central clearing.\260\ The
Commission agrees that the definition being adopted will allow for this
type of approach to the clearing requirement.
---------------------------------------------------------------------------

\260\ DTCC/FICC Letter, supra note 33, at 12-13.
---------------------------------------------------------------------------

Several commenters discussed whether securities lending should be
included within the scope of this definition.\261\ Securities lending
transactions do not fall within the scope of the definition of an
eligible secondary market transaction and are not currently available
for central clearing.
---------------------------------------------------------------------------

\261\ See BNY Mellon Letter, supra note 33, at 2 (suggesting
additional analysis before requiring the central clearing of
securities lending transactions, as well as consideration of a non-
cash model for central clearing such transactions); Federated Hermes
Letter, supra note 85, at 7-8 (stating that securities lending
transactions should not be included in a clearing mandate because
they are subject to different market infrastructure than repurchase
agreements, which has not been adapted to facilitate cleared
securities lending transactions); Letter from Fran Garritt,
Director, Securities Lending & Market Risk and Mark Whipple,
Chairman, Committee on Securities Lending Risk Management
Association (Dec. 23, 2022) (arguing generally that the scope of an
eligible secondary market transaction not be expanded to include
securities lending transactions because of the negative impact on
beneficial owners, the increased costs, and lack of infrastructure);
SIFMA/IIB Letter, supra note 37, at 22; ICI Letter, supra note 85,
at 12 n.35.
---------------------------------------------------------------------------

One commenter requested clarification that the definition of an
eligible secondary market transaction does not apply to final
settlement under physical-delivery futures contracts on U.S. Treasury
bonds or notes (``Treasury futures''). The commenter noted that such
Treasury futures are already subject to a central clearing requirement
and described how the physical delivery process works, that is, if a
Treasury future goes to delivery, then the commenter, which centrally
clears Treasury futures, would inform long clearing members of the U.S.
Treasury securities that will be delivered by the short position
holders to whom they have been matched and the invoice amounts that the
short clearing members must receive in payment.\262\ The Commission
agrees with the commenter that the physical settlement of Treasury
futures does not fall within the definition of an eligible secondary
market transaction because it does not fit within the specific
categories set forth in the rule. In addition, the Treasury futures are
already subject to central clearing, thereby ensuring that the benefits
of central clearing are already present in this aspect of the market.
---------------------------------------------------------------------------

\262\ CME Letter, supra note 81, at 7-8.
---------------------------------------------------------------------------

Another commenter did not support a requirement to clear repos, but
stated that if such a requirement were adopted, it should be limited to
repos by interdealer brokers (``IDBs'') and broker-dealers because (1)
the counterparties to such transactions are the most active
participants in the Treasury repo markets, thereby allowing the
Commission to meaningfully increase central clearing without applying a
more categorical requirement, and (2) such transactions are more
interconnected with the rest of the market and have a higher
possibility to transfer risk to outside parties (including potentially
a U.S. Treasury securities CCA).\263\ The Commission disagrees that the
definition of an eligible secondary market transaction should be
limited in this manner. As discussed in part II.A.2.a supra, there are
substantive benefits that will arise from the broad scope of the repo
market, including with respect to balance sheet netting and greater
capacity of dealers to intermediate repos. Further, the Commission
disagrees that these transactions are ``more interconnected with the
rest of the market,'' because it generally is not possible to quantify
interconnectedness in this manner. Even if a repo is between a dealer
and its customer neither of which is an IDB or a broker-dealer, the
failure of that transaction could have an impact on its counterparties
and transmit that risk to the broader market.
---------------------------------------------------------------------------

\263\ SIFMA/IIB Letter, supra note 37, at 19-20.
---------------------------------------------------------------------------

In addition, several commenters requested exemptions for
transactions entered into outside of the operating hours of a U.S.
Treasury securities CCA that would settle on or before the next day on
which the CCA is open for business. For example, one commenter stated
that firms routinely enter into U.S. Treasury securities transactions
after the close of business at FICC, for legitimate business or
operational reasons, including for treasury management purposes, and
that firms will need the ability to enter into transactions at times
that a CCA is not open to accept transactions for novation. The
commenter compared the situation to the derivatives context in which a
swap subject to mandatory clearing is executed after 4 p.m. or not on a
business day, it must then be submitted by the next business day when a
derivatives clearing organization is open.\264\ Another commenter
stated that market participants may enter into a transaction after the
close of a CCA's operating/business hours, making it unable to accept
the transaction for clearing and novation. The commenter stated that
the Commission should therefore exempt these transactions from a final
rule, unless and until the existing U.S. Treasury securities CCA can
change its operating hours to account for such transactions or another
CCA becomes available with 24/7 clearing capabilities.\265\
---------------------------------------------------------------------------

\264\ SIFMA/IIB Letter, supra note 37, at 21 (citing CFTC Rules
50.1 and 50.2).
\265\ AIMA Letter II, supra note 115, at 2-3.
---------------------------------------------------------------------------

Such an exemption is not necessary. The existing U.S. Treasury
securities CCA accepts all bilateral DVP trades for novation from 7
a.m. until 8 p.m. eastern time.\266\ This window is available for
submission and novation of bilateral repo transactions, which would be
novated in real-time upon submission. The Commission understands that
market participants may enter Treasury repo transactions outside the
normal U.S. business hours when trades are accepted by U.S. Treasury
CCA for novation. A review of repo trading data shows that the largest

[[Page 2741]]

share of repo trading activity is conducted during the first 1.5 hours
of a trading day from 7 a.m. to 8:30 a.m. eastern time.\267\ This early
morning activity may include repo trades that were arranged prior to
the U.S. Treasury market opening at 7:00 a.m. The Commission does not
anticipate the final rule affecting this established market practice.
With respect to triparty repo, any U.S. Treasury securities CCA must
interact with the timelines for triparty repo more generally, which
rely upon the Fedwire Funds Service to transfer funds, and Fedwire has
a deadline for initiating transfers for the benefit of a third party is
6 p.m. eastern time.\268\ The existing U.S. Treasury securities CCA
accepts triparty submissions from 7 a.m. until 5 p.m. and novates the
activity upon settlement of the start leg of the triparty repos,
provided that settlement occurs by 5:30 p.m.\269\ The existing timeline
accommodates completion of the activity at the CCA before the Fedwire
deadline.
---------------------------------------------------------------------------

\266\ See FICC Rules, Schedule of Timeframes, supra note 19.
\267\ Clark et al., Intraday Timing of General Collateral Repo
Markets, Federal Reserve Bank of New York Liberty Street Economics
(July 14, 2021), available at https://libertystreeteconomics.newyorkfed.org/2021/07/intraday-timing-of-general-collateral-repo-markets.
\268\ See Fedwire Funds Services, available at https://
www.federalreserve.gov/paymentsystems/
fedfunds_about.htm#:~:text=The%20Fedwire%20Funds%20Service%20business
,p.m.%20on%20the%20preceding%20Sunday.
\269\ See FICC Rules, Schedule of Sponsored GC Trade Timeframes,
supra note 19.
---------------------------------------------------------------------------

Finally, one commenter requested clarification that the definition
of an eligible secondary market transactions would not include
instances in which market participants post U.S. Treasury securities as
collateral to secure transactions in a wide range of asset classes,
including cleared and uncleared swaps and listed futures.\270\ This
type of transaction does not meet the definition of a repurchase or
reverse repurchase agreement adopted in Rule 17ad-22(a); therefore, it
would not be within the scope of an eligible secondary market
transaction.
---------------------------------------------------------------------------

\270\ See Morgan Stanley Letter, supra note 85, at 2-3.
---------------------------------------------------------------------------

ix. Final Rule
For the reasons set forth in part II.A.2.a, the Commission is
adopting the definition of an eligible secondary market transaction in
Rule 17ad-22(a), specifically as it relates to repurchase and reverse
repurchase agreements, as proposed, except that it is adopting
exclusions from the scope of that definition for repos by other
clearing organizations, repos by state and local governments, and
inter-affiliate repos.
b. Purchases and Sales of U.S. Treasury Securities
With respect to cash transactions (i.e., purchases and sales of
U.S. Treasury securities), the proposal defined an eligible secondary
market transaction as including:
Any purchases and sales entered into by a direct
participant and any counterparty if the direct participant (A) brings
together multiple buyers and sellers using a trading facility (such as
a limit order book) and (B) is a counterparty to both the buyer and
seller in two separate transactions (``IDB transactions''); and
Any purchases and sales of U.S. Treasury securities
between a direct participant and a counterparty that is either (i) a
registered broker-dealer, government securities dealer, or government
securities broker (``broker-dealer transactions''), (ii) a hedge fund,
that is any private fund (other than a securitized asset fund): (a)
with respect to which one or more investment advisers (or related
persons of investment advisers) may be paid a performance fee or
allocation calculated by taking into account unrealized gains (other
than a fee or allocation the calculation of which may take into account
unrealized gains solely for the purpose of reducing such fee or
allocation to reflect net unrealized losses); (b) that may borrow an
amount in excess of one-half of its net asset value (including any
committed capital) or may have gross notional exposure in excess of
twice its net asset value (including any committed capital); or (c)
that may sell securities or other assets short or enter into similar
transactions (other than for the purpose of hedging currency exposure
or managing duration) (``hedge fund transactions''), or (iii) an
account at a registered broker-dealer, government securities dealer, or
government securities broker where such account may borrow an amount in
excess of one-half of the value of the account or may have gross
notional exposure of the transactions in the account that is more than
twice the value of the account (``leveraged account transactions'').
When describing the categories included within the definition, the
Commission stated its belief that including this set of transactions in
the eligible secondary market definition and therefore subjecting these
transactions to the proposal represents an incremental first step to
address potential risks arising to a U.S. Treasury securities CCA.\271\
The Commission referenced recent data indicating that an estimated 68
percent of the overall dollar value of cash market transactions in U.S.
Treasury securities are not centrally cleared, and an estimated 19
percent of the overall dollar value of such transactions are subject to
so-called hybrid clearing (as described above).\272\
---------------------------------------------------------------------------

\271\ Proposing Release, supra note 14, 87 FR at 64622.
\272\ Id. (citing 2021 IAWG Report, supra note 4, at 30; TMPG
White Paper, supra note 13, at 12).
---------------------------------------------------------------------------

Regarding IDB transactions, in the Proposing Release, the
Commission stated its belief that including these transactions in the
definition of an eligible secondary market transaction would
specifically address the potential for contagion risk associated with
hybrid clearing that a number of commentators have highlighted. Hybrid
clearing refers to transactions that are executed on an IDB platform in
which one counterparty is a member of a CCA and submits its transaction
with the IDB for central clearing, while the other counterparty is not
a member of a CCA and bilaterally clears its transaction with the
IDB.\273\ As the Commission explained in the Proposing Release, the
configuration of counterparty risk presented by hybrid clearing allows
the U.S. Treasury securities CCA to manage the risks arising from the
IDB-CCA direct participant transaction, but the U.S. Treasury
securities CCA cannot manage the risks arising from the IDB's
offsetting transaction with its non-member counterparty and the
potential counterparty credit risk and settlement risk posed to the IDB
from that trade.\274\ Thus, under the current hybrid clearing model,
the U.S. Treasury securities CCA is indirectly exposed to the IDB's
non-centrally cleared transaction, but it lacks the ability to risk
manage its indirect exposure to this non-centrally cleared leg of the
transaction. Specifically, it does not know who the ultimate
counterparty of the transaction is and cannot collect margin on that
transaction. This, in turn, results in margin collection at the CCP
which is based upon only one transaction and

[[Page 2742]]

has been calculated to cover this seemingly directional position, as
well as an inability to net these offsetting transactions and provide
the benefits of central clearing. In particular, if the IDB's non-CCP
member counterparty fails to settle a transaction that is subject to
hybrid clearing, such IDB may not be able to settle the corresponding
transaction that has been cleared with the U.S. Treasury securities CCA
due to a lack of financial resources at the IDB, which could lead the
IDB to default.\275\ As part of its existing default management
procedures, the U.S. Treasury securities CCA could seek to mutualize
its losses from the IDB's default, which could in turn transmit stress
to the market as a whole.
---------------------------------------------------------------------------

\273\ Proposing Release, supra note 14, 87 FR at 64622 (citing
TMPG, supra note 13, at 12). These estimates use FR2004 data, which
are reports provided to the Federal Reserve Bank of New York
regarding primary dealer market activity in U.S. Government
securities, covering the first half of 2017 and are based on various
assumptions specified in the TMPG White Paper. See also FR2004,
Government Securities Dealer Reports, available at https://www.federalreserve.gov/apps/reportforms/reportdetail.aspx?sOoYJ+5BzDZq2f74T6b1cw.
\274\ See, e.g., Proposing Release, supra note 14, 87 FR at
64622 (citing TMPG White Paper, supra note 13, at 22 (noting that in
a hybrid clearing arrangement, an IDB's rights and obligations to
the CCP are not offset and the IDB is not in a net zero settlement
position with respect to the CCP at settlement date)).
\275\ See 2021 IAWG Report, supra note 4, at 31; Depository
Trust and Clearing Corporation, More Clearing, Less Risk: Increasing
Centrally Cleared Activity in the U.S. Treasury Cash Market, at 5
(May 2021), available at https://www.dtcc.com/-/media/Files/PDFs/DTCC-US-Treasury-Whitepaper.pdf (``DTCC May 2021 White Paper'').
---------------------------------------------------------------------------

In the Proposing Release, the Commission reiterated its belief that
membership requirements help to guard against defaults of any CCP
member, as well as to protect the CCP and the financial system as a
whole from the risk that one member's default could cause others to
default, potentially including the CCP itself. Further, contagion
stemming from a CCP member default could undermine confidence in the
financial system as a whole, even if the health of the CCP is not
implicated, causing others to back away from participating in the
market. This risk of decreased participation could be particularly
problematic if the defaulting participant was an IDB, whose withdrawal
from the market could impact other market participants' ability to
access the market for on-the-run U.S. Treasury securities,
approximately 49.7% of which trade on IDBs.\276\ Including such
transactions as eligible secondary market transactions would therefore
help protect against this risk by requiring that a U.S. Treasury
securities CCA ensure that direct participants who are IDBs centrally
clear both sides of their transactions, thereby eliminating the various
aspects of potential contagion risk posed by so-called hybrid clearing.
---------------------------------------------------------------------------

\276\ TMPG White Paper, supra note 13, at 32; see part
IV.B.3.a.i infra.
---------------------------------------------------------------------------

Regarding broker-dealer transactions, in the Proposing Release, the
Commission explained that the enumerated types of market participants
(i.e., a registered broker-dealer, government securities broker, or
government securities dealer) are market intermediaries that are
engaged in the business of effecting transactions in securities for the
account of others (in the case of brokers) or for their own accounts
(in the case of dealers).\277\ The Commission relied upon data
indicating that a majority of trades in the secondary cash Treasury
market now clear bilaterally and estimated that the trading volume of
non-FICC members exceeds that of FICC members.\278\ The Commission
stated its belief that their collective trading activity likely is
responsible for a not insignificant portion of the volume of
transactions involving Treasury securities and could present contagion
risk to a U.S. Treasury securities CCA.
---------------------------------------------------------------------------

\277\ Proposing Release, supra note 14, 87 FR at 64623.
\278\ Id. (citing TMPG White Paper, supra note 13, at 21; 2021
IAWG Report, supra note 4, at 30).
---------------------------------------------------------------------------

Regarding hedge fund transactions, the Commission in the Proposing
Release described its intent in including transactions with hedge funds
in the definition of an eligible market transaction as two-fold. First,
hedge funds generally can engage in trading strategies that may pose
heightened risks of potential financial distress to their
counterparties, including those who are direct participants of a U.S.
Treasury securities CCA. There are several characteristics of hedge
fund strategies that could raise such issues, including using financial
institutions that may have systemic importance to obtain leverage,
employing investment strategies that may use leverage, derivatives,
complex structured products, and short selling in an effort to generate
returns, and relying upon strategies involving high volumes of trading
and concentrated investments.\279\ The Commission stated its belief
that significant hedge fund failures, resulting from their investment
positions or use of leverage or both, could result in material losses
at the financial institutions that lend to them if collateral securing
this lending is inadequate, and that these losses could have systemic
implications if they require these financial institutions to scale back
their lending efforts or other financing activities generally. For
these reasons, the Commission stated its belief that that if any of a
hedge fund's activities, even those that are not related to the U.S.
Treasury market, cause financial stress to a counterparty that is a
direct participant of a U.S. Treasury securities CCA, the inclusion of
a hedge fund's U.S. Treasury securities cash transactions with a direct
participant in the definition of an eligible secondary market
transaction should help ensure that such financial stress would not
transmit to the U.S. Treasury securities CCA and through to the U.S.
Treasury market.
---------------------------------------------------------------------------

\279\ Proposing Release, Reporting by Investment Advisers to
Private Funds and Certain Commodity Pool Operators and Commodity
Trading Advisors on Form PF, Release No. IA-3145 (Jan. 26, 2011), 76
FR 8068, 8073 (Feb. 12, 2011) (``Form PF Proposing Release''). The
Commission adopted the hedge fund definition with some amendments
thereafter. Final Rule, Reporting by Investment Advisers to Private
Funds and Certain Commodity Pool Operators and Commodity Trading
Advisors on Form PF, Release No. IA-3308 (Oct. 31, 2011), 76 FR
71127 (Nov. 16, 2011).
---------------------------------------------------------------------------

Second, the Commission relied upon the role of hedge funds in the
overall U.S. Treasury market to support its proposal to include hedge
fund transactions in the definition of an eligible secondary market
transaction.\280\ The Commission stated its belief that hedge funds
transacting in the U.S. Treasury market present a potential contagion
risk to a U.S. Treasury securities CCA because, similar to the risks
posed to a U.S. Treasury securities CCA by non-centrally cleared trades
entered into by an IDB, non-centrally cleared transactions entered into
between hedge funds and direct participants of the CCA could cause
risks to the CCA in the event that the hedge fund is not able to meet
its obligations to the direct participant, which could, in turn, create
stress to the direct participant and through to the CCA. Therefore, the
Commission stated that including the direct participant's purchase and
sale transactions with hedge funds within the definition of an eligible
secondary market transaction should reduce the potential for financial
distress arising from the transactions that could affect the direct
participant and the U.S. Treasury securities CCA.
---------------------------------------------------------------------------

\280\ Proposing Release, supra note 14, 87 FR at 64624 (citing
Private Funds Statistics for Q4 2021, Table 46 (July 22, 2022),
available at https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q4.pdf; Ayelen Banegas,
Sizing Hedge Funds' Treasury Market Activities and Holdings (Oct. 6,
2021), available at https://www.federalreserve.gov/econres/notes/feds-notes/sizing-hedge-funds-treasury-market-activities-and-holdings-20211006.htm; see also Daniel Barth & R. Jay Kahn, Hedge
Funds and the Treasury Cash-Futures Disconnect (Apr. 1, 2021),
available at https://www.financialresearch.gov/working-papers/2021/04/01/hedge-funds-and-the-treasury-cash-futures-disconnect/; Hedge
Fund Treasury Trading and Funding Fragility: Evidence from the
COVID-19 Crisis, available at https://www.federalreserve.gov/econres/feds/files/2021038pap.pdf; 2021 IAWG Report, supra note 4,
at 34; SEC Staff Report on U.S. Credit Markets Interconnectedness
and the Effects of the COVID-19 Economic Shock (Oct. 2020),
available at https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf).
---------------------------------------------------------------------------

The proposed definition of a hedge fund was described as consistent
with the Commission's definition of a hedge fund in Form PF.\281\ The
Commission

[[Page 2743]]

stated its belief that defining a hedge fund in a manner consistent
with Form PF is reasonable, because such definition should encompass
those funds that use strategies that the Commission has determined
merit additional reporting to allow a better picture of the potential
systemic risks posed by such activities.\282\ Including transactions
with such funds within the definition of an eligible secondary market
transaction should help to limit the potential contagion risk that
could arise from any financial distress experienced at such a fund that
could, in turn, be transmitted to a direct participant of a U.S.
Treasury securities CCA (and to the CCA) via any non-centrally cleared
transactions. The Commission further states its belief that using a
definition consistent with that of Form PF to identify transactions
with a U.S. Treasury securities CCA's direct participant as part of the
definition of an eligible secondary market transaction should capture
transactions with entities whose default would be most likely to cause
potential contagion risk to the Treasury securities CCA. For example,
hedge funds' use of leverage can make them more vulnerable to liquidity
shocks, which could, in turn, make them unable to deliver in a
transaction with a direct participant of a U.S. Treasury securities
CCA.
---------------------------------------------------------------------------

\281\ 17 CFR 279.9 (Form PF Glossary of Terms).
\282\ Final Rule, Reporting by Investment Advisers to Private
Funds and Certain Commodity Pool Operators and Commodity Trading
Advisors on Form PF, Release No. IA-3308 (Oct. 31, 2011), 76 FR
71127 (Nov. 16, 2011). The reporting requirements for Form PF vary
based on the amount of private fund assets under management for an
investment adviser registered with the Commission. For example, if
an investment adviser's private fund assets under management,
including with respect to hedge funds, are less than $150 million on
the last day of the most recent fiscal year, then the investment
adviser is not required to file Form PF. Separately, additional
reporting requirements apply to large hedge fund advisers with at
least $1.5 billion in hedge fund assets under management. See Form
PF, Instructions 1 and 3. However, the Commission believes that
including all hedge funds within paragraph (ii)(C) of the definition
of an ``eligible secondary market transaction'' in Proposed Rule
17ad-22(a) would be consistent with its overall policy goals for
central clearing in the U.S. Treasury market and ensuring that hedge
fund transactions with direct participants in a U.S. Treasury
securities CCA do not adversely impact the direct participant and,
potentially, the CCA.
---------------------------------------------------------------------------

Regarding leveraged account transactions, in the Proposing Release,
the Commission stated its belief that the inclusion of transactions
with such accounts, i.e., those that can take on significant amounts of
leverage, within the definition of an eligible secondary market
transaction should encompass transactions between direct participants
of a U.S. Treasury securities CCA and a prime brokerage account, which,
based on the Commission's supervisory knowledge, may hold assets of
entities, such as, for example, private funds or separately managed
accounts, and may use leverage that poses a risk to U.S. Treasury
securities CCA and the broader financial system. The Commission further
stated that by including the account, and not the entity using the
account, this aspect of the proposal is targeted to the activity that
could bring the most potential risk to a U.S. Treasury securities CCA
and the financial system more generally.
The Commission addresses each of these particular types of
transactions in parts II.B.2.b.ii through iv infra, after addressing
more general comments with respect to cash transactions.
i. Comments Regarding Cash Clearing Generally
Several commenters supported the Commission's proposal overall,
including the cash clearing requirement.\283\ By contrast, other
commenters opposed cash clearing generally. One commenter did not
support a clearing requirement or otherwise see the current imperative
for incentivizing the central clearing of cash transactions. The
commenter stated that any requirement to clear cash transactions will
serve to increase costs, generate operational complexities, and reduce
liquidity without producing meaningful benefits to address perceived
issues with respect to the cash market.\284\ The commenter explained
that the increased costs would be substantial and would include, among
other things, increased margin, default fund contributions, and
clearing fees, as well as the costs incurred to put in place the
operations, infrastructure, and standard documentation required to
support central clearing.\285\ The commenter also explained that intra-
day margin calls will ``simply create operational burdens and costs''
with no obvious benefit given that many margin calls will be met late
in the day only to be returned to the posting party the next day. The
commenter stated that to the extent that dealers are required to post
collateral to a covered clearing agency without compensation or to
incur other costs associated with client clearing, those costs will
have to be absorbed either by clients or dealers, which may reduce
their capacity and further constrain liquidity.\286\ The commenter also
stated that additional netting benefits for dealers are unclear as
accounting rules already allow dealers to net unsettled cash
transactions across all counterparties on their balance sheets.\287\
Another commenter also opposed the requirement to clear cash
transactions, but supported the exclusion of money market funds from
the scope of included cash transactions within the definition of an
eligible secondary market transaction.\288\
---------------------------------------------------------------------------

\283\ AFREF Letter, supra note 33, at 2; Better Markets Letter,
supra note 33, at 2, 6-8.
\284\ SIFMA AMG Letter, supra note 35, at 3.
\285\ Id. at 3; see also MFA Letter II, supra note 125, at 5
(regarding increased costs associated with clearing cash
transactions).
\286\ SIFMA AMG Letter, supra note 35, at 7.
\287\ SIFMA AMG Letter, supra note 35, at 3.
\288\ Federated Letter, supra note 85, at 2.
---------------------------------------------------------------------------

In response to the commenters opposed to the inclusion of any cash
transactions in the definition of an eligible secondary market
transaction, the Commission disagrees. As discussed in the Proposing
Release, currently, the majority of cash market transactions are not
centrally cleared, which is in contrast to the market conditions in the
mid-2000s when most cash transactions were centrally cleared. The fact
that more than half of market activity occurs outside central clearing
could represent a contagion risk to any U.S. Treasury securities CCA
serving the market. Therefore, the Commission identified a set of cash
transactions to include in the definition of an eligible secondary
market transaction that would represent an incremental first step in
the cash market, to address risks to the CCA, and identified a specific
rationale with respect to each set of categories, as discussed in part
II.A.2.b supra. Addressing these risks is a meaningful benefit in that
it would ensure that a U.S. Treasury securities CCA is well positioned
to understand and manage the risks posed by its participants'
transactions.
Further, as discussed in more detail in part IV.C, although, as the
commenter states, additional clearing likely would result in increased
margin contributions and clearing fees, simply to account for the
increased clearing volume, as well as the one-time costs regarding the
institution of new contractual arrangements to access central
clearing,\289\ the benefits of central clearing, as discussed in part
II.A.1 supra, justify these costs.
---------------------------------------------------------------------------

\289\ The commenter also references increased default fund
contributions. However, the only U.S. Treasury securities CCA
serving the U.S. Treasury market does not currently maintain a
default fund; therefore, the Commission disagrees that some increase
in such contributions would result from the proposal.
---------------------------------------------------------------------------

The commenter's discussion regarding the operational issues of
intraday margin calls does not specify the particular operational
complexities that would arise, and it does not take into account the
risk management

[[Page 2744]]

benefit arising from such calls, that is, ensuring that a covered
clearing agency can address the risks presented by significant intraday
changes to market volatility or a member's portfolio of net unsettled
positions. Without such an ability, a covered clearing agency would
face potential exposure in the event of the default of a clearing
member; therefore, the additional risk management that a clearing
agency can accomplish using intraday margin calls must be considered.
Moreover, the Commission disagrees with the commenter's implication
that this proposal needs to address the entirety of the ``perceived
issues'' with respect to the cash market. The Commission stated in the
Proposing Release that the requirement to clear eligible secondary
market transactions will not, by itself, necessarily prevent future
market disruptions, but that it could improve the functioning of the
U.S. Treasury market.\290\ Although it may have other effects beyond
the immediate requirement for U.S. Treasury securities CCAs, the
requirement being adopted in this release is designed to improve the
resilience of such CCAs by expanding their ability to manage the risks
arising from direct participants who currently engage in non-centrally
cleared transactions away from the CCA \291\ and need not solve all the
issues that commentators have identified regarding the U.S. Treasury
market.
---------------------------------------------------------------------------

\290\ Proposing Release, supra note 14, 87 FR at 64614.
\291\ Id.
---------------------------------------------------------------------------

By contrast, several commenters suggested that the scope of
eligible secondary market transactions in the cash market be broadened.
One commenter stated that the Commission should align the scope of the
definition with respect to cash transactions with the proposed scope
for repos, subject to certain limited exceptions for investors that
trade de minimis volumes. The commenter argued that the Commission's
approach with respect to cash transactions will increase costs for a
specific subset of market participants (i.e., hedge funds, leveraged
accounts, and those using IDBs), thereby putting them at a competitive
disadvantage, while failing to deliver the envisaged market-wide
benefits associated with central clearing (i.e., it would materially
reduce the associated multilateral netting benefits, impair the risk
management practices of clearing agencies, and hinder the evolution in
trading protocols that can be expected from a market-wide clearing
requirement).\292\ For similar reasons, another commenter also stated
that the benefits of central clearing detailed will only materialize if
``a market-wide mandate is implemented'' and supported defining the
scope of eligible secondary market transactions for cash transactions
as broadly as that proposed for repos.\293\ Another commenter stated
that limiting the scope of the cash clearing mandate would result in
unwarranted competitive disadvantages and related market distortions
for some types of investors, such as hedge funds, or some types of
trading platforms, such as anonymous trading facilities.\294\ An
additional commenter stated that the proposed definition leaves out
other important market participants' cash Treasury transactions that
also make up a large segment of Treasury market liquidity, and that the
Commission should require other market participants' cash Treasury
transactions in which a direct participant is involved to be cleared,
so that the benefits of central clearing that the Commission cites will
accrue throughout the broader cash Treasury market.\295\ In addition,
another commenter acknowledged the benefits of a comprehensive clearing
requirement, but acknowledged the need for a pragmatic approach and
supported the Commission's proposed requirements as a reasonable
foundation to begin mandatory central clearing in this market.\296\
---------------------------------------------------------------------------

\292\ Citadel Letter, supra note 81, at 5.
\293\ ARB et al. Letter, supra note 81, at 4 (stating that the
netting benefits associated with transitioning only proprietary
trading firm (``PTF'') transactions into central clearing are much
smaller, given the substantial netting that already occurs directly
with IDBs; the trading-related benefits of central clearing will
only accrue to market participants if their transactions are covered
by the proposed mandate; and that clearing agency resiliency will be
negatively impacted if only one segment of the market is cleared).
\294\ MFA Letter, supra note 81, at 2.
\295\ AIMA Letter, supra note 81, at 7.
\296\ GTS Letter, supra note 81, at 3-5.
---------------------------------------------------------------------------

In response to the comments that the scope of the cash transactions
that are included in the definition of an eligible secondary market
transaction should be broadened, the scope is not being broadened and,
in fact, is being further narrowed, as discussed further in part
II.A.2.b.iii regarding hedge fund and leveraged account cash
transactions (unless captured by another portion of the rule, e.g., as
an IDB transaction). As stated in the Proposing Release and discussed
in part II.2.b supra, the Commission proposed a deliberate and targeted
approach to clearing in the cash market in the Proposing Release,
limiting the clearing requirement to specific types of entities
transacting with members of a U.S. Treasury securities CCA that pose
heightened risks when clearing cash market treasury transactions
bilaterally. Specifically, the Commission proposed eligible secondary
market transaction to be defined as, with reference to cash market
transactions, a purchase or sale between a direct participant of a
covered clearing agency and (A) any participant if the direct
participant is an IDB; (B) a registered broker-dealer, government
securities broker, or government securities dealer that is not a member
of a covered clearing agency; (C) a hedge fund; or (D) a leveraged
account. In each case, the Commission explained the reasoning for why
such counterparties were to be included in the scope of the
proposal.\297\
---------------------------------------------------------------------------

\297\ Proposing Release, supra note 14, 87 FR at 64622-25.
---------------------------------------------------------------------------

In response to the comments that the benefits of central clearing
would only materialize with a market-wide mandate and that the targeted
cash scope would fail to deliver the market-wide benefits associated
with central clearing, the Commission disagrees because the increased
clearing of cash transactions, targeted to address the differing risk
profiles of each market segment, would still bring the benefits of
central clearing to some portion of the market, even if not as widely
as the scope for repo transactions, while also addressing the risks
inherent in these particular market segments. The Commission does not
believe that the benefits of central clearing exist only if the entire
market is centrally cleared. The increased costs for certain market
participants, that is, those whose transactions with direct
participants of a U.S. Treasury securities CCA are included in the
definition of an eligible secondary market transaction, are justified
by the benefit of addressing the risks inherent in those particular
transactions, and the Commission addresses each of these categories
separately in parts II.A.2.b.ii through iii infra. Moreover, other
types of cash transactions do not present the same types of risk to the
CCA in terms of potential contagion risk.
ii. IDB Transactions
The proposed definition of an eligible secondary market transaction
would include, among other things, any purchase or sale between a
direct participant of a U.S. Treasury securities CCA and any
counterparty, if the direct participant of the covered clearing agency
(A) brings together multiple buyers and sellers using a trading
facility (such as a limit order book) and

[[Page 2745]]

(B) is a counterparty to both the buyer and seller in two separate
transactions.
One commenter anticipated that certain other commenters would
advocate for a definition of eligible secondary market transaction that
would include IDB transactions and would exclude dealer-to-client over-
the-counter trades, which is not what the Commission proposed.\298\ The
commenter cautioned against such an ``uneven'' approach because it
would incentivize market participants to trade bilaterally instead of
using an IDB to avoid central clearing.\299\
---------------------------------------------------------------------------

\298\ See CME Letter, supra note 81, at 5.
\299\ See id.
---------------------------------------------------------------------------

Thus, the commenter supports the scope of the definition of an
eligible secondary market transaction as proposed, that is, including
both IDB transactions and the other categories of transactions set
forth in the definition.\300\ The Commission agrees with the commenter
that the definition, as proposed, would not incentivize market
participants to trade away from IDBs to avoid central clearing because
the definition of what constitutes an eligible secondary market
transaction is broader than simply IDB transactions, such that avoiding
IDBs alone would not be sufficient to avoid the requirement to submit
eligible secondary market transactions for clearing.
---------------------------------------------------------------------------

\300\ See CME Letter, supra note 81, at 5-6 (stating the
commenter's belief that the proposal appears to have been carefully
drafted to avoid encouraging market participants to trade away from
IDBs).
---------------------------------------------------------------------------

In addition, commenters expressed concerns that including IDB
transactions in the definition of an eligible secondary market
transaction could draw trading activity away from IDBs, thereby
reducing market liquidity and market stability.\301\ The commenters
also noted that IDBs are anonymous platforms that currently support
all-to-all trading, and that the Commission has recognized that all-to-
all trading would improve market structure and stability.\302\ The
commenters argued that including IDB transactions in the definition of
an eligible secondary market transaction could, therefore, hinder all-
to-all trading.\303\ One of these commenters further argued that by
discouraging market participants from trading on IDBs, the definition
of an eligible secondary market transaction could limit the choices of
market participants with respect to trading venues.\304\ The inclusion
of IDB transactions, along with other types of transactions, would not
necessarily lead to decreased liquidity and market stability or
negatively impact all-to-all trading in the U.S. Treasury market. The
market function provided by IDBs, that is, bringing together buyers and
sellers anonymously, will continue to be desirable, even if such
transactions are eligible secondary market transactions, meaning that
market participants likely still would use IDBs to transact in the U.S.
Treasury market. Because market participants likely would continue to
transact on IDBs, the commenters' concerns regarding decreased
liquidity and market stability would not materialize.
---------------------------------------------------------------------------

\301\ See ICI Letter, supra note 85, at 3, 11; MFA Letter, supra
note 81, at 20; Tradeweb Letter, supra note 81, at 3-4.
\302\ See ICI Letter, supra note 85, at 3, 11; MFA Letter, supra
note 81, at 20-21; Tradeweb Letter, supra note 81, at 3-4.
\303\ See id.
\304\ See MFA Letter, supra note 81, at 20.
---------------------------------------------------------------------------

Moreover, even if some of these concerns materialize from the
inclusion of IDB transactions, including them is justified as it would
allow the U.S. Treasury securities CCA to better risk manage ``hybrid''
transactions that are currently not being submitted for central
clearing.\305\ Specifically, including IDB transactions in the
definition of an eligible secondary market transaction would address
the potential for contagion risk associated with hybrid clearing. As
explained in the Proposing Release, the configuration of counterparty
risk presented by hybrid clearing allows the U.S. Treasury securities
CCA to manage the risks arising from the IDB-CCA direct participant
transaction, on the one hand, but the U.S. Treasury securities CCA
cannot manage the risks arising from the IDB's offsetting transaction
with its non-member counterparty and the potential counterparty credit
risk and settlement risk arising to the IDB from that trade.\306\ Thus,
under the current hybrid clearing model, the U.S. Treasury securities
CCA is indirectly exposed to the IDB's non-centrally cleared
transaction, but it lacks the ability to risk manage its indirect
exposure to this non-centrally cleared leg of the transaction.
Specifically, it does not know who the ultimate counterparty of the
transaction is and cannot collect margin on that transaction. This, in
turn, results in margin collection at the CCP which is based upon only
one transaction and has been calculated to cover this seemingly
directional position, as well as an inability to net these offsetting
transactions and provide the benefits of central clearing. In
particular, if the IDB's non-CCP member counterparty fails to settle a
transaction that is subject to hybrid clearing, such IDB may not be
able to settle the corresponding transaction that has been cleared with
the U.S. Treasury securities CCA due to a lack of financial resources
at the IDB, which could lead the IDB to default.\307\ As part of its
existing default management procedures, the U.S. Treasury securities
CCA could seek to mutualize its losses from the IDB's default, which
could in turn transmit stress to the market as a whole.
---------------------------------------------------------------------------

\305\ The term ``IDB'' typically refers only to IDBs that are
also ATSs. See note 643 infra.
\306\ See, e.g., Proposing Release, supra note 14, 87 FR at
64622 (citing TMPG White Paper, supra note 13, at 22 (noting that in
a hybrid clearing arrangement, an IDB's rights and obligations to
the CCP are not offset and the IDB is not in a net zero settlement
position with respect to the CCP at settlement date)). Thus, the IDB
is not able to net all of its positions for clearing at a U.S.
Treasury securities CCA, and the IDB's positions appear to the CCA
to be directional, which impacts the amount of margin that the CCA
collects for the transaction.
\307\ See 2021 IAWG Report, supra note 4, at 31; Depository
Trust and Clearing Corporation, More Clearing, Less Risk: Increasing
Centrally Cleared Activity in the U.S. Treasury Cash Market, at 5
(May 2021), available at https://www.dtcc.com/-/media/Files/PDFs/DTCC-US-Treasury-Whitepaper.pdf (``DTCC May 2021 White Paper'').
---------------------------------------------------------------------------

The Commission has previously stated that membership requirements
help to guard against defaults of any CCP member, as well as to protect
the CCP and the financial system as a whole from the risk that one
member's default could cause others to default, potentially including
the CCP itself.\308\ Further, contagion stemming from a CCP member
default could undermine confidence in the financial system as a whole,
even if the health of the CCP is not implicated. This is because the
default could cause others to back away from participating in the
market. This risk of decreased participation could be particularly
problematic if the defaulting participant was an IDB, whose withdrawal
from the market could impact other market participants' ability to
access the market for on-the-run U.S. Treasury securities,
approximately 49.7% of which trade on IDBs.\309\ Including such
transactions within the definition of an eligible secondary market
transaction would therefore help protect against this risk by requiring
that a U.S. Treasury securities CCA ensure that direct participants who
are IDBs centrally clear both sides of their transactions, thereby
eliminating the various aspects of potential contagion risk posed by
so-called hybrid clearing.
---------------------------------------------------------------------------

\308\ See Proposing Release, supra note 14, 87 FR at 64623.
\309\ TMPG White Paper, supra note 13, at 32; section IV.B.4
(Table 1) infra.
---------------------------------------------------------------------------

One commenter urged the Commission to consider adopting the
proposal in increments based on further

[[Page 2746]]

study, with IDB transactions as the first market segment to be included
in the definition due to the distinct settlement risks associated with
the IDBs' hybrid clearing model.\310\ In contrast, another commenter
supported adopting the proposal as drafted, arguing that to include
only IDB transactions would be an uneven approach that would
incentivize market participants to execute their transactions
bilaterally, damaging liquidity on IDB platforms.\311\ Commenters
identified the inclusion of IDB transactions as a targeted option to
include in the definition of an eligible secondary market transaction
to address contagion risk.\312\ One commenter stated that, if the
Commission's concern is the hybrid clearing at IDBs, it would be more
effective to focus on the regulation of the platforms.\313\
---------------------------------------------------------------------------

\310\ See SIFMA/IIB Letter, supra note 37, at 2-3, 16-18
(limiting the proposal to IDB transactions in the cash market would
address the most salient risks that could be addressed through
central clearing).
\311\ See CME Letter, supra note 81, at 5-6.
\312\ AIMA Letter, supra note 81, at 7; SIFMA/IIB Letter, supra
note 37, at 16-18.
\313\ SIFMA AMG Letter, supra note 35, at 11.
---------------------------------------------------------------------------

The Commission agrees with all of the commenters regarding the
appropriateness of Commission action to mitigate the risks associated
with IDBs' hybrid clearing model. The Commission included IDB
transactions in the definition of an eligible secondary market
transaction in order to eliminate the potential contagion risk posed by
hybrid clearing. However, the Commission disagrees with the commenters
arguing in favor of limiting the scope of the definition to include IDB
transactions only or taking an entirely different approach that would
simply regulate IDB platforms. As discussed above, to single out IDBs
(whether in the definition of eligible secondary market transaction or
through another regulatory approach), without including the other cash
transactions included in the definition of an eligible secondary market
transaction, could incentivize market participants to trade away from
IDBs, creating the potential for negative effects on market liquidity,
market stability, all-to-all trading, and participant choice of trading
venue. Accordingly, the Commission is adopting the definition as
proposed.
Two commenters argued that transactions by registered funds that
take place on an IDB should be excluded from the definition of an
eligible secondary market transaction. Specifically, one commenter
urged the Commission to expressly exclude registered funds (e.g.,
mutual funds, exchange-traded funds, closed-end funds, and unit
investment trusts) from the effects of including IDB transactions in
the Membership Proposal.\314\ Similarly, another commenter supported an
exclusion for registered money market funds.\315\
---------------------------------------------------------------------------

\314\ See ICI Letter, supra note 85, at 11.
\315\ See Federated Letter, supra note 85, at 2.
---------------------------------------------------------------------------

The Commission does not agree with these commenters and is not
including any exclusion for registered funds transacting on an IDB. If
a fund chooses to transact on an IDB, the same potential hybrid
contagion risk to the U.S. Treasury securities CCA arises as when other
market participants transact on an IDB. Therefore, the Commission does
not believe that such an exclusion is appropriate.
iii. Other Cash Transactions
The Commission also proposed to include certain additional
categories of cash transactions of U.S. Treasury securities by the
direct participants of a U.S. Treasury securities CCA in the definition
of an eligible secondary market transaction subject to the Membership
Proposal.
First, the Commission proposed that the definition of an eligible
secondary market transaction include those cash purchase and sale
transactions in which the counterparty of the direct participant is a
registered broker-dealer, government securities broker, or government
securities dealer. Each of these entities is a type of market
intermediary that is engaged in the business of effecting transactions
in securities for the account of others (in the case of brokers) or for
their own accounts (in the case of dealers).\316\
---------------------------------------------------------------------------

\316\ See generally TMPG, Automated Trading in Treasury Markets
(White Paper, June 2015), available at https://www.newyorkfed.org/TMPG/medialibrary/microsites/tmpg/files/TPMG-June-2015-Automated-Trading-White-Paper.pdf (``TMPG Automated Trading White Paper'').
---------------------------------------------------------------------------

Commenters did not address this aspect of the definition of an
eligible secondary market transaction. For the reasons stated in the
Proposing Release and as discussed in part II.A.2.b supra, the
Commission continues to believe that these portions of the definition
are appropriate.\317\ The Commission is therefore adopting this aspect
of the exclusions as proposed.
---------------------------------------------------------------------------

\317\ Proposing Release, supra note 14, 87 FR at 64623.
---------------------------------------------------------------------------

Second, the Commission proposed to include within the definition of
an eligible secondary market transaction any purchase and sale
transaction between a direct participant of a U.S. Treasury securities
CCA and a hedge fund, that is any private fund (other than a
securitized asset fund): (a) with respect to which one or more
investment advisers (or related persons of investment advisers) may be
paid a performance fee or allocation calculated by taking into account
unrealized gains (other than a fee or allocation the calculation of
which may take into account unrealized gains solely for the purpose of
reducing such fee or allocation to reflect net unrealized losses); (b)
that may borrow an amount in excess of one-half of its net asset value
(including any committed capital) or may have gross notional exposure
in excess of twice its net asset value (including any committed
capital); or (c) that may sell securities or other assets short or
enter into similar transactions (other than for the purpose of hedging
currency exposure or managing duration). Third, the Commission proposed
to include within the definition of an eligible secondary market
transaction any purchase and sale transaction between a direct
participant of a U.S. Treasury securities CCA and an account at a
registered broker-dealer, government securities dealer, or government
securities broker that either may borrow an amount in excess of one-
half of the net value of the account or may have gross notional
exposure of the transactions in the account that is more than twice the
net value of the account. This would apply to accounts that can take on
significant leverage, that is, by borrowing an amount that is more than
one half of its net value or take on exposures worth more than twice
the account's net value (referred to herein as ``leveraged accounts'').
Some commenters supported the proposed inclusion of transactions
with hedge funds within the definition of an eligible secondary market
transaction.\318\ However, other commenters asserted that transactions
with a hedge fund or a leveraged account \319\ should not be within the
definition of an eligible secondary market transaction.
---------------------------------------------------------------------------

\318\ See DTCC/FICC Letter, supra note 33, at 12; Better Markets
Letter, supra note 33, generally; AFREF Letter, supra note 33, at 2-
3.
\319\ Commenters generally addressed the inclusion of leveraged
account transactions in the definition of an eligible secondary
market transaction as part of a broader discussion including both
hedge fund transactions and leveraged account transactions.
Therefore, the Commission is considering both types of transactions
together for purposes of discussing the comments.
---------------------------------------------------------------------------

One commenter stated that the inclusion of hedge funds within the
counterparties to an eligible secondary market transaction would
arbitrarily single out hedge funds' cash Treasury transactions.\320\
Another commenter

[[Page 2747]]

stated that there is no data to support imposing a clearing requirement
that targets hedge funds and leveraged accounts and expressed concern
that a partial mandate may result in some dealers choosing to offer
liquidity only in a cleared environment thereby reducing the liquidity
available today to accounts in the uncleared cash market.\321\ Another
commenter stated that the inclusion of hedge funds within the
counterparties to an eligible secondary market transaction would create
an uneven playing field that will subject hedge funds to much higher
costs than other market participants.\322\
---------------------------------------------------------------------------

\320\ AIMA Letter, supra note 81, at 7.
\321\ SIFMA AMG Letter, supra note 35, at 11; see also MFA
Letter II, supra note 125, at 7 (regarding decreased liquidity and
potentially shifting transactions away from the requirement to clear
eligible secondary market transactions).
\322\ MFA Letter II, supra note 125, at 7.
---------------------------------------------------------------------------

In addition, certain commenters also raised concerns with the
definition of a hedge fund in the Proposing Release, stating that
because of the nature of the definition, eligible secondary market
transactions would include those with firms that may (but in practice
might not actually) exceed the quantitative thresholds without regard
to the risks that these firms actually take on, or their investment
models and strategies.\323\
---------------------------------------------------------------------------

\323\ MFA Letter, supra note 81, at 18-20; AIMA Letter, supra
note 81, at 6; SIFMA AMG Letter, supra note 35, at 11.
---------------------------------------------------------------------------

The Commission is not adopting proposed sections (ii)(C) and (D) of
the definition of an eligible secondary market transaction with respect
to hedge funds and leveraged accounts in light of questions raised by
commenters regarding the inclusion of a hedge fund and a leveraged
account as proposed that merit further consideration, and the
Commission will continue to evaluate the issues raised to determine if
any further action is appropriate with respect to transactions in the
cash market. This change from the proposal allows for a more
incremental approach to requiring central clearing of transactions in
the cash market. However, the requirement to clear eligible secondary
market transactions that are repos encompasses repos between a direct
participant of a U.S. Treasury securities CCA and a hedge fund or
leveraged account, as discussed in part II.A.2.a supra. This
requirement should ensure that many of the risks posed by hedge funds,
including the repo portion of a basis trade,\324\ would be addressed by
the proposal.
---------------------------------------------------------------------------

\324\ See note 723 infra.
---------------------------------------------------------------------------

Moreover, repo transactions between a direct participant of a U.S.
Treasury securities CCA and a hedge fund or leveraged account would be
within the scope of the definition of an eligible secondary market
transaction discussed in part II.A.2.a supra. This inclusion is
important because it addresses the risks posed by hedge fund and
leveraged account repo activity in the U.S. Treasury market, which is
often highly leveraged and subject to low or zero haircut.\325\
---------------------------------------------------------------------------

\325\ See, e.g., Ayelen Banegas and Phillip Monin, Hedge Fund
Treasury Exposures, Repo, and Margining (Sept. 8, 2023), available
at https://www.federalreserve.gov/econres/notes/feds-notes/hedge-fund-treasury-exposures-repo-and-margining-20230908.html.
---------------------------------------------------------------------------

iv. Comments Regarding Cash Transactions for Registered Funds
As discussed in part II.A.2.b supra, the definition of eligible
secondary market transactions does not include transactions between
direct participants of a U.S. Treasury securities CCA and registered
funds. However, if a registered fund were transacting on an IDB, that
transaction would be an eligible secondary market transaction because
it otherwise meets the definition of such a transaction (i.e., it is an
IDB transaction) and not because it is a registered fund.
Certain commenters addressed cash market transactions specifically
with respect to registered funds. One commenter supported an exclusion
from the definition of an eligible secondary market transaction for
registered funds.\326\ The commenter stated that applying a cash
Treasury clearing mandate to funds would not promote risk reduction or
enhancements to market liquidity to a degree that would justify the
considerable costs and burdens to funds, which would have to build out
an entire new clearing infrastructure, with such costs borne indirectly
by fund investors. The commenter stated that the characteristics of
typical fund cash Treasury transactions are distinguishable from the
types of transactions that the Commission is seeking to capture under
the mandate for risk reduction purposes, i.e., those using significant
leverage and/or giving rise to potential contagion risk. According to
the commenter, registered funds, by contrast, invest in cash Treasury
securities for purposes such as obtaining desired exposure, hedging
risks associated with investments in other markets, diversifying their
portfolios, and protecting capital, among other reasons. The commenter
stated that these transactions are generally not linked to other
leveraged strategies, and observed that funds are limited in their
ability to incur leverage, both by statute (i.e., Section 18 of the
1940 Act) and by SEC rules (e.g., Rule 18f-4 under the 1940 Act). The
commenter further asserted that as a matter of investment strategy as
well, buy-side market participants such as bond funds generally do not
acquire significant leverage, including when investing in Treasury
securities. For these reasons, the commenter asserted that including
registered fund transactions in the definition of an eligible secondary
market transaction would not yield additional risk reduction
benefits.\327\
---------------------------------------------------------------------------

\326\ ICI Letter, supra note 85, at 10.
\327\ ICI Letter, supra note 85, at 10.
---------------------------------------------------------------------------

An additional commenter stated that applying this mandate to money
market funds would yield minimal benefits while potentially imposing
significant costs on such funds.\328\ The commenter stated that its
money market funds do not normally utilize leverage in the cash
purchase of Treasury securities, but instead are generally investing in
Treasury securities on a long-term basis or are using them to hedge
risks, for capital protection or for diversifying the risk in their
investment portfolios. The commenter stated that these strategies are
generally not linked to other leveraged strategies and therefore there
is minimal contagion risk evident in these transactions. The commenter
further stated that the costs of such a mandate would be significant as
the commenter currently does not clear cash Treasury transactions and
therefore would need to establish the technological, operational and
legal frameworks that are necessary to support such a clearing mandate,
meaning that any anticipated benefits of money market funds, as well as
other registered funds, clearing their cash Treasury purchases would be
vastly outweighed by the costs and burdens associated with such a
mandate. The commenter also supported a broader exclusion for
transactions with registered funds from the definition of an eligible
secondary market transaction.\329\
---------------------------------------------------------------------------

\328\ Federated Letter, supra note 85, at 5.
\329\ Id.
---------------------------------------------------------------------------

As stated in the Proposing Release, the Commission identified
certain categories of purchases and sales of U.S. Treasury securities
that should be part of the definition of an eligible secondary market
transaction, and these categories represented an incremental first step
to address potential risks arising to a U.S. Treasury securities CCA.
The Proposing Release did not include transactions with registered
funds as a counterparty within the definition of an eligible secondary
market transaction, and the Commission does not believe that a

[[Page 2748]]

specific exclusion for registered funds is necessary. Although a
transaction with a registered fund may constitute an eligible secondary
market transaction if the transaction otherwise meets the definition,
it would not be because of the fact of the registered fund as a
counterparty, but, rather, because the transaction met some other
criteria of the definition.
The Commission understands generally that, consistent with the
commenters' statements, registered funds, including money market funds,
typically do not use cash transactions in U.S. Treasury securities to
take on leverage, both as a matter of strategy and because of
applicable regulatory requirements, and that they instead use cash
transactions to obtain desired exposure, hedge risks associated with
investments in other markets, diversify portfolios, or protect capital.
However, in response to the commenters that argued that registered
funds' lack of leverage means that they pose no counterparty risk, the
Commission believes that, to the extent that a registered fund chooses
to transact on an inter-dealer broker, such transactions would pose the
same type of contagion risk as other transactions executed on an inter-
dealer broker. For the reasons discussed in part II.A.2.b.ii supra, in
such cases, it is appropriate that registered funds' cash transactions,
if on an IDB, would be encompassed within the definition of an eligible
secondary market transaction because of the risks such transactions
present as an IDB transaction and the potential for a default at the
IDB to have a knock-on effect at the CCA.
v. Final Rule
For the reasons set forth in part II.A.2.b, the Commission is
adopting the definition of an eligible secondary market transaction in
Rule 17ad-22(a), as set forth in sections (ii)(A) and (B) of that
definition with respect to IDB transactions and transactions with a
registered broker-dealer, but it is not adopting the definition of an
eligible secondary market transaction as set forth in sections (ii)(C)
and (D) of that definition with respect to hedge fund and leveraged
account transactions.
3. Other Exclusions From the Definition of an Eligible Secondary Market
Transaction
Proposed Rule 17ad-22(a) would exclude transactions between direct
participants of a U.S. Treasury securities CCA and certain
counterparties from the definition of an eligible secondary market
transaction in U.S. Treasury securities. These exclusions would apply
to any purchase or sale transaction in U.S. Treasury securities or
repurchase or reverse repurchase agreement collateralized by U.S.
Treasury securities between a direct participant and a central bank, a
sovereign entity, or an international financial institution. A central
bank would, in turn, be defined as a reserve bank or monetary authority
of a central government (including the Board of Governors or any of the
Federal Reserve Banks) and the Bank of International Settlements. A
sovereign entity would be defined as a central government (including
the U.S. Government), or an agency, department, or ministry of a
central government. An international financial institution would be
defined by specifying the entities, i.e., (1) African Development Bank;
(2) African Development Fund; (3) Asian Development Bank; (4) Banco
Centroamericano de Integraci[oacute]n Econ[oacute]mica; (5) Bank for
Economic Cooperation and Development in the Middle East and North
Africa; (6) Caribbean Development Bank; (7) Corporaci[oacute]n Andina
de Fomento; (8) Council of Europe Development Bank; (9) European Bank
for Reconstruction and Development; (10) European Investment Bank; (11)
European Investment Fund; (12) European Stability Mechanism; (13)
Inter-American Development Bank; (14) Inter-American Investment
Corporation; (15) International Bank for Reconstruction and
Development; (16) International Development Association; (17)
International Finance Corporation; (18) International Monetary Fund;
(19) Islamic Development Bank; (20) Multilateral Investment Guarantee
Agency; (21) Nordic Investment Bank; (22) North American Development
Bank, and providing that the term would also include any other entity
that provides financing for national or regional development in which
the United States government is a shareholder or contributing member.
In addition, Proposed Rule 17ad-22(a) would also exclude
transactions in U.S. Treasury securities between a direct participant
of a U.S. Treasury securities CCA and a natural person.
Commenters expressed support for these exclusions.\330\ For the
reasons stated in the Proposing Release, the Commission believes that
these exclusions are appropriate.\331\ The Commission is therefore
adopting the exclusions as proposed.
---------------------------------------------------------------------------

\330\ SIFMA/IIB Letter, supra note 37, at 20; CME Letter, supra
note 81, at 6.
\331\ Proposing Release, supra note 14, 87 FR at 64625-26.
---------------------------------------------------------------------------

In addition, several commenters requested an exclusion for market
participants that engage in cash or repo transactions but are unable to
access a U.S. Treasury securities CCA. For example, one commenter
stated that this inability to access a CCA could be because of the
CCA's existing rules or otherwise.\332\ Another commenter stated that
this inability could result from being ineligible under the CCA's
existing rules, regulatory burdens, or other material impediments that
prevent such access. The commenter further stated that that not all
market participants will be able to work with a U.S. Treasury
securities CCA to determine if there are serious obstacles to access
during the proposal's comment period and that it may take more time for
any possible issues to surface.\333\ It is difficult to determine what
entities will be ``unable'' to access central clearing and for what
reasons, given that, for example, the existing rules of a CCA may
change during the implementation period, see part III infra, and that
different market participants may face different regulatory or other
requirements that could have an effect on its access to central
clearing. Therefore, such an exclusion would be overly broad and would
undermine the policy goals of the requirement to clear eligible
secondary market transactions. The Commission has identified a number
of exclusions in this release and would consider any additional
specific requests for exclusions in the future as market participants
work to finalize arrangements to implement the requirements of this
release.
---------------------------------------------------------------------------

\332\ See AIMA Letter II, supra note 115, at 4.
\333\ SIFMA/IIB Letter, supra note 37, at 21.
---------------------------------------------------------------------------

4. Policies and Procedures Regarding U.S. Treasury Securities CCA's
Monitoring of Its Direct Participants' Transactions
The proposed amendments to Rule 17ad-22(e)(18)(iv)(B) would require
that a U.S. Treasury securities CCA establish, implement, maintain and
enforce written policies and procedures reasonably designed to, as
applicable, identify and monitor its direct participants' required
submission of transactions for clearing, including, at a minimum,
addressing a direct participant's failure to submit transactions.
One commenter supported this aspect of the proposal.\334\ The
commenter

[[Page 2749]]

noted that this aspect of the proposal uses the phrase ``identify and
monitor,'' which is an understood phrase used elsewhere in the Covered
Clearing Agency Standards.\335\ Accordingly, the commenter anticipated
that implementation of this aspect of the proposal would be similar to
implementation of other Covered Clearing Agency Standards provisions
that use that phrase.\336\ For example, the commenter stated that it
expects a U.S. Treasury securities CCA would require its direct
participants to submit information regarding their U.S. Treasury
transactions as well as attestations from senior officials that the
participant is in compliance with its obligations.\337\ The commenter
stated that it further expects that a U.S. Treasury securities CCA
would review publicly available information (e.g., information
collected through FINRA's Trade Reporting and Compliance Engine
(``TRACE'') reporting) as well as information made available to it by
regulatory and self-regulatory organizations.\338\ Additionally, the
commenter stated that it expects a U.S. Treasury securities CCA would
seek to identify opportunities to coordinate with market participants
and self-regulatory organizations to examine collected data and
identify possible instances of non-compliance.\339\ The commenter
cautioned, however, that the ability of a U.S. Treasury securities CCA
to effectively identify and monitor its direct participants' required
submission of transactions for clearing would depend on the quality and
comprehensiveness of available data, and the commenter asked that the
Commission continually review and improve the quality of available
data.\340\ The commenter stated that it expects a U.S. Treasury
securities CCA would take steps to remediate non-compliance on the part
of its direct participants in a manner consistent with the Covered
Clearing Agency Standards and breaches of the CCA's own rules.\341\ The
commenter cautioned, however, that a U.S. Treasury securities CCA's
capacity to monitor participant non-compliance is limited because a CCA
does not have authority over non-participants that may seek to evade
the requirement to clear eligible secondary market transactions.\342\
Therefore, the commenter asked that the Commission utilize its
supervisory authority to help support any requirement to clear eligible
secondary market transactions.\343\
---------------------------------------------------------------------------

\334\ See DTCC/FICC Letter, supra note 33, at 21-22.
\335\ See DTCC/FICC Letter, supra note 33, at 21.
\336\ See id.
\337\ See id.
\338\ See id.
\339\ See id.
\340\ See DTCC/FICC Letter, supra note 33, at 21-22.
\341\ See DTCC/FICC Letter, supra note 33, at 22.
\342\ See id.
\343\ See id.
---------------------------------------------------------------------------

Consistent with the commenter, the Commission continues to believe
that such a requirement should ensure that a U.S. Treasury securities
CCA has a framework in place for oversight of participants' compliance
with the policies that would be adopted as part of the requirement to
submit eligible secondary market transactions for clearing. Without
such policies and procedures, it would be difficult for the CCA to
assess if the direct participants are complying with the amendments to
Rule 17ad-22(e)(18)(iv)(A) that would require the submission of
eligible secondary market transactions for clearing.
The Commission continues to believe that there are a number of
possible methods that a U.S. Treasury securities CCA could establish to
assess its direct participants' compliance with the policies and
procedures adopted pursuant to the Membership Proposal. For example,
the Commission agrees with the commenter that a U.S. Treasury
securities CCA could require direct participants to submit to the CCA
information regarding their U.S. Treasury securities transactions or to
require attestations from senior officials of the CCA's direct
participants as to their submission of the required transactions and
compliance with their obligations to submit such transactions. The
Commission further agrees that a U.S. Treasury securities CCA also
could review publicly available information and information made
available to it by regulatory and self-regulatory organizations as part
of its assessment of its direct participants' compliance.
The Commission continues to believe that requiring a U.S. Treasury
securities CCA to adopt policies and procedures that address a failure
of a direct participant to submit transactions that are required to be
submitted is consistent with section 17A(b)(3)(G) of the Exchange Act.
That section requires that the rules of a registered clearing agency
provide that its participants shall be appropriately disciplined for
violation of any provision of the rules of the clearing agency by
expulsion, suspension, limitation of activities, functions, and
operations, fine, censure, or any other fitting sanction. The
Commission continues to believe that policies and procedures consistent
with this aspect of the proposal should specify how a U.S. Treasury
securities CCA would penalize its participants who do not submit the
required transactions, whether by a particular fine or other action.
For these reasons, the Commission is adopting the requirement in
Rule 17ad-22(e)(18)(iv)(B) as proposed.
5. Alternative Approaches Proposed by Commenters
As discussed in part II.A.1.a supra, commenters identified several
methods by which the Commission could or should incentivize additional
central clearing without adopting a requirement to clear eligible
secondary market transactions. The Commission discusses its views on
each of these in turn, including whether it has the authority to adopt
certain initiatives. However, as a general matter, the Commission is
not persuaded that incentivizing central clearing would be sufficient
at this point, as those types of changes would not ensure that the
current risks to U.S. Treasury securities CCAs are addressed.
Therefore, the requirement to clear eligible secondary market
transactions is necessary.
First, commenters identified the proposed amendments to Rule 15c3-3
discussed in part II.C infra as a method to incentivize additional
central clearing.\344\ One commenter stated that the practical effect
of this change would be to allow broker-dealers to use margin collected
from customers to satisfy margin requirements associated with such
customers' transactions, rather than using proprietary funds to finance
customer margin as is the case today, and expressed its support for
this amendment because it will free up broker-dealer resources by
reducing the amount of proprietary funds needed to finance customer
margin and therefore lower the cost of clearing, while continuing to
protect customer funds.\345\ Another commenter stated that the proposed
change to allow a debit under the Rule 15c3-3a customer reserve formula
should incentivize central clearing of U.S. Treasury securities
transactions by reducing costs.\346\ One commenter stated that this
change would reduce the costs of centrally clearing U.S. Treasury
securities transactions and thus incentivize more central clearing of
such transactions.\347\
---------------------------------------------------------------------------

\344\ SIFMA AMG Letter, supra note 35, at 8; SIFMA/IIB Letter,
supra note 37, at 12; MFA Letter, supra note 81, at 3, 10.
\345\ MFA Letter, supra note 81, at 10.
\346\ SIFMA AMG Letter, supra note 35, at 8.
\347\ SIFMA/IIB Letter, supra note 37, at 12.
---------------------------------------------------------------------------

Second, commenters identified the proposed amendments to require
U.S. Treasury securities CCAs to segregate customer positions and
margin

[[Page 2750]]

discussed in part II.C.1 infra as a method to incentivize additional
central clearing.\348\ One commenter stated that this change would
ensure that a direct participant's proprietary positions would be
available to net against other proprietary positions, which would
incentivize additional central clearing.\349\ An additional commenter
stated that the segregation of customer positions should allow for a
dealer's proprietary positions to be netted against that dealer's
proprietary positions vis-[agrave]-vis other dealers, allowing more
central clearing of U.S. Treasury securities transactions.\350\
---------------------------------------------------------------------------

\348\ SIFMA AMG Letter, supra note 35, at 8; SIFMA/IIB Letter,
supra note 37, at 12; MFA Letter, supra note 81, at 3.
\349\ SIFMA/IIB Letter, supra note 37, at 12, 25.
\350\ SIFMA AMG Letter, supra note 35, at 8.
---------------------------------------------------------------------------

Third, commenters identified requiring CCAs to review their access
models and/or adopt particular access models or features thereof as a
method to incentivize clearing, as discussed in part II.B.2 infra.\351\
---------------------------------------------------------------------------

\351\ SIFMA/IIB Letter, supra note 37, at 13; SIFMA AMG Letter,
supra note 35, at 8; MFA Letter, supra note 81, at 3, 6-10.
---------------------------------------------------------------------------

The Commission agrees that the methods identified by the commenters
could incentivize and facilitate additional central clearing. The
Commission therefore is adopting the amendments to Rule 15c3-3, the
requirement to segregate house and customer margin, and the requirement
to ensure access to central clearing, as discussed in parts II.C,
II.B.1, and II.B.2 infra respectively. However, the Commission
disagrees with these commenters that these changes alone, without also
requiring that U.S. Treasury securities CCAs obligate their direct
participants to submit eligible secondary market transactions for
clearing, are enough. Merely incentivizing and facilitating greater
central clearing is not sufficient, as those types of changes would not
ensure that the current risks to U.S. Treasury securities CCAs are
addressed. Therefore, for the reasons discussed in part II.2.a and b,
the requirement to clear is also necessary.
Fourth, one commenter argued that another way the Commission could
incentivize greater central clearing without requiring it was to
require FICC to consider amending its clearing fund structure to
separate initial margin from default fund requirements that can be
subject to loss mutualization, which would result in capital
efficiencies for bank or bank-affiliated dealers and also may allow for
increased participation from counterparty types that are restricted
from participating in loss mutualization arrangements (e.g., money
market funds).\352\ Another commenter also stated that changing the
sponsored member clearing fund contribution to a pool of margin that is
used in the event of a default of the underlying sponsored member would
more closely align a sponsored member's exposure to potential losses in
a default scenario with its own creditworthiness (i.e., the defaulter
pays first) and be more cost effective for sponsoring members.\353\
Another commenter stated that FICC must be required to separate initial
margin from default fund requirements that can be subject to loss
mutualization, prior to the imposition of a clearing requirement.\354\
---------------------------------------------------------------------------

\352\ SIFMA/IIB Letter, supra note 37, at 3.
\353\ ICI Letter, supra note 85, at 14.
\354\ MFA Letter II, supra note 125, at 4.
---------------------------------------------------------------------------

The Commission recognizes that the particular clearing fund
structure used by FICC may bring some level of capital inefficiency to
banks who choose to join a CCA.\355\ However, the Commission previously
has declined a commenter's suggestion to impose such a
requirement.\356\ As it stated when considering a similar comment when
adopting the Covered Clearing Agency Standards, the Commission
acknowledges that loss mutualization and other pooling-of-resources
arrangements involve tradeoffs that a CCA generally should carefully
assess and balance. A CCA may be better able to manage multiple
defaults in extreme conditions more efficiently using pooled resources
because the pooled resources would be greater than the resources of any
single defaulting participant. Further, because the arrangements are
prefunded, participants can model and manage the risks they face from
the clearing agency while being able to take into account the amount of
resources that they have provided to the clearing agency. The pooling
of resources, however, can increase interdependencies among, and
therefore the potential risks to, participants of the CCA. The use of
loss mutualization and other pooling-of-resources arrangements
generally should, to minimize systemic risk, balance the safety and
soundness of the CCA against the potential for increased exposures
among participants that may arise from the manner the CCA holds
financial resources. For all these reasons, the Commission continues to
believe that it should not impose such a requirement on CCAs,
notwithstanding the potential capital efficiencies arising from a
different clearing fund structure at a CCA.
---------------------------------------------------------------------------

\355\ Banking regulations may result in different treatment for
collateral posted as margin to a CCP if that collateral is
potentially subject to loss mutualization versus collateral that is
not subject to loss mutualization. Specifically, a bank has to treat
potentially mutualized collateral, like clearing fund posted to FICC
or, more generally, the guaranty fund posted to derivatives CCPs,
differently from collateral that would be used only in the event of
the specific bank member's default to the CCP. Such banking
regulations are outside the scope of this rulemaking or the
Commission's authority in general.
\356\ CCA Standards Adopting Release, supra note 10, 81 FR at
70813.
---------------------------------------------------------------------------

Pursuant to Rule 17ad-22(e)(23), a covered clearing agency must
establish, implement, maintain and enforce written policies reasonably
designed to disclose, among other things, key aspects of its default
rules and procedures and the risks, fees, and other material costs
participants incur by participating in the covered clearing agency. The
availability of these policies and procedures should allow participants
to understand in advance a covered clearing agency's reliance on such
resources and to consider their own ability to meet the CCA's
membership obligations, including with respect to financial resources,
prior to becoming members of the covered clearing agency.
Fifth, several commenters discussed facilitating cross-margining of
indirect participants' transactions in U.S. Treasury securities with
those in U.S. Treasury futures as a method to incentivize additional
clearing.\357\ One commenter stated that the Commission should take
steps to allow cross-margining of customer transactions between
Treasury securities and U.S. Treasury futures, because the reduced
margin requirements obtained through cross-margining serves an
important function in increasing market liquidity through balance sheet
savings and incentivizing risk reduction through hedging. The commenter
also referred to the work of the G-30, which observed that wider use of
cross-margining would reduce the risk that increases in initial margin
requirements on the futures leg of cash-futures basis trades result in
forced sales of Treasury securities, which may have contributed to
selling pressures in the market in March 2020.\358\ Another commenter
stated that cross-margining would lower costs for market participants
by allowing them to apply margin across positions submitted for
clearing through various clearinghouses. The commenter stated that this
would ensure that a market participant can post margin adequate to
support its positions without having to

[[Page 2751]]

post margin in excess of regulatory requirements due to an inability to
apply margin across platforms.\359\ Another commenter stated that the
Commission should explore developing a framework that would allow cross
margining of futures and securities transactions, and an additional
commenter added that this type of framework would ensure a level
playing field between direct and indirect members and noting that,
unlike direct participants, clients are not permitted to cross-margin
positions cleared at FICC with futures positions cleared at CME Group
under FICC's current cross-margining framework, which significantly
increases clearing costs for clients (depending on the trading
strategies involved), discouraging clearing and creating an unlevel
playing field between direct members and clients at FICC.\360\
---------------------------------------------------------------------------

\357\ MFA Letter, supra note 81, at 11; SIFMA/IIB Letter, supra
note 37, at 13; SIFMA AMG Letter, supra note 35, at 8.
\358\ SIFMA/IIB Letter, supra note 37, at 13.
\359\ MFA Letter, supra note 81, at 11. The commenter further
stated that the Commission should ensure indirect participants also
can take into account offsetting positions when calculating margin
requirements. MFA Letter II, supra note 125, at 4.
\360\ SIFMA/AMG Letter, supra note 35, at 8; ARB et al. Letter,
supra note 81, at 9.
---------------------------------------------------------------------------

The current cross-margining agreement between FICC and CME is part
of FICC's rulebook, any changes to which have to be filed with the
Commission pursuant to Section 19(b) of the Exchange Act. The
Commission historically has supported and approved cross-margining at
clearing agencies and recognized the potential benefits of cross-
margining systems, which include freeing capital through reduced margin
requirements, reducing clearing costs by integrating clearing
functions, reducing clearing agency risk by centralizing asset
management, and harmonizing liquidation procedures.\361\ The Commission
has stated that cross-margining arrangements may be consistent with
Section 17A(b)(3)(F) of the Exchange Act in that they may strengthen
the safeguarding of assets through effective risk controls that more
broadly take into account offsetting positions of participants in both
the cash and futures markets, and promote prompt and accurate clearance
and settlement of securities through increased efficiencies.\362\ For
these reasons, the Commission continues to believe that market
participants can benefit from cross-margining arrangements and
encourages U.S. Treasury securities CCAs to consider the potential of
such benefits.
---------------------------------------------------------------------------

\361\ Self-Regulatory Organizations; the Fixed Income Clearing
Corporation; Order Granting Approval of Proposed Rule Change To
Amend and Restate the Cross-Margining Agreement Between FICC and
CME, Exchange Act Release No. 98327 (Sept. 8, 2023), 88 FR 63185,
63187 (Sept. 14, 2023); see also Exchange Act Release No. 90464
(Nov. 19, 2020), 85 FR 75384, 75386 (Nov. 25, 2020) (approving a
second amended and restated cross-margining agreement between the
Options Clearing Corp. and CME); Exchange Act Release No. 38584 (May
8, 1997), 62 FR 26602, 26604-05 (May 14, 1997) (establishing a
cross-margining agreement with the Options Clearing Corp., CME, and
the Commodity Clearing Corporation).
\362\ Id.
---------------------------------------------------------------------------

Sixth, commenters identified a number of regulations that
purportedly could be changed to further incentivize central clearing
that are outside the Commission's jurisdiction. For example, one
commenter stated that requiring counterparties to post margin for non-
centrally cleared bilateral repos through internationally agreed upon
standards could level the playing field for margin requirements in
Treasury repos, whether or not centrally cleared, and therefore
incentivize market participants to centrally clear repos.\363\ The
Commission alone cannot prescribe standards applicable to all market
participants with respect to uncleared repo, and imposing requirements
solely upon entities regulated by the Commission could lead to
potential regulatory arbitrage. In addition, the commenter stated that
FICC should have the ability to access a Federal Reserve standing
repurchase facility for FICC as a systemically important financial
market utility, which would (i) reduce the need for a participant-
funded liquidity resources at a CCA, thereby reducing costs and
incentivizing further central clearing, and (ii) mitigate the increased
concentration risk of substantially increasing the Treasury
transactions cleared at FICC.\364\ However, the Commission does not
have the authority to provide that access.
---------------------------------------------------------------------------

\363\ SIFMA/IIB Letter, supra note 37, at 13.
\364\ SIFMA/IIB Letter. supra note 37, at 13-14.
---------------------------------------------------------------------------

In addition, the commenter stated that exempting a clearing
member's exposure to FICC's CCLF from the Single Counterparty Credit
Limits (``SCCL'') or increasing the SCCL with respect to exposures to
FICC, due to the larger possible CCLF exposure that bank holding
companies may end up incurring, would allow market participants to
clear additional transactions at FICC without risking exceeding SCCL
limits.\365\ Another commenter suggested that the Commission work with
other regulators to advocate for improvements to prudential rules which
would have the effect of enhancing liquidity in the U.S. Treasury
market (i.e., the Supplementary Leverage Ratio and other capital
requirements).\366\ The SCCL and the Supplementary Leverage Ratio, as
well as other bank capital requirements, arise from regulations of the
Board of Governors.\367\ Therefore, any changes to the SCCL and banking
capital regulations are outside the Commission's jurisdiction.
---------------------------------------------------------------------------

\365\ SIFMA/IIB Letter, supra note 37, at 14.
\366\ SIFMA AMG Letter, supra note 35, at 8.
\367\ See 12 CFR part 252 subpart H (regulations regarding
SCCL); 12 CFR 217.10(c) (SLR regulation) and part 217 generally
regarding bank capital requirements); see also Final Rule, Single-
Counterparty Credit Limits for Bank Holding Companies and Foreign
Banking Organizations, 83 FR 38460 (Aug. 6, 2018).
---------------------------------------------------------------------------

One commenter suggested promoting alternatives to central clearing
that could improve liquidity and strengthen the U.S. Treasury market.
The commenter stated that CUSIP aggregation has been applied
successfully in the past to agency mortgage-backed securities and may
improve liquidity by increasing the size of certain off-the-run U.S.
Treasury issuances. The commenter further stated that the U.S. Treasury
could also continue to consider engaging in buybacks of existing U.S.
Treasury securities as a way of improving liquidity. The commenter also
stated that the Commission could further engage with the industry in
discussions on how to expand all-to-all trading in secondary market
cash transactions as a way to promote liquidity. Finally, the commenter
stated that other recent rule proposals and enhancements to the TRACE
reporting obligations for U.S. Treasury securities will in time give
the Commission greater visibility into this market.\368\
---------------------------------------------------------------------------

\368\ SIFMA AMG Letter, supra note 35, at 8.
---------------------------------------------------------------------------

In response to the comments regarding CUSIP aggregation and buyback
of U.S. Treasury securities, those actions would be undertaken by
either the Federal Reserve Bank of New York (or other market
participants) or the U.S. Department of the Treasury,
respectively.\369\ The Commission does not have the authority to
conduct such actions, and these actions would not impact the overall
level of central clearing in the market. In response to the comments
regarding all-to-all liquidity, the Commission agrees that increased
all-to-all trading could improve liquidity in the U.S. Treasury market
and, as stated in the Proposing

[[Page 2752]]

Release, believes that increased central clearing could, in fact,
increase all-to-all trading.\370\ However, all-to-all trading does not,
on its own, address the risks to CCAs that the proposal was designed to
address. The Commission therefore believes that imposing requirements
on CCAs to have their members centrally clear eligible secondary market
transactions should proceed, regardless of the current status of all-
to-all trading, to address these issues. Similarly, in response to the
comments regarding TRACE reporting, the Commission does not believe
that the increased reporting would address the risks to CCAs arising
from current clearing practices in the U.S. Treasury market. Therefore,
relying on reporting alone would not be sufficient.
---------------------------------------------------------------------------

\369\ See FRBNY, Statement Regarding Aggregation of Agency
Mortgage-Backed Securities Holdings (Oct. 6, 2022), available at
https://www.newyorkfed.org/markets/opolicy/operating_policy_221006;
31 CFR part 375, Marketable Treasury Securities Redemption
Operations (establishing the terms and conditions by which the U.S.
Department of the Treasury may redeem outstanding, unmatured
marketable Treasury securities).
\370\ Proposing Release, supra note 14, 87 FR at 64628; see also
FRBNY Staff Report No. 1036, All-to-All Trading in the U.S. Treasury
Market at 12-13 (Oct. 2022), available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr1036.pdf?sc_lang=en (discussing how central clearing could make
all-to-all trading more likely to expand in the Treasury market,
while also potentially increasing the costs).
---------------------------------------------------------------------------

Eighth, one commenter stated that the Commission should require
enhanced transparency regarding FICC's margining calculations and
default management procedures. The commenter states that the proposal
does not set default management standards or require disclosure of such
standards. The commenter asserts that while FICC has disclosed ``key
aspects'' of its default rules and procedures, greater transparency
into these procedures, including, in particular, with respect to how
FICC manages the default risk of indirect participants, would be
beneficial. The commenter also stated that the proposal does not set
margin requirements or require transparency into how margin
requirements are set. The commenter states that with respect to both
default management and margin calculations, enhanced transparency would
enhance confidence in, and the resilience of, FICC, which will, in turn
increase market participants' confidence in submitting additional
transactions for clearing.\371\ Another commenter also referenced the
``broad opacity'' of FICC margin models and the challenges that posed
for participants, stating that the participants' inability to replicate
FICC's margin models left the direct and indirect participants as not
being able to accurately predict the daily (or more) margin calls to a
reasonable degree.\372\
---------------------------------------------------------------------------

\371\ MFA Letter, supra note 81, at 11-12; see also MFA Letter
II, supra note 125, at 5.
\372\ SIA Partners Comment, supra note 52, at 18; see also id.
at 74-75.
---------------------------------------------------------------------------

The Commission's existing rules address these issues and require
transparency into default management, and margin methodology. On
default management, Rule 17ad-22(e)(13) requires that a covered
clearing agency establish, implement, maintain and enforce written
policies and procedures reasonably designed to ensure the covered
clearing agency has the authority and operational capacity to take
timely action to contain losses and liquidity demands and continue to
meet its obligations by, at a minimum, requiring the covered clearing
agency's participants and, when practicable, other stakeholders to
participate in the testing and review of its default procedures,
including any close-out procedures, at least annually and following
material changes thereto.\373\ When adopting the Covered Clearing
Agency Standards, the Commission declined to prohibit or adopt specific
loss allocation or default management tools suggested by commenters,
relying upon the Commission's belief that, when determining the content
of its policies and procedures with respect to default management, each
CCA must have the ability to enhance its policies and procedures to
meet the evolving challenges and risks in the securities market that
the CCA serves.\374\ For these reasons, the Commission continues to
believe that it should not set particular default management procedures
for CCAs.
---------------------------------------------------------------------------

\373\ 17 CFR 240.17ad-22(e)(13).
\374\ CCA Standards Adopting Release, supra note 10, 81 FR at
70829.
---------------------------------------------------------------------------

In addition, Rule 17ad-22(e)(6) requires that a CCA establish,
implement, maintain and enforce written policies and procedures
reasonably designed to cover, if the covered clearing agency provides
central counterparty services, its credit exposures to its participants
by establishing a risk-based margin system.\375\ Thus, CCAs are
required to develop policies governing how they calculate margin. In
addition, under the amendments to Rule 17ad-22(e)(6) being adopted in
this release, CCAs will be obligated to have policies and procedures to
calculate house margin separately from customer margin.
---------------------------------------------------------------------------

\375\ 17 CFR 240.17ad-22(e)(6).
---------------------------------------------------------------------------

Further, both default management and margin calculation generally
constitute material aspects of the operations of a CCA, meaning that
they should be considered stated policies, practices, or
interpretations under Exchange Act Rule 19b-4.\376\ As such, they are
subject to the filing obligations applicable to SROs under Section
19(b) of the Exchange Act. This means that the default management
processes and margin methodologies are described in SRO rule filings
upon which market participants may comment and that the Commission must
review and approve. CCAs have adopted rules on these topics pursuant to
the SRO rule filing process.\377\ The filing obligations under Section
19(b) of the Exchange Act provide transparency into the covered
clearing agencies' default management processes and margin
methodologies.
---------------------------------------------------------------------------

\376\ 17 CFR 240.19b-4(a)(6)(i).
\377\ Regarding default management, see, e.g., FICC Rule 4,
sections 6, 7, 7a, and 7b (addressing application of clearing fund
deposits and other Amounts to defaulting members' obligations, loss
allocation waterfall, corporate contribution, and withdrawal from
membership in the event of a loss allocation); FICC Rule 3A,
sections 12, 15, and 16 (addressing loss allocation in the Sponsored
Service and the insolvency of either a sponsoring or sponsored
member), supra note 19; Self-Regulatory Organizations; Fixed Income
Clearing Corporation; Order Approving a Proposed Rule Change, as
Modified by Amendment No. 1, to Amend the Loss Allocation Rules and
Make Other Changes, Exchange Act Release No. 83970 (Aug. 28, 2018).
Regarding margin methodologies, see e.g., FICC Rule 4, section 1b
(setting forth the GSD unadjusted margin portfolio amount) and
section 2a (describing the intraday supplemental required fund
deposit), in conjunction with Rule 1 (defining the various
components of the margin methodology, including, among other things,
the VaR Charge, the Backtesting Charge, and the Margin Liquidation
Adjustment Charge), supra note 19; see also Self-Regulatory
Organizations; Fixed Income Clearing Corporation; Notice of Filing
of Amendment No. 1 and Order Granting Accelerated Approval of a
Proposed Rule Change, as Modified by Amendment No. 1, To Implement
Changes to the Required Fund Deposit Calculation in the Government
Securities Division Rulebook, Exchange Act Release No. 83362 (June
1, 2018), 83 FR 26514 (June 7, 2018).
---------------------------------------------------------------------------

Second, in addition to the aforementioned obligations under the
Covered Clearing Agency Standards specific to default management and
margin, Rule 17ad-22(e)(23) also imposes a set of requirements related
to transparency and disclosure. Specifically, a CCA is obligated to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for publicly disclosing all
relevant rules and material procedures, including key aspects of its
default rules and procedures, and providing sufficient information to
enable participants to identify and evaluate the risks, fees, and other
material costs they incur by participating in the CCA.\378\ In
addition, a CCA must produce a comprehensive public disclosure that
describes its material rules, policies, and procedures regarding its
legal, governance, risk management, and operating framework, accurate
in all material respects at the time of publication, that includes,
among other things, a standard-by-standard summary narrative for each
applicable standard set forth in

[[Page 2753]]

paragraph (e)(1) through (23) of the Covered Clearing Agency Standards
section with sufficient detail and context to enable a reader to
understand the CCA's approach to controlling the risks and addressing
the requirements in each standard.\379\ Thus, each CCA issues a public
document designed to address each standard, including those with
respect to fees, default management, and margin.\380\ In addition, CCAs
provide a variety of additional tools to assist their participants in
understanding their margin obligations, such as descriptions of the
components, including their calculations, and margin calculators that
can be used to estimate margin requirements based on potential changes
to a participant's portfolio.\381\
---------------------------------------------------------------------------

\378\ 17 CFR 240.17ad-22(e)(23)(i) and (ii).
\379\ 17 CFR 240.17ad-22(e)(23)(iii).
\380\ See, e.g., FICC Disclosure Framework, available at https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/FICC_Disclosure_Framework.pdf.
\381\ See, e.g., FICC Government Securities Division, Overview
of the Clearing Fund Methodology (Oct. 2023), available at https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/GSD-Clearing-Fund-Methodology-Overview-October-2023.pdf; Comment
Letter from FICC re: SR-FICC-2020-017 and SR-FICC-2020-804,
available at https://www.sec.gov/comments/sr-ficc-2020-017/srficc2020017-8451684-229787.pdf (describing the different
capabilities provided at FICC to enable direct participants to
determine their margin requirements, including, but not limited to a
calculator that provides functionality to direct participants to
enter ``what if'' position data and recalculate their VaR Charge to
determine margin impact pre-trade execution and to see the impact to
VaR if specific transactions are executed or to anticipate the
impact of an increase or decrease to a current clearing position).
---------------------------------------------------------------------------

Accordingly, because of the existing framework applicable to
transparency, the Commission disagrees that enhanced transparency into
margining calculations and default management procedures is necessary
or that it would meaningfully incentivize greater clearing. However,
the Commission encourages market participants and CCAs to engage
regarding the existing tools and potential additional resources that
could be provided to better assist market participants at understanding
potential margin obligations.
Finally, one commenter encouraged the Commission to consider
whether proposal should specifically require FICC to establish rules
ensuring that fees charged by direct participants are transparent and
reasonable.\382\ Section 17A(b)(3)(E) of the Exchange Act requires that
the rules of a clearing agency do not impose any schedule of prices, or
fix rates or other fees, for services rendered by its participants. In
light of this statutory provision, a rule such as that suggested by the
commenter would not be appropriate.
---------------------------------------------------------------------------

\382\ MFA Letter, supra note 81, at 11.
---------------------------------------------------------------------------

For all these reasons, the Commission disagrees with commenters
that would support not requiring the clearance of eligible secondary
market transactions. The Commission believes that requiring direct
participants of U.S. Treasury securities CCAs to clear their eligible
secondary market transactions is essential to improving risk management
at U.S. Treasury securities CCAs (including contagion risk) and to
obtaining the benefits of central clearing in the U.S. Treasury market,
as discussed in part II.A.1.a supra. As discussed in more detail in
parts III and IV infra, the Commission does not believe that further
study is necessary, but believes that, as discussed in more detail in
part III, a phased implementation schedule for the requirements
discussed in part II, beginning with some of the items identified as
incentives to central clearing, should address commenters' concerns
that the necessary market infrastructure is not in place to support the
requirement to clear eligible secondary market transactions.

B. Additional Changes to Covered Clearing Agency Standards

The Commission also proposed additional changes to the Covered
Clearing Agency Standards, designed to address the likely increase in
the volume of U.S. Treasury securities transactions submitted for
central clearing resulting from the proposed requirement that direct
participants of a U.S. Treasury securities CCA submit eligible
secondary market transactions for clearance and settlement. The
Commission is adopting these additional changes, for the reasons
discussed in more detail below.
1. Netting and Margin Practices for House and Customer Accounts
The proposed amendments to Rule 17ad-22(e)(6)(i) would require a
U.S. Treasury securities CCA to establish, implement, maintain and
enforce written policies and procedures reasonably designed to, as
applicable, calculate, collect, and hold margin amounts from a direct
participant for its proprietary U.S. Treasury securities positions
separately and independently from margin calculated and collected from
that direct participant in connection with U.S. Treasury securities
transactions by an indirect participant that relies on the services
provided by the direct participant to access the covered clearing
agency's payment, clearing, or settlement facilities. This rule would
prohibit a U.S. Treasury securities CCA from netting customer and
proprietary positions.
In the Proposing Release, the Commission stated it believed that
the separation of house and customer positions could reduce the
potential risk to the U.S. Treasury securities CCA arising from such
transactions. Such changes should allow a U.S. Treasury securities CCA
to better understand the source of potential risk arising from the U.S.
Treasury securities transactions it clears and potentially further
incentivize central clearing.\383\
---------------------------------------------------------------------------

\383\ Proposing Release, supra note 14, 87 FR at 64633.
---------------------------------------------------------------------------

Importantly, the amendment to Rule 17ad-22(e)(6)(i) would not
require that a CCA's direct participant collect a specified amount of
margin from its customers or determine customer margin in a particular
manner, such as on a gross basis; the calculation and collection of
margin between a CCA direct participant and its customers would be left
to other applicable regulations and, to the extent applicable,
bilateral negotiation between the member and its customer. As the
Commission stated in the Proposing Release,\384\ the amendments to Rule
17ad-22(e)(6)(i) would, in this way, require policies and procedures
that closely resemble the calculation, collection, and holding of
margin for listed options.\385\ When considering and adopting the
Covered Clearing Agency Standards, the Commission noted that customer
segregation can be achieved through such an omnibus account structure,
where all collateral belonging to all customers of a particular member
is commingled and held in a single account segregated from that of the
member,\386\ which is consistent with the practice at the clearing
agency for listed options and this amendment to Rule 17ad-22(e)(6)(i).
---------------------------------------------------------------------------

\384\ Proposing Release, supra note 14, 87 FR at 64634.
\385\ Currently, the covered clearing agency that clears and
settles listed options transactions holds margin for customer trades
separately from the proprietary trades of the submitting participant
in an omnibus account. See Options Clearing Corp. Rules 601(c) and
(d), available at https://www.theocc.com/getmedia/9d3854cd-b782-450f-bcf7-33169b0576ce/occ_rules.pdf (``OCC Rules''). This approach
is also similar to the approach used for futures customers. See 17
CFR 1.22 and Advanced Notice of Proposed Rulemaking, Protection of
Cleared Swaps Customers Before and After Commodity Broker
Bankruptcies, 75 FR 75162, 75163 (Dec. 2, 2010) (describing the
futures model).
\386\ See Proposing Release, supra note 14, 87 FR at 64634
(discussing CCA Standards Proposing Release, supra note 8, 79 FR at
29547; CCA Standards Adopting Release, supra note 10, 81 FR at
70832-33).

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

[[Page 2754]]

Commenters generally supported the proposed amendment to Rule 17ad-
22(e)(6)(i).\387\ One commenter agreed that this amendment would
further the risk management benefits associated with central clearing
and help avoid a direct participant's disorderly default because FICC
would have a more holistic view of the market than currently available,
and that because a direct participant's margin would be calculated,
collected and held separately and independently than that of its
customers, the direct participant's trades with its customers can be
netted against the direct participant's trades with other direct
participants.\388\ One commenter stated that the proposed changes with
respect to risk management requirements would facilitate the proposal's
goals of increased central clearing, and that it would also
appropriately assign the risk of centrally cleared customer U.S.
Treasury securities transactions to the customer.\389\
---------------------------------------------------------------------------

\387\ ICE Letter, supra note 33, at 3; DTCC/FICC Letter, supra
note 33, at 25; ICI Letter, supra note 85, at 25-26; SIFMA/IIB
Letter, supra note 37, at 25-26; Tradeweb Letter, supra note 81, at
3; AIMA Letter, supra note 81, at 8; AFREF Letter, supra note 33, at
5; SIFMA AMG Letter, supra note 35, at 8.
\388\ AIMA Letter, supra note 81, at 8.
\389\ SIFMA/IIB Letter, supra note 37, at 25.
---------------------------------------------------------------------------

However, commenters also raised several additional issues with
respect to the separation of house and customer margin that the
Commission will address below.
First, several commenters argued that this rule should also
prohibit the use of separate customer margin for any other purpose,
including loss mutualization (i.e., when a clearing agency uses non-
defaulting customers' funds in the event of a default, thereby
``mutualizing'' the loss).\390\ Another commenter stated that
prohibiting the use of customer margin for loss mutualization would
mitigate higher risk-weighted assets under certain bank capital rules
and may also facilitate clearing for market participants that are
subject to restrictions regarding exposure to loss mutualization.\391\
---------------------------------------------------------------------------

\390\ SIFMA/IIB Letter, supra note 37, at 26-27; ICI Letter,
supra note 85, at 19 (supporting strong protections for funds in
whatever models FICC chooses to adopt, including LSOC protections,
and stating that customer funds must be identified as fund assets
and have the benefit of customer treatment); AIMA Letter, supra note
81, at 8 (stating that the Commission should specify that client
initial margin should not be included as part of a clearing agency's
default waterfall and subject to loss mutualization); ARB et al.
Letter, supra note 81, at 8 (``in no event should margin posted for
client positions be available for use as part of a clearing agency's
default waterfall''); MFA Letter, supra note 81, at 7 (``it is
crucial that indirect participants are able to post margin on a
segregated basis such that their clients are not subject to the
credit risk of others (and, likewise, that their funds are not
subject to loss mutualization''); see also SIFMA AMG Letter, supra
note 35, at 12-13 (``it will be difficult to support expanding
cleared trading in U.S. Treasury securities until we have a
framework which ensures customers can access clearing solutions
where their margin and collateral will be adequately protected,
including from loss mutualization by the clearing agency'').
\391\ Letter from Ann Battle, Senior Counsel, Market
Transitions, International Swaps and Derivatives Association, Inc.,
at 2 (Dec. 27, 2022) (``ISDA Letter'').
---------------------------------------------------------------------------

What the commenters seek is akin to the requirements applicable to
derivatives clearing organizations clearing swaps, that is, the
``legally segregated, operationally commingled'' (``LSOC'') model,
which, as the Commission stated in the Proposing Release, differs from
the requirements proposed in Rule 17ad-22(e)(6)(i).\392\ Under such an
approach, customer collateral may be held in one combined account and
commingled, but in the event of a customer default, the collateral of
non-defaulting customers would not be available to cover any losses
attributable to the defaulting customer (i.e., they would be legally
separated from the collateral of the defaulting customer and not
available for loss mutualization).\393\ As discussed in the Proposing
Release, the Commission previously has declined to require such an
approach for covered clearing agencies, preferring to allow each
covered clearing agency to determine the method that works best for the
products it clears and markets it serves.\394\ When discussing that
conclusion, the Commission also noted that this type of segregation
does not occur at the CCP level under the current market structure for
cash securities and listed options, and that customer positions and
funds in the cash securities and listed options markets are eligible
for protection under SIPA, which is not the case for futures and
cleared swaps.\395\
---------------------------------------------------------------------------

\392\ Proposing Release, supra note 14, 87 FR at 64634
(discussing 17 CFR 22.15).
\393\ See, e.g., Protection of Cleared Swaps Customer Contracts
and Collateral; Conforming Amendments to the Commodity Broker
Bankruptcy Provisions, 77 FR 6336, 6339 (Feb. 7, 2012) (describing
the LSOC approach and adopting final rules for this approach).
\394\ See Proposing Release, supra note 14, 87 FR at 64634
(discussing CCA Standards Adopting Release, supra note 10, 81 FR at
70832).
\395\ Id.
---------------------------------------------------------------------------

The Commission continues to believe that it would not be
appropriate to require an LSOC model for U.S. Treasury security CCAs,
because customer positions and funds in the market for cash securities
and listed options would be eligible for protection under SIPA, unlike
in other markets which use an LSOC model. However, a U.S. Treasury
securities CCA may choose to offer such a model, based upon what works
best for both direct and indirect participants or to satisfy other
regulatory obligations. In practice, U.S. Treasury securities CCAs
seeking to provide services that would allow broker-dealers to
rehypothecate customer margin to the CCA, as discussed further in part
II.C.2 infra, would, consistent with that flexibility, choose to adopt
practices that would ensure that customer funds can be used only for a
loss arising from customer activity and could not be used for loss
mutualization. Thus, adopting the changes described in section II.C.2
below should also result in U.S. Treasury securities CCAs incorporating
access models that provide for the type of segregation requested by the
commenters.
Another commenter argued that the Commission should consider
additional changes that would compel FICC to require that all margin
requirements related to customer positions be satisfied by those
customers, to appropriately allocate risk to those customers and lower
barriers to participation in central clearing for customers by direct
participants who otherwise may not be able to submit margin on behalf
of their customers.\396\ The requirement to collect, calculate, and
hold customer margin separate from proprietary margin should ensure
that, at the CCA level, the risks arising from customer clearing are
sufficiently margined to protect the CCA from the exposure arising from
customer clearing. In the event that a direct participant of the CCA is
not able to submit margin on behalf of its customers, such participants
could elect to take advantage of the amendments to Rule 15c3-3, as
discussed in part II.C.2 infra, regarding Rule 15c3-3, which would
require the participant to collect 100% customer margin in order to be
able to onward post the margin.
---------------------------------------------------------------------------

\396\ SIFMA/IIB Letter, supra note 37, at 26 (analogizing to the
CFTC requirement that DCOs collect at least 100% of margin to cover
customer positions, see 17 CFR 39.13(g)(8)).
---------------------------------------------------------------------------

An additional commenter described the proposed rule as requiring
customers to be margined individually and requiring FICC to collect
margin even where a member's overall customer position is netted, which
would ``exponentially'' increase the margin requirement on all those
involved in the U.S. Treasury market.\397\ The Commission disagrees
that the proposed amendments to Rule 17ad-22(e)(6)(i) would require
customers to

[[Page 2755]]

be margined individually or that FICC would be required to collect
margin even where a participant's overall position is netted. As
discussed in the Proposing Release, the proposed changes would require
that a U.S. Treasury securities CCA calculate, collect, and hold margin
for positions in U.S. Treasury securities transactions of a direct
participant in a U.S. Treasury securities CCA separately from those of
customers or other indirect participants that rely on the direct
participant to access the covered clearing agency's payment, clearing,
or settlement facilities, but this does not mandate the calculation of
margin for individual customers, that is, on a gross basis for each
customer.\398\ A U.S. Treasury securities CCA would have the discretion
to collect a single netted amount for each clearing member's customer
account as a whole, that is, netting each customer's margin against
that of other customers within the overall customer account.\399\
---------------------------------------------------------------------------

\397\ IDTA Letter, supra note 66, at 4.
\398\ Proposing Release, supra note 14, 87 FR at 64634.
\399\ Id.
---------------------------------------------------------------------------

The commenter also discusses the impact of this purported gross
margining on small and mid-size broker-dealers who are
disproportionately affected by FICC's Excess Capital Premium (``ECP'')
charge, which is a margin add-on that collects a premium when a
member's VaR charge exceeds the member's Net Capital, net assets or
equity capital (as applicable to that member based on its type of
regulation).\400\ The commenter explained the potential impact of the
ECP charge in conjunction with FICC's Sponsored Service, stating that
``the combination of gross margining and ECP currently in use under the
Sponsored Model, and what is prescribed in the Proposed Rule,
effectively prevents smaller and middle market broker dealers from
materially participating in the Treasury market.'' \401\ The commenter
states that the potential effect of the ECP charge would be exacerbated
when customer/institutional counterparty margin is included in the
calculation, and the surcharge prevents smaller independent broker-
dealers from sponsoring institutional counterparties/customers.\402\
The commenter states that the proposal must be changed to ensure that
the combined effect of gross margining and the ECP does not excessively
burden smaller, middle-market broker dealers and their institutional
investor customers.\403\ The commenter's concerns regarding the
interplay between purported required gross margining and the ECP charge
rests on the assumption that gross margin is required under the
proposal, which, as discussed in the prior paragraph, is not the case.
In addition, FICC recently has indicated that it intends to make
available client clearing models that do not require gross margin,
consistent with its current offerings.\404\ Therefore, the Commission
does not believe that the proposal needs to be changed to address this
issue. With respect to the ECP charge on its own, the Commission is not
taking any action with respect to the ECP charge as part of adopting
these new requirements. The ECP charge is part of FICC's existing
rulebook, and any change to that rulebook would be made pursuant to the
proposed SRO rule change process under Section 19(b).\405\
---------------------------------------------------------------------------

\400\ IDTA Letter, supra note 66, at 4; see also FICC Rule 4,
section 14, supra note 19.
\401\ IDTA Letter, supra note 66, at 5.
\402\ IDTA Letter, supra note 66, at 5.
\403\ IDTA Letter, supra note 66, at 6.
\404\ See DTCC 2023 White Paper, supra note 107, at 6
(discussing that the proposal would allow the option to calculate
and collect margin associated with customer activity on a gross or
net basis depending on the client clearing model selected by the
member and stating that FICC would offer options via different
access models that would allow those parties to balance the benefits
of netting and segregation in different ways).
\405\ 15 U.S.C. 78s(b); see also 15 U.S.C. 78s(c).
---------------------------------------------------------------------------

Another commenter stated that the Commission should encourage FICC
to hear and consider input from indirect participants regarding
potential changes to fee and governance models.\406\ The Commission has
adopted a requirement that registered clearing agencies must establish,
implement, maintain and enforce written policies and procedures
reasonably designed to solicit, consider, and document its
consideration of the views of participants and other relevant
stakeholders of the registered clearing agency regarding material
developments in its governance and operations on a recurring
basis.\407\ Requiring these policies and procedures should ensure that
FICC considers input from indirect participants regarding potential
changes to fee and governance models.
---------------------------------------------------------------------------

\406\ AIMA Letter, supra note 81, at 8.
\407\ Adopting Release, Clearing Agency Governance and Conflicts
of Interest, Exchange Act Release No. 98959 (Nov. 16, 2023), 88 FR
84454 (Dec. 5, 2023) (adopting Rule 17ad-25(j)).
---------------------------------------------------------------------------

For the reasons discussed above, the Commission is therefore
adopting the amendments to Rule 17ad-22(e)(6)(i) as proposed.
2. Facilitating Access to U.S. Treasury Securities CCAs
Proposed Rule 17ad-22(e)(18)(iv)(C) would require that a U.S.
Treasury securities CCA establish, implement, maintain and enforce
written policies and procedures reasonably designed to, as applicable,
ensure that it has appropriate means to facilitate access to clearance
and settlement services of all eligible secondary market transactions
in U.S. Treasury securities, including those of indirect participants,
which policies and procedures the U.S. Treasury securities CCA's board
of directors reviews annually. In the Proposing Release, the Commission
explained that this provision does not prescribe specific methods for
market participants to obtain indirect access to a U.S. Treasury
securities CCA.\408\
---------------------------------------------------------------------------

\408\ Proposing Release, supra note 14, 87 FR at 64635.
---------------------------------------------------------------------------

In the Proposing Release, the Commission stated its understanding
that indirect participants may have significantly different preferences
with respect to how they access and obtain clearing services from
direct participants of U.S. Treasury securities CCAs. The Commission
explained that this proposed requirement is intended to help ensure
that all U.S. Treasury security CCAs review their indirect access
models and ensure that they facilitate access to clearance and
settlement services in a manner suited to the needs and regulatory
requirements of market participants throughout the U.S. Treasury
securities market, including indirect participants.\409\
---------------------------------------------------------------------------

\409\ Id.
---------------------------------------------------------------------------

a. Comments Supporting the Commission's Proposed Rule
Commenters generally supported the Commission's attention to the
need for appropriate access to the U.S. Treasury securities CCA,\410\
and several commenters specifically agreed that the Commission should
not prescribe any particular model. One commenter cautioned that
dictating a single model of clearing would close off clearing to many
market participants, force indirect participants to bear additional
clearing costs, increase concentration, reduce competition, and
negatively impact market liquidity.\411\ In addition, another commenter
stated that clearing agencies should have flexibility to innovate in
this area.\412\ Another commenter stated that it supported the
proposal's approach of allowing clearing agencies to engage on
potential reforms directly with affected market participants via the
clearing agencies' existing rulemaking processes, particularly given
the many

[[Page 2756]]

risks involved and given that various models may be appropriate for
different firms and different situations.\413\
---------------------------------------------------------------------------

\410\ MFA Letter, supra note 81, at 5.
\411\ DTCC/FICC Letter, supra note 33, at 14, 18.
\412\ ICE Letter, supra note 33, at 3.
\413\ ISDA Letter, supra note 391, at 3.
---------------------------------------------------------------------------

Another commenter asked the Commission to retain optionality in
access models for U.S. Treasury securities CCAs, because all access
models have costs and benefits and different access models may be
appropriate for different market participants or commercial
arrangements. The commenter agreed with the Commission that neither the
Commission nor the rulebook of a U.S. Treasury securities CCA should
mandate a single approach to access or require that direct participants
that clear for indirect participants offer all possible access models.
The commenter stated that a U.S. Treasury securities CCA should provide
the flexibility necessary to allow market participants to match access
models with optimal use cases, which would encourage maximum market
participation from a diverse group.\414\
---------------------------------------------------------------------------

\414\ SIFMA/IIB Letter, supra note 37, at 23.
---------------------------------------------------------------------------

The Commission agrees with these commenters regarding the need for
flexibility in a U.S. Treasury securities CCA's access models. These
CCAs should be able to develop models that meet the needs of different
market participants, and they should not mandate a single approach to
access or require that direct participants that clear for indirect
participants offer all possible access models. When considering whether
its models meet the needs of different market participants, a U.S.
Treasury securities CCA generally should consider certain topics
related to its access models, such as their sustainability, the need
for additional models or revisions, and potential applicability of
models used in other markets, as part of the CCA's consideration of its
compliance with this proposed rule. Many commenters also expressed that
the Commission should impose additional requirements regarding access
to a U.S. Treasury securities CCA. These comments are discussed in the
following parts II.B.2.b and c.
b. Comments Regarding the Commission's Authority To Require a CCA To
Accept Done Away Transactions
Several commenters stated that the Commission should require that a
U.S. Treasury securities CCA obligate its members to accept done-away
transactions and/or that the Commission should prohibit anticompetitive
practices at CCPs, including prohibiting clearing members from
requiring clients to bundle execution and clearing.\415\ The commenters
argued that the Commission had the statutory authority to implement
such a requirement. First, the commenters stated that ``since a
clearing requirement cannot be implemented in the Treasury market
unless the Commission ensures that both direct and indirect participant
have a way to access a clearing agency, the two topics are inseparable
and the Commission can rely on the statutory authority underlying the
clearing requirement in order to address related access issues,
including promoting the prompt and accurate clearance and settlement of
Treasury securities.'' \416\ Second, the commenters stated that Section
17A of the Exchange Act grants the Commission broad authority to
improve access and competitive practices at a clearing agency. The
commenters identified the Commission's authority to adopt rules for
clearing agencies that are necessary or appropriate in the public
interest or otherwise in furtherance of the purposes of this chapter,
noting that the purposes of Section 17A include maintaining fair
competition among brokers and dealers and scrutinizing clearing agency
rules to ensure they do not permit unfair discrimination among
participants in the use of the clearing agency and do not impose any
burden on competition not necessary or appropriate.\417\ Another
commenter stated that the Commission has the authority in Section 17A
to prohibit anticompetitive practices at all CCAs.\418\
---------------------------------------------------------------------------

\415\ See, e.g., ARB et al. Letter, supra note 81, at 7; MFA
Letter II, supra note 125, at 3-4; see also Citadel Letter, supra
note 81, at 7.
\416\ ARB et al. Letter, supra note 81, at 7; see also Citadel
Letter, supra note 81, at 7.
\417\ See Citadel Letter, supra note 81, at 7; ARB et al.
Letter, supra note 81, at 6.
\418\ AIMA Letter, supra note 81, at 6.
---------------------------------------------------------------------------

Similarly, one commenter asserted that requiring a direct
participant that offers clearing services to indirect participants to
accept those indirect participants' done away transactions would be
consistent with Exchange Act Section 17A, including, in particular,
requirements relating to addressing unnecessary costs, maintaining fair
competition, removing impediments to a national market system, and
promoting the public interest and protection of investors. The
commenter also suggested, at a minimum, that the Commission should
require that if a clearing agency permits its direct participants to
condition an indirect participant's access to clearing on the indirect
participant also executing transactions with the direct participant or
its affiliate, the clearing agency must specify in its rules when such
conditional access is permitted, which should be limited to
circumstances where the clearing agency can show such conditional
access is consistent with the Exchange Act.
The commenters cited several provisions of Section 17A in support
of their views. First, several commenters referenced language in
Section 17A(a)(1), which sets forth the Congressional findings
underpinning Section 17A. Specifically, Congress found that,
inefficient procedures for clearance and settlement impose unnecessary
costs on investors and persons facilitating transactions by and acting
on behalf of investors, and that the linking of all clearance and
settlement facilities and the development of uniform standards and
procedures for clearance and settlement will reduce unnecessary costs
and increase the protection of investors and persons facilitating
transactions by and acting on behalf of investors. These findings,
including the reference to ``unnecessary costs,'' do not provide the
Commission with authority to adopt rules requiring CCAs to impose
particular requirements on their direct participants regarding the
direct participants' business models. Instead, they represent Congress'
findings about the consequences of the situation at the time Section
17A was adopted in 1975.
Second, the commenters relied upon language in Section 17A(a)(2)
setting forth the Congressional direction to the Commission regarding a
national system for clearance and settlement. This direction instructs
the Commission to take into account, among other things, the
maintenance of fair competition among brokers and dealers when
facilitating the establishing of a national system for the prompt and
accurate clearance and settlement of securities transactions.
Third, commenters relied upon language in Section 17A(b)(3)(F) and
(I). These provisions set forth certain requirements for a clearing
agency's rules that must be met in order for the Commission to register
the clearing agency. In the portions cited by commenters, Section
17A(b)(3)(F) states that the clearing agency's rules should be, among
other things, designed to remove impediments to and perfect the
mechanism of a national system for the prompt and accurate clearance
and settlement of securities transactions, and, in general, to protect
investors and the public interest, and that they should not be designed
to permit unfair discrimination among participants in the use of the
clearing agency. Section

[[Page 2757]]

17A(b)(3)(I) states that the clearing agency's rules should not impose
any burden on competition not necessary or appropriate in furtherance
of the purposes of this chapter.
The type of requirement sought by commenters differs from the
requirement to clear eligible secondary market transactions, in that
the requirement to clear eligible secondary market transactions relates
to transactions that the direct participant already has determined to
enter into, based on its own business model.\419\ It is not requiring
the direct participant to engage in particular transactions or to offer
particular business models. By contrast, the commenters' support for a
prohibition on anti-competitive practices or a requirement to accept
done-away transactions would require clearing agencies to, in turn,
require their direct participants to transact with their customers in
specific ways and limit their ability to offer certain types of pricing
services. As discussed in the Proposing Release, the current client
clearing models in place at FICC allow for the submission of done-away
transactions and allows non-FICC entities to access the CCA through
multiple direct participants, but do not require any direct participant
to submit done-away transactions on behalf of other market
participants.\420\ Therefore, the Commission disagrees that the failure
to require the submission of done-away transactions necessarily
constitutes ``unfair discrimination,'' as discussed in Section
17A(b)(3)(F). Moreover, in order to encourage market participants to
provide services to enable indirect access to central clearing, the
Commission believes it is best not to remove the ability of a direct
participant of a U.S. Treasury securities CCA to determine what risk it
will take with respect to guaranteeing transactions to the CCA. In
addition, the Commission would not agree with the commenter that, at
this time, the current access models offered by the existing U.S.
Treasury securities CCA constitute a burden on competition that is not
necessary or appropriate, as discussed in Section 17A(b)(3)(I).
---------------------------------------------------------------------------

\419\ Specifically, the definition of an eligible secondary
market transaction would simply identify various types of
transactions but would not favor or require one over another.
\420\ Proposing Release, supra note 14, 88 FR at 64635.
---------------------------------------------------------------------------

More generally, the Commission disagrees that it should impose a
particular access model at this time. The Commission is adopting a
number of changes with regard to the method by which CCAs will provide
services to the U.S. Treasury market, including the segregation of
house and customer margin and the potential ability to use Rule 15c3-3
to rehypothecate customer margin to the CCA to meet margin
requirements, and regarding the CCA's obligations with respect to
ensuring access. These changes will present both new obligations, but
also potentially new business opportunities, for existing direct
participants of the U.S. Treasury securities CCA. It is appropriate to
allow the U.S. Treasury market to take these new requirements into
account, before determining that additional access models are needed.
Currently, FICC's models do allow for done-away transactions, and the
Commission therefore disagrees that an additional model is a
prerequisite to the requirement to clear eligible secondary market
transactions.\421\
---------------------------------------------------------------------------

\421\ In addition, the Commission notes that any additional
model would have to be consistent with Section 17A(b)(3)(E), which
requires that the rules of a registered clearing agency not impose
any schedule of prices, or fix rates or other fees, for services
rendered by its participants.
---------------------------------------------------------------------------

Finally, a commenter also stated that in order to satisfy the
proposal's principles-based access requirement, a clearing agency
should have to demonstrate that, for each clearing model it considers
necessary to offer to satisfy that access standard, the clearing agency
is clearing a material volume of transactions through that model (i.e.,
if permitting done away clearing is necessary for the clearing agency
to satisfy the proposal, then the clearing agency must demonstrate that
material volume of done away clearing is actually taking place).\422\
The Commission agrees with the commenter that the CCA generally should
consider the volumes and proportion of the market that are being
centrally cleared through different access models as part of the CCA's
consideration of whether its access models are meeting the needs of the
market.
---------------------------------------------------------------------------

\422\ MFA Letter, supra note 81, at 9.
---------------------------------------------------------------------------

c. Other Comments Regarding Access
Other commenters supported additional Commission requirements
regarding customer clearing models, particularly with respect to done-
away transactions. One commenter stated that the Commission needs to be
more prescriptive in directing covered clearing agencies on how they
design their access models, disagreeing with the amount of discretion
left to the clearing agency and its board. The commenter stated that a
successful clearing model must also facilitate and incentivize the
clearing of ``done away'' transactions, which will require changes to
incentives so that clearing brokers are compensated for facilitating
this activity. The commenter identified ``the only viable path'' to a
clearing requirement as the Commission's issuing a detailed rulemaking
establishing a common clearing model and standards which must be met by
any U.S. Treasury securities CCA, including FICC.\423\
---------------------------------------------------------------------------

\423\ SIFMA AMG Letter, supra note 35, at 9-10.
---------------------------------------------------------------------------

The Commission addressed similar comments in the discussion in part
II.B.2.b supra. As discussed there, the Commission is not prescribing
particular access models. The Commission agrees with commenters that a
workable done-away model will be critical to this market, to
accommodate the increased central clearing that would result from
implementation of this rule, and encourages FICC and other market
participants to consider how to offer and price the currently available
models to ensure that indirect participants can access central
clearing.
One commenter stated that the Commission should adopt more robust
and direct measures to ensure fair and open access, specifically to
make sure that market participants have sufficient access to
clearing.\424\ This commenter identified three overarching principles
or concerns with respect to FICC's current clearing access models
``that must be addressed in any final rule.'' First, the commenter
stated that FICC's rules must ensure that an indirect participant can
consolidate the clearing of its portfolio in one or a small number of
direct participants by requiring a direct participant offering customer
clearing to accept transactions executed by the customer with third-
party executing firms (that is, to accept ``done-away'' transactions).
The commenter stated that under the current FICC rules, indirect
participants may be prevented by their clearing firms from clearing
these ``done-away'' transactions, which means that the indirect
participant often needs to establish a clearing relationship with each
executing counterparty, which divides portfolios, increases margin
costs and operational complexity, and potentially reduces netting
efficiencies.\425\ In response to this comment, for the reasons
explained above, the Commission is not prescribing particular access
models.
---------------------------------------------------------------------------

\424\ MFA Letter, supra note 81, at 5; MFA Letter II, supra note
125, at 3-4.
\425\ MFA Letter, supra note 81, at 7; MFA Letter II, supra note
125, at 3-4.
---------------------------------------------------------------------------

Second, the commenter stated that indirect participants should be
able to access central clearing models providing for FICC to guarantee
settlement of their

[[Page 2758]]

transactions, which the commenter asserts is not the case with certain
models today including FICC's correspondent and prime broker models.
The commenter states that these models do not afford indirect
participants the benefits of central clearing because settlement of the
transactions they clear through those models remains dependent upon the
direct participant because the indirect participant does not face FICC
directly. The commenter states that because a clearing mandate would,
in practice, force many market participants to contract with FICC
direct participants to access clearing (and would disallow various
bilateral settlement models), it is critical that the Commission ensure
that settlement of such market participants' transactions is not
contingent upon circumstances outside the indirect participants'
control, including, for example, the solvency of a direct
participant.\426\
---------------------------------------------------------------------------

\426\ MFA Letter, supra note 81, at 7; see also MFA Letter II,
supra note 125, at 4.
---------------------------------------------------------------------------

The Commission recognizes that certain access models offered by
FICC may not result in a contractual relationship or direct obligation
between FICC and the indirect participant, meaning that FICC itself
cannot guarantee settlement of such transactions. The Commission
observes that this generally would be the case in any agent clearing
relationship in which an indirect participant relies upon a direct
participant to submit transactions for clearing on its behalf. For
example, customers who access DCOs through an FCM that is a direct
participant in the DCO may face exposure if the FCM fails. DCO rules
generally require that it take steps to port the customer transactions
(i.e., to transfer the customer positions to a new direct participant
if the customer's original direct participant defaults), but ultimately
retain the ability to close out the transactions if needed, leaving the
customer to seek redress from its direct participant.\427\ However,
this structure still provides the benefits of central clearing to the
market as a whole, as described in part II.A.1 supra, despite the fact
that an indirect participant may face continued exposure to its agent
direct participant.
---------------------------------------------------------------------------

\427\ See, e.g., ICE Clear Credit Rule 20A-02(a) (describing
what happens in the event that FICC determines to effect the
closing-out Process for client-related positions of a defaulting
participant); CME Group Exchange Rule 802.G(1) (describing the DCO's
ability to terminate transactions in a customer futures account).
---------------------------------------------------------------------------

Third, the commenter states that an indirect participant should
have the ability (although not the obligation) to fund the margin
obligations of the direct participant clearing on its behalf which are
attributable to the indirect participant. The commenter states that
given that many indirect participants have fiduciary obligations to
their own clients, it is crucial that indirect participants are able to
post margin on a segregated basis such that their clients are not
subject to the credit risk of others (and, likewise, that their funds
are not subject to loss mutualization), which would promote systemic
risk mitigation by facilitating a defaulter-pays model for clearing by
indirect participants.\428\ The Commission addressed this issue in its
discussion of a similar comment in part II.A.2.a.ii supra.
---------------------------------------------------------------------------

\428\ MFA Letter, supra note 81, at 7.
---------------------------------------------------------------------------

One commenter stated that the Commission should undertake a study
of possible models to access U.S. Treasury securities CCAs, including
models used in other markets. The commenter stated that current access
models may not be suited for all participants or commercial
arrangements, for various reasons including FICC membership
requirements, operational constraints, and resource costs associated
with legal documentation. The commenter stated that implementing a
central clearing requirement without a comprehensive analysis regarding
the suitability of current models to access U.S. Treasury securities
CCAs and whether there is a need for additional models or revisions to
current models could drive market participants away from transacting
with direct participants or from the Treasury market entirely, if such
participants do not believe there is a reasonable means of accessing a
CCA. The commenter stated that such study should take place prior to
the adoption of any rule requiring additional central clearing.\429\
Another commenter suggested that the Commission conduct a holistic
review of FICC rules to ensure fair access for all market participants
(both direct participants and indirect participants), prior to imposing
any requirements.\430\
---------------------------------------------------------------------------

\429\ SIFMA/IIB Letter, supra note 37, at 24.
\430\ MFA Letter II, supra note 125, at 5.
---------------------------------------------------------------------------

The Commission does not agree that a formal study or holistic
review of access models must occur before adoption of the proposal. As
discussed in part II.C.2 supra, a U.S. Treasury securities CCA
generally should consider these topics, such as the sustainability of
current models and the need for additional models or revisions, as well
as the potential applicability of models used in other markets, as part
of the CCA's consideration of its compliance with this proposed rule.
The Commission will have the opportunity to consider these issues as
well, in its review of any changes to access models filed pursuant to
Section 19(b) of the Exchange Act.
Finally, one commenter stated that the Commission's goal of
ensuring access for indirect participants to U.S. Treasury securities
CCAs should be balanced against sufficiently robust membership criteria
to ensure risk is appropriately managed.\431\ The commenter cautioned
that any expansion of access to U.S. Treasury securities CCA services
should not relax membership requirements essential for appropriate risk
management.\432\ The commenter stated that less stringent membership
requirements in the name of increasing access to central clearing would
increase the risk of a participant default, increasing risk to
FICC.\433\ The Commission agrees with the commenter that membership
requirements are essential to a covered clearing agency's risk
management. As the Commission stated in the Proposing Release,
membership requirements help to guard against defaults of any CCP
member, as well as to protect the CCP and the financial system as a
whole from the risk that one member's default could cause others.\434\
Membership requirements will remain essential even with the requirement
to clear eligible secondary market transactions, and U.S. Treasury
securities CCAs generally should not relax membership requirements to
accommodate such a requirement. A U.S. Treasury securities CCA is
subject to Rule 17ad-22(e)(18)(i), (ii), and (iii), which requires that
a CCA establish, implement, maintain and enforce written policies and
procedures reasonably designed to establish objective, risk-based, and
publicly disclosed criteria for participation, which permit fair and
open access by direct and, where relevant, indirect participants and
other financial market utilities, require participants to have
sufficient financial resources and robust operational capacity to meet
obligations arising from participation in the clearing agency, and
monitor compliance with such participation requirements on an ongoing
basis. These requirements should help ensure that CCAs are not able to
use less stringent membership requirements to comply with the
requirement to clear eligible secondary market transactions. Moreover,
any changes to FICC's membership

[[Page 2759]]

requirements would necessarily encompass a change to FICC's Rules,
which would be subject to Commission review and consideration pursuant
to Section 19(b) of the Exchange Act.
---------------------------------------------------------------------------

\431\ SIFMA/IIB Letter, supra note 37, at 23.
\432\ SIFMA/IIB Letter, supra note 37, at 24.
\433\ Id. at 25.
\434\ Proposing Release, supra note 14, 87 FR at 64623.
---------------------------------------------------------------------------

\435\ ICI Letter, supra note 85, at 26-28.
---------------------------------------------------------------------------

With respect to the start leg of the transaction, the commenter
stated that, within the Sponsored Service, FICC does not novate the
settlement of the start leg of a repo transaction that is submitted for
clearing between a Sponsoring Member and a Sponsored Member, although
it does novate the end leg of the transaction, meaning that the
counterparties continue to be responsible for settlement outside of
FICC and bear the risk of a settlement fail vis [agrave] vis one
another. The commenter also states that the lack of central clearing
for the start leg of repo transactions in the Sponsored Service means
that a requirement to clear eligible secondary market transactions may
not eliminate counterparty credit risk issues to the extent the
Commission anticipates, which, in turn, means that the proposal may not
increase competition or reduce spreads as the Commission predicted in
the Proposing Release.
A U.S. Treasury repo transaction generally encompasses both the
start leg and the end leg of a U.S. Treasury repo. The Commission
understands that, currently, the only U.S. Treasury securities CCA
novates the start legs of many types of repo transactions cleared by
the CCA, but does not provide central clearing for the start legs of
repo transactions cleared through a particular client clearing access
model.
The Commission understands that, contrary to transactions cleared
at FICC outside the Sponsored Service, FICC currently does not novate
the start legs of same-day settling Sponsored DVP Repos where the
Sponsored Member's pre-novation counterparty is its Sponsoring Member
(i.e., ``done-with'' Sponsored DVP Repo) or of Repos. The Commission
acknowledges that this transaction occurring outside central clearing
could somewhat reduce the benefits of central clearing in this limited
instance, but the counterparty credit risk arising from the start legs
of such transactions are largely addressed by the fact that they
usually settle on a delivery-versus-payment basis between the
counterparties, meaning that the securities and funds are exchanged
simultaneously and resulting in less counterparty credit risk to
address. The Commission does not believe that the lack of clearing for
the start leg undermines the overall benefits of the requirement to
clear eligible secondary market transactions. However, the Commission
further understands that FICC has stated that it is able to clear the
start leg of any repo transaction and currently does clear the start
leg of all repos between two direct participants, the start leg of any
Sponsored DVP repo where the Sponsored Member's pre-novation
counterparty is a third-party member of FICC (i.e., ``done-away'' from
the Sponsoring Member), and any Sponsored DVP Repo where the start leg
of such repo is scheduled to settle on some business day in the future
(i.e., forward-settling repos).\436\ The Commission would consider any
proposal to provide additional clearing of repo start legs in
particular access models in due course, consistent with its obligations
under Section 19(b) of the Exchange Act.
---------------------------------------------------------------------------

\436\ See FICC Rule 11, section 2, supra note 19; FICC Buyside
FAQ, supra note 169, at 2-3.
---------------------------------------------------------------------------

With respect to the completion of settlement of a Sponsored
Member's transactions if the Sponsoring Member defaults, the commenter
states that neither the Sponsored Bilateral DVP Service nor the
Sponsored GC Repo Service compel FICC to complete the settlement of a
sponsored member's transactions in the event of a sponsoring member's
default, and that this approach is not consistent with the Commission's
assumption that central clearing increases the likelihood of
settlement.\437\ The Commission agrees that in most cases of a
Sponsoring Member's default, the ability for the CCA to settle its
sponsored transactions likely would tend to minimize market disruption.
However, the Commission understands that the current structure of the
Sponsored Service, as set forth in FICC's rules, would allow FICC the
ability to, potentially, terminate the Sponsored Member's transaction
in such circumstances, and that this structure arises from the fact
that, by design, the Sponsoring Member serves as the processing agent
for all movement of funds and securities for its Sponsored Members.
FICC is not able to guarantee that an insolvent Sponsoring Member,
which may be subject to the control of another legal entity, such as a
bankruptcy trustee, would be able to continue processing such
transactions, thereby allowing settlement to occur. This aspect of
FICC's rules is consistent with how other central counterparties have
addressed the potential termination of customer transactions in the
event of their agent's default.\438\ The Commission does not believe
that the potential for FICC to terminate these transactions, in the
unlikely event of a Sponsoring Member default in which it is unable to
work with the controlling legal entity, means that the benefits in the
Proposing Release would not be, to a great extent, realized. Based on
its supervisory knowledge, the Commission is not aware of any instance
in which FICC was unable to work with the controlling legal entity for
a defaulting member (i.e., a member for which FICC has ceased to act).
Therefore, this is an extremely infrequent event and would depend on
the facts and circumstances of a particular insolvency.
---------------------------------------------------------------------------

\437\ ICI Letter, supra note 85, at 27.
\438\ See note 427 supra.
---------------------------------------------------------------------------

With respect to the overall structure of the Sponsored Service, one
commenter stated that market participants have raised concerns about
the ability, as sponsored members, to engage with FICC to address
issues arising from repo transactions that have been submitted through
sponsored clearing, which, if not addressed, may prove to be a further
impediment to the expansion of sponsored repo clearing. The commenter
also states that market participants have cited challenges with seeking
recourse from FICC in cases where the sponsoring member is in
default.\439\ As discussed in the prior paragraph, the Commission
understands that this is inherent to the design of the Sponsored
Service, in that the Sponsoring Member serves as a processing agent for
all the Sponsored Member's cleared transactions. FICC's rules address
how it would proceed in the event of a Sponsoring Member default,
including in the event that it closes out a Sponsored Member's
transactions.\440\ In the event that FICC chooses to revisit this
structure to provide some additional ability for the Sponsored Member
to directly access FICC, without relying on its Sponsoring Member, the
Commission would consider such a proposal in due course,

[[Page 2760]]

consistent with its obligations under Section 19(b) of the Exchange
Act.
---------------------------------------------------------------------------

\439\ ICI Letter, supra note 85, at 27-28.
\440\ See FICC Rule 3A, section 14(c) (stating that FICC would
rely upon Rule 22, section 3 to close out Sponsored Member
transactions and to determine the amount owed to or due from a
Sponsoring Member), supra note 19.
---------------------------------------------------------------------------

d. Final Rule
For the reasons discussed in parts II.B.2.a through c, the
Commission is adopting Rule 17ad-22(e)(18)(iv)(C) as proposed. To
facilitate compliance with this requirement, a U.S. Treasury securities
CCA generally should conduct and document an initial review of its
access models and related policies and procedures. As it conducts this
review, in view of the critical services it provides, the U.S. Treasury
securities CCA generally should seek to provide access in as flexible a
means as possible, consistent with its responsibility to provide sound
risk management and comply with other provisions of the Exchange Act,
the Covered Clearing Agency Standards, and other applicable regulatory
requirements. A U.S. Treasury securities CCA generally should consider
a wide variety of appropriate means to facilitate access to clearance
and settlement services of all eligible secondary market transactions
in U.S. Treasury securities, including those of indirect participants.
To ensure that it considers a sufficiently broad set of perspectives,
the U.S. Treasury securities CCA generally should consult with a wide-
range of stakeholders, including indirect participants, as it seeks to
comply with proposed rule 17ad-22(e)(18)(iv)(C).
A U.S. Treasury securities CCA generally should review and document
any instance in which its policies and procedures treat transactions
differently based on the identity of the participant submitting the
transaction, the fact that an indirect participant is a party to the
transaction, or the method of execution, or in any other way, and
confirm that any variation in the treatment of such transactions is
necessary and appropriate to meet the minimum standards regarding,
among other things, operations, governance, and risk management
identified in the Covered Clearing Agency Standards. The review by a
U.S. Treasury securities CCA's board of directors under proposed Rule
17ad-22(e)(18)(iv)(C) generally should include consideration of whether
to establish policies and procedures that enable direct members to
submit to the U.S. Treasury securities CCA eligible transactions for
clearance and settlement that have been executed by two indirect
participants of the U.S. Treasury securities CCA, which could
potentially help address some of the concerns potential participants
raised about the inability to present ``done away'' trades for
clearance and settlement described above. Finally, as part of its
consideration, a U.S. Treasury securities CCA generally should consider
the volumes and proportion of the market that are being centrally
cleared through different access models as part of the CCA's
consideration of whether its access models are meeting the needs of the
market. To the extent that a U.S. Treasury securities CCA's initial (or
any subsequent) review occasions a change to its rules, such U.S.
Treasury securities CCA would need to file such changes for Commission
review and approval, as appropriate, under section 19(b) of the
Exchange Act and Title VIII of the Dodd-Frank Act.\441\ The review by a
U.S. Treasury securities CCA's board of directors under proposed Rule
17ad-22(e)(18)(iv)(C) generally should include consideration whether
the U.S. Treasury securities CCA's written policies and procedures are
reasonably designed to ensure appropriate means to facilitate access to
clearance and settlement services of all eligible secondary market
transactions in U.S. Treasury securities, including those of indirect
participants.
---------------------------------------------------------------------------

\441\ See 15 U.S.C. 78s(b); 17 CFR 240.19b-4; 12 U.S.C. 5465(e).
---------------------------------------------------------------------------

C. Amendments to Rule 15c3-3a

1. Introduction
The rules adopted above could cause a substantial increase in the
margin broker-dealers must post to a U.S. Treasury securities CCA
resulting from their customers' cleared U.S. Treasury positions.\442\
Currently, Rules 15c3-3 and 15c3-3a do not permit broker-dealers to
include a debit in the customer reserve formula equal to the amount of
margin required and on deposit at a U.S. Treasury securities CCA. This
is because no U.S. Treasury securities CCA has implemented rules and
practices designed to segregate the margin and limit it to being used
solely to cover obligations of the broker-dealer's customers.
Therefore, increases in the amount of margin required to be deposited
at a U.S. Treasury securities CCA as a result of the adoption of the
Membership Proposal would result in corresponding increases in the need
to use broker-dealers' cash and securities to meet these new
requirements.\443\
---------------------------------------------------------------------------

\442\ See Proposing Release, supra note 14, 87 FR at 63637.
\443\ Proposing Release, supra note 14, 87 FR at 64637.
---------------------------------------------------------------------------

To facilitate implementation of the Membership Proposal, the
Commission proposed to amend Rule 15c3-3a to permit margin required and
on deposit at a U.S. Treasury securities CCA to be included as a debit
item in the customer reserve formula, subject to the conditions
discussed below. This new debit item would offset credit items in the
Rule 15c3-3a formula and, thereby, free up resources that could be used
to meet the margin requirements of a U.S. Treasury securities CCA. The
debit item would be reported on a newly created Item 15 of the Rule
15c3-3a reserve formula. The proposed amendments also set forth a
number of conditions that would need to be met to include the debit in
the reserve formula. As discussed below, these proposed conditions were
designed to permit the inclusion of the debit under conditions that
would provide maximum protection to the broker-dealer's customers. The
goal of the proposed amendments was to facilitate implementation of the
Membership Proposal in a way that does not diminish the customer-
protection objective of Rules 15c3-3 and 15c3-3a.\444\
---------------------------------------------------------------------------

\444\ Proposing Release, supra note 14, 87 FR at 64637.
---------------------------------------------------------------------------

The proposed conditions would be set forth in a new Note H to the
reserve formula similar to how the conditions for including a debit in
the reserve formula with respect to margin required and on deposit at a
securities futures clearing agency or DCO are set forth in Note G. The
proposed amendments were based, in part, on the conditions in Note G
and the requirements in Rules 15c3-3 and 15c3-3b for including a debit
with respect to margin required and on deposit at security-based swap
clearing agency. The Note G conditions and requirements of Rules 15c3-3
and 15c3-3b similarly were designed to permit the debit under
circumstances that provide protection to customers.\445\
---------------------------------------------------------------------------

\445\ Proposing Release, supra note 14, 87 FR at 64637.
---------------------------------------------------------------------------

Overall, commenters supported the proposal to permit this debit
item.\446\ Commenters stated that the proposed amendments would make
clearing more efficient and free up resources that could be used to
meet the CCA's margin requirements, while continuing to protect
customer funds.\447\ Commenters also stated that the proposal would
incentivize central clearing.\448\ A commenter stated that the proposal
would extend to margin held at a U.S. Treasury securities CCA the same

[[Page 2761]]

treatment as margin posted to other clearing organizations.\449\ As a
result, this commenter stated that the proposal would facilitate
greater access to clearing and eliminate an undue burden on
competition. Another commenter--in supporting this aspect of the
proposal--stated that it does not make sense that margin cannot be
freely rehypothecated from a customer through a broker-dealer to a U.S.
Treasury securities CCA without the broker-dealer receiving a
beneficial adjustment as part of its customer reserve formula
calculation.\450\ For greater and more efficient client clearing,
another commenter encouraged the Commission to adopt this proposal
irrespective of whether the Membership Proposal is adopted.\451\
---------------------------------------------------------------------------

\446\ See AIMA Letter, supra note 81, at 8; CME Letter, supra
note 81, at 4; DTCC/FICC Letter, supra note 33, at 28-29; ICE
Letter, supra note 33, at 3; MFA Letter, supra note 81, at 10; ISDA
Letter, supra note 391, at 2; SIFMA AMG Letter, supra note 35, at 8.
\447\ See AIMA Letter, supra note 81, at 8; MFA Letter, supra
note 81, at 10; SIFMA/IIB Letter, supra note 37, at 27-28.
\448\ See CME Letter, supra note 81, at 4; SIFMA AMG Letter,
supra note 35, at 8.
\449\ See DTCC/FICC Letter, supra note 33, at 28.
\450\ See SIFMA AMG Letter, supra note 35, at 8.
\451\ See ISDA Letter, supra note 391, at 2.
---------------------------------------------------------------------------

Commenters did suggest certain modifications to the proposal. The
Commission's responses to comments, modifications to the proposed rule
text made in response to comments, and the final amendments are
discussed below.
2. Credit Items
Cash delivered by a customer to the broker-dealer to be posted by
the broker-dealer to a U.S. Treasury securities CCA would be a free
credit balance or other credit balance in the customer's securities
account. Thus, this cash will need to be included in Item 1 to the Rule
15c3-3a formula. Further, when a broker-dealer uses customer margin
securities to borrow funds or execute a securities loan transaction,
the firm must put a credit in the formula.\452\ The credit items are
designed to require the broker-dealer to reserve sufficient funds to be
able to retrieve securities that collateralize the borrowed funds or
have been loaned. There is not a specific Item in the Rule 15c3-3a
formula to include the credit arising from the broker-dealer's use of
customers' securities to meet a margin requirement imposed on the
broker-dealer by a U.S. Treasury securities CCA. Consequently, the
Commission proposed to amend Note B to Item 2 of the Rule 15c3-3a
formula to instruct broker-dealers to include as a credit in Item 2 the
market value of customers' U.S. Treasury securities on deposit at a
U.S. Treasury securities CCA that meets the definition of a ``qualified
clearing agency'' in Note H.\453\ The Commission did not receive any
comments on this aspect of the proposal and is adopting it
substantially as proposed.\454\
---------------------------------------------------------------------------

\452\ See Items 2 and 3 to Rule 15c3-3a.
\453\ See Proposing Release, supra note 14, 87 FR at 64638, n.
232.
\454\ See Note B to Item 2 of Rule 15c3-3a, as adopted. The
phrase ``customers' U.S. Treasury securities'' in the note--as
proposed--has been replaced with the more generic phrase
``customers' securities'' in the note, as adopted. Id. This
modification conforms the note to modifications discussed below that
expand the type of customer collateral that can be posted to the
U.S. Treasury securities CCA. As proposed, the broker-dealer was
limited to posting customer cash or U.S. Treasury securities. See
Proposing Release, supra note 14, 87 FR at 64638. This provision is
being modified to include any securities accepted as margin by the
U.S. Treasury securities CCA, subject to certain conditions. See
Note H(a)(1) to Item 15, as adopted.
---------------------------------------------------------------------------

3. New Debit Item
On the debit side of the formula, the Commission proposed
renumbering current Item 15 of the Rule 15c3-3a formula as Item
16.\455\ As proposed, new Item 15 would identify as a debit in the Rule
15c3-3a formula margin required and on deposit with a clearing agency
registered with the Commission under section 17A of the Exchange Act
resulting from the following types of transactions in U.S. Treasury
securities in customer accounts that have been cleared, settled, and
novated by the clearing agency: (1) purchases and sales of U.S.
Treasury securities; and (2) U.S. Treasury securities repurchase and
reverse repurchase agreements (together ``customer position
margin'').\456\ As proposed, this debit item was limited to customer
position margin required and on deposit at a clearing agency that
clears, settles, and novates transactions in U.S. Treasury securities.
Except for the debits identified in current Items 13 and 14 of the Rule
15c3-3a formula, margin required and on deposit at other types of
clearing agencies or for other types of securities transactions would
not qualify as a debit item under the proposal. Further, this debit
item would be limited to customer position margin required and on
deposit at the U.S. Treasury securities CCA resulting from U.S.
Treasury positions in customer accounts. Margin required and on deposit
at the U.S. Treasury securities CCA as result of the broker-dealer's
proprietary U.S. Treasury positions could not be included in this debit
item. This proposed limitation would effectuate a fundamental aspect of
Rule 15c3-3: that customer cash and securities not be used by the
broker-dealer to finance its proprietary business activities.
---------------------------------------------------------------------------

\455\ Current Item 15 is where the broker-dealer reflects the
amount, if any, that total credits exceed total debits.
\456\ See Proposing Release, supra note 14, 87 FR at 64637.
---------------------------------------------------------------------------

Finally, the debit would be limited to customer position margin
required and on deposit at the U.S. Treasury securities CCA. This would
mean that the broker-dealer could not include in this debit item
amounts on deposit at the U.S. Treasury securities CCA that exceed the
broker-dealer's margin requirement resulting from its customers'
cleared U.S. Treasury securities positions. This limitation is designed
to prevent the broker-dealer from artificially increasing the amount of
the debit item by depositing cash and securities at the U.S. Treasury
securities CCA that are not needed to meet a margin requirement
resulting from its customers' U.S. Treasury securities positions. The
Commission did not receive any comments on these aspects of the
proposal and is adopting them as proposed.\457\
---------------------------------------------------------------------------

\457\ See Item 15 of the Rule 15c3-3a formula, as adopted.
---------------------------------------------------------------------------

4. Note to New Debit Item
As proposed, Item 15 of the Rule 15c3-3a formula would have a Note
H (``Note H'') that sets forth conditions that would need to be met to
include the amount of customer position margin required and on deposit
at the U.S. Treasury securities CCA as a debit.\458\ Each of the
conditions in Note H to Item 15 would need to be met for a broker-
dealer to include a debit equal to the amount of customer position
margin required and on deposit at the U.S. Treasury securities CCA. As
discussed below, the Commission is adopting the conditions largely as
proposed, with some modifications in response to comments.\459\
---------------------------------------------------------------------------

\458\ Proposing Release, supra note 14, 87 FR at 64638-40.
\459\ See Note H to Rule 15c3-3a, as adopted.
---------------------------------------------------------------------------

a. First Condition--Permitted Collateral
The first condition--set forth in paragraph (a) of Note H--provided
that the debit item could be included in the Rule 15c3-3a formula to
the extent that the customer position margin is in the form of cash or
U.S. Treasury securities and is being used to margin U.S. Treasury
securities positions of the customers of the broker-dealer that are
cleared, settled, and novated at the U.S. Treasury securities CCA.\460\
The objective was to limit the assets underlying the debit item to the
safest and most liquid instruments, given that the debit item would
offset credit items (cash owed to customers).\461\ As

[[Page 2762]]

discussed above, the liquidity of the debit items protects the
customers whose cash or securities are used to finance or facilitate
customer transactions.
---------------------------------------------------------------------------

\460\ Proposing Release, supra note 14, 87 FR at 64638.
\461\ See, e.g., 17 CFR 240.15c3-3(e) (limiting the assets that
can be deposited into the customer reserve account to cash and
qualified securities); 17 CFR 240.15c3-3(a)(6) (defining the term
``qualified security'' to mean a security issued by the United
States or a security in respect of which the principal and interest
are guaranteed by the United States).
---------------------------------------------------------------------------

In response to the proposed first condition, commenters stated that
the Commission should expand the types of securities that could be used
to meet the customer position margin requirement.\462\ Specifically,
one commenter stated that the use of the debit should not be limited to
margin in the form of cash or Treasury securities.\463\ This commenter
stated that FICC accepts additional securities for clearing fund
deposits, including eligible obligations of U.S. agencies or government
sponsored entities and eligible mortgage-backed securities.\464\ The
commenter also stated that the Commission found--in the context of
approving a FICC rule change--that the expanded scope of acceptable
forms of clearing fund collateral deposits would ``better enable FICC
to assure the safeguarding of securities and funds in its custody or
control or for which it is responsible,'' and therefore was consistent
with the requirements of the Exchange Act and other governing
regulations.\465\
---------------------------------------------------------------------------

\462\ See ISDA Letter, supra note 391; SIFMA/IIB Letter, supra
note 37, at 29.
\463\ See SIFMA/IIB Letter, supra note 37, at 29.
\464\ See SIFMA/IIB Letter, supra note 37, at 29.
\465\ See SIFMA/IIB Letter, supra note 37, at 29 (citing Self-
Regulatory Organizations; Fixed Income Clearing Corporation; Order
Approving Proposed Rule Change to Modify its Rules to Diversify and
Standardize Clearing Fund Collateral Requirements Across the
Divisions to Improve Liquidity and Minimize Risk for its Members,
Exchange Act Release No. 54969 (Dec. 26, 2006), 71 FR 77837, 77838
(Dec. 27, 2006)).
---------------------------------------------------------------------------

In response to comments, the Commission is modifying paragraph (a)
of Note H to permit ``qualified customer securities'' to be used to
meet the customer position margin requirement in addition to cash and
U.S. Treasury securities.\466\ The term ``qualified customer
securities'' is defined to mean securities of a customer of the broker-
dealer (other than U.S. Treasury securities) that are held in custody
by the broker-dealer for the customer and that under the rules of the
U.S. Treasury securities CCA are eligible to be used to margin U.S.
Treasury securities positions of the customer that are cleared,
settled, and novated by the CCA.\467\ Therefore, a broker-dealer may
post cash, U.S. Treasury securities, and qualified customer securities
(i.e., securities other than U.S. Treasury securities that are accepted
by the U.S. Treasury securities CCA) to meet a customer position margin
requirement.
---------------------------------------------------------------------------

\466\ See Rule 15c3-3a, Note H(a)(1), as adopted. To implement
this modification, paragraph (a) of Note H is being divided into
subparagraphs (a)(1) and (2). Subparagraph (a)(1) identifies the
types of collateral that can be used to meet the customer position
margin requirement (i.e., cash, U.S. Treasury securities, and
qualified customer securities), and subparagraph (a)(2) contains the
text that provides that the collateral must be used to margin U.S.
Treasury securities positions of the customers of the broker-dealer
that are cleared, settled, and novated by the qualified clearing
agency, as was proposed. See Rule 15c3-3a, Note H(a)(1) and (2), as
adopted.
\467\ See Rule 15c3-3a, Note H(c), as adopted.
---------------------------------------------------------------------------

As proposed, paragraph (b) of Note H set forth the second, third,
and fourth conditions that would need to be met to include the amount
of customer position margin required and on deposit at the U.S.
Treasury securities CCA as a debit item.\468\
---------------------------------------------------------------------------

\468\ See Note H(b)(1) through (3) of Rule 15c3-3a, as proposed.
---------------------------------------------------------------------------

b. Second Condition--Customer Position Margin
The second condition--set forth in paragraph (b)(1) of Note H--
provided that the customer position margin must consist of cash owed to
the customer of the broker-dealer or U.S. Treasury securities held in
custody by the broker-dealer for the customer that was delivered by the
broker-dealer to meet to meet a margin requirement resulting from that
customer's U.S. Treasury securities positions cleared, settled, and
novated at the U.S. Treasury securities CCA and not for any other
customer's or the broker-dealer's U.S. Treasury securities positions
cleared, settled, and novated at the U.S. Treasury securities CCA.\469\
In sum, to meet this condition, the broker-dealer would need to: (1)
use customer assets exclusively to meet the customer position margin
requirement; (2) use a particular customer's assets exclusively to meet
the amount of the customer position margin requirement resulting from
that customer's cleared U.S. Treasury securities positions; and (3)
have delivered the customer's assets to the U.S. Treasury securities
CCA.
---------------------------------------------------------------------------

\469\ Proposing Release, supra note 14, 87 FR at 64638.
---------------------------------------------------------------------------

The objective of the first component of the second condition--the
need to use customer assets exclusively--was to segregate the customer
assets being used to meet the customer position margin requirement from
the broker-dealer's proprietary assets.\470\ Additional conditions--
under the proposal--provided that the U.S. Treasury securities CCA must
hold the assets being used to meet the customer position margin
requirement in an account of the broker-dealer that is segregated from
any other account of the broker-dealer and is identified as being held
for the exclusive benefit of the broker-dealer's customers.\471\ The
first prong of the condition was designed to ensure that only customer
assets are held in the account.
---------------------------------------------------------------------------

\470\ Proposing Release, supra note 14, 87 FR at 64638.
\471\ See Proposing Release, supra note 14, 87 FR at 64639-40
(discussing these additional conditions). As discussed below, the
Commission is adopting these additional conditions, substantially as
proposed.
---------------------------------------------------------------------------

The objective of the second component of the second condition--the
need to use a particular customer's assets exclusively to meet the
amount of the customer position margin requirement resulting from that
customer's cleared U.S. Treasury securities positions--was to avoid the
use of one customer's assets to meet another customer's margin
requirement.\472\ For example, FICC's Sponsored Member program allows
its members to sponsor a person's (i.e., a Sponsored Member's) U.S.
Treasury securities transactions for clearance and settlement. FICC
interacts solely with the sponsoring member as processing agent for
purposes of the day-to-day satisfaction of the Sponsored Member's
obligation to or from FICC, including the Sponsored Member's cash and
securities settlement obligations. However, FICC calculates a separate
margin requirement for each Sponsored Member's trading activity and the
sum of each sponsored member's margin calculation is the aggregate
margin requirement that must be met by the sponsoring member. Further,
this margin is held in an omnibus account that is separate from the
account that holds the Sponsoring Member's net margin obligation for
non-sponsored securities transactions. In this scenario, the U.S.
Treasury securities CCA's margin calculations and resulting
requirements can be traced to a specific customer's cleared U.S.
Treasury securities positions. Consequently, the broker-dealer would be
able to allocate the amount of the U.S. Treasury securities CCA's daily
customer position margin requirement attributable to a specific
customer. Under this component of the second condition, the broker-
dealer would need to deliver cash or U.S. Treasury securities belonging
to that specific customer to meet the amount of the U.S. Treasury
securities CCA's customer position margin requirement resulting from
that customer's cleared U.S. Treasury securities positions. This would
mitigate the risk to all the broker-dealer's customers by limiting when
their assets can be used to meet the U.S.

[[Page 2763]]

Treasury securities CCA's customer position margin requirement.
---------------------------------------------------------------------------

\472\ Proposing Release, supra note 14, 87 FR at 64638.
---------------------------------------------------------------------------

The objective of the third component of the second condition--that
the broker-dealer had delivered the customer's assets to the U.S.
Treasury securities CCA--was to address the potential that a customer
may use more than one broker-dealer to engage in U.S. Treasury
securities transactions.\473\ In this case, two or more broker-dealers
may be subject to customer position margin requirements of the U.S.
Treasury securities CCA resulting from the customer's cleared U.S.
Treasury securities positions. The intent was to prevent a broker-
dealer from including as a debit the amount of customer position margin
that another broker-dealer delivered to the U.S. Treasury securities
CCA with respect to U.S. Treasury securities positions of a customer of
both the broker-dealers. The amount that a given broker-dealer's debit
items can offset its credit items should be limited to the amount of
customer position margin it delivered to the U.S. Treasury securities
CCA. Otherwise, the customers of the broker-dealer would be put at risk
for transactions effected by another broker-dealer.
---------------------------------------------------------------------------

\473\ Proposing Release, supra note 14, 87 FR at 64638-39.
---------------------------------------------------------------------------

Two commenters stated that broker-dealers should not be limited to
posting the same assets received from its customer to a U.S. Treasury
securities CCA.\474\ One stated that in many instances, broker-dealers
post proprietary assets to a clearing agency on behalf of a customer
given timing and operational constraints.\475\ The other commenter
stated that FICC collects clearing fund margin on a faster timeline
than broker-dealers are able to collect margin from their
customers.\476\ More specifically, this commenter stated that FICC
collects margin from direct participants on an overnight and intraday
basis, while most broker-dealers generally provide their customers with
a full business day to post margin. As a result, this commenter stated
that most broker-dealers generally post clearing fund margin to FICC
and then subsequently collect that clearing fund margin from their
customers. One of these commenters stated that posting proprietary
collateral is permissible in the context of margin posted to the other
clearing agencies and should also be permissible with respect to margin
posted to a U.S. Treasury Securities CCA.\477\ Finally, one of these
commenters stated that not allowing the use of proprietary assets would
significantly undercut the benefits to the Rule 15c3-3a proposal.\478\
---------------------------------------------------------------------------

\474\ See DTCC/FICC Letter, supra note 33, at 32; SIFMA/IIB
Letter, supra note 37, at 30.
\475\ See SIFMA/IIB Letter, supra note 37, at 30.
\476\ See DTCC/FICC Letter, supra note 33, at 32.
\477\ See SIFMA/IIB Letter, supra note 37, at 30.
\478\ See DTCC/FICC Letter, supra note 33, at 32.
---------------------------------------------------------------------------

In response to comments, the Commission is modifying Note H under
the final rule to permit broker-dealers to elect to deliver proprietary
U.S. Treasury securities to meet a margin requirement of a customer
resulting from that customer's U.S. Treasury securities positions
cleared, settled, and novated at the qualified clearing agency.\479\
This will address the concern raised by commenters that the U.S.
Treasury securities CCA may call for margin from a broker-dealer
arising from a customer's cleared U.S. Treasury security transaction
before the customer is able to deliver the requisite margin to the
broker-dealer. However, the final rule places strict limits on this
requirement. First, the broker-dealer must use proprietary U.S.
Treasury securities for this purpose and, therefore, it cannot use
other types of securities collateral acceptable to the U.S. Treasury
securities CCA.\480\ For example, as discussed above, a broker-dealer
can post qualified customer securities (which are securities other than
U.S. Treasury securities acceptable to the U.S. Treasury securities
CCA), provided the customer has delivered them to the broker-dealer.
However, the broker-dealer could not post these types of securities if
they belong to the broker-dealer. This is designed to ensure that the
safest most liquid securities of the broker-dealer are commingled with
the customer cash and securities in the account.\481\ It also will
prevent the broker-dealer from using customer cash deposited with the
broker-dealer to purchase less liquid securities and post them to the
U.S. Treasury securities CCA to meet a customer position margin
requirement.
---------------------------------------------------------------------------

\479\ See Note H(b)(1)(iii) of Rule 15c3-3a, as adopted. To
implement this modification, paragraph (b)(1) is being divided into
subparagraphs (b)(1)(i) through (iii). Subparagraphs (b)(1)(i) and
(ii) contain the proposed components of the second condition that
the broker-dealer can use cash owed to a customer or U.S. Treasury
securities held in custody by the broker-dealer for the customer to
meet a margin requirement of the U.S. Treasury securities CCA
resulting from that customer's U.S. Treasury securities transactions
cleared at the CCA, with the modifications that cash and securities
are now addressed in a separate subparagraphs (subparagraphs
(b)(1)(i) and (ii), respectively) and qualified customer securities
held in custody by the broker-dealer for the customer also can be
used for this purpose. See Note H(b)(1)(i) and (ii) of Rule 15c3-3a,
as adopted. Subparagraph (b)(1)(iii) contains the new provision--
discussed below--permitting the use of the broker-dealer's
proprietary securities, subject to certain conditions. See Note
H(b)(1)(iii) of Rule 15c3-3a, as adopted.
\480\ See prefatory text of Note H(b)(1)(iii) of Rule 15c3-3a,
as adopted.
\481\ See supra note 461; see also Section I. Introduction
(describing the critical and unique role that U.S. Treasury
securities play a critical in the U.S. and global economy) and
Section IV.B. Economic Analysis--Baseline (describing U.S. Treasury
securities and repos, and clearance and settlement of these
positions); see also 17 CFR 240.15c3-1(c)(2)(vi)(A)(1) (prescribing
haircuts under the broker-dealer net capital rule for a security
issued or guaranteed as to principal or interest by the United
States or any agency thereof ranging from 0 to 6%).
---------------------------------------------------------------------------

Second, the broker-dealer's ability to post proprietary U.S.
Treasury securities is limited to circumstances where the broker-dealer
did not owe the customer or hold in custody for the customer sufficient
cash, U.S. Treasury securities, and/or qualified customer securities to
meet a margin requirement resulting from that customer's U.S. Treasury
securities positions cleared, settled, and novated at the qualified
clearing agency at the time the margin requirement arose.\482\ Thus,
the broker-dealer is limited to using proprietary U.S. Treasury
securities to address the specific concern raised by commenters: a
timing mismatch between when margin must be delivered to the U.S.
Treasury securities CCA and when the broker-dealer receives the margin
from the customer.
---------------------------------------------------------------------------

\482\ See Note H(b)(1)(iii)(A) of Rule 15c3-3a, as adopted.
---------------------------------------------------------------------------

Third, the broker-dealer must call for the customer to deliver a
sufficient amount of cash, U.S. Treasury securities, and/or qualified
customer securities to meet the margin requirement on the day the
margin requirement arose and must receive a sufficient amount of cash,
U.S. Treasury securities, and/or qualified customer securities to meet
the margin requirement by the close of the next business day after the
margin requirement arose.\483\ Thus, the broker-dealer can deliver
proprietary U.S. Treasury securities to meet a margin call related to
its customers' transactions as an interim step before receiving the
associated margin from its customer no later than the close of the next
business day. The objective is to narrowly confine the ability to use
proprietary U.S. Treasury securities and thereby promote the final
rule's objective of using a specific customer's collateral to meet a
customer position margin requirement generated by that customer's
cleared U.S. Treasury securities transactions.
---------------------------------------------------------------------------

\483\ See Note H(b)(1)(iii)(B) and (C) of Rule 15c3-3a, as
adopted.

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

[[Page 2764]]

c. Third Condition--Rules of U.S. Treasury Securities CCA
The third condition for including customer position margin as a
debit in the Rule 15c3-3a formula was set forth in proposed paragraph
(b)(2) of Note H.\484\ Under this condition, the customer position
margin needed to be treated in accordance with rules of the U.S.
Treasury securities CCA designed to protect and segregate the customer
position margin, and the U.S. Treasury securities CCA and broker-dealer
would need to be in compliance with those rules (as applicable). As
proposed, paragraph (b)(2) of Note H identified five sets of rules that
would need to be implemented by the U.S. Treasury securities CCA.\485\
---------------------------------------------------------------------------

\484\ Proposing Release, supra note 14, 87 FR at 64639.
\485\ Proposing Release, supra note 14, 87 FR at 64639-40.
---------------------------------------------------------------------------

The first rule set--identified in paragraph (b)(2)(i) of Note H--
provided that the customer position margin must be treated in
accordance with rules requiring the qualified U.S. Treasury securities
CCA to calculate a separate margin amount for each customer of the
broker-dealer and the broker-dealer to deliver that amount of margin
for each customer on a gross basis.\486\ As discussed above, a
component of the second condition--set forth in paragraph (b)(1) of
Note H, as proposed--was that the broker-dealer use a particular
customer's assets exclusively to meet the amount of the customer
position margin requirement resulting from that customer's cleared U.S.
Treasury securities positions.\487\ The proposal that the U.S. Treasury
securities CCA implement these margin calculation rules was designed to
facilitate that condition. This would allow the broker-dealer to
allocate the amount of the customer position margin requirement
attributable to each of its customers. In addition, the rules needed to
require the broker-dealer to deliver the margin amount calculated for
each customer on a gross basis. This would mean that the risk of one
customer's positions could not be offset by the risk of another
customer's positions in determining the amount of customer position
margin the broker-dealer would need to have on deposit at the U.S.
Treasury securities CCA. As a result, the broker-dealer would not be
able to deliver assets belonging to one customer to meet the margin
requirement of another customer.
---------------------------------------------------------------------------

\486\ Proposing Release, supra note 14, 87 FR at 64639.
\487\ Proposing Release, supra note 14, 87 FR at 64638-39.
---------------------------------------------------------------------------

In response to this aspect of the proposal, a commenter suggested
that the Commission modify the requirement to be consistent with the
requirements of Item 13 and Note F to the reserve formula which covers
margin required and on deposit with the Options Clearing Corporation
(``OCC'') for all option contracts written or purchased in customer
accounts.\488\ In particular, the permitted debit under Item 13 and
Note F is based on a margin amount posted to OCC that is calculated on
a net basis across all the broker-dealer's customers with listed
options positions. This is different than the proposal to permit a
debit with respect to margin posted to a U.S. Treasury securities CCA
in that the margin amount needed to be calculated for each customer on
a gross basis and that gross amount to be delivered to the CCA. For the
reasons discussed below, the Commission is retaining the requirement
that the U.S. Treasury securities CCA implement rules requiring that
the margin be calculated and delivered on a gross basis for each
customer.\489\
---------------------------------------------------------------------------

\488\ See DTCC/FICC Letter, supra note 33, at 31.
\489\ See Note H(b)(2)(i) of Rule 15c3-3a, as adopted.
---------------------------------------------------------------------------

Listed options cleared at the OCC are subject to customer margin
requirements of the broker-dealer SROs.\490\ Under Rule 15c3-3, a
broker-dealer can use customer cash or securities that are serving as
margin for listed options positions under SRO margin rules, subject to
certain limitations.\491\ If the margin is in the form of cash, the
broker-dealer needs to treat it as an ``other credit balance'' in the
customer's securities account and include it in Item 1 in the Rule
15c3-3a reserve formula.\492\ The broker-dealer can use this cash to
finance a margin loan to another customer, to borrow securities to
effect a short sale of another customer, or to deliver it to the OCC to
meet a margin requirement for other customers' listed options positions
cleared at the OCC.\493\ In each case, the ``other credit balance'' on
the credit side of the Rule 15c3-3a reserve formula is offset by a
corresponding debit balance on the debit side of the formula. If the
margin is in the form of securities, the broker-dealer can
rehypothecate them to obtain a bank loan, to deliver on a securities
loan, or to meet a margin requirement of the OCC.\494\ The broker-
dealer's use of the customer's margin securities generates a credit in
the Rule 15c3-3a reserve formula that generally is offset by debits in
the formula stemming from the broker-dealer's financing of the
customer's margin loan, facilitating the customer's short sale, or
delivering margin to the OCC to meet margin requirements arising from
customer options positions.\495\
---------------------------------------------------------------------------

\490\ See, e.g., FINRA Rule 4210(f)(2); Cboe Rules 10.1 et seq.;
see also 12 CFR 220.12(f). Generally, buyers of options (i.e., long
options) that expire in nine months or less must pay for these
positions in full. Margin requirements for option writers (i.e.,
short options) are complex and are not the same for every type of
underlying security or component value. SRO rules generally require
an option writer to post 100% of the options proceeds to the margin
account, plus a specific percentage of the market value of the
underlying securities or component value as options margin (e.g.,
20% for an option on a single equity security). SRO rules also
recognize certain spread positions. Finally, equity-based options
also are eligible positions under SRO securities portfolio margin
rules. See, e.g., FINRA Rule 4210(f)(2) and (g); Cboe Rules 10.3 and
10.4.
\491\ See 17 CFR 240.15c3-3.
\492\ See 17 CFR 240.15c3-3a, Item 1.
\493\ See 17 CFR 240.15c3-3(e)(2) (providing, in pertinent part,
that a broker-dealer must not accept or use any of the amounts under
items comprising Total Credits under the Rule 15c3-3a reserve
formula except for the specified purposes indicated under items
comprising Total Debits under the formula); 17 CFR 240.15c3-3a,
Items 10, 11, and 13.
\494\ See 17 CFR 240.15c3-3(a)(3), (4), and (5) (defining,
respectively, the terms ``fully paid securities,'' ``margin
securities,'' and ``excess margin securities''); 17 CFR 240.15c3-
3(b)(1) (providing, in pertinent part, that a broker-dealer shall
promptly obtain and shall thereafter maintain the physical
possession or control of all fully-paid securities and excess margin
securities carried by a broker-dealer for the account of customers
but not applying this requirement to margin securities).
\495\ See 17 CFR 240.15c3-3a, Items 2 and 3 (requiring,
respectively, credits to be added to the Rule 15c3-3a reserve
formula for: (1) monies borrowed collateralized by securities
carried for the accounts of customers; and (2) monies payable
against customers' securities loaned); 17 CFR 240.15c3-3a, Items 10,
11, and 13 (requiring, respectively, debits to be added to the
reserve formula for: (1) debit balances in customers' cash and
margin accounts; (2) securities borrowed to effectuate short sales
by customers; and (3) margin required and on deposit with the
Options Clearing Corporation for all option contracts written or
purchased in customer account).
---------------------------------------------------------------------------

SRO options margin requirements help to protect the broker-dealer
from the consequences of a customer default, because the required
equity in a customer's account (because of the SRO option margin
requirements) serves to over-collateralize an option customer's
obligations to the broker-dealer. This buffer also protects the
customers whose cash was used to facilitate the broker-dealer's
financing of securities transactions of other customers (i.e., margin
loans, short sales, or to meet a margin requirement for other
customers' listed options positions cleared at the OCC). For example,
if the broker-dealer fails, the customer debits, because they generally
are over-collateralized, should be attractive assets for another
broker-dealer to purchase or, if not purchased by another broker-
dealer, they should be able to be liquidated to a net positive

[[Page 2765]]

equity.\496\ The proceeds of the debits sale or liquidation can be used
to repay the customer cash used to finance the customer obligations.
This cash plus the funds and/or U.S. government securities held in the
customer reserve account should equal or exceed the total amount of
customer credit items (i.e., the total amount owed by the broker-dealer
to its customers).\497\
---------------------------------------------------------------------------

\496\ The attractiveness of the over-collateralized debits
facilitates the bulk transfer of customer accounts from a failing or
failed broker-dealer to another broker-dealer.
\497\ See Net Capital Requirements for Broker-Dealers; Amended
Rules, Exchange Act Release No. 18417 (Jan. 13, 1982), 47 FR 3512,
3513 (Jan. 25, 1982) (``The alternative approach is founded on the
concept that, if the debit items in the Reserve Formula can be
liquidated at or near their contract value, these assets along with
any cash required to be on deposit under the [customer protection]
rule, will be sufficient to satisfy all liabilities to customers
(which are represented as credit items in the Reserve Formula).'').
---------------------------------------------------------------------------

In contrast, although SRO margin rules require the collection of
margin for certain transactions in U.S. Treasury securities,
transactions between dealers and institutional customers generally are
subject to a variable ``good-faith'' margin standard, which the
Commission understands--based on its supervisory experience--can often
result in a broker-dealer collecting less (or no) margin collateral
from a customer with respect to transactions in U.S. Treasury
securities.\498\ Consequently, the SRO margin requirements for U.S.
Treasury securities transactions do not result in the same levels of
over-collateralization that the SRO margin requirements for listed
options impose and, therefore, would not provide the same level
protection to the broker-dealer's customers. Accordingly, modifying the
proposal to align it with how margin posted to the OCC is treated would
diminish an important protection that the proposal is designed to
achieve in terms of protecting the broker-dealer's customers:
preventing one customer's cash or securities to be used to meet a
margin requirement of the U.S. Treasury securities CCA resulting from
another customer's cleared U.S. Treasury securities transactions. This
protection is achieved through the proposed requirements that the U.S.
Treasury securities CCA calculate a gross margin amount for each of the
broker-dealer's customers and that the broker-dealer must meet that
gross margin amount with cash or securities owned by the customer whose
U.S. Treasury securities transactions generated the margin
requirement.\499\
---------------------------------------------------------------------------

\498\ SRO rules provide for the collection of margin for cash
U.S. Treasury transactions. See, e.g., FINRA Rule 4210(e)(2)(A)
(setting forth margin requirements for U.S. Treasury securities and
certain other bonds). However, these rules do not necessarily apply
to exempt accounts. See FINRA Rule 4210(e)(2)(F) (permitting FINRA-
member broker-dealers to not collect margin for certain good faith
securities held in exempt accounts and providing for a capital
charge for any uncollected mark-to-market loss); FINRA Rule
4210(a)(13) (defining exempt account). Although SRO rules also
require a broker-dealer to establish procedures to review limits and
types of credit extended to all customers, formulate their own
``house''' margin requirements, and review the need for instituting
higher margin requirements than are required for individual
securities or customer accounts, based on the Commission's
supervisory experience, the resulting customer margin collection is
often less than that required pursuant to FICC's margin model. See
Proposing Release, supra note 14, 87 FR at 64627 n.171.
\499\ As discussed above, under the final rule, the broker-
dealer can use proprietary U.S. Treasury securities in limited
circumstances and under strict conditions to meet a margin
requirement of the U.S. Treasury securities CCA resulting from a
particular customer's cleared U.S. Treasury securities transactions.
See Note H(b)(1)(iii) of Rule 15c3-3a.
---------------------------------------------------------------------------

Moreover, cash delivered by a customer to the broker-dealer to be
posted by the broker-dealer to a U.S. Treasury securities CCA generally
would be a free credit balance, given the minimal margin requirements
of the SROs with respect to the types of U.S. Treasury securities
transactions that would be cleared (i.e., the cash would not have the
same status as cash serving as margin for a listed options position
under the SRO margin rules). For the same reason, securities delivered
by a customer to the broker-dealer to be posted by the broker-dealer to
a U.S. Treasury securities CCA generally would be fully paid securities
(i.e., they would not have the same status as margin securities serving
as margin for listed options under the SRO margin rules). The
proposal--consequently--set forth strict limitations on the broker-
dealer's ability to use the cash or securities to meet a margin
requirement the U.S. Treasury securities CCA imposed on the broker-
dealer. These limitations were designed to restrict the broker-dealer's
ability to use the customer cash and securities--and thereby protect
them--given that these customer assets generally otherwise would need
to be treated as a free credit balance or fully paid securities in the
customer's securities account.
For these reasons, the Commission is retaining the requirement that
the U.S. Treasury securities CCA implement rules requiring that the
margin be calculated and delivered on a gross basis for each
customer.\500\ Therefore, the Commission is adopting the gross
margining requirement, as proposed.
---------------------------------------------------------------------------

\500\ See Note H(b)(2)(i) of Rule 15c3-3a, as adopted.
---------------------------------------------------------------------------

The second rule set--identified in paragraph (b)(2)(ii) of Note H--
provided that the customer position margin be treated in accordance
with rules requiring that the U.S. Treasury securities CCA be limited
to investing it in U.S. Treasury securities with a maturity of one year
or less.\501\ The objective was to limit the assets underlying the
debit item to the safest and most liquid instruments. The Commission
did not receive comments on this aspect of the proposal and is adopting
it as proposed.\502\
---------------------------------------------------------------------------

\501\ See Proposing Release, supra note 14, 87 FR at 64639.
\502\ See Note H(b)(2)(ii) of Rule 15c3-3a, as adopted.
---------------------------------------------------------------------------

However, one commenter sought clarification that the conditions of
Rule 15c3-3 would not preclude a U.S. Treasury securities CCA from
entering into a repurchase transaction using customer cash margin, so
long as the purchased securities under such repurchase transaction
consist of U.S. Treasury securities held in a segregated account for
the benefit of customers and satisfy certain other requirements.\503\
The commenter stated that the proposal was not clear whether the
conditions related to Rule 15c3-3 would preclude a U.S. Treasury
securities CCA from using customer margin for liquidity purposes, and
that there are ways to use customer margin for liquidity purposes that
ensure that cash or Treasury securities having a value equal to or
exceeding the posted customer margin remain in a segregated account for
the benefit of customers.\504\ The commenter further explained that if
a U.S. Treasury securities CCA could not use customer margin as a
qualifying liquid resource, for purposes of its obligations under Rule
17ad-22(e)(7), it might need to obtain liquidity resources from other
sources, which could mean increasing certain requirements applicable to
direct participants or increasing the cash margin requirements
applicable to direct participants and/or other indirect
participants.\505\ Finally, the commenter suggested adding language to
Note H that a CCA's use of cash margin for liquidity purposes would not
cause item 15 to cease to apply, so long as (i) the CCA only uses the
cash margin after it determines that it does not have the

[[Page 2766]]

ability to obtain liquidity from other resources in order to satisfy
the cash payment obligations that were originally due to be paid by a
defaulting member, (ii) in connection with such usage, the CCA deposits
into and maintains an account of the broker-dealer that generally
satisfies the requirements for a special reserve account U.S. Treasury
securities or cash that at all relevant times have a value of no less
than the value amount of used cash, and (iii) the CCA replenishes the
cash margin promptly after the liquidity need is satisfied.\506\
---------------------------------------------------------------------------

\503\ Letter from Brian Steele, Managing Director, President of
DTCC Clearing Agency Services, Head of Global Business Operations,
and Laura Klimpel, General Manager of FICC, Head of SIFMU Business
Development, at 1-2 (Nov. 10, 2023) (``DTCC/FICC Letter II'').
\504\ Id. at 2. The commenter stated that a U.S. Treasury
securities CCA could enter into a repurchase transaction with a
broker-dealer, as agent for its customers, pursuant to which the
broker-dealer purchases U.S. Treasury securities using customer cash
margin and holds such securities in a segregated account of the
broker-dealer. Id.
\505\ Id. at 5.
\506\ Id. at 7-8.
---------------------------------------------------------------------------

The objective of the conditions for including the debit in the
customer reserve formula is to provide maximum protection to the cash
or securities delivered to the U.S. Treasury securities CCA. The
commenter provides a summary of potential protections that could be put
in place to ensure that--if a U.S. Treasury securities CCA uses cash in
the broker-dealer's segregated account for liquidity purposes--the cash
will be protected through collateral comprising U.S. Treasury
securities deposited into the account and other measures. The
Commission would need to review a more detailed plan for how the cash
will be used and customers protected before taking any action on any
formal request. In this regard, were FICC to file proposed rule changes
that provide specific details regarding the protections and how cash
will be used, the Commission will consider those proposed rule changes
at that time consistent with the statutory standard for approval under
Section 19(b).
The third rule set--identified in paragraph (b)(2)(iii) of Note H--
provided that the customer position margin be treated in accordance
with rules designed to address the segregation of the broker-dealer's
account at the U.S. Treasury securities CCA that holds the customer
position margin and set strict limitations on the U.S. Treasury
securities CCA's ability to use the margin.\507\ The required rules
were modeled on the requirements for a broker-dealer to include a debit
with respect to margin delivered to a security-based swap clearing
agency.\508\ In particular, the note provided that the customer
position margin needed to be treated in accordance with rules requiring
that it must be held in an account of the broker-dealer at the U.S.
Treasury securities CCA that is segregated from any other account of
the broker-dealer at the U.S. Treasury securities CCA and that is:
---------------------------------------------------------------------------

\507\ Proposing Release, supra note 14, 87 FR at 64639.
\508\ See 17 CFR 240.15c3-3(p)(1)(iii) (defining the term
``qualified clearing agency account''); 17 CFR 240.15c3-3b, Item 15
(permitting a broker-dealer to include a debit in the security-based
swap reserve formula equal to the margin required and on deposit in
a qualified clearing agency account at a clearing agency).
---------------------------------------------------------------------------

Used exclusively to clear, settle, novate, and margin U.S.
Treasury securities transactions of the customers of the broker-dealer;
Designated ``Special Clearing Account for the Exclusive
Benefit of the Customers of [name of broker-dealer]'';
Subject to a written notice of the U.S. Treasury
securities CCA provided to and retained by the broker-dealer that the
cash and U.S. Treasury securities in the account are being held by the
U.S. Treasury securities CCA for the exclusive benefit of the customers
of the broker-dealer in accordance with the regulations of the
Commission and are being kept separate from any other accounts
maintained by the broker-dealer or any other clearing member at the
U.S. Treasury securities CCA; and
Subject to a written contract between the broker-dealer
and the U.S. Treasury securities CCA which provides that the cash and
U.S. Treasury securities in the account are not available to cover
claims arising from the broker-dealer or any other clearing member
defaulting on an obligation to the U.S. Treasury securities CCA or
subject to any other right, charge, security interest, lien, or claim
of any kind in favor of the U.S. Treasury securities CCA or any person
claiming through the U.S. Treasury securities CCA, except a right,
charge, security interest, lien, or claim resulting from a cleared U.S.
Treasury transaction of a customer of the broker-dealer effected in the
account.
The objective was to protect the customer position margin that the
broker-dealer deposits with the U.S. Treasury securities CCA to margin
its customers' U.S. Treasury security positions by isolating it from
any other assets of the broker-dealer at the U.S. Treasury securities
CCA and to prevent it from being used to cover any obligation other
than an obligation of the broker-dealer's customer resulting from a
U.S. Treasury transaction cleared, settled, and novated in the
account.\509\ Further, the account designation and written notice
requirements were designed to alert creditors of the broker-dealer and
U.S. Treasury securities CCA that the assets in this account are not
available to satisfy any claims they may have against the broker-dealer
or the U.S. Treasury securities CCA. The written contract requirement
was designed to limit the U.S. Treasury securities CCA's rights to use
the customer position margin for any purpose other than an obligation
of the broker-dealer's customers. For example, the assets in the
account could not be used to cover an obligation of the broker-dealer
to the U.S. Treasury securities CCA if the broker-dealer defaults on
the obligation. Similarly, the assets in the account could not be used
to mutualize the loss across the U.S. Treasury securities CCA's members
if a member defaulted and its clearing funds were insufficient to cover
the loss. The Commission did not receive comments on this aspect of the
proposal and is adopting it substantially as proposed.\510\
---------------------------------------------------------------------------

\509\ Proposing Release, supra note 14, 87 FR at 64639.
\510\ See Note H(b)(2)(iii) of Rule 15c3-3a, as adopted. The
rule text of this paragraph has been modified to add the phrase
``and qualified customer securities'' after the phrase ``U.S.
Treasury securities'' wherever the latter appears in the paragraph
to conform the rule text to the modification discussed above
relating to the broker-dealer's ability to post qualified customer
securities.
---------------------------------------------------------------------------

The fourth rule set--identified in paragraph (b)(2)(iv) of Note H--
provided that the customer position margin be treated in accordance
with rules designed to address how the U.S. Treasury securities CCA
holds the customer position margin.\511\ The objective was to isolate
the customer position margin and prevent it from being used to satisfy
the claims any creditors may have against the U.S. Treasury securities
CCA. In particular, the note provided that the customer position margin
needed to be treated in accordance with rules of the U.S. Treasury
securities CCA requiring that the U.S. Treasury securities CCA hold the
customer position margin itself or at either a U.S. Federal Reserve
Bank or a ``bank'' (as defined in section 3(a)(6) of the Exchange Act
(15 U.S.C. 78c(a)(6)) that is insured by the Federal Deposit Insurance
Corporation. The objective was to have the U.S. Treasury securities CCA
hold the customer position margin at a safe financial institution. In
addition, the rules would need to provide that the U.S. Treasury
securities CCA's account at the U.S. Federal Reserve Bank or bank be:
---------------------------------------------------------------------------

\511\ Proposing Release, supra note 14, 87 FR at 64640.
---------------------------------------------------------------------------

Segregated from any other account of the U.S. Treasury
securities CCA or any other person at the U.S. Federal Reserve Bank or
bank and used exclusively to hold cash and U.S. Treasury securities to
meet current margin requirements of the U.S. Treasury securities CCA
resulting from positions in U.S. Treasury securities of the customers
of the broker-dealer

[[Page 2767]]

members of the qualified U.S. Treasury securities CCA;
Subject to a written notice of the U.S. Federal Reserve
Bank or bank provided to and retained by the U.S. Treasury securities
CCA that the cash and U.S. Treasury securities in the account are being
held by the U.S. Federal Reserve Bank or bank pursuant to Rule 15c3-3
and are being kept separate from any other accounts maintained by the
U.S. Treasury securities CCA or any other person at the U.S. Federal
Reserve Bank or bank; and
Subject to a written contract between the U.S. Treasury
securities CCA and the U.S. Federal Reserve Bank or bank which provides
that the cash and U.S. Treasury securities in the account are subject
to no right, charge, security interest, lien, or claim of any kind in
favor of the U.S. Federal Reserve Bank or bank or any person claiming
through the U.S. Federal Reserve Bank or bank.
These conditions with respect to the account designation, written
notice, and written contract would be designed to achieve the same
objectives as the analogous conditions discussed above with respect to
the broker-dealer's account at the U.S. Treasury securities CCA. The
Commission did not receive comments on this aspect of the proposal and
is adopting it substantially as proposed.\512\
---------------------------------------------------------------------------

\512\ See Note H(b)(2)(iv) of Rule 15c3-3a, as adopted. The rule
text of this paragraph has been modified to add the phrase ``and
qualified customer securities'' after the phrase ``U.S. Treasury
securities'' wherever the latter appears in the paragraph to conform
the rule text to the modification discussed above relating to the
broker-dealer's ability to post qualified customer securities.
---------------------------------------------------------------------------

The fifth rule set--identified in paragraph (b)(2)(v) of Note H--
provided that the customer position margin be treated in accordance
with rules of the clearing agency requiring systems, controls,
policies, and procedures to return customer position margin to the
broker-dealer that is no longer needed to meet a current margin
requirement resulting from positions in U.S. Treasury securities of the
customers of the broker-dealer no later than the close of the next
business day after the day the customer position margin is no longer
needed for this purpose.\513\ As discussed above, the debit would be
limited to customer position margin required and on deposit at the U.S.
Treasury securities CCA. This would mean that the broker-dealer could
not include in this debit item the amount of customer position margin
on deposit at the U.S. Treasury securities CCA that exceeds the broker-
dealer's margin requirement resulting from its customers' cleared U.S.
Treasury securities positions. The objective of this condition was to
effectuate the prompt return of customer position margin to the broker-
dealer.
---------------------------------------------------------------------------

\513\ Proposing Release, supra note 14, 87 FR at 64640.
---------------------------------------------------------------------------

Several commenters opposed the proposed requirement to return
excess collateral within one business day.\514\ A commenter stated that
this requirement does not apply to margin posted to other clearing
agencies or DCOs and does not seem to serve any customer protection
benefit.\515\ The commenter stated further that FICC does not have a
mechanism to push excess margin to direct participants and direct
participants do not have the capability of accepting unsolicited excess
margin. Rather, similar to other clearing organizations, this commenter
stated that FICC regularly notifies direct participants of excess
margin every time margin is calculated and then allows such direct
participants to demand a return of such margin. Furthermore, this
commenter stated that some direct participants prefer to leave excess
margin with FICC to serve as a buffer for future margin calls. Another
commenter stated that the proposed requirement was inconsistent with
other cleared products and unnecessary for customer protection.\516\
Finally, a commenter stated that a required automatic return would add
significant operational burdens, as broker-dealer participants would
need to update their systems to accept an automatic return of excess
margin without a request and ensure that any such amounts are
appropriately treated as customer assets.\517\
---------------------------------------------------------------------------

\514\ See, e.g., DTCC/FICC Letter, supra note 33, at 31-32; ICE
Letter, supra note 33, at 3; SIFMA/IIB Letter, supra note 37, at 30.
\515\ See DTCC/FICC Letter, supra note 33, at 31.
\516\ See ICE Letter, supra note 33, at 3-4.
\517\ See SIFMA/IIB Letter, supra note 37, at 30.
---------------------------------------------------------------------------

The Commission agrees with commenters that the proposed requirement
may add significant operational burdens to broker-dealers if a U.S.
Treasury securities CCA is required to return excess collateral to a
broker-dealer no later than the close of the next business day after
the day the collateral is no longer needed to meet a current margin
requirement resulting from positions in U.S. Treasury securities of the
customers of the broker-dealer. Moreover, because the debit is limited
to margin required and on deposit at the U.S. Treasury securities CCA,
the broker-dealer has an incentive to obtain the prompt return of
excess margin collateral held by the CCA that is in the form of
securities. Specifically, the amount of the excess margin would remain
a credit in the Rule 15c3-3a formula with no offsetting debit because
the excess margin amount is no longer required by the U.S. Treasury
securities CCA. Consequently, maintaining the excess margin collateral
at the U.S. Treasury CCA could increase the amount that the broker-
dealer must deposit into the customer reserve account.\518\
---------------------------------------------------------------------------

\518\ See Item 15 of the Rule 15c3-3a formula, as adopted
(requiring that the debit in Item 15 of the Rule 15c3-3a formula
equal the margin required and on deposit with a clearing agency
registered with the Commission under section 17A of the Exchange Act
resulting from the following types of transactions in U.S. Treasury
securities in customer accounts that have been cleared, settled, and
novated by the clearing agency: (1) purchases and sales of U.S.
Treasury securities; and (2) U.S. Treasury securities repurchase and
reverse repurchase agreements); see also Item 13 of the Rule 15c3-3a
formula (requiring that the debit in Item 13 of the 15c3-3a reserve
formula equal the margin required and on deposit with the OCC for
all option contracts written or purchased in customer accounts).
---------------------------------------------------------------------------

For these reasons, the Commission is removing this aspect of the
requirement from the final rule. However, the final rule retains the
provision that the customer position margin is treated in accordance
with rules of the clearing agency requiring systems, controls,
policies, and procedures to return customer position margin to the
broker-dealer that is no longer needed to meet a current margin
requirement resulting from positions in U.S. Treasury securities of the
customers of the broker-dealer.\519\ Thus, it retains the overall
objective of the proposal to effectuate the prompt return of customer
position margin to the broker-dealer that is no longer needed to meet a
margin requirement but leaves it to the broker-dealer and the U.S.
Treasury securities CCA arrange when that amount will be returned.
---------------------------------------------------------------------------

\519\ See Note H(b)(2)(v) to Rule 15c3-3a, as adopted. To
implement the modification discussed above, the phrase ``no later
than the close of the next business day after the day the cash and
U.S. Treasury securities are no longer needed for this purpose'' was
deleted from the rule text. In addition, the rule text of this
paragraph has been modified to add the phrase ``and qualified
customer securities'' after the phrase ``U.S. Treasury securities''
to conform the rule text to the modification discussed above
relating to the broker-dealer's ability to post qualified customer
securities.
---------------------------------------------------------------------------

d. Fourth Condition--Commission Approval of Rules of U.S. Treasury
Securities CCA
The fourth condition for including customer position margin as a
debit in the Rule 15c3-3a formula was set forth in paragraph (b)(3) of
Note H.\520\ Under

[[Page 2768]]

this condition, the Commission would need to have approved rules of the
U.S. Treasury securities CCA that meet the conditions of proposed Note
H and the Commission would had to have published (and not subsequently
withdrawn) a notice that brokers-dealers may include a debit in the
customer reserve formula when depositing customer position margin to
meet a margin requirement of the U.S. Treasury securities CCA resulting
from positions in U.S. Treasury securities of the customers of the
broker-dealer. The Commission staff would analyze the U.S. Treasury
securities CCA's approved rules and practices regarding the treatment
of customer position margin and make a recommendation as to whether
they adequately implement the customer protection objectives of the
conditions set forth in proposed Note H. If satisfied with the staff's
recommendation, the Commission would publish a positive notice. The
objective was to permit the debit only after the Commission has
approved the U.S. Treasury securities CCA's rules pursuant to section
19(b) of the Exchange and published the notice.\521\ Any changes to
those rules and practices that would undermine these customer
protection objectives could result in the Commission withdrawing the
notice, at which point the Commission would no longer permit the debit.
The Commission did not receive comments on this aspect of the proposal
and is adopting it substantially as proposed.\522\
---------------------------------------------------------------------------

\520\ Proposing Release, supra note 14, 87 FR at 64640.
\521\ See 15 U.S.C. 78s.
\522\ See Note H(b)(3) to Rule 15c3-3a, as adopted. The rule
text of this paragraph has been modified to add the phrase ``and
qualified customer securities'' after the phrase ``U.S. Treasury
securities'' to conform the rule text to the modification discussed
above relating to the broker-dealer's ability to post qualified
customer securities.
---------------------------------------------------------------------------

5. PAB Reserve Computation
Finally, broker-dealers are required to perform a separate reserve
computation for PAB accounts and maintain a separate reserve account
with respect to that computation.\523\ The Rule 15c3-3a computation
provides that this separate PAB reserve computation must be performed
in accordance with the Rule 15c3-3a computation for the broker-dealer's
non-PAB customers, except as provided in Notes to the PAB
Computation.\524\ Therefore, the amendments discussed above adding a
new debit in Item 15 would apply to the PAB reserve computation.
Further, the Commission proposed to amend Note 9 Regarding the PAB
Reserve Bank Account Computation--which permits a debit in the PAB
reserve computation for clearing deposits required to be maintained at
registered clearing agencies--to clarify that the conditions set forth
in new Note H with respect to including a debit in the non-PAB customer
reserve computation would apply to the PAB reserve computation as
well.\525\ The Commission did not receive comments on this aspect of
the proposal and is adopting it as proposed.\526\
---------------------------------------------------------------------------

\523\ See 17 CFR 240.15c3-3(a)(16) (defining the term ``PAB
account'' to mean a proprietary securities account of a broker-
dealer (which includes a foreign broker-dealer, or a foreign bank
acting as a broker-dealer) other than a delivery-versus-payment
account or a receipt-versus-payment account); 17 CFR 240.15c3-3(e)
(requiring separate reserve accounts and reserve account
computations for PAB accounts).
\524\ See 17 CFR 240.15c3-3a, Notes 1 through 10 Regarding the
PAB Reserve Bank Account Computation.
\525\ Proposing Release, supra note 14, 87 FR at 64640.
\526\ See Rule 15c3-3a, Note 9 Regarding the PAB Reserve Bank
Account Computation.
---------------------------------------------------------------------------

III. Compliance Dates

In the Proposing Release, the Commission sought input from
commenters on the appropriate compliance date or implementation
schedule for the proposed amendments.\527\
---------------------------------------------------------------------------

\527\ Proposing Release, supra note 14, 87 FR at 64641.
---------------------------------------------------------------------------

Commenters generally supported a staged approach to implementation
and compliance. Specifically, commenters stated that as a first step,
the proposed requirements related to the segregation of house and
customer margin (discussed in part II.B.1), access to central clearing
(discussed in part II.B.2), and Rule 15c3-3 (discussed in part II.C)
should become effective, and that as a second step, the proposed
requirements related to clearing eligible secondary market transactions
(discussed in part II.A) should become effective thereafter. Commenters
also generally supported a lengthy or substantial timeframe for
implementation. These comments are discussed in detail in this part.
For example, one commenter which currently is a U.S. Treasury
securities CCA stated that it would take the commenter and the U.S.
securities industry as a whole substantial time to make the
documentation, operational, organizational, and systems changes needed
to comply with the proposal, and that the commenter would need to amend
its rules, which amendments the Commission would need to approve.\528\
The commenter stated that it would be advisable to adopt a phased
implementation schedule, under which different requirements of the
proposal become effective, beginning with the customer segregation
requirement. The commenter stated that, depending on when any final
rule is adopted, FICC and market participants may be able to implement
the segregation requirement by 2025, giving market participants a full
year after the expected implementation of T+1 to focus on these
changes.\529\
---------------------------------------------------------------------------

\528\ FICC/DTCC Letter, supra note 33, at v. The commenter
elaborated that it will take market participants substantial time to
scope the transactions subject to the requirement, execute the
documentation necessary to submit such transactions for central
clearing, implement internal procedures and systems to monitor and
ensure compliance, and establish the relevant accounts and
operational integrations with a Treasury CCA. It also stated that,
concurrently, the commenter will need to develop and test the
systems, operations, and documentation needed to accommodate a far
greater volume of transactions, create a strategy and framework to
identify and monitor compliance, and establish margin segregation
arrangements. Id. at 27-28.
\529\ FICC/DTCC Letter, supra note 33, at v, 28.
---------------------------------------------------------------------------

Another commenter stated that a phased approach to implementation
is necessary to ensure that the market can support a clearing mandate
without undue costs to market participants and market liquidity or
stability.\530\ The commenter stated that the Commission should first
adopt rules to ensure that market participants have sufficient access
to clearing, including changes to the access models, the segregation of
house and customer margin, and changes to Rule 15c3-3. The commenter
then recommended that subsequent to the Commission's adoption of such
rules and FICC's implementation of the necessary corresponding changes
to its access models, which would require at a minimum two years, the
Commission should provide 18 months for the implementation of a
tailored clearing mandate that applies to bilateral repo
transactions.\531\ The commenter stated that the Commission and market
participants could then observe the effects of the clearing mandate in
the bilateral repo market and consider whether and how to apply the
mandate to triparty repo transactions.\532\
---------------------------------------------------------------------------

\530\ MFA Letter, supra note 81, at 21.
\531\ Id. at 21; MFA Letter II, supra note 125, at 8.
\532\ MFA Letter, supra note 81, at 21; see also MFA Letter II,
supra note 125, at 5.
---------------------------------------------------------------------------

Another commenter stated, in considering an appropriate compliance
timeframe, the Commission must build in the time necessary for: (i)
FICC to work with the Commission to identify changes to its rules
necessary to address the issues we have identified above with respect
to the Sponsored Program; (ii) FICC to propose and adopt additional
rules or amendments, subject to public notice and comment, that may be

[[Page 2769]]

needed to address these issues; (iii) the Commission to propose and
adopt amendments to its rules, subject to public notice and comment,
and provide regulatory relief as needed to address the issues for funds
that we have highlighted above; and (iv) FICC and industry participants
to implement the extensive changes to policies and procedures,
documentation, and operations (as detailed above for funds) that will
be needed to comply with final rules.\533\ The commenter stated that
these steps will require a significant amount of time and recommended
that the Commission propose a multi-year, staged, compliance schedule,
including, at a minimum, that a requirement to comply with a clearing
requirement should go into effect no earlier than three years after the
Commission and FICC have adopted final rules and amendments, as
described in (ii) and (iii).\534\
---------------------------------------------------------------------------

\533\ ICI Letter, supra note 85, at 31.
\534\ ICI Letter, supra note 85, at 31.
---------------------------------------------------------------------------

Another commenter stated that the Commission should implement any
central clearing requirement in stages and at a measured pace
commensurate with the size, scope and scale of the implementation
program required.\535\ The commenter stated that the Commission should
work to determine an implementation that will be the least disruptive
to the market and that accounts for the practical challenges that
different industry participants may face as they prepare for a central
clearing requirement, which may not be clear until participants are
able to review any proposals from FICC regarding implementation. The
commenter stated that staging implementation would allow the Commission
to appropriately calibrate the costs and benefits of any requirement to
clear eligible secondary market transactions and referenced that
similarly significant changes to market structure (i.e., triparty
market reform and swaps clearing) were successfully phased-in over five
or more years to allow adequate time for market readiness while
mitigating the potential for disruption.\536\
---------------------------------------------------------------------------

\535\ SIFMA/IIB Letter, supra note 37, at 33.
\536\ ICI Letter, supra note 85, at 33.
---------------------------------------------------------------------------

Another commenter stated that, if adopting a clearing requirement,
a measured approach to implementation is required. The commenter
specified that any new requirement to clear should be introduced only
after enhancements to the clearing infrastructure are achieved, FICC's
readiness is assured, and at least one other covered clearing agency
registered with the Commission is ready to support the market in
clearing eligible secondary market transactions.\537\ The commenter
further stated that industry participants should have at least 18
months to engage with each CCA on the design of an appropriate clearing
model thar provides the minimum level of protection it described in its
comment letter. The commenter also stated a timetable for clearing
requirements should only be set only once sufficient consensus has
emerged around the appropriate clearing model and appropriate
regulatory requirements are developed. The commenter recommended that
the clearing requirement should be phased in over several years based
on the volume of U.S. Treasury securities transaction activity in which
a market participant engages (like the phase-in approach which was
followed for regulatory initial margin requirements for uncleared OTC
derivatives which took more than five years following the publication
of final rules to be fully implemented). The commenter stressed the
importance of phasing in the new requirements in a manner that avoids
too many market participants looking to finalize documentation and go-
live with clearing all on the same day.\538\
---------------------------------------------------------------------------

\537\ SIFMA AMG Letter, supra note 35, at 15.
\538\ SIFMA AMG Letter, supra note 35, at 15.
---------------------------------------------------------------------------

The commenter also stated that a long phase-in period is essential,
as there will be a significant implementation effort needed to comply
with any new requirements.\539\ The commenter stated that it is
difficult to estimate the potential scope of this work and the effort
involved until the access models are more developed. The commenter
stated that given the breadth of participation in the U.S. Treasury
markets, the potential scale of the effort and time required to
complete this work, implementation will take many years to complete
after a final rule.\540\
---------------------------------------------------------------------------

\539\ SIFMA AMG Letter, supra note 35, at 15. For direct
participants, these efforts would include obtaining information to
classify their counterparties to determine who qualifies as an IDM,
a hedge fund, or a leveraged account and negotiating clearing
agreements with each hedge fund and leveraged account. For asset
managers, these efforts would include implementation of
documentation such as clearing agreements, give-up agreements, and
related infrastructure. For managed funds, these efforts would
include revisiting existing formation and distribution
documentation, such as investment management agreements and
investment guidelines, as they do not permit clearing activity or
contemplate the clearing of U.S. Treasury securities. Buy-side firms
will have to undertake a significant operational build to be able to
settle and margin cleared transactions. The commenter, a trade
association, stated that many of its members trade in blocks on
behalf of multiple underlying accounts, and that the industry will
have to consider and address how a mandatory requirement to clear
would impact an asset manager's transaction allocation process where
some accounts are required to clear and others are not. Id. at 15-
16.
\540\ SIFMA AMG Letter, supra note 35, at 16.
---------------------------------------------------------------------------

An additional trade association commenter stated that its members
would incur incredible costs as they establish numerous costly clearing
relationships to ensure that all its transactions can be cleared as
required, which will take a significant amount of time.\541\ The
commenter therefore recommended a compliance date of at least 30 months
after the publication of any final rule in the Federal Register.\542\
An additional commenter recognized that clearing requirements can have
unintended and disruptive consequences and therefore recommended that
the Commission implement the changes with respect to the segregation of
house and customer margin, access models, and Rule 15c3-3 before moving
forward with any expanded clearing requirements.\543\
---------------------------------------------------------------------------

\541\ AIMA Letter, supra note 81, at 9.
\542\ AIMA Letter, supra note 81, at 9.
\543\ CME Letter, supra note 81, at 8.
---------------------------------------------------------------------------

Finally, an additional commenter supported an extensive
implementation timeframe that is appropriately prioritized and
sequenced due to the breadth of the proposal, the time and resources
necessary for a covered clearing agency to revise its policies and
procedures, and the changes necessary for market participants'
compliance. The commenter referred to tri-party market reform as a
successful example of the time and sequencing involved in such a
significant change.\544\
---------------------------------------------------------------------------

\544\ BNY Mellon Letter, supra note 33, at 3.
---------------------------------------------------------------------------

The Commission agrees with commenters that a phased approach to
implementation and compliance would be appropriate for these
amendments. As discussed in the Proposing Release, the Commission
understands that the amendments to Rule 17ad-22(e)(18)(iv)(A) will
likely result in a significant increase in the volume of U.S. Treasury
securities transactions submitted for central clearing, including
transactions of market participants that currently may not submit such
transactions for central clearing.\545\ The Commission therefore stated
its belief that additional changes with respect to the segregation of
house and customer margin and access, as proposed in Rule 17ad-
22(e)(6)(i) and (e)(18)(iv)(C), respectively, may be warranted. These
changes were designed to improve risk management by and access to the
U.S. Treasury securities CCA and would also serve to help manage the
risks and

[[Page 2770]]

facilitate access that would likely result from the requirement to
clear eligible secondary market transactions.\546\ In addition, the
Commission proposed changes to Rule 15c3-3 to facilitate implementation
of the requirement to clear eligible secondary market transactions, by
reducing the amount of broker-dealers cash and securities that would be
needed to meet the requirements of Rule 15c3-3.\547\
---------------------------------------------------------------------------

\545\ Proposing Release, supra note 14, 87 FR at 64632, 64637.
\546\ Id. at 64632-33.
\547\ Id. at 64637.
---------------------------------------------------------------------------

The Commission continues to believe that the changes with respect
to the segregation of house and customer margin, ensuring access to
central clearing, and Rule 15c3-3 would help facilitate the central
clearing of additional U.S. Treasury securities transactions, as will
likely result when a requirement to clear eligible secondary market
transactions goes into place. The Commission also agrees with the
commenters, that it would be appropriate to implement those changes
prior to the imposition of any clearing requirement. This would allow
for the development of additional infrastructure that would support the
eventual increased amount of central clearing that would occur upon the
applicability of a requirement to clear eligible secondary market
transactions.
To do so, the Commission is adopting a different compliance date
for the amendments to Rule 17ad-22(e)(6)(i) (regarding separation of
house and customer margin), 17ad-22(e)(18)(iv)(C) (regarding access),
and 15c3-3 (regarding the broker-dealer customer protection rule), from
the compliance date for the amendments to Rule 17ad-22(e)(18)(iv)(A)
and (B) (regarding the requirements to clear eligible secondary market
transactions and monitoring of the submission of such transactions).
This staging would allow market participants, including U.S. Treasury
securities CCAs, the opportunity to incorporate changes to their rules,
systems, practices, contractual arrangements, and other documentation,
prior to the applicability of a clearing requirement. It also would
provide time between the implementation of structural changes to
accommodate the separation of house and customer margin, the potential
ability to rehypothecate margin pursuant to Rule 15c3-3, as amended,
and additional access by new types of market participants, on the one
hand, and the requirement for a U.S. Treasury securities CCA to require
its direct participants to clear eligible secondary market
transactions, on the other hand.
On the latter point, the Commission is incorporating two stages of
compliance for the requirement to clear eligible secondary market
transactions: the first would apply to the cash market transactions
described in section (i) of the definition of an eligible secondary
market transaction, and the second would apply to the repo market
transactions described in section (ii) of the definition of an eligible
secondary market transaction. Providing additional time for repo
transactions to be centrally cleared should allow time for many market
participants who are active in the repo market but do not centrally
clear this volume of their transactions to plan for and implement
necessary contractual arrangements and processes to manage the increase
in volume of central clearing.
With respect to the changes to Rule 17ad-22(e)(6)(i) (regarding
separation of house and customer margin), 17ad-22(e)(18)(iv)(C)
(regarding access), and 15c3-3 (regarding the broker-dealer customer
protection rule), (1) each covered clearing agency will be required to
file with the Commission any proposed rule changes regarding those
amendments required under Section 19(b) and/or advance notices required
under Title VIII of the Dodd-Frank Act no later than 60 days following
January 16, 2024, and (2) the proposed rule changes must be effective
by March 31, 2025. With respect to the proposed changes to Rule 17ad-
22(e)(18)(iv)(A) and (B) (regarding the requirements to clear eligible
secondary market transactions and monitoring of the submission of such
transactions), (1) each covered clearing agency will be required to
file with the Commission any proposed rule changes regarding those
amendments required under Section 19(b) and/or advance notices required
under Title VIII of the Dodd-Frank Act no later than 150 days following
January 16, 2024, and (2) the proposed rule changes must be effective
by December 31, 2025, for cash market transactions encompassed by
section (ii) of the definition of an eligible secondary market
transaction, and by June 30, 2026, for repo transactions encompassed by
section (i) of the definition of an eligible secondary market
transactions. Compliance by the direct participants of a U.S. Treasury
securities CCA with the requirement to clear eligible secondary market
transactions would not be required until December 31, 2025, and June
30, 2026, respectively, for cash and repo transactions.
This staged implementation timeframe will encompass two and a half
years from the time of the action set forth in this release. This
amount of time is consistent with commenters who sought a staged,
multi-year approach to implementation for this proposal, which, as
adopted, is less extensive than what was proposed.\548\ It is also
consistent with the comment of the existing U.S. Treasury securities
CCA that stated that it and market participants would need until at
least 2025 to implement any final rule, as it allows for that
timeframe. Although some commenters referred to potentially longer
timeframes for implementation, whether expressly (e.g., by referring to
some particular length of time, such as 18 months or three years after
the U.S. Treasury securities CCA has updated its rules \549\) or more
generally (e.g., by referring to the need for a lengthy timeline or
several years to impose clearing requirements \550\), the Commission
believes that this timeframe would allow the benefits of greater
central clearing to be achieved sooner and therefore is adopting the
staged implementation timeframe discussed in this part.\551\
---------------------------------------------------------------------------

\548\ See AIMA Letter, supra note 81, at 9 (seeking 30 months
after publication of any final rule in the Federal Register).
\549\ See MFA Letter, supra note 81, at 21; ICI Letter, supra
note 85, at 33.
\550\ See SIFMA/IIB Letter, supra note 37, at 33; BNY Mellon
Letter, supra note 33, at 3; SIFMA AMG Letter, supra note 35, at 16.
\551\ In addition, with respect to the compliance date, several
commenters requested the Commission to consider interactions between
the proposed rule and other recent Commission rules. In determining
compliance dates, the Commission considers the benefits of the rules
as well as the costs of delayed compliance dates and potential
overlapping compliance dates. For the reasons discussed throughout
the release, to the extent that there are costs from overlapping
compliance dates, the benefits of the rule justify such costs. See
infra parts IV.A and IV.C.2.e for a discussion of the interactions
of the final rule with certain other Commission rules.
---------------------------------------------------------------------------

In addition, one commenter also stated its belief that, given the
complexity and extent of changes that will be necessary to implement
the proposal, it would be advisable to engage in a consultative process
regarding the implementation timeline, with that process occurring
after any adoption of the proposal because it is difficult for market
participants to assess how long it will take to implement a requirement
when they do not yet know with clarity the scope of the final
requirement.\552\ The commenter specifically stated that, after any
adoption of the proposal, the Commission should require U.S. Treasury
CCAs to submit to the Commission a proposed rule change, pursuant to
Section 19 of the Exchange Act, containing an implementation schedule
by no later than 180 days after

[[Page 2771]]

the publication of the final rule in the Federal Register. The
commenter stated that this would provide market participants with the
ability to comment on the timing and requirements set forth in the
proposed rule change with the benefit of knowing the requirements'
scope, and that the Commission and the commenter could then consider
those comments in adopting a final implementation schedule. The
commenter stated that this kind of deliberative and consultative
approach would facilitate the adoption of a realistic timeline and
thereby avoid the need for successive extensions and the attendant
uncertainty and disruption such shifting timelines present.\553\
However, the Commission's phased compliance timeline allows for the
type of deliberation and consultation that the commenter recommends. A
U.S. Treasury securities CCA will be required to submit proposed rule
changes to comply with the requirements being adopted in this release,
and there will be opportunity for comment on those proposals by market
participants, thereby allowing for consultation about the potential
impact of any such proposed rule changes.
---------------------------------------------------------------------------

\552\ FICC/DTCC Letter, supra note 33, at v.
\553\ FICC/DTCC Letter, supra note 33, at v.
---------------------------------------------------------------------------

IV. Economic Analysis

The Commission is mindful of the economic effects that may result
from these amendments, including the benefits, costs, and the effects
on efficiency, competition, and capital formation. Exchange Act section
3(f) requires the Commission, when it is engaged in rulemaking pursuant
to the Exchange Act and is required to consider or determine whether an
action is necessary or appropriate in the public interest, to consider,
in addition to the protection of investors, whether the action will
promote efficiency, competition, and capital formation.\554\ In
addition, Exchange Act section 23(a)(2) requires the Commission, when
making rules pursuant to the Exchange Act, to consider among other
matters the impact that any such rule would have on competition and not
to adopt any rule that would impose a burden on competition that is not
necessary or appropriate in furtherance of the purposes of the Exchange
Act.\555\
---------------------------------------------------------------------------

\554\ See 15 U.S.C. 78c(f).
\555\ See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

The Commission is adopting amendments to its rules that impose
additional requirements for any U.S. Treasury securities CCA.\556\
First, the amendments require that U.S. Treasury securities CCAs
establish, implement, maintain and enforce written policies and
procedures reasonably designed to, as applicable, establish objective,
risk-based, and publicly disclosed criteria for participation, which
require that the direct participants of such covered clearing agency
submit for clearance and settlement all of the eligible secondary
market transactions to which they are a counterparty.\557\ In addition,
the amendments require that such CCAs establish, implement, maintain
and enforce written policies and procedures reasonably designed to, as
applicable, identify and monitor its direct participants' required
submission of transactions for clearing, including, at a minimum,
policies and procedures that address any failures to submit
transactions.\558\ Strengthening the membership standards will help
reduce contagion risk to U.S. Treasury securities CCAs and bring the
benefits of central clearing to more transactions involving U.S.
Treasury securities, thereby lowering the risk of disruptions to the
U.S. Treasury securities market.\559\
---------------------------------------------------------------------------

\556\ See part II supra.
\557\ See part II.A.1 and part II.A.2 supra for a description of
the requirement to clear eligible secondary market transactions
including the definition of ``eligible secondary market
transaction.''
\558\ See part II.A.4 supra.
\559\ See part IV.A infra.
---------------------------------------------------------------------------

Second, the Commission is adopting additional requirements on how
U.S. Treasury securities CCAs calculate, collect, and hold margin
posted on behalf of indirect participants (i.e., customers) who rely on
the services of a direct participant (i.e., the member of the U.S.
Treasury securities CCA) to access the CCA's services.\560\ As
discussed in more detail below, such requirements also will improve the
risk management practices at U.S. Treasury securities CCAs and
incentivize and facilitate additional central clearing in the U.S.
Treasury securities market.
---------------------------------------------------------------------------

\560\ See part II.C supra.
---------------------------------------------------------------------------

Third, the Commission is adopting amendments that will require that
a U.S. Treasury securities CCA establish, implement, maintain and
enforce written policies and procedures reasonably designed to, as
applicable, ensure that it has appropriate means to facilitate access
to clearance and settlement services of all eligible secondary market
transactions in U.S. Treasury securities, including those of indirect
participants, and that its board of directors reviews these policies
and procedures annually.\561\ Although these requirements do not
prescribe specific methods for market participants to obtain indirect
access to a U.S. Treasury securities CCA, they are intended to help
ensure that all U.S. Treasury security CCAs review their indirect
access models and ensure that they facilitate access to clearance and
settlement services in a manner suited to the needs and regulatory
requirements of market participants throughout the U.S. Treasury
securities market, including indirect participants.
---------------------------------------------------------------------------

\561\ See part II.B.2 supra.
---------------------------------------------------------------------------

Lastly, the Commission is amending its rules to permit margin
required and on deposit at a U.S. Treasury securities CCA to be
included as a debit item in the customer reserve formula, subject to
certain conditions.\562\ As discussed further below, these amendments
to its rules, in conjunction with the amendments requiring the
separation of house and customer margin, should incentivize and
facilitate additional central clearing in the U.S. Treasury securities
market.
---------------------------------------------------------------------------

\562\ See part II.C supra.
---------------------------------------------------------------------------

The discussion of the economic effects of the rule amendments
begins with a discussion of the risks inherent in the clearance and
settlement process and how the use of a CCP can mitigate those risks.
This is followed by a baseline of current U.S. Treasury securities
market practices. The economic analysis then discusses the likely
economic effects of the rule amendments, as well as their effects on
efficiency, competition, and capital formation. The Commission has,
where practicable, attempted to quantify the economic effects expected
to result from these rule amendments. In some cases, however, data
needed to quantify these economic effects is not currently available.
For example, prior to the proposal the reporting of data for
bilaterally cleared repo transactions was not a regulatory requirement,
so counterparty-specific statistics were not available and any
aggregate statistics on this market segment may not have been
comprehensive.\563\ In the intervening period, and as discussed further
below, the Department of the Treasury's Office of Financial Research
(OFR) has reported the results of a pilot data collection of non-
centrally cleared bilateral repo.\564\ Likewise, the reporting

[[Page 2772]]

of U.S. Treasury securities transactions to TRACE has been until
recently \565\ limited to cash transactions in which at least one of
the counterparties is a FINRA member, so analyses based on that data
will necessarily be incomplete.
---------------------------------------------------------------------------

\563\ Samuel J. Hempel, R. Jay Kahn, Vy Nguyen, and Sharon Y.
Ross, Non-Centrally Cleared Bilateral Repo, The OFR Blog (Aug. 24,
2022) (``Hempel et al. (2022)''), available at https://www.financialresearch.gov/the-ofr-blog/2022/08/24/non-centrally-cleared-bilateral-repo/.
\564\ See part IV.B.3.b.ii infra. See also Samuel J. Hempel, R.
Jay Kahn, Robert Mann, and Mark Paddrik, Why Is So Much Repo Not
Centrally Cleared?, OFR Brief (May 12, 2023) (``Hempel et al.
(2023)''), available at https://www.financialresearch.gov/briefs/2023/05/12/why-is-so-much-repo-not-centrally-cleared/. The OFR has
also proposed rulemaking mandating the collection of daily
transaction level data from certain financial companies on their
non-centrally cleared bilateral repurchase agreement trades. See
Office of Financial Research, Office of Financial Research Releases
Proposal to Collect Data on Certain Repo Transactions (Jan. 5,
2023), available at https://www.financialresearch.gov/press-releases/2023/01/05/office-of-financial-research-releases-proposal-to-collect-data-on-certain-repo-transactions/.
\565\ Reporting of additional cash transactions to TRACE, by
certain U.S. and foreign banks, began on Sept. 1, 2022, but the
recent nature of that change makes it difficult to draw conclusions
from the limited data available. See generally Federal Reserve
System, Agency Information Collection Activities: Announcement of
Board Approval Under Delegated Authority and Submission to OMB, 86
FR 59716 (Oct. 28, 2021); see also Bd. Governors Fed. Rsrv. Sys.,
Supporting Statement for the Treasury Securities and Agency Debt and
Mortgage-Backed Securities Reporting Requirements,
Federalreserve.gov, available at https://www.federalreserve.gov/reportforms/formsreview/FR%202956%20OMB%20SS.pdf (last visited Dec.
11, 2023).
---------------------------------------------------------------------------

In many cases, and as noted below, the Commission is unable to
quantify the economic effects of the rule amendments and in the
proposal solicited comment, including estimates and data from
interested parties, to help inform the estimates of the economic
effects of the proposal. As discussed further below, several commenters
stated the importance of further research and to better understand the
potential intended and unintended impacts of the rule. Although many of
the commenters calling for additional research did not provide
additional data or propose how any remaining uncertainty might be
resolved, as discussed below, some commenters did provide limited data
on quantifiable costs.\566\
---------------------------------------------------------------------------

\566\ See part IV.C.2 infra.
---------------------------------------------------------------------------

Costs and benefits will depend in part on how market participants
access central clearing in order to clear eligible secondary market
transactions. As some commenters have highlighted, the current clearing
framework may need to be changed and extended to support the
requirement to clear eligible secondary market transactions. The
Commission agrees that changes to the current clearing framework are
necessary and therefore is adopting as proposed Rule 17ad-
22(e)(18)(iv)(C) that requires that a U.S. Treasury securities CCA
establish, implement, maintain and enforce written policies and
procedures reasonably designed to, as applicable, ensure that it has
appropriate means to facilitate access to clearance and settlement
services of all eligible secondary market transactions in U.S. Treasury
securities, including those of indirect participants, which policies
and procedures the U.S. Treasury securities CCA's board of directors
reviews annually.

A. Broad Economic Considerations

Clearance and settlement risk is the risk that a counterparty fails
to deliver a security or cash as agreed upon at the time when the
security was traded. One method of reducing such risk is to require one
or both counterparties to the trade to post collateral.\567\ The
purpose of posting collateral in financial transactions is to alleviate
frictions caused by adverse selection and moral hazard.\568\ The amount
of collateral needed to support a set of unsettled trades, however, can
depend on whether trades are cleared bilaterally or through a CCP. In
cases where market participants have several outstanding buy and sell
orders, central clearing reduces the total collateral required to
support a given set of trades due to multilateral netting.\569\ A
simple example illustrates the effect. Suppose there are 3 firms trying
to complete three bilateral trades among themselves. Firm A is buying
$90 million in U.S. Treasury securities from Firm B, Firm B is buying
$80 million in the same U.S. Treasury securities from Firm C, and Firm
C is buying $100 million in the same U.S. Treasury securities from Firm
A. This means that over the settlement cycle, the firms in this example
would need to post collateral to cover a total of $270 million in gross
obligations to complete these three trades. If these trades were
centrally cleared, however, then the net obligations would be
substantially smaller. In this example, the collateral required would
no longer be that required to support $270 million in outstanding
obligations, but instead would reduce to $40 million: $20 million for
Firm C, and $10 million each for Firms A and B.\570\ Central clearing
can, in part, replace a trading network made up of a web of bilateral
relationships with a simpler hub and spoke model. As each connection is
a potential source of failure, a simpler system can imply less risk.
---------------------------------------------------------------------------

\567\ An alternative method of reducing counterparty credit risk
is delivery versus payment (``DVP''). Under DVP, counterparties aim
to deliver securities and payment simultaneously, so that the
transfer of securities happens if and only if payment has also been
made.
\568\ For example, if the fulfillment of a contract depends on a
counterparty exerting unobservable and costly effort, collateral can
be used as a commitment device by putting more of the counterparty's
resources at stake in the case of nonfulfillment. See Bengt
Holmstrom & Jean Tirole, Financial Intermediation, Loanable Funds,
and the Real Sector, 112 Q. J. Econ. 663 (Aug. 1997); Albert J.
Menkveld & Guillaume Vuillemey, The Economics of Central Clearing,
13 Ann. Rev. Fin. Econ. 153, 158 (2021).
\569\ Darrell Duffie & Haoxiang Zhu, Does a Central Clearing
Counterparty Reduce Counterparty Risk? 1 Rev. Asset Pricing Stud. 74
(2011), available at https://academic.oup.com/raps/article-abstract/1/1/74/1528254. The authors note that this benefit scales with the
square root of the number of participants when the trading positions
are statistically independent and identically distributed. The
authors also note certain conditions that can impact netting
efficiencies, e.g., when cross asset netting is allowed in non-
centrally cleared markets, asset specific CCPs can negatively impact
netting efficiency. We also note, as discussed below, that certain
aspects of client clearing models can impact netting efficiency.
\570\ This example is from Duffie, supra note 27.
---------------------------------------------------------------------------

Clearance and settlement through a CCP can also make trades less
``informationally sensitive'' in the sense that the value of the trade
does not depend on information about the creditworthiness of the
counterparties, thereby reducing adverse selection.\571\ This occurs
when the trade is novated to the CCP, and the CCP becomes the buyer to
every seller and the seller to every buyer. This reduces the need for
investors to acquire private information about the credit risk of their
counterparty. By mitigating adverse selection through the substitution
of the CCP's counterparty credit risk evaluation for a market
participant's own, central clearing through a CCP lowers the cost of
trading by market participants and should increase their willingness to
trade, thereby improving market liquidity. Reducing the information
sensitivity of trades also increases the uniformity of the asset that
is traded. In the absence of novation, the U.S. Treasury security is
essentially bundled together with counterparty risk. That is, when
buying or selling a security, if there is counterparty risk, the
pricing depends not only on the security itself but also on the
reliability of the counterparty to the trade. It is as if, from an
economic perspective, one is ``buying'' both the security and the
characteristics of the counterparty. Besides the reduction in adverse
selection, reducing counterparty credit risk makes the security a more
standard product. Standardization itself increases liquidity.\572\
---------------------------------------------------------------------------

\571\ See Gary Gorton & George Pennacchi, Financial
Intermediaries and Liquidity Creation, 45 J. Fin. 49 (1990); see
also Francesca Carapella & David Mills, Information Insensitive
Securities: the Benefits of Central Counterparties (N.Y. Fed,
working paper Oct. 17, 2012), available at https://www.newyorkfed.org/medialibrary/media/research/conference/2012/MP_Workshop/Carapella_Mills_information_insensitive_securities.pdf.
\572\ See Ben Bernanke, Clearing and Settlement During the
Crash, 3 Rev. Fin. Stud. 133 (1990).
---------------------------------------------------------------------------

Financial networks that incorporate a CCP can further improve the
resilience

[[Page 2773]]

of financial markets. The Bank for International Settlements stated in
2015 that the shift to central clearing had helped to mitigate the
risks that emerged in non-centrally cleared markets before and during
the 2007-2009 financial crisis. Further, it had reduced financial
institutions' exposure to counterparty credit risk shocks through
netting, margining and collateralization.\573\
---------------------------------------------------------------------------

\573\ Dietrich Domanski, Leonardo Gambacorta, and Cristina
Picillo, Central clearing: trends and current issues, BIS Q. Rev.
(Dec. 2015), available at https://www.bis.org/publ/qtrpdf/r_qt1512g.pdf.
---------------------------------------------------------------------------

Another potential benefit of central clearing is it should reduce
the magnitude of, or even prevent, fire sales of assets. This
mitigation of fire sale risk is achieved when a member defaults and the
CCP manages the liquidation of assets. Central management of asset
liquidation may mitigate suboptimal outcomes in the face of capital or
margin constraints. For example, if investors believe the counterparty
will sell in the case of a missed margin call, other investors may join
the selloff, leading to further declines in asset prices. If market
participants can pledge to not sell, then a more efficient equilibrium
in which there is no fire sale could be achieved. In this way, the CCP
acts as a way to select into the more efficient equilibrium by allowing
members to credibly pre-commit to the coordinated liquidation of assets
in the case of a missed margin call.\574\
---------------------------------------------------------------------------

\574\ John Chi-Fong Kuong, Self-Fulfilling Fire Sales: Fragility
of Collateralized Short-Term Debt Markets, 34 Rev. Fin. Stud. 2910
(2021), available at https://academic.oup.com/rfs/article/34/6/2910/5918033?login=true.
---------------------------------------------------------------------------

Finally, broadening central clearing could lead to a wider group of
liquidity providers, which likely would increase the reliability of
access to funding during periods of market stress.\575\ The reason is
that novation of the trade to a central counterparty reduces one of the
major reasons for not doing business with a particular counterparty:
the risk that that counterparty may fail to deliver on its obligations.
It also reduces one of the reasons for failing to provide liquidity,
namely concerns over the credit risk of counterparties. Therefore, as a
result of increased levels of central clearing and the resulting
increased centralization of counterparty credit risk evaluation by a
CCP and the CCP's application of consistent and transparent risk
management,\576\ more counterparties--who would also be potential
liquidity providers--would be willing to compete to provide liquidity
to buy-side investors and to each other. In addition, several academic
studies following the 2008 financial crisis emphasize the role of
intermediary balance sheet constraints as a cause of financial
crises.\577\ Moreover, losses experienced by market participants can
lead to an increase in risk aversion leading those market participants
to exit, creating a need for new market participants to replace them in
order to provide liquidity.\578\ Therefore, either because of increased
risk aversion or because some friction implies that the liquidity
providers who find themselves warehousing the asset can no longer do so
due to trading losses, outside liquidity providers may play an
important role in stabilizing the market. In addition, central clearing
facilitates anonymized all-to-all trading that would enable the
provision of market liquidity by investors.^{579 580}
---------------------------------------------------------------------------

\575\ G-30 Report, supra note 5, at 13.
\576\ See TMPG White Paper, supra note 13 (``[b]ilateral
clearing involves varying risk management practices that are less
uniform and less transparent to the broader market . . .''). In
addition, FICC has been designated by FSOC as a systemically
important financial market utility, which brings heightened risk
management requirements and additional regulatory supervision by
both its primary regulator and the Board of Governors. See also U.S.
Dept. of the Treasury, Fin. Stability Oversight Council, 2012 Annual
Report, App. A, available at https://home.treasury.gov/system/files/261/2012-Annual-Report.pdf (``FSOC 2012 Annual Report'').
\577\ See e.g., Markus K. Brunnermeier & Yuliy Sannikov, A
Macroeconomic Model with a Financial Sector, 104 a.m. Econ. Rev. 379
(Feb. 2014); see also Zhiguo He & Arvind Krishnamurthy, Intermediary
Asset Pricing, 103 a.m. Eco. Rev. 732 (Apr. 2013). Balance sheet
constraints and the impact of losses on risk aversion both affect
the ability and willingness of market participants to provide
liquidity. A CCP is not similarly affected as it does not supply
liquidity.
\578\ See, e.g., John Y. Campbell & John H. Cochrane, By Force
of Habit: A Consumption-Based Explanation of Aggregate Stock Market
Behavior, 107 J. Pol. Econ. 205 (Apr. 1999).
\579\ G-30 Report, supra note 5, at 13. See also Duffie, supra
note 27, at 4 (``Further, given broad access to a CCP, some Treasury
transactions could flow directly from ultimate sellers to ultimate
buyers without necessarily impinging on dealer balance sheet
space.'').
\580\ The market responded to the stress of 2020 through some
increase in all-to-all trading. See MarketAxess, FIMSAC Slides, at 6
(Oct. 5, 2020), available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/mcvey-fimsac-slides-100120.pdf Additional
central clearing may have enabled a greater increase.
---------------------------------------------------------------------------

Several commenters were generally supportive of benefits of central
clearing. One commenter stated that it, `` . . . supports central
clearing because, when calibrated appropriately, it has increased
resiliency, liquidity and transparency in financial markets.'' \581\
Another commenter stated that ``[i]f implemented thoughtfully,
increased central clearing of Treasury cash and repurchase (``repo'')
transactions will reduce systemic risk and meaningfully improve
counterparty risk management, market liquidity, and resiliency.'' \582\
Several additional commenters made similar statements.\583\
---------------------------------------------------------------------------

\581\ AIMA Letter, supra note 81, at 2.
\582\ Citadel Letter, supra note 81, at 1.
\583\ See AIMA Letter, supra note 81, at 2; CME Group, supra
note 81, at 2; DTCC/FICC Letter, supra note 33, at 1; GTS Letter,
supra note 81, at 3; ISDA Letter, supra note 391, at 2; LSEG Letter,
supra note 33, at 2; MFA Letter, supra note 81, at 2; ARB Trading et
al. Letter, supra note 81, at 1; SIFMA/IIB Letter, supra note 37, at
1; Sunthay Letter, supra note 33, at 4; Tradeweb Letter, supra note
81, at 2; Better Markets Letter, supra note 33, at 8; ICE Letter,
supra note 33, at 1.
---------------------------------------------------------------------------

Several commenters, including some who were generally supportive of
the benefits of central clearing, referenced the need to do additional
study before imposing any requirement on U.S. Treasury securities CCAs
for their participants to clear and settle eligible secondary market
transactions. One commenter stated that the Commission should conduct
detailed analysis on the costs and benefits of central clearing across
market segments and participant types, as well as analyze the overall
impact on Treasury market liquidity. The commenter stated that it is
widely recognized within existing literature on Treasury market
structure reform that further detailed study is needed in this area.
The commenter also stated that increased central clearing resulting
from incentives to centrally clear U.S. Treasury securities
transactions would provide additional data for this analysis.\584\
---------------------------------------------------------------------------

\584\ SIFMA/IIB Letter, supra note 37, at 2.
---------------------------------------------------------------------------

In support of its claim that it is widely recognized within
existing literature on Treasury market structure reform that further
study is needed, the commenter cites two working papers.\585\ The first
citation includes a quote stating that it would be difficult to
estimate the amount of liquidity savings associated with central
clearing without further study.\586\ However, the cited work is
generally supportive of central clearing, stating that ``Without a
broad central clearing mandate, the size of the Treasury market will
outstrip the capacity of dealers to safely intermediate the market on
their own balance sheets, raising doubts over the safe-haven status of
U.S. Treasuries and concerns over the cost to taxpayers of financing
growing federal deficits.'' \587\
---------------------------------------------------------------------------

\585\ SIFMA/IIB Letter, supra note 37, at 2 (citing working
papers by Duffie, supra note 27, and Liang and Parkinson, supra note
28).
\586\ Id. at 2.
\587\ Duffie, supra note 27, at 1.
---------------------------------------------------------------------------

The second citation provided by the commenter also focuses on the
potential benefit of improved liquidity.\588\ The working paper states
that a potential mandate for wider use of central

[[Page 2774]]

clearing for Treasury securities is the second of four complementary
measures for enhancing the liquidity of U.S. Treasury markets when
under stress.\589\ The cited work also does not address the potential
benefits of increased central clearing other than the potential for
improved liquidity. Immediately following the authors' statement in
favor of further study, they state that ``If such a study were to
conclude that expanded clearing is not appropriate for Treasury
securities, it should explain what distinguishes Treasury markets from
the many other markets, such as equities and Treasury futures, for
which there is a clearing mandate.'' \590\
---------------------------------------------------------------------------

\588\ Liang and Parkinson, supra note 28.
\589\ Id.
\590\ Id. at 3.
---------------------------------------------------------------------------

Another commenter stated that the Commission should substantiate
the benefits and potential costs of clearing through additional studies
and data. The commenter stated that the Commission's proposal should be
considered after the Commission has had an opportunity to gather
additional data and further assess whether increased clearing is the
best way to mitigate the risks confronting the U.S. Treasury market,
including a more in-depth understanding of how these changes will
affect the costs of transactions for institutional investors who depend
on access to these markets for active portfolio management and, as a
result, represent a significant source of market liquidity.\591\ In
addition, one commenter, which surveyed market participants as the
basis of its comment, conveyed a ``strong belief that insufficient
review and examination has been given to the proposal by the official
sector and that such work needs to be detailed and focused to properly
vet a mixture of economic, operational, legal and market challenges
before the proposal is enacted.'' \592\
---------------------------------------------------------------------------

\591\ SIFMA AMG Letter, supra note 37, at 2-3.
\592\ SIA Partners Comment, supra note 52, at 8.
---------------------------------------------------------------------------

The Commission has reviewed the academic literature on central
clearing as well as the reports published by the G-30, the TMPG, the
OFR, and others \593\ and does not agree with commenters that suggest
that additional study should precede adoption of a requirement for U.S.
Treasury securities CCAs to obligate direct participants to clear
eligible secondary market transactions. Although the Commission
recognizes that some of the benefits of additional central clearing of
eligible secondary market transactions may be mitigated for certain
transactions,\594\ the Commission has consulted with other regulators
regarding this proposal and believes it has performed sufficient
analysis in both the Proposing Release and in this release to consider
the costs and benefits arising from its proposal.
---------------------------------------------------------------------------

\593\ See, e.g., Duffie, supra note 27; Duffie and Zhu, supra
note 569; Duffie, infra note 718; Duffie et al., infra note 718; G-
30 Report, supra note 5; TMPG White Paper, supra note 13; TMPG Repo
White Paper, supra note 75; Hempel et al. (2022), supra note 563;
Hempel et al. (2023), supra note 564; Kahn & Olson, supra note 628;
2017 OFR Report, infra note 797; 2021 IAWG Report, supra note 4;
Staffs of the U.S. Department of the Treasury, Board of Governors of
the Federal Reserve System, Federal Reserve Bank of New York, U.S.
Securities and Exchange Commission, and U.S. Commodity Futures
Trading Commission, Enhancing the Resilience of the U.S. Treasury
Market: 2022 Staff Progress Report (Nov. (2023), supra note 564;
Kahn & Olson, supra note 628; 2017 OFR Report, infra note 797; 2021
IAWG Report, supra note 4; Staffs of the U.S. Department of the
Treasury, Board of Governors of the Federal Reserve System, Federal
Reserve Bank of New York, U.S. Securities and Exchange Commission,
and U.S. Commodity Futures Trading Commission, Enhancing the
Resilience of the U.S. Treasury Market: 2022 Staff Progress Report
(Nov. 2022), available at https://home.treasury.gov/system/files/136/2022-IAWG-Treasury-Report.pdf (``2022 IAWG Report''); Staffs of
the U.S. Department of the Treasury, Board of Governors of the
Federal Reserve System, Federal Reserve Bank of New York, U.S.
Securities and Exchange Commission, and U.S. Commodity Futures
Trading Commission, Enhancing the Resilience of the U.S. Treasury
Market: 2023 Staff Progress Report (Nov. 2023), available at https://home.treasury.gov/system/files/136/20231106_IAWG_report.pdf (``2023
IAWG Report''); 2017 Treasury Report, infra note 736; Joint Staff
Report, supra note 4.
\594\ See, e.g., part IV.B.5 infra.
---------------------------------------------------------------------------

As discussed in more detail throughout this release, and especially
in part IV.C infra, the Commission understands that the costs
associated with the requirement to clear eligible secondary market
transactions will vary depending on how a market participant is able to
and/or chooses to access central clearing. The degree to which market
participants have increased costs will depend largely on whether and
how they currently access central clearing, and therefore, costs likely
will vary greatly across different types of market participants. For
example, for certain indirect participants whose transactions with
direct participants of a U.S. Treasury securities CCA are not submitted
for central clearing currently, the costs of establishing some indirect
participant relationship, whether through FICC's Sponsored Service or
some other client clearing model, may be high. In addition, following
the initial costs, the ongoing costs of submitting transactions for
central clearing, such as posting margin and paying fees to a direct
participant which facilitates access, may also be high.\595\
---------------------------------------------------------------------------

\595\ See part IV.C.2.a.ii infra.
---------------------------------------------------------------------------

However, benefits will accrue from the requirement to submit for
clearing and settlement eligible secondary market transactions. As
discussed earlier in this section and in part IV.C.1 supra, one of the
several cited benefits of additional central clearing is the increased
resiliency of centrally cleared markets. The economic costs of market
disruptions can be high so market changes that decrease the probability
of such events by even a small amount can result in a large expected
economic benefit. Discussion of disruptions in the U.S. Treasury
Securities Market over the last decade typically discuss the size of
the market and interconnectedness of the U.S. Treasuries markets with
other financial markets as evidence of their importance; estimates of
the cost to the U.S. economy as a result of these disruptions are less
common.\596\ However, there is evidence that the costs of extreme
financial crises can be high.\597\
---------------------------------------------------------------------------

\596\ See part IV.B.6 infra, for a discussion of the Mar. 2020,
Sept. 2019, and Oct. 2014 market disruptions. See SEC Staff Report
on U.S. Credit Markets Interconnectedness and the Effects of the
COVID-19 Economic Shock (Oct. 2020), supra note 280, for discussion
of the interconnectedness of financial crisis and market
disruptions.
\597\ Barnichon et al., estimate that ``the 2007-08 financial
crisis persistently lowered output by roughly 7 percentage points.
This is a large number: In dollar terms, it represents a lifetime
income loss in present-discounted value terms of about $70,000 for
every American.'' Regis Barnichon, Christian Matthes, and Alexander
Ziegenbein, The Financial Crisis at 10: Will We Ever Recover?, FRBSF
Econ. Letter 2018-19 (Aug. 13, 2018), available at https://www.frbsf.org/economic-research/publications/economic-letter/2018/august/financial-crisis-at-10-years-will-we-ever-recover/?utm_source=frbsf-home-economic-letter-title&utm_medium=frbsf&utm_campaign=economic-letter. Romer and Romer
(2017) study a panel of countries in the Organization for Economic
Co-operation and Development and find that gross domestic product is
typically about 9 percentage points lower five years after an
extreme financial crisis. Christina Romer and David Romer, New
Evidence on the Aftermath of Financial Crises in Advanced Countries,
107 a.m. Econ. Rev. 3,072 (Oct. 2017).
---------------------------------------------------------------------------

In addition, the requirement for direct participants to clear such
transactions will reduce risk to the U.S. Treasury securities CCA, by
reducing counterparty risk and enabling additional multilateral netting
and centralized default management, as discussed in part II.A.1 supra.
Further, to the extent that implementation costs arise from changes to
the CCA's rules, the CCA's implementation of the requirement will
provide further opportunity to consider the costs and benefits of
particular methods of implementation. Because CCAs are self-regulatory
organizations, any rule changes to implement the requirement will need
to be reviewed by the Commission,\598\ and commenters will be able to
comment on the particular

[[Page 2775]]

changes and issues raised by such changes, including costs and
benefits.
---------------------------------------------------------------------------

\598\ See Exchange Act section 19(b) and Rule 19b-4.
---------------------------------------------------------------------------

B. Baseline

The baseline against which the costs, benefits, and the effects on
efficiency, competition, and capital formation of the final rule are
measured consists of the current state of the market for U.S. Treasury
securities, including the repo market, current practice as it relates
to the purchase and sale of U.S. Treasury securities, and the current
regulatory framework. The economic analysis considers existing
regulatory requirements, including recently adopted rules, as part of
its economic baseline against which the costs and benefits of the final
rule are measured.\599\
---------------------------------------------------------------------------

\599\ See, e.g., Nasdaq v. SEC, 34 F.4th 1105, 1111-15 (D.C.
Cir. 2022). This approach also follows SEC staff guidance on
economic analysis for rulemaking. See SEC Staff, Current Guidance on
Economic Analysis in SEC Rulemaking (Mar. 16, 2012), available at
https://www.sec.gov/divisions/riskfin/rsfi_guidance_econ_analy_secrulemaking.pdf (``The economic
consequences of proposed rules (potential costs and benefits
including effects on efficiency, competition, and capital formation)
should be measured against a baseline, which is the best assessment
of how the world would look in the absence of the proposed
action.''); id. at 7 (``The baseline includes both the economic
attributes of the relevant market and the existing regulatory
structure.''). The best assessment of how the world would look in
the absence of the proposed or final action typically does not
include recently proposed actions, because that would improperly
assume the adoption of those proposed actions.
---------------------------------------------------------------------------

Certain commenters requested the Commission to consider
interactions between the economic effects of the proposed rule and
other recent Commission proposals.\600\ The Commission recently adopted
six of the proposed rules mentioned by commenters as potentially
impacting the economic effects of the final rule,\601\ namely the May
2023 SEC Form PF Amending Release,\602\ Private Fund Advisers Adopting
Release,\603\ Beneficial Ownership Amending Release,\604\ the Rule 10c-
1a Adopting Release,\605\ the Short Position Reporting Adopting
Release,\606\ and the Securitizations Conflicts Adopting Release.\607\
These rules were not included as part of the baseline in the Proposing
Release because they had not been adopted at that time. In response to
commenters, this economic analysis considers potential economic effects
arising from any overlap between the compliance period for the final
amendments and these recently adopted rules.\608\
---------------------------------------------------------------------------

\600\ Letter from Eric Pan, Pres. & CEO, and Susan Olsen,
General Counsel, Investment Company Institute at 1 (Aug. 17, 2023)
(``ICI Letter 2'') (``The Commission has issued a wide range of
interconnected rule proposals . . . [that] in the aggregate warrant
further analysis by the Commission.''); Letter from Jennifer W. Han,
Executive Vice President, Chief Counsel & Head of Global Regulatory
Affairs, Managed Funds Association at 6 (July 21, 2023) (``MFA
Letter 2'') (``the Commission should holistically examine all of the
pending Proposals, consider the potential overlap between them, and
. . . evaluat[e] the costs and benefits of the Proposals in light of
one another.''); see also ARB et al. Letter, supra note 81, at 9
(``the Commission has simultaneously put forward multiple proposals
designed to achieve [ ] objectives without considering how these
various proposals interact with each other.''); cf. AIMA Letter II,
supra note 115, at 4 (``Together, the Treasury Clearing Proposal and
ATS Proposal render the [then-proposed amendments to the definition
of dealer] unnecessary.'').
\601\ Those six proposals are: Amendments to Form PF to Require
Current Reporting and Amend Reporting Requirements for Large Private
Equity Advisers and large Liquidity Fund Advisers, Release No. IA-
5950 (Jan. 26, 2022) 87 FR 9106 (Feb 17, 2022) (see MFA Letter 2,
supra note 600, at 10-12); Modernization of Beneficial Ownership
Reporting, Release Nos. 33-11030, 34-94211 (Feb. 10, 2022), 87 FR
13846 (Mar. 10, 2022) (see MFA Letter 2, supra note 600, at 14-15);
Short Position and Short Activity Reporting by Institutional
Investment Managers, Release No. 34-94313 (Feb. 25, 2022), 87 FR
14950 (Mar. 16, 2022) (see MFA Letter 2, supra note 600, at 15-16);
Private Fund Advisers; Documentation of Registered Investment
Adviser Compliance Reviews, Release No. IA-5955 (Feb. 9, 2022), 87
FR 16886 (Mar. 24, 2022) (see MFA Letter 2, supra note 600, passim);
Prohibition Against Conflicts of Interest in Certain
Securitizations, Release No. 33-11151 (Jan. 25, 2023), 88 FR 9678
(Feb. 14, 2023) (see MFA Letter 2, supra note 600, at 21-22);
Outsourcing by Investment Advisers, Release No. IA-6176 (Oct. 26,
2022), 87 FR 68816 (Nov. 16, 2022) (see MFA Letter 2, supra note
600, at 17-18).
\602\ Form PF; Event Reporting for Large Hedge Fund Advisers and
Private Equity Fund Advisers; Requirements for Large Private Equity
Fund Adviser Reporting, Release No. IA-6297 (May 3, 2023) 88 FR
38146 (June 12, 2023) (``May 2023 SEC Form PF Amending Release'').
The Form PF amendments require large hedge fund advisers and all
private equity fund advisers to file reports upon the occurrence of
certain reporting events. The compliance dates are Dec. 11, 2023,
for the event reports in Form PF sections 5 and 6, and June 11,
2024, for the remainder of the Form PF amendments.
\603\ Private Fund Advisers; Documentation of Registered
Investment Adviser Compliance Reviews, Release No. IA-6383 (Aug. 23,
2023), 88 FR 63206 (Sept. 14, 2023) (``Private Fund Advisers
Adopting Release''). The Private Fund Advisers Adopting Release
includes new rules designed to protect investors who directly or
indirectly invest in private funds by increasing visibility into
certain practices and restricting other practices, along with
amendments to the Advisers Act books and records rule and compliance
rule. The amended Advisers Act compliance provision for registered
investment advisers has a Nov. 13, 2023, compliance date. The
compliance date is Mar. 14, 2025, for the rule's quarterly statement
and audit requirements for registered investment advisers with
private fund clients. For the rule's adviser-led secondaries,
restricted activity, and preferential treatment requirements, the
compliance date is Sept. 14, 2024, for larger advisers and Mar. 14,
2025, for smaller advisers. See Private Fund Advisers Adopting
Release, sections IV, VI.C.1.
\604\ Modernization of Beneficial Ownership Reporting, Release
No. 33-11253 (Oct. 10, 2023), 88 FR 76896 (Nov. 7, 2023)
(``Beneficial Ownership Amending Release''). Among other things, the
amendments shorten the filing deadlines for beneficial ownership
reports filed on Schedule 13D and Schedule 13G. The compliance dates
are 90 days after publication in the Federal Register, for Schedule
13D amended filing deadlines; Sept. 30, 2024, for the Schedule 13G
amended filing deadlines; and Dec. 18, 2024, for the structured data
requirement.
\605\ Reporting of Securities Loans, Release No. 34-98737 (Oct.
13, 2023), 88 FR 75644 (Nov. 3, 2023) (``Rule 10c-1a Adopting
Release''). The securities loan reporting rule requires any person
who loans a security on behalf of itself or another person to report
information about securities loans to a registered national
securities association (namely, FINRA) and requires FINRA to make
certain information it receives available to the public. The covered
persons will include market intermediaries, securities lenders,
broker-dealers, and reporting agents. The final rule's compliance
dates require that FINRA propose its rules within four months of the
effective date of final Rule 10c-1a, or approximately May 2024, and
finalize them no later than 12 months after the effective date of
final Rule 10c-1a, or approximately Jan. 2025; that FINRA implement
data retention and availability requirements for reporting 24 months
after the effective date of final Rule 10c-1a, or approximately Jan.
2026; that covered persons report Rule 10c-1a information to FINRA
starting on the first business day thereafter; and that FINRA
publicly report Rule 10c-1a information within 90 calendar days
thereafter, or approximately Apr. 2026. See Rule 10c-1a Adopting
Release, section VIII, at 75691.
\606\ Short Position and Short Activity Reporting by
Institutional Investment Managers, Release No. 34-98738 (Oct. 13,
2023), 88 FR 75100 (Nov. 1, 2023) (``Short Position Reporting
Adopting Release''). The new rule and related form are designed to
provide greater transparency through the publication of short sale-
related data to investors and other market participants. Under the
new rule, institutional investment managers that meet or exceed
certain specified reporting thresholds are required to report, on a
monthly basis using the related form, specified short position data
and short activity data for equity securities. The compliance date
for the rule is 12 months after the effective date of the release,
which will be approximately Jan. 2025. In addition, the Short
Position Reporting Adopting Release amends the national market
system plan governing CAT to require the reporting of reliance on
the bona fide market making exception in the Commission's short sale
rules. The compliance date for the CAT amendments is 18 months after
the effective date, or approximately July 2025.
\607\ Prohibition Against Conflicts of Interest in Certain
Securitizations, Release No. 33-11254 (Nov. 27, 2023), 88 FR 85396
(Dec. 7, 2023) (``Securitizations Conflicts Adopting Release''). The
new rule prohibits an underwriter, placement agent, initial
purchaser, or sponsor of an asset-backed security (ABS) (including a
synthetic ABS), or certain affiliates or subsidiaries of any such
entity, from engaging in any transaction that would involve or
result in certain material conflicts of interest. The compliance
date is 18 months after publication in the Federal Register, or June
9, 2025.
\608\ In addition, commenters indicated there could also be
overlapping compliance costs between the final amendments and
proposals that have not been adopted. See, e.g., ICI Letter 2, supra
note 600, at 8 n.13. To the extent those proposals are adopted, the
baseline in those subsequent rulemakings will reflect the existing
regulatory requirements at that time.
---------------------------------------------------------------------------

1. U.S. Treasury Securities
U.S. Treasury securities are direct obligations of the U.S.
Government issued by the U.S. Department of the Treasury. After
issuance in the primary market U.S. Treasury securities trade in

[[Page 2776]]

an active secondary market.\609\ A number of types of market
participants intermediate between investors in U.S. Treasury
securities. These investors hold U.S. Treasury securities as a
relatively riskless way of saving, as a way of placing a directional
bet on interest rates, or as a means of hedging against deflation. U.S.
Treasury securities can also function directly as a medium of exchange
in some instances, and, as described in more detail below, as
collateral for loans.
---------------------------------------------------------------------------

\609\ There is also an active market for U.S. Treasury
securities that trade on a ``when-issued'' (WI) basis. ``Based on
Treasury TRACE transactions data, WI trading volume averaged $80
billion per day between July 1, 2019, and June 30, 2020, accounting
for 12% of the $651 billion traded daily across all Treasury
securities.'' See Michael Fleming, Or Shachar, and Peter Van Tassel,
Treasury Market When-Issued Trading Activity, Liberty Street
Economics Blog (Nov. 30, 2020), available at https://libertystreeteconomics.newyorkfed.org/2020/11/treasury-market-when-issued-trading-activity/. As discussed in the Proposing Release,
supra note 14, 87 FR at 64615, for purposes of this rulemaking only
the WI market after the auction but before issuance (WI on-the-run
issues) is considered part of the secondary market for U.S. Treasury
securities. Most of the WI trading in the Fleming, Shachar, and Van
Tassel analysis occurred in on-the-run issues. (``WI trading that
occurs up to and including the auction day (account[s] for about
one-third of WI trading) and WI trading that occurs after the
auction day (account[s] for about two-thirds of WI trading'').) For
a discussion of how WI trading functions in the context of central
clearing, see Kenneth D. Garbade & Jeffrey F. Ingber, The Treasury
Auction Process: Objectives, Structure, and Recent Adaptations, 11
Current Issues Econ. & Fin. 1 (2005), available at https://www.newyorkfed.org/medialibrary/media/research/current_issues/ci11-2.html.
---------------------------------------------------------------------------

Market participants refer to the most recently issued U.S. Treasury
securities as ``on-the-run,'' with earlier issues referred to as ``off-
the-run''.\610\ Figure 1 shows the outstanding value of on-the-run
(Panel A) and off-the-run (Panel B) U.S. Treasury securities. On-the-
run U.S. Treasury securities have consistently made up approximately 3%
of the total value of all marketable U.S. Treasury securities during
the 2012-2022 period, but, as Figure 3 shows, account for a
disproportionate share of trading volume. Thus, an on-the-run security
is generally far more liquid than a similar off-the-run security.
---------------------------------------------------------------------------

\610\ On-the-run U.S. Treasury securities are the most recently
auctioned nominal coupon securities. These securities are referred
to as ``on-the-run'' starting the day after they are auctioned.
Nominal coupon securities pay a fixed semi-annual coupon and are
currently issued at original maturities of 2, 3, 5, 7, 10, 20, and
30 years. These standard maturities are commonly referred to as
``benchmark'' securities because the yields for these securities are
used as references to price a number of private market transactions.
[GRAPHIC] [TIFF OMITTED] TR16JA24.000

As of November 2023, the total market value outstanding of
marketable U.S. Treasury securities held by the public was $26.3
trillion.\611\ As shown in Figure 2, the value of marketable U.S.
Treasury securities outstanding has increased by approximately $19
trillion since 2000. The total amount of marketable U.S. Treasury
securities issued during 2022 was $17.4 trillion.\612\
---------------------------------------------------------------------------

\611\ See SIFMA US Treasury Securities Statistics, available at
https://www.sifma.org/resources/research/us-treasury-securities-statistics/.
\612\ U.S. Treasury, Debt Position and Activity Report (July 31,
2023), available at https://www.treasurydirect.gov/government/public-debt-reports/debt-position-and-activity-report/.

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

[[Page 2777]]

[GRAPHIC] [TIFF OMITTED] TR16JA24.001

In the primary market, the Treasury Department auctions securities
(i.e., debt) to the public through a competitive bidding process and
subsequently issues awarded securities to finance the Federal
Government.\613\ Financial institutions designated by the Federal
Reserve Bank of New York as ``primary dealers'' are expected to submit
competitive bids on a pro-rata basis and participate meaningfully in
all U.S. Treasury auctions at reasonably competitive rates or
yields.\614\ The Treasury Department typically issues U.S. Treasury
securities a few days after the auction and trade on the secondary
market.\615\ The subsequent trading of U.S. Treasury securities is
defined as the secondary market. Figure 3 reports weekly trading values
in the secondary market for U.S. Treasury securities. According to
industry reports, 67% of the $913.2 billion in average daily trading
volume of U.S. fixed income securities in 2022 was in U.S. Treasury
securities.\616\ As shown in Figure 3, average weekly trading volume
was approximately $3 trillion in 2022, with notable peaks in March 2020
and early 2021.\617\
---------------------------------------------------------------------------

\613\ TMPG White Paper, supra note 13, at 6. The Federal Reserve
Bank of New York serves as fiscal agent for the U.S. Treasury in
conducting auctions of marketable U.S. Treasury debt. See 12 U.S.C.
391.
\614\ See Federal Reserve Bank of New York, Administration of
Relationships with Primary Dealers, available at https://www.newyorkfed.org/markets/primarydealers.html. Specifically,
primary dealers are required to be either (1) a registered broker-
dealer or government securities broker-dealer, which is approved as
a member of the Financial Industry Regulatory Authority, Inc. and
has net regulatory capital of at least $50 million, or (2) a state
or federally chartered bank or savings association (or a state or
federally licensed branch or agency of a foreign bank) that is
subject to bank supervision and maintains at least $1 billion in
Tier 1 capital. Id. Thus, for those primary dealers that fall into
the former category, they are a subset of the broader set of
registered broker-dealers or government securities broker-dealers.
\615\ The Treasury Department typically announces a new security
that it intends to sell several days before the auction at which it
is first sold to the public. These securities begin trading after
announcement before the auction and through issuance, which occurs a
few days after the auction. Such trading is known generally as
``when-issued'' trading; however, in the timeframe between the
announcement and the auction, such trading is known as when-issued
and referred to as such by market participants, but after the
auction and before issuance, the securities are typically referred
to simply as on-the-run, consistent with market practice. See
Fleming et. al. supra note 609.
\616\ Another 26% was Agency MBS, 4% corporate debt, with the
remainder in municipal, non-agency mortgage-backed, Federal agency
debt and asset-backed securities. SIFMA, US Fixed Income Securities
Statistics (last updated Aug. 7, 2023), available at https://www.sifma.org/resources/research/us-fixed-income-securities-statistics/.
\617\ Id.

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

[[Page 2778]]

[GRAPHIC] [TIFF OMITTED] TR16JA24.002

2. U.S. Treasury Repurchase Transactions
A U.S. Treasury repurchase transaction generally refers to a
transaction in which one market participant sells a U.S. Treasury
security to another market participant and commits to repurchase the
security at a specified price on a specified later date.\618\ Because
one side of the transaction receives cash, and the other side receives
securities, to be returned at a later date, the transaction is a sale
and purchase of securities that is economically similar to borrowing
cash against securities as collateral. The amount the lender pays for
the security in the initial leg may be less than the market price. The
difference between the market price and the price paid divided by the
market price of the collateral is known as the ``haircut.'' A positive
haircut implies that the loan is over-collateralized: the collateral is
worth more than the cash that is loaned. A related term is ``initial
margin''--the ratio of the purchase price to the market value of the
collateral.
---------------------------------------------------------------------------

\618\ See supra note 74.
---------------------------------------------------------------------------

General collateral repurchases are an important variation on the
above type of transaction, where one participant purchases from a
class, not a specific issue, of U.S. Treasury securities.\619\ U.S.
Treasury repo for a specific asset is generally a bilaterally settled
arrangement, whereas general collateral repurchases are usually settled
with a third agent, known as a triparty agent. In bilaterally settled
repo arrangements (bilateral repo), the repo buyer has the title to the
specific asset in question and can sell or re-hypothecate it. In repo
that is settled through a triparty agent (triparty repo), which is
discussed below, the repo buyer has more limited use of the collateral.
However, this collateral is often re-hypothecated within the same
triparty system; namely, a buyer may use the securities purchased from
the seller for its own reverse repo transaction.
---------------------------------------------------------------------------

\619\ More specifically, general collateral is a set of security
issues which trade in the repo market at the same or a very similar
repo rate. These security issues can therefore be substituted for
one another without changing the repo rate. In other words, the
buyer in a general collateral repo is indifferent to which of the
general collateral securities she will receive. The basket of
security issues that form a particular general collateral repo
market belong to the same class (e.g., government bonds) or sub-
class (e.g., government bonds with no more than five years remaining
to maturity). See International Capital Market Association, [FAQ] 8.
What is General Collateral (GC)?, ICMA ERCC Publications (Jan.
2019), available at https://www.icmagroup.org/market-practice-and-regulatory-policy/repo-and-collateral-markets/icma-ercc-publications/frequently-asked-questions-on-repo/8-what-is-general-collateral-gc.
---------------------------------------------------------------------------

As described in the Proposing Release, repurchase agreements are
generally classified by the term over which they take place, either
``overnight'' or ``term.'' \620\ In overnight repurchase agreements,
the repurchase of the security takes place the day after the initial
purchase, meaning that these agreements serve, essentially, as
overnight loans collateralized by U.S. Treasury securities. Term
repurchase agreements, conversely, take place over a longer
horizon.\621\
---------------------------------------------------------------------------

\620\ See Proposing Release, supra note 14, 87 FR at 64616.
\621\ Overnight repurchase agreements account for 87.5% of daily
transaction volume. See Figure 5 and the associated discussion for
more details. In addition to term repo agreements with fixed
maturity dates, there exist term repurchase agreements with embedded
options that lead to an uncertain maturity date. For example,
``callable'' repos include an option for the lender to call back
debt (i.e., resell securities) at its discretion. ``Open'' repos
have no defined term but rather allow either party to close out at
the contract at any date after initiation of the agreement.
---------------------------------------------------------------------------

U.S. Treasury repo has various economic uses. First, it is
analogous to secured borrowing and lending, allowing some market
participants to, in effect, turn their U.S. Treasury securities

[[Page 2779]]

into cash positions, and others to temporarily invest cash that is not
in use in a way that mitigates exposure to, for example, the
counterparty risk of a depository institution. Bilateral repo can allow
market participants to effectively price interest rate expectations
into bonds, and to arbitrage differences in the market prices of
closely related U.S. Treasury securities, because it provides financing
for U.S. Treasury security purchases and facilitates short sales.
Repos also play a role in monetary policy. The Federal Reserve
operates a reverse repurchase facility in which it receives cash from
eligible market participants in exchange for collateral consisting of
U.S. Treasury securities. The interest rate on these repurchase
agreements is the overnight reverse repurchase offer rate set by the
Federal Reserve to aid implementation of monetary policy by firming up
the floor for the effective Federal funds rate.\622\
---------------------------------------------------------------------------

\622\ See Federal Reserve Bank of New York, Monetary Policy
Implementation, available at https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation.
---------------------------------------------------------------------------

There is some evidence of dealer concentration in repo markets. In
a December 2019 report, the BIS reported that as repo rates rose above
the interest rate on excess reserves in mid-2018, the four largest U.S.
banks appeared to have turned into the marginal lender in repo
markets.\623\ However, in 2021 the Federal Reserve Bank of New York
economists reported that the secured funding portion of the repo market
is competitive.\624\ Using data on centrally cleared U.S Treasury repo
transactions and all triparty settled transactions, the New York Fed
economists filtered the data using the same filters used in the
construction of SOFR in order to eliminate transactions likely driven
by considerations other than secured funding and then reported measures
of dealer concentration.\625\ The authors report that the top 5 (10)
dealers comprise 44.2 (63.6) percent of repo selling (cash-lending)
activity and 40.2 (56.7) percent of repo purchasing (cash-borrowing)
activity and conclude that the centrally cleared and triparty portion
of the repo market is less concentrated than might appear from the BIS
study.\626\
---------------------------------------------------------------------------

\623\ See Fernando Avalos, Torsten Ehlers and Egemen Eren,
September stress in dollar repo markets: passing or structural?, BIS
Q. Rev. (Dec. 2019), available at https://www.bis.org/publ/qtrpdf/r_qt1912v.htm. Up to July 28, 2021, interest was paid at an IORR
(interest on required reserves) rate and at an IOER (interest on
excess reserves) rate. The IORR rate was paid on balances maintained
to satisfy reserve balance requirements, and the IOER rate was paid
on excess balances. Effective Mar. 24, 2020, the Board amended
Regulation D to set all reserve requirement ratios for transaction
accounts to 0%, eliminating all reserve requirements. To account for
those changes, the Board approved a final rule amending Regulation D
to replace references to an IORR rate and to an IOER rate with
references to a single IORB (interest rate on required balance)
rate. See Board of Governors of the Federal Reserve, Interest on
Reserve Balances (IORB) Frequently Asked Questions (July 29, 2021),
available at https://www.federalreserve.gov/monetarypolicy/iorb-faqs.htm.
\624\ Adam Copeland, R. Jay Kahn, Antoine Martin, Matthew
McCormick, William Riordan, Kevin Clark, and Tim Wessel, How
Competitive are U.S. Treasury Repo Markets?, Federal Reserve Bank of
New York Liberty Street Economics (Feb. 18, 2021), available at
https://libertystreeteconomics.newyorkfed.org/2021/02/how-
competitive-are-us-treasury-repo-markets/
#:~:text=In%20contrast%2C%20the%20GCF%20Repo,both%20sides%20of%20the%
20market.
\625\ Among other filters, transactions to which the Federal
Reserve is a counterparty are excluded. See Additional Information
about Reference Rates Administered by the New York Fed, Federal
Reserve Bank of New York (Jan. 24, 2022), available at https://www.newyorkfed.org/markets/reference-rates/additional-information-about-reference-rates#treasury_repo_data_exclusions.
\626\ See supra note 623. The New York Fed makes available data
on top 3 dealer concentration (see Tri-Party/GCF Repo, Federal
Reserve Bank of New York, available at https://www.newyorkfed.org/data-and-statistics/data-visualization/tri-party-repo#interactive/concentration (last visited Dec. 12, 2023)) in the tri-party/GCF
repo segment; however, the New York Fed's statistics treat its own
Overnight Reverse Repo Facility as a dealer. Since the use of this
facility has grown from zero to $2.2 trillion since 2021 Q1, the New
York Fed's data on the concentration of the top 3 ``dealers'' is
difficult to interpret and is not included here.
---------------------------------------------------------------------------

The market for repos is dominated by large, sophisticated
institutions, at least as compared to the cash market. The institutions
that participate in the market for repos are also those for whom access
to central clearing may be the least costly economically. Relatedly,
although difficult to quantify precisely, the number of participants is
one or more orders of magnitude greater in the cash market as compared
with the repo market: e.g., tens of thousands as opposed to thousands.
As Figure 4 shows, the U.S. Treasury securities repurchase market is
large; throughout 2020 and through May of 2021, daily transaction
volume of repo that was either centrally cleared or settled on the
triparty platform ranged between $1.4 and $2.1 trillion per day. Since
May 2021, the daily volume has increased considerably--as high as $4.6
trillion per day--coinciding with the growth in the Federal Reserve's
overnight reverse repurchase operations. Figure 4 further splits these
totals into three categories based on 3 of the 4 repo market components
discussed in part IV.B.3.b supra: non-centrally cleared triparty, FICC
DVP Service, and FICC GCF Repo Service.\627\ Despite steadily
increasing volumes of centrally cleared repurchase transactions, due in
part to the development of services to enable acceptance of more types
of repurchase transactions at the covered clearing agency, the
Commission understands that the volume of bilateral repurchase
transactions that are cleared and settled directly between the two
counterparties remains substantial, representing approximately half of
all bilateral repurchase transactions in 2021.\628\
---------------------------------------------------------------------------

\627\ Figure 4 does not include bilateral repo transactions--
including most inter-affiliate transactions--that are not settled on
the tri-party platform or centrally cleared through FICC for which
comprehensive data is not currently available. Trades resulting from
the Federal Reserve Bank of New York's standing repo facility and
reverse repo facility are cleared and settled on the tri-party
platform and are included in Figure 4. See Federal Reserve Bank of
New York, FAQs: Standing Repo Facility (July 26, 2023), available at
https://www.newyorkfed.org/markets/repo-agreement-ops-faq and
Federal Reserve Bank of New York, FAQs: Reverse Repurchase Agreement
Operations (July 26, 2023), available at https://www.newyorkfed.org/markets/rrp_faq.
\628\ See R. Jay Kahn & Luke M. Olson, Who Participates in
Cleared Repo?, OFR Brief Series (July 8, 2021), available at https://www.financialresearch.gov/briefs/files/OFRBr_21-01_Repo.pdf.

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

[[Page 2780]]

[GRAPHIC] [TIFF OMITTED] TR16JA24.003

The triparty segment of the U.S. Treasury securities repurchase
agreement market is large, with an average of approximately $575
billion of daily trading volume in 2020, and has taken on a
substantially larger role since the beginning of 2021, peaking at
approximately $3.1 trillion in transaction volume in the March of
2023.\629\ Of this, overnight repos is the largest segment, making up
92% on average of daily transaction volume since 2020, as shown in
Figure 5. Although different types of securities are used as collateral
in triparty repos, over 70% of daily volume of triparty repo since 2020
are transactions with U.S. Treasury securities as collateral.\630\ The
remainder are agency securities, referring to mortgage-backed
securities issued by U.S government agencies and government sponsored
enterprises, and various other securities including corporate bonds,
non-U.S. sovereign debt, equity, municipal debt, and commercial
paper.\631\
---------------------------------------------------------------------------

\629\ See Figure 4.
\630\ See Figure 5.
\631\ See Mark E. Paddrik, Carlos A. Ram[inodot]rez, & Matthew
J. McCormick, The Dynamics of the U.S. Overnight Triparty Repo
Market (FEDS Notes, Aug. 2, 2021), available at https://www.federalreserve.gov/econres/notes/feds-notes/the-dynamics-of-the-us-overnight-triparty-repomarket-20210802.htm.

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

[[Page 2781]]

[GRAPHIC] [TIFF OMITTED] TR16JA24.004

3. Clearance and Settlement of U.S. Treasury Security Transactions
The secondary market includes the ``cash market,'' for outright
purchases and sales of securities, and the repo market, where one
participant sells a U.S. Treasury security to another participant and
commits to repurchase the security at a specified price on a specified
later date.\632\ These rule amendments and new rules apply to the
secondary market for U.S. Treasury securities.
---------------------------------------------------------------------------

\632\ See 2021 IAWG Report, supra note 4, at 3. The secondary
market also includes the market for U.S. Treasury futures, which
trade electronically on the Chicago Board of Trade, a designated
contract market operated by the Chicago Mercantile Exchange
(``CME'') Group, and centrally cleared by CME Clearing. U.S.
Treasury futures are generally regulated by the U.S. Commodity
Futures Trading Commission.
---------------------------------------------------------------------------

a. Cash Market
The cash market has two main components: the interdealer market and
the dealer-to-customer market. In the interdealer market, dealers
primarily trade with each other and with principal trading firms
(``PTFs''), which trade as principals for their own accounts. In the
dealer-to-customer market, dealers trade with their customers.
i. Interdealer
The majority of trading in the interdealer market in on-the-run
U.S. Treasury securities occurs on trading platforms operated by IDBs,
as described in part II.A.2.b.ii, supra.\633\ These IDBs are generally
direct participants of a U.S. Treasury securities CCA and stand as
counterparties to both sides of each trade on their platforms.\634\
---------------------------------------------------------------------------

\633\ Joint Staff Report, supra note 4, at 11, 35-36.
\634\ 2021 IAWG Report, supra note 4, at 21.
---------------------------------------------------------------------------

The majority of trades in the interdealer markets are trades in
``on-the-run'' issues. The majority of interdealer trading for off-the-
run U.S. Treasury securities occurs via bilateral transactions through
traditional voice-assisted brokers and electronic trading platforms
offering various protocols to bring together buyers and sellers,
although some interdealer trading in off-the-run U.S. Treasury
securities does occur on IDBs that anonymously bring together buyers
and sellers.\635\
---------------------------------------------------------------------------

\635\ Joint Staff Report, supra note 4, at 35.
---------------------------------------------------------------------------

Most IDBs are FICC direct participants, and the trades between an
IDB, which is a FICC direct participant, and another FICC direct
participant are submitted for central clearing to FICC, which, as
discussed below, is currently the only U.S. Treasury securities CCA.
Direct participants of FICC are generally either dealers (both bank-
affiliated and independent) or banks. FICC's current rules generally
require that FICC direct participants submit for clearing all trades
with other FICC direct participants.\636\ However, FICC's rules do not
require that a trade between a FICC direct participant and a party that
is not a FICC direct participant be submitted for clearing. Therefore,
for trades on IDBs between a party that is not a FICC direct
participant (which, on an IDB, is generally a PTF) and a dealer that is
a FICC direct participant--which results in two separate transactions,
between the IDB and the dealer, on the one hand, and between the IDB
and the PTF, on the other hand--the transaction between the dealer and
the IDB would be centrally cleared. But the transaction between a PTF
which is not a FICC member and the IDB, on the other side, would not be
centrally cleared and instead would be settled bilaterally with the
IDB, often through a clearing agent acting on behalf of the non-FICC
direct participant.\637\
---------------------------------------------------------------------------

\636\ FICC Rule 2A section 7(e) (requirement that FICC Netting
Members submit to FICC all of its eligible trades with other Netting
Members); FICC Rule 18 section 2 (similar requirement with regard to
Repo transactions), supra note 19.
\637\ See TMPG White Paper, supra note 13, at Figures 5A and 5B
(providing graphical description of this type of clearing).

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

[[Page 2782]]

Estimates from the first half of 2017 further suggest that only 13
percent of the cash transactions in the U.S. Treasury securities market
are centrally cleared. These estimates suggest that another 19 percent
of transactions in this market are subject to so-called hybrid clearing
in which one leg of a transaction facilitated by an IDB platform is
centrally cleared and the other leg of the transaction is cleared
bilaterally.\638\
---------------------------------------------------------------------------

\638\ See 2021 IAWG Report, supra note 4, at 30; see also TMPG
White Paper, supra note 13, at 12. The figures are estimated using
FR 2004 data covering the first half of 2017 and are based on
various assumptions: (a) primary dealers account for all dealer
activity, (b) 5% of dealers' trading not through an IDB is with
another dealer, (c) the shares of dealer and non-dealer activity in
the IDB market for coupon securities equal the weighted averages of
the shares reported in the Oct. 15 report (that is, 41.5% and 58.5%,
respectively), (d) only dealers trade bills, FRNs, and TIPS in the
IDB market, and (e) the likelihood of dealer and non-dealers trading
with one another in the IDB market solely reflects their shares of
overall volume. Commission staff understands that these assumptions
may be less appropriate for more recent time periods (e.g., PTFs are
responsible for a growing share of IDB activity).
---------------------------------------------------------------------------

Until the mid-2000s, most inter-dealer trading occurred between
primary dealers who were FICC members and thus was centrally
cleared.\639\ Today, PTFs actively buy and sell large volumes of U.S.
Treasury securities on an intraday basis using high-speed and other
algorithmic trading strategies.\640\ PTFs are not generally FICC
members and, as such, their trades are often not centrally cleared.
Moreover, PTFs compose a substantial portion of trading volume,
averaging about 20% of overall U.S. Treasury cash market volume and
accounting for around 50-60% of IDB volume in outright purchases and
sales of U.S. Treasury securities.\641\ Primary dealers, who are FICC
members and who transact the 40-50% of IDB volume not accounted for by
PTFs, are required by Federal Reserve Bank of New York policy to
centrally clear their U.S. Treasury securities primary market cash
activity.\642\
---------------------------------------------------------------------------

\639\ See G-30 Report, supra note 5; 2021 IAWG Report, supra
note 4, at 5-6; TMPG White Paper, supra note 13, at 6.
\640\ See Joint Staff Report, supra note 4, at 1, 8, 32, 35-36,
39.
\641\ See James Collin Harkrader & Michael Puglia, Principal
Trading Firm Activity in Treasury Cash Markets (FEDS Notes, Aug.
2020) (``Harkrader and Puglia FEDS Notes''), available at https://www.federalreserve.gov/econres/notes/feds-notes/principal-trading-firm-activity-in-treasury-cash-markets-20200804.htm.
\642\ See Federal Reserve Bank of New York, Administration of
Relationships with Primary Dealers, available at https://www.newyorkfed.org/markets/primarydealers.html.
---------------------------------------------------------------------------

As Tables 1 and 2 below show, during the 6-month period ending in
June 2023 trading volume of on-the-run U.S. Treasury securities was
approximately two and half times that of off-the-run U.S. Treasury
securities. Over half (57.9%) of on-the-run U.S. Treasury security
trading volume and approximately one quarter (22.9%) of off-the-run
U.S. Treasury security trading volume occurred on ATSs (which are also
IDBs) and non-ATS IDBs.\643\ Of the on-the-run U.S. Treasury security
trading volume that occurred on ATS IDBs and non-ATS IDBs, 34.0% were
dealer trades, 18.4% were PTF trades, and the remainder were customer
trades. For off-the-run trading in U.S. Treasury securities, the
comparable figures are 19.0% dealer trades, 1.2% PTF trades, and the
remainder are customer trades. In contrast to trades that take place on
an ATS or a non-ATS IDB, 42.0% of on-the-run U.S. Treasury security
transactions and 77.1% of off-the-run U.S. Treasury security
transactions are traded bilaterally. The majority of these (78.5% of
on-the-run and 84.3% of off-the-run) are dealer-to-customer trades.
---------------------------------------------------------------------------

\643\ The term ``IDB'' typically refers only to IDBs that are
also ATSs. The entities referred to as IDBs here are encompassed in
the ATSs category in the tables set forth in this section because of
the way that such IDBs are categorized in TRACE. Specifically, the
``ATS'' category in TRACE encompasses these IDBs. By contrast, the
non-ATS IDBs category in TRACE encompasses the voice-based or other
non-anonymous methods of bringing together buyers and sellers, which
are also sometimes referred to as interdealer brokers by market
participants.
---------------------------------------------------------------------------

Bilaterally cleared trades make up 87% of total trading in the
secondary U.S. Treasury securities market, making them the most
prevalent trade type in the market.\644\ These trades include at least
one party that is not a netting member of the single U.S. Treasury
securities CCA. The bilateral clearing process comes with risks. After
the trade is executed, the principals to the trade face counterparty
credit risk, in the event that either party fails to deliver on its
obligations.\645\
---------------------------------------------------------------------------

\644\ TMPG White Paper, supra note 13, at 12. This figure is
estimated from 2017H1 data and includes approximately 19% hybrid
clearing. As reported by TMPG, the estimates are based on various
assumptions: (a) primary dealers account for all dealer activity,
(b) 5% of dealers' trading not through an IDB is with another
dealer, (c) the shares of dealer and non-dealer activity in the IDB
market for coupon securities equal the weighted averages of the
shares reported in the Oct. 15 report (that is, 41.5% and 58.5%,
respectively), (d) only dealers trade bills, FRNs, and TIPS in the
IDB market, and (e) the likelihood of dealer and non-dealers trading
with one another in the IDB market solely reflects their shares of
overall volume. Commission staff understands that these assumptions
may be less appropriate for more recent time periods (e.g., PTFs are
responsible for a growing share of IDB activity).
\645\ TMPG White Paper, supra note 13, at 13.

Table 1--On-the-Run U.S. Treasury Securities Trading Volume
----------------------------------------------------------------------------------------------------------------
Number of Average weekly Volume share
venues volume ($M) (%)
----------------------------------------------------------------------------------------------------------------
ATSs.......................................................... 16 874,284 49.4
Customer trades........................................... 12 38,338 2.2
Dealer trades............................................. 16 510,296 28.8
PTF trades................................................ 7 325,649 18.4
Non-ATS Interdealer Brokers................................... 24 151,353 8.5
Customer trades........................................... 22 59,639 3.4
Dealer trades............................................. 23 91,714 5.2
Bilateral dealer-to-dealer trades............................. 283 159,760 9.0
Bilateral dealer-to-customer trades........................... 521 584,832 33.0
-------------------------------------------------

[[Page 2783]]

Total................................................. .............. 1,770,229 100.0
----------------------------------------------------------------------------------------------------------------
This table reports trading volume and volume share for ATSs,\a\ Non-ATS interdealer brokers, bilateral dealer-to-
dealer transactions, bilateral dealer-to-customer, and bilateral dealer-to-PTF transactions for on-the-run
U.S. Treasury Securities. On-the-run U.S. Treasury Securities are the most recently issued nominal coupon
securities and Treasury Inflation Protected Securities (TIPS). Nominal coupon securities pay a fixed semi-
annual coupon and are currently issued at original maturities of 2, 3, 5, 7, 10, 20, and 30 years. Treasury
Bills and Floating Rate Notes are excluded. Volume is the average weekly dollar volume in par value (in
millions of dollars) over the six-month period, from Jan. 1, 2023, to June 30, 2023.\b\ Number of Venues is
the number of different trading venues in each category and the number of distinct MPIDs for bilateral
transactions.\c\ Volume Share (%) is the measure of the dollar volume as a percent of total dollar volume.\d\
The volumes of ATSs and non-ATS interdealer brokers are broken out by Customer trades, Dealer trades, and PTF
trades within each group.\e\ Data is based on the regulatory version of TRACE for U.S. Treasury Securities
from Jan. 1, 2023, to June 30, 2023. Bilateral trades are a catchall classification that may include trades
conducted via bilateral negotiation, as well as trades conducted electronically via platforms not registered
with FINRA as an ATS.
\a\ This analysis is necessarily limited to transactions reported to TRACE, which may not be all transactions in
U.S. Treasury securities. Transactions that take place on non-FINRA member ATSs or between two non-FINRA
members are not reported to TRACE. Entities in the ATS TRACE category encompass the IDBs described in the
preamble of this release. By contrast, the non-ATS IDB category in TRACE encompasses the voice-based or other
non-anonymous methods of bringing together buyers and sellers. PTFs that are FINRA members are included as
dealers while PTFs refer to PTFs that are not FINRA members. See Proposing Release note 43 and referencing
text.
\b\ FINRA reports volume as par volume, where par volume is the volume measured by the face value of the bond,
in dollars. See relevant weekly volume files, available at https://www.finra.org/filing-reporting/trace/data/trace-treasury-aggregates.
\c\ Dealers are counted using the number of distinct MPIDs.
\d\ Total dollar volume (in par value) is calculated as the sum of dollar volume for ATSs, non-ATS interdealer
brokers, bilateral dealer-to-dealer transactions, and bilateral dealer-to-customer transactions.
\e\ We identify ATS trades and non-ATS interdealer broker trades using MPID. The regulatory version of TRACE for
U.S. Treasury securities includes an identifier for customer and interdealer trades. Furthermore, we use MPID
for non-FINRA member subscriber counterparties in the regulatory version of TRACE for U.S. Treasury securities
to identify PTF trades on ATSs.

Table 2--Off-the-Run U.S. Treasury Securities Trading Volume
----------------------------------------------------------------------------------------------------------------
Number of Average weekly Volume share
venues volume ($M) (%)
----------------------------------------------------------------------------------------------------------------
ATSs.......................................................... 13 126,489 18.0
Customer trades........................................... 9 10,713 1.5
Dealer trades............................................. 13 107,304 15.2
PTF trades................................................ 5 8,472 1.2
Non-ATS Interdealer Brokers................................... 24 34,796 4.9
Customer trades........................................... 19 7,967 1.1
Dealer trades............................................. 22 26,829 3.8
Bilateral dealer-to-dealer trades............................. 568 85,178 12.1
Bilateral dealer-to-customer trades........................... 732 458,070 65.0
-------------------------------------------------
Total................................................. .............. 704,533 100.0
----------------------------------------------------------------------------------------------------------------
This table reports trading volume and volume share for ATSs,\a\ non-ATS interdealer brokers, bilateral dealer-to-
dealer transactions, bilateral dealer-to-customer, and bilateral dealer-to-PTF transactions for off-the-run
U.S. Treasury Securities. Off-the-run or ``seasoned'' U.S. Treasury Securities include TIPS, STRIPS, and
nominal coupon securities issues that preceded the current on-the-run nominal coupon securities. Number of
Venues is the number of different trading venues in each category and the number of distinct MPIDs for
bilateral transactions. Volume is the average weekly dollar volume in par value (in millions of dollars) over
the six-month period, from Jan. 1, 2023, to June 30, 2023. Volume Share (%) is the measure of the dollar
volume as a percent of the total dollar volume. The volumes of ATSs and non-ATS interdealer brokers are broken
out by Customer trades, Dealer trades, and PTF trades within each group.\b\ Data is based on the regulatory
version of TRACE for U.S. Treasury Securities from Jan. 1, 2023, to June 30, 2023. Bilateral trades are a
catchall classification that may include trades conducted via bilateral negotiation, as well as trades
conducted electronically via platforms not registered with FINRA as an ATS.
\a\ The analysis based on TRACE is necessarily limited to transactions reported to TRACE, which may not be all
transactions in government securities. Transactions that take place on non-FINRA member ATSs or between two
non-FINRA members are not reported to TRACE. The analysis based on TRACE is necessarily limited to
transactions reported to TRACE, which may not be all transactions in government securities. Transactions that
take place on non-FINRA member ATSs or between two non-FINRA members are not reported to TRACE. Entities in
the ATS TRACE category encompass the IDBs described in the preamble of this release. By contrast, the non-ATS
IDB category in TRACE encompasses the voice-based or other non-anonymous methods of bringing together buyers
and sellers. PTFs that are FINRA members are included as dealers while PTFs refer to PTFs that are not FINRA
members. See Proposing Release note 43 and referencing text.
\b\ We identify ATS trades and non-ATS interdealer broker trades using MPID in the regulatory version of TRACE
for U.S. Treasury securities. The regulatory version of TRACE for U.S. Treasury securities includes an
identifier for customer and interdealer trades. Furthermore, we use MPID for non-FINRA member subscriber
counterparties in the regulatory version of TRACE for U.S. Treasury Securities to identify PTF trades on ATSs.

ii. Dealer-to-Customer
Dealer-to-customer trading generally involves ``off-the-run''
issues more often than the interdealer market and typically is
conducted via voice or electronically (i.e., electronic ``request for
quote'' systems referred to in Tables 1 and 2, supra as non-ATS
IDBs).\646\ Trading in the dealer-to-customer cash market is
generally--and has historically been--conducted through bilateral
transactions. Customers have not traditionally traded directly with
other end users.\647\ Rather, non-dealers primarily trade with dealers,
and dealers use the interdealer market as a source of orders and
trading interest to

[[Page 2784]]

help facilitate their trading with customers in the dealer-to-customer
market. Generally, trades in the dealer-to-customer market are not
centrally cleared.\648\
---------------------------------------------------------------------------

\646\ G-30 Report, supra note 5, at 1; TMPG White Paper, supra
note 13, at 1-2.
\647\ See Exchange Act Release No. 90019 (Sept. 28, 2020), 85 FR
87106, 87108 (Dec. 30, 2020).
\648\ G-30 Report, supra note 5, at 1; 2021 IAWG Report, supra
note 4, at 3; TMPG White Paper, supra note 13, at 6.
---------------------------------------------------------------------------

In cash U.S. Treasury security transactions that are bilaterally
cleared, the process generally begins with participants initiating the
trade by an electronic or voice trading platform, and both parties
booking the details of the trade in their internal systems and
confirming the details of the trade with one another. Once the details
are confirmed, each party then sends messages to its clearing or
settlement agents to initiate the clearing process. Different types of
institutions use different clearing and settlement agents, with buy-
side firms typically using custodial banks, dealers using clearing
banks, and hedge funds and PTFs using prime brokers.
b. U.S. Treasury Repo Market
Depending on clearing and settlement practices, the U.S. Treasury
repo market consists of four main components: (1) non-centrally
cleared, settled bilaterally, (2) centrally cleared, settled
bilaterally, (3) non-centrally cleared, settled on a triparty platform,
and (4) centrally cleared, settled on a triparty platform. The Office
of Financial Research has collected transaction level data for
centrally cleared repo transactions since October 2019, and the New
York Fed collects data on triparty repo transactions through its
supervisory role. However, as discussed in part II.A.2.a supra, the
lack of reporting of non-centrally cleared bilateral repo makes
estimating the size of this segment of the repo market difficult.
i. Non-Centrally Cleared Bilateral Repo
For non-centrally cleared bilateral U.S. Treasury repos, the
parties agree to the terms and settle the trades between themselves,
without involving a CCP or other third-party. As mentioned above,
FICC's rules require its direct participants to submit for central
clearing all eligible trades with other direct participants. Therefore,
non-centrally cleared bilateral U.S. Treasury repos may involve at
least one party that is not a FICC direct participant (e.g., a hedge
fund or PTF); alternatively, or additionally, such repos may also
involve a transaction type that FICC does not accept for clearing.
In January of 2022, the Federal Reserve Bank of New York updated
its primary dealer statistics to capture the segments of the repo
market used by primary dealers. On average during the first three
quarters of 2022, the non-centrally cleared bilateral market made up
$1.19 trillion of primary dealer reverse repo (60% of the total) and
$0.94 trillion of primary dealer repo (37% of the total).\649\ At more
than $2 trillion in total exposure, this would make non-centrally
cleared bilateral repo the largest segment of the repo market in gross
exposure by primary dealers.
---------------------------------------------------------------------------

\649\ See Hempel et al. (2022), supra note 563.
---------------------------------------------------------------------------

The Office of Financial Research (OFR) conducted a pilot collection
of data on non-centrally cleared bilateral repurchase agreement trades
spanning nine dealers over three reporting dates in June 2022.\650\
Using that pilot data collection, the OFR finds that with regard to
rates, counterparty types, and collateral, pilot participants' activity
in the non-centrally cleared bilateral repo segment roughly mirrors
their activity in the centrally cleared bilateral segment.\651\
However, as discussed in part IV.B.5 infra, haircuts in this segment
differ from those in the centrally cleared segments.\652\
---------------------------------------------------------------------------

\650\ The OFR has a proposed rulemaking that mandates the
collection of daily transaction level data from certain financial
companies on their non-centrally cleared bilateral repurchase
agreement trades. See supra note 564.
\651\ See Hempel et al. (2023), supra note 564, at 1.
\652\ Id. at 3.
---------------------------------------------------------------------------

ii. Centrally Cleared Bilateral Repo
For centrally cleared bilateral U.S. Treasury repos, for parties
that are FICC direct participants, each party submits agreed-upon trade
details to FICC for central clearing, and those trades are settled
delivery versus payment using the members' clearing banks and/or
Fedwire Securities Service. Market participants that are not direct
participants of FICC may access central clearing through a customer
model, such as the Sponsored Service or the Prime Broker/Correspondent
clearing models.\653\ Although a U.S. Treasury repo transaction
generally encompasses both the start leg and the end leg of a U.S.
Treasury repo, currently the only U.S. Treasury securities CCA does not
provide central clearing for the start leg of certain
transactions.\654\ Central clearing of U.S. Treasury repo is further
discussed below.
---------------------------------------------------------------------------

\653\ See Proposing Release, supra note 14, 87 FR at 64616.
\654\ FICC Rule 11, section 2, supra note 19.
---------------------------------------------------------------------------

Data on the extent of central clearing in the U.S. Treasury
securities market is limited. As discussed previously, the Commission
believes that approximately half of bilateral repo trades are centrally
cleared.\655\
---------------------------------------------------------------------------

\655\ See part IV.B.3.b.i, supra. See also note 75, supra.
---------------------------------------------------------------------------

iii. Non-Centrally Cleared Repo Settled on a Triparty Platform
For non-centrally cleared triparty U.S. Treasury repos, repo buyers
(cash lenders (e.g., money market funds)) provide financing to repo
sellers (cash borrowers (e.g., dealers)). The parties agree to the
terms of a trade and arrange for a clearing bank to facilitate
settlement. Like non-centrally cleared bilateral repos, at least one
party to the transaction is not a FICC member. While the clearing bank
provides a triparty platform to help facilitate the movement of cash
and securities among accounts of counterparties to the transaction, it
does not itself become a counterparty to the transactions and does not
guarantee either counterparty's performance of its obligations.
Collateral posted to the triparty platform generally cannot be
repledged outside the platform, thereby protecting against settlement
fails.\656\
---------------------------------------------------------------------------

\656\ See generally Reference Guide to U.S. Repo and Securities
Lending Markets (Nov. 9, 2015), available at https://www.financialresearch.gov/working-papers/files/OFRwp-2015-17_Reference-Guide-to-U.S.-Repo-and-Securities-Lending-Markets.pdf.
---------------------------------------------------------------------------

iv. Centrally Cleared Repo Settled on a Triparty Platform
For centrally cleared U.S. Treasury triparty repos, the parties are
FICC members that submit agreed-upon trade details to FICC for central
clearing through FICC's General Collateral Finance (``GCF'') Repo
Service. Unlike centrally cleared bilateral repos, these triparty repos
are settled on the clearing bank's triparty platform. Like centrally
cleared bilateral repos, centrally cleared triparty repos are novated
to FICC, and FICC acts as a CCP for these transactions, including by
collecting margin pursuant to its margin methodology for such
transactions. Until recently, centrally cleared triparty repos were
only conducted through the GCF Repo Service between two direct members
of FICC. However, in September 2021, FICC introduced its Sponsored
General Collateral Service (``Sponsored GC Service''), which enables
centrally cleared triparty repos between a sponsored member and its
sponsoring member.\657\ The Sponsored GC Service accepts general
collateral in a number of generic CUSIPs, and though U.S. Treasury
securities are among the

[[Page 2785]]

general collateral types acceptable in the Sponsored GC Service, other
types of collateral including agency and mortgage backed securities are
acceptable for use as collateral as well.\658\ Each type of eligible
collateral for the Sponsored GC Service is assigned its own generic
CUSIP number, and security types are not mixed.\659\
---------------------------------------------------------------------------

\657\ Exchange Act Release No. 92808 (Aug. 30, 2021), 86 FR
49580 (Sept. 3, 2021). Currently, the Bank of New York Mellon
operates the triparty platform that facilitates trades conducted via
the GCF Repo Service and Sponsored GC Service.
\658\ See generally DTCC Sponsored General Collateral Service
(``DTCC SGCS''), available at https://www.dtcc.com/-/media/Files/Downloads/Clearing-Services/FICC/GOV/SponsoredGC-FS-INTL.pdf (last
visited Dec. 11, 2023).
\659\ Id.
---------------------------------------------------------------------------

v. Inter-Affiliate Repo
Current FICC rules require the submission of transactions of a
netting member's ``Covered Affiliate'' with another FICC netting member
where a Covered Affiliate is defined as an affiliate of a netting
member that: (1) is not itself a netting member; (2) is not a foreign
person; and (3) is a broker-dealer, bank, trust company, and/or FCM, if
that transaction is with another netting member or a Covered Affiliate
of another netting member.\660\ FICC rules do not require the
submission of transactions between (1) a netting member and an
affiliate or (2) between a netting member's affiliates.
---------------------------------------------------------------------------

\660\ GSD Rule 11, Section 3 (along with Rule 1 for the
definition of a Covered Affiliate), supra note 19.
---------------------------------------------------------------------------

The Commission understands that inter-affiliate repo transactions
represent an important tool to transfer liquidity and risk within an
affiliated group. These transactions may serve different purposes,
including, but not limited to, providing U.S. Treasury securities for
delivery when an affiliate has taken a long or short position in U.S.
Treasury securities as a hedge against other exposures, allowing the
movement of U.S. Treasury securities to allow them to be posted as
margin on an affiliate's transaction, ensuring that U.S. Treasury
securities can serve as a liquidity buffer for an affiliated bank,\661\
or to meet liquidity composition targets. To get the U.S. Treasury
securities to the appropriate entity with an affiliated group, the
affiliate often enters into repos or reverse repos with a direct
participant of a U.S. Treasury securities CCA.
---------------------------------------------------------------------------

\661\ A liquidity buffer generally refers to liquid assets that
a banking organization manages to enable it to meet expected and
unexpected cash flows and collateral needs without adversely
affecting the banking organization's daily operations. See generally
FRB, FDIC, & OCC, Q&As on Statement Regarding the Use of Capital and
Liquidity Buffers (Mar. 17, 2020), available at https://www.fdic.gov/news/financial-institution-letters/2020/fil20020a.pdf.
---------------------------------------------------------------------------

Using assets and liabilities data reported by the five largest U.S.
broker-dealers in their 2022 annual audited financial statements, the
Commission observed that the value of repo and reverse repo from inter-
affiliate transactions ranges from 25-75% of total repo and reverse
repo reported at the end of year.
4. Central Clearing in the U.S. Treasury Securities Market
Currently, FICC is the sole provider of clearance and settlement
services for U.S. Treasury securities.\662\ On July 18, 2012, FSOC
designated the FICC as a systemically important financial market
utility under Title VIII of the U.S. Dodd-Frank Act. FSOC assigned this
designation on the basis that a failure or a disruption to FICC could
increase the risk of significant liquidity problems spreading among
financial institutions or markets and thereby threaten the stability of
the financial system in the United States.
---------------------------------------------------------------------------

\662\ See part I, supra.
---------------------------------------------------------------------------

Should a trade be centrally cleared, the CCP receives a notice of
the executed trade from both parties, and after comparison (i.e.,
matching of the trade details), the CCP guarantees and novates the
contract, where novation refers to the process by which the CCP becomes
the counterparty to both the buyer and seller in the original trade.
Once the trading day ends and all trades have been reported to the CCP
(i.e., end of T+0), the CCP determines its net obligations to each CCP
participant for each security and communicates the resulting settlement
obligations to the counterparties. The participants then have the
obligation to settle their portion of the trade on T+1. Once this
information is communicated, the participants send instructions to
their settlement agents. In contrast to the bilateral case, central
clearing reduces the credit risk that both parties are exposed to
throughout the trade. While at execution both CCP members hold the
usual counterparty credit risk to one another, this risk is
transformed, generally within minutes of trade execution, when the
trade details are sent to the CCP and the CCP guarantees and novates
the trade. Consequently, both parties to the trade now hold centrally
cleared credit risk, and the CCP has counterparty risk to both members.
Direct membership in FICC typically consists of banks and
registered dealers, who must meet specified membership criteria.\663\
In other markets such as U.S. equity markets, not all active
participants are direct members of the clearing agency. For this
reason, it is likely that under the requirement to clear eligible
secondary market transactions, some market participants will access
clearing indirectly. At FICC, the indirect clearing models are its
Sponsored Program and a prime broker/correspondent clearing
program.\664\ As of August 14, 2023, FICC has 208 direct members.\665\
---------------------------------------------------------------------------

\663\ The Commission believes that not all market participants
likely would satisfy a covered clearing agency's stringent
membership criteria. See 17 CFR 17ad-22(e)(18); FICC Rule 2A, supra
note 19. Even among those that do, legal operational or other
considerations may preclude many market participants from becoming
direct members of a CCP that clears and settles government
securities transactions.
\664\ See, e.g., FICC Rules, 8, 18, 3A (providing for prime
brokerage and correspondent clearing, as well as sponsored
membership), supra note 19.
\665\ See FICC Member Directories, available at https://www.dtcc.com/client-center/ficc-gov-directories (last visited Dec.
12, 2023) (This includes all members who make use of Netting,
Repurchase Netting, and/or GCF services.).
---------------------------------------------------------------------------

Centrally cleared institutional triparty (``CCIT'') membership is a
limited direct membership for entities who buy repo using FICC's GCF
Repo Service that settles using triparty settlement.\666\ In 2017, FICC
developed the CCIT Service to allow repo cash providers to access
central clearing as limited-purpose members without the sponsorship or
intermediation of a direct participant.\667\ These entities pledge to
FICC the purchased securities under their repos in order to secure
their obligation to perform under the transaction. As of July 27, 2023,
there were 7 CCIT members, all of which were affiliated with a single
investment firm.\668\
---------------------------------------------------------------------------

\666\ DTCC, CCIT Service, available at https://www.dtcc.com/clearing-services/ficc-gov/centrally-cleared-institutional-triparty.
\667\ The Commission has not yet approved registered investment
companies to participate in CCIT. See Order Granting Approval of
Proposed Rule Change to Establish the Centrally Cleared
Institutional Triparty Service and Make Other Changes, Exchange Act
Release No. 80574, File No. SR-FICC-2017-005, 82 FR 21439, 21440
n.11 (May 2, 2017).
\668\ DTCC, FICC-Gov Member Directory (July 27, 2023), available
at https://www.dtcc.com/client-center/-/media/Files/Downloads/client-center/FICC/FICC-GSD-Member-Directory-CCIT.xlsx.
---------------------------------------------------------------------------

FICC interacts solely with the Sponsoring Member/direct participant
as agent for purposes of the Sponsoring Member's clients/Sponsored
Members' obligations to and from FICC. Sponsoring Members also
guarantee to FICC the payment and performance obligations of their
Sponsored Members.\669\ Sponsoring Members can

[[Page 2786]]

be either bank direct participants of FICC that meet certain capital
and other requirements or any other FICC direct participant that meets
what FICC determines to be the appropriate financial resource
requirements; in practice, Sponsoring Members include both banks and
broker-dealers.\670\ Sponsored Members have to be ``qualified
institutional buyers'' as defined by Rule 144A under the Securities Act
of 1933, as amended, or otherwise meet the financial standards
necessary to be a ``qualified institutional buyer,'' and currently,
Sponsored Members generally consist of hedge funds, money market funds,
other asset managers, and smaller banks.\671\
---------------------------------------------------------------------------

\669\ See Exchange Act Release No. 51896 (June 21, 2005), 70 FR
36981 (June 27, 2005); see also FICC Rule 3A, supra note 19. For
general information and statistics regarding the Sponsored Service,
see DTCC, Sponsored Service, available at https://www.dtcc.com/clearing-services/ficc-gov/sponsored-membership, as well as part
IV.B.7.d.i infra. The Sponsored Service also allows the submission
of cash transactions; however, at this time, the service is
generally used only for U.S. Treasury repo transactions.
\670\ See FICC Rule 3A, section 2(a) and (b), supra note 19;
DTCC, FICC GSD Member Directory (Oct. 31, 2023), available at
https://www.dtcc.com/-/media/Files/Downloads/client-center/FICC/Mem-GOV-by-name.xlsx (identifying Sponsoring Members as those with
Omnibus accounts).
\671\ See FICC Rule 3A, section 3(a), supra note 19; FICC
Sponsored Membership Listing, available at https://www.dtcc.com/client-center/ficc-gov-directories.
---------------------------------------------------------------------------

The Sponsored Service allows eligible direct participants
(Sponsoring Members) to (i) sponsor their clients into a limited form
of FICC membership (Sponsored Members) and then (ii) submit certain
eligible client securities transactions for central clearing. The
requirement to clear eligible secondary market transactions could
affect Sponsored Members. FICC interacts solely with the Sponsoring
Member/direct participant as agent. Sponsoring Members guarantee to
FICC the payment and performance obligations of its Sponsored
Members.\672\ Following FICC's expansion in 2021 of its Sponsored
Service to allow Sponsored Members to clear triparty repos through the
program,\673\ there are now approximately 350 Sponsoring Members and
approximately 2,200 Sponsored Members \674\ with access to central
clearing. During the 12-month period ending on August 15, 2023, the
total dollar value of Sponsored Members' daily repo and reverse repo
activity ranged from a high of $771.7 billion on June 30, 2023, to a
low of $265.8 billion on September 14, 2022.\675\
---------------------------------------------------------------------------

\672\ See FICC's GSD Rule 3A, supra note 663. Sponsored Members
have to be Securities Act Rule 144A ``qualified institutional
buyers,'' or otherwise meet the financial standards necessary to be
a ``qualified institutional buyer.'' See id., Rule 3A, section 3(a).
\673\ See Self-Regulatory Organizations; Fixed Income Clearing
Corporation; Order Approving a Proposed Rule Change to Expand
Sponsoring Member Eligibility in the Government Securities Division
Rulebook and Make Other Changes, Exchange Act Release No. 85470
(Mar. 29, 2019).
\674\ In its 2022 annual report, DTCC reported that FICC's
sponsored service expanded during the year to more than 35
sponsoring members. DTCC 2022 Annual Report, supra note 737, at 29.
See also supra note 668.
\675\ This information was available from DTCC on the 1 year
version of the FICC Sponsored Activity chart as of Aug. 15, 2023.
DTCC, Sponsored Membership (last updated Dec. 1, 2023), available at
https://www.dtcc.com/charts/membership.
---------------------------------------------------------------------------

Among the various types of financial firms that are Sponsored
Members are (i) over 1,400 funds, including a number of hedge funds,
many money market funds, other mutual funds, and a smaller number of
exchange-traded funds (``ETFs''); \676\ (ii) banks, including a small
number of national, regional Federal Home Loan Banks, and international
banks; and (iii) other asset managers including a few insurance
companies.\677\
---------------------------------------------------------------------------

\676\ For various persons, direct participation in FICC may not
be an alternative to the Sponsored Membership program. For example,
``[a] subset of market participants, such as certain money market
funds, face legal obstacles to joining FICC because they are
prohibited from mutualizing losses from other clearing members in
the way that FICC rules currently require.'' Marta Chaffee and Sam-
Schulhofer-Wohl, infra note 678, at 2.
\677\ FICC Membership Listing, supra note 670.
---------------------------------------------------------------------------

From a direct participant's perspective, clearing a U.S. Treasury
securities transaction at FICC between that participant and its non-
participant counterparty (i.e., a dealer-to-client trade) need not
result in a separate collection of margin for each transaction.
Transactions between direct participants are novated by FICC, and, by
virtue of multilateral netting, all of a member's positions are netted
into a single payment obligation--either to or from the CCP. In
contrast, in a dealer-to-client trade, there is no transaction between
two direct participants that FICC membership rules would require to be
novated to the CCP, and as a result, FICC does not provide any guaranty
of settlement or otherwise risk manage this trade.\678\ In other words,
as one recent publication explained, ``if a dealer were to buy a
security from its own customer and submit this transaction to FICC,
there would be no effect on the dealer's net position at, obligations
to, or guarantees from FICC.'' \679\ Indeed, except for its sponsored
program, because FICC nets all trades at a dealer before calculating
margin, as at present, customer trades with their own dealers generate
no margin requirement and are not collateralized at the CCP.
---------------------------------------------------------------------------

\678\ See Marta Chaffee and Sam-Schulhofer-Wohl, Is a Treasury
Clearing Mandate the Path to Increased Central Clearing?, Chicago
Fed Insights, https://www.chicagofed.org/publications/blogs/chicago-fed-insights/2021/treasury-clearing-mandate (June 23, 2021)
(explaining that this conclusion follows from that fact that ``FICC
nets members' trades for their own accounts against trades by the
members' customers, so the dealer's and customer's sides of the
trade would cancel out in the netting process.'').
\679\ Id.
---------------------------------------------------------------------------

Sponsored Members participating in FICC's Sponsored Service are
indirect members of FICC, and upon novation of their U.S. Treasury
transactions, FICC becomes obligated to such Sponsored Members.\680\
FICC requires that its Sponsoring Members provide margin on a gross
basis for its Sponsored Member positions.\681\ In FICC's correspondent
clearing and prime brokerage clearing models, the client of the netting
member does not have a legal relationship with FICC.\682\ FICC only has
CCP obligation to the correspondent clearer or prime broker itself, as
applicable, who is a FICC member.
---------------------------------------------------------------------------

\680\ FICC-GSD Rule 3A sections 3 (membership) and 7 (novation),
supra note 19.
\681\ FICC Rule 3A, section 10(c), supra note 19. See also The
Depository Trust and Clearing Corporation (DTCC), Making the U.S.
Treasury Market Safer for All Participants: How FICC's Open Access
Model Promotes Central Clearing (white paper, Oct. 2021), available
at https://www.dtcc.com/-/media/Files/Downloads/WhitePapers/Making-the-Treasury-Market-Safer-for-all-Participants.pdf (``DTCC October
2021 White Paper'') at 5-6.
\682\ FICC Rule 8, supra note 19. See DTCC October 2021 White
Paper, supra note 681, at 5, which reports that $80 billion plus of
activity are observed clearing and settling daily through FICC's
correspondent clearing and prime broker clearing models.
---------------------------------------------------------------------------

Certain aspects of FICC's Sponsored Service are worth noting, as
they may have an effect on some market participants' willingness to
participate in the service. For example, once a trade is novated, FICC
makes delivery of cash or securities to the Sponsoring Member as agent
for the Sponsored Member.\683\ Therefore, market participants may
consider the ability of their Sponsoring Member to make delivery to
them in situations in which the Sponsoring Member is in default, when
determining whether to use the Sponsored Service. In addition, if a
Sponsoring Member defaults, FICC continues to guarantee any novated
sponsored trades and may determine whether to close out a sponsored
trade and/or to permit the Sponsored Member to settle the trade.\684\
This may lead a potential sponsored member to decline to enter a
sponsoring relationship unless it was willing to trade bilaterally with
those sponsoring firms. The Commission understands that some Sponsoring
Members also may limit which market participant's trades they are
willing to sponsor based on firm type. Sponsored triparty repo is a
relatively recent addition.\685\ Volumes of sponsored repo

[[Page 2787]]

fluctuate, but they appear to be substantial as Figure 6 shows.
---------------------------------------------------------------------------

\683\ FICC Rule 3A, sections 8 and 9, supra note 19.
\684\ FICC Rule 3, section 14(c), supra note 19.
\685\ See generally DTCC SGCS, supra note 658.
---------------------------------------------------------------------------

In addition, the Commission understands that it is common practice
for sponsoring members to only offer clearing services for transactions
in which the sponsor is the counterparty to the sponsored member. This
bundling of execution and central clearing sponsor services means that
should a non-FICC member wish to centrally clear a U.S. Treasury
transaction, it is limited in the counterparties with which it can
trade to those FICC direct members with which it has an existing
sponsoring member relationship.
[GRAPHIC] [TIFF OMITTED] TR16JA24.005

In order for a CCP to perform as the guarantor of trades that have
been novated to it, the CCP must have resources available to absorb the
costs of clearing member non-performance. FICC is required by
Commission rule to have policies and procedures reasonably designed to
maintain financial resources at the minimum to enable it to cover a
wide range of foreseeable stress scenarios that include, but are not
limited to, the default of the participant family that would
potentially cause the largest aggregate credit exposure in extreme but
plausible market conditions.\686\ A CCP's plan to deal with a clearing
member default is referred to as its default waterfall. The default
waterfall provides an identification of resources that the CCP will use
in attempting to recoup losses from clearing member defaults. The FICC
waterfall comprises the defaulting clearing member's contribution
(i.e., margin, as well as any other resources the member has on deposit
such as excess margin, the proceeds from liquidating the member's
portfolio, and any amounts available from cross-guaranty agreements),
the corporate contribution to the clearing fund, followed by non-
defaulting clearing members' margin.\687\
---------------------------------------------------------------------------

\686\ 17 CFR 240.17ad-22(e)(4)(iii).
\687\ FICC Rule 4, sections 6 and 7, supra note 19.
---------------------------------------------------------------------------

In addition, with respect to liquidity risk, the Commission's rules
require FICC to have policies and procedures reasonably designed to
meet a ``cover-1'' standard and hold qualifying liquid resources
sufficient to complete its settlement obligations in the event of the
default of the largest member and its affiliates.\688\ For example, if
a clearing member has a net long position in a security that has not
yet settled, the CCP must have the cash available to complete the
purchase. The securities can be subsequently liquidated and any losses
that may result would be covered by the resources in the default
waterfall. The first liquidity source that FICC would use in the event
of a member default is the cash portion of the clearing fund.\689\
Second, FICC can pledge securities in the clearing fund as a source of
cash, including securities that would have otherwise been delivered to
the defaulting member.\690\ Should additional liquid resources be
required FICC could make use of the CCLF.\691\
---------------------------------------------------------------------------

\688\ Specifically, the Commission's rules require FICC to have
policies and procedures reasonably designed to maintain sufficient
liquid resources at the minimum in all relevant currencies to effect
same-day and, where appropriate, intraday and multiday settlement of
payment obligations with a high degree of confidence under a wide
range of foreseeable stress scenarios that includes, but is not
limited to, the default of the participant family that would
generate the largest aggregate payment obligation for the covered
clearing agency in extreme but plausible market conditions, and to
hold qualifying liquid resources sufficient to meet that
requirement. See 17 CFR 240.17ad-22(e)(7)(i) and (ii).
\689\ FICC Rule 4, sections 5 and 6, supra note 19.
\690\ Id.
\691\ FICC Rule 22A, section 2a, supra note 19.
---------------------------------------------------------------------------

The CCLF is a rules-based arrangement in which FICC members are
obligated to participate as a condition of their membership. Should
FICC declare a CCLF event, each member would be obligated to enter into
repurchase agreements with FICC up to

[[Page 2788]]

a member-specific limit.\692\ The CCLF is not prefunded, and it is
separate from FICC's margin requirements. Each FICC member is required,
by FICC's rules, to attest that its CCLF requirement has been
incorporated into its liquidity planning and related operational plans
at least annually and in the event of any changes to such Member's CCLF
requirement.\693\ Thus, the members are obligated to have such
resources lined up, which can be costly.\694\
---------------------------------------------------------------------------

\692\ These repurchase agreements may continue for up to 30
days. See FICC Rule 22A, section 2a(a)(L), supra note 19.
\693\ FICC Rule 22A, section 2a(d), supra note 19.
\694\ See Independent Dealer & Trader Association, White Paper
on the Repo Market Affecting U.S. Treasury and Agency MBS 8 (Dec. 6,
2019), available at https://static1.squarespace.com/static/5ad0d0abda02bc52f0ad4922/t/5dea7fb6af08dd44e68f48cc/1575649207172/IDTA+-+White+Paper+%2812.6.19%29-c2.pdf (``In light of the fact that
a significant component of a firm's CCLF obligation is based on its
overnight liquidity exposures at FICC, middle-market dealers
immediately took to reducing their reliance on overnight liquidity.
Some middle-market dealers reduced the size of their portfolio and
extended liquidity terms in place of overnight funding, adding to
both financing and opportunity costs. Others have incorporated
liquidity plans for which commitment and administration fees
materially added to the cost of doing business.'').
---------------------------------------------------------------------------

The CCLF provides a mechanism for FICC to enter into repurchase
transactions based on the clearing activity of the defaulted
participant. Specifically, in the event that FICC declares a CCLF
event, FICC's members would be required to hold and fund their
deliveries to the defaulting member, up to a predetermined capped
dollar amount, by entering into repurchase transactions with FICC until
FICC completes the associated closeout.\695\ The aggregate size of the
CCLF is the historical cover-1 liquidity requirement (i.e., the largest
liquidity need generated by an Affiliated Family during the preceding
six-month period) plus a liquidity buffer (i.e., the greater of 20
percent of the historical cover-1 liquidity requirement or $15
billion).\696\
---------------------------------------------------------------------------

\695\ See generally FICC Rule 22A, section 2a(b), supra note 19.
For details on the process, see Order Approving a Proposed Rule
Change to Implement the Capped Contingency Liquidity Facility in the
Government Securities Division Rulebook, Exchange Act Release No.
82090 (Nov. 15, 2017), 82 FR 52457 (Nov. 21, 2017).
\696\ FICC Rule 1 (definitions of Aggregate Total Amount and
Liquidity Buffer) and 22A, section 2, supra note 19.
---------------------------------------------------------------------------

The first $15 billion of the total amount of the CCLF is shared, on
a scaled basis, across all members. Any remaining amount is allocated
to members who present liquidity needs greater than $15 billion, using
a liquidity tier structure based on frequency of liquidity created
across liquidity tiers in $5 billion increments.\697\ The size of the
CCLF and each member's share is reset every 6 months or as
appropriate.\698\ Figure 7 provides data on the aggregate amount of the
CCLF from 2018 quarter 4 through 2023 quarter 1. The aggregate size of
the CCLF was over $76 billion in 2023 quarter 1.
---------------------------------------------------------------------------

\697\ FICC Rule 22A, section 2a(b)(iii), (iv), and (v), supra
note 663. See also Exchange Act Release No. 82090, supra note 695,
82 FR at 55429-30.
\698\ FICC Rule 22A, section 2a(b)(ii), (iii), (iv), and (v),
supra note 19.
[GRAPHIC] [TIFF OMITTED] TR16JA24.006

[[Page 2789]]

5. Margin Practices in U.S. Treasury Secondary Markets
As described above, posting of margin is one way to manage the risk
of settlement in cash trades. Indeed, for trades that are centrally
cleared, the CCP collects margin on an intraday basis, typically twice
per day.\699\ Varying bespoke arrangements appear to characterize
current margining practices in the bilateral, non-centrally cleared
cash market.\700\ A recent publication stated that competitive
pressures in the bilaterally settled market for repo transactions has
exerted downward pressure on haircuts, sometimes to zero.\701\ The
Commission understands that most non-centrally cleared bilateral repo
trades go unmargined.\702\ For non-centrally cleared repo including
that which is settled using the triparty platform, haircuts serve as a
counterparty credit risk mitigant. The median haircut on U.S. Treasury
collateral for non-centrally cleared bilateral repo that is settled on
the triparty platform has been 2% since at least 2010.\703\
---------------------------------------------------------------------------

\699\ TMPG White Paper, supra note 13, at 3.
\700\ Id. at 3. Non-centrally cleared cash trades are negotiated
and settled bilaterally, and the Commission has little direct
insight into the arrangements market participants use to manage
their counterparty exposure. The TMPG observes in the White Paper
that non-centrally cleared trades are ``. . . not margined in a
uniform or transparent manner, thereby creating uncertainty about
counterparties' exposure to credit and market risk.'' Id.
\701\ G-30 Report, supra note 5, at 13.
\702\ TMPG White Paper, supra note 13, at 3 (``Margining has not
been a common practice for regularly settling bilaterally cleared
transactions. . .'').
\703\ See Tri-Party/GCF Repo, Federal Reserve Bank of New York,
available at https://www.newyorkfed.org/data-and-statistics/data-visualization/tri-party-repo/#interactive/margins.
---------------------------------------------------------------------------

In a study of non-centrally cleared bilateral repo trade data
collected in its June 2022 pilot study, the OFR reports that 74% of all
volume is transacted at zero haircut.\704\ The report also suggests
that this finding is in part due to the use of netted packages, in
which a dealer will conduct both a repo and a reverse repo with the
same counterparty and the same tenor but over different pieces of
Treasury collateral.\705\ The report also provides evidence that
haircuts reflect not only the riskiness of the collateral but also the
relative credit risk of the counterparties. For example, haircuts on
Treasury repo where dealers are selling repo to hedge fund customers
are usually zero or negative, while haircuts where dealers buying repo
from hedge funds are usually zero or positive.\706\
---------------------------------------------------------------------------

\704\ See Hempel et al. (2023), supra note 564, at 3 and 7-9.
\705\ Id.
\706\ Id. at 7.
---------------------------------------------------------------------------

The reduction of haircuts, which serve as the primary counterparty
credit risk mitigant in non-centrally cleared and bilaterally settled
repos, could result in greater exposure to potential counterparty
default risk in non-centrally cleared repos. Such arrangements (in both
cash and repo) may not take into account the value of margin in
protecting against systemic events, because they are designed to be
optimal for the counterparties rather than the larger financial market.
For centrally cleared cash U.S. Treasury transactions, however,
FICC rules dictate that margin must be posted based on the net
positions of all members with the clearing agency.\707\ Positions in
securities with longer maturities--for example, 20+ year U.S. Treasury
bonds--require more margin to be posted because they are more sensitive
to interest rate changes. Required margin is also larger for short
positions, and it rises with volatility in the U.S. Treasury securities
market.\708\ For example, during the first quarter of 2020, a period
which includes the U.S. Treasury securities market disruption of March
2020, total initial margin required was 9.4% higher than the previous
quarter and the average total variation margin paid was 72%
higher.\709\
---------------------------------------------------------------------------

\707\ See Part IV.B.3.4, supra for a discussion of how FICC
requires for margining of sponsored positions.
\708\ See FICC Rule 4, section 1b, supra note 19. FICC's margin
requirements are discussed in more detail below. A key component of
the margin requirement is a Value-at-Risk charge, where the
calculated margin requirement is based in part on the historical
volatility of the traded security. Securities that are more
sensitive to interest rates should have higher VaR, all else equal.
\709\ See CPMI IOSCO Quantitative Disclosure Results for 2020Q1
and 2019Q4, items 6.1.1 and 6.6.1, available at https://www.dtcc.com/legal/policy-and-compliance.
---------------------------------------------------------------------------

FICC Rules set forth the various components of a member's margin
requirements.\710\ The largest component is a Value-at-Risk (VaR)
charge, which is calculated both intraday and end-of-day and reflects
potential price volatility of unsettled positions. FICC typically
calculates VaR using ten years of historical data; for securities
without the requisite amount of data, FICC instead employs a haircut
approach, where the required margin is some percentage of the traded
security's value. Other components of FICC's margin requirements
include a liquidity adjustment charge, which is levied against members
who have large, concentrated positions in particular securities that
FICC determines to be difficult to liquidate, and special charges that
can be levied in response to changes in aggregate market conditions
(such as increases in market-wide volatility).
---------------------------------------------------------------------------

\710\ FICC Rule 4, section 1b, supra note 19.
---------------------------------------------------------------------------

In the market for bilaterally cleared repo, margin typically comes
in the form of haircuts. For example, if a repo buyer is providing $100
of cash in return for $102 of securities from the repo seller, then the
haircut would be $2. The difference between the value of the securities
sold and the initial price paid, which is essentially a form of initial
margin, protects the buyer by making it more costly for the seller to
fail to repurchase the securities as agreed at the end of the repo,
while also protecting the buyer against the risk that short-term
volatility erodes the value of the purchased securities.\711\ The
difference between the cash provided and the value of the securities is
known colloquially as a ``haircut.'' Triparty repo also features
overcollateralization, where the haircut is again negotiated
bilaterally between the two counterparties.\712\ Data from the Federal
Reserve Bank of New York show that a 2% haircut is the norm in the
Triparty/GCF repo market, though there are occasionally some deviations
from the norm.\713\ Money market funds also generally require margin of
2%, which is generally the case for other investment companies as
well.\714\ Outside of money market funds and

[[Page 2790]]

other investment companies, due to the lack of reporting requirements
for bilateral repo, the Commission lacks good insight into margin
practices of participants in the market for bilaterally cleared repo.
Anecdotally, the Commission understands that--as with the cash market--
some participants may not be required to post any margin.\715\
---------------------------------------------------------------------------

\711\ With respect to registered investment company lenders
seeking to rely on Rule 5b-3 under the 1940 Act, the value of the
collateral received under a repo must be at least equal to the
resale price, reduced by the transaction costs (including loss of
interest) that the investment company reasonably could expect to
incur if the cash borrower defaults. See Rule 5b-3(a); (c)(1).
\712\ Although triparty repo transactions are settled through a
clearing bank, the terms of the transactions are bilaterally
negotiated. Although haircuts vary by collateral type, the variance
of haircuts is small for U.S. Treasury repo compared to other
collateral types. See Paddrik et al., supra note 631.
\713\ For data on the median, 10th, and 90th percentiles of
overcollateralization in Triparty repo, see Tri-Party/GCF Repo,
Federal Reserve Bank of New York, available at https://www.newyorkfed.org/data-and-statistics/data-visualization/tri-party-repo. The median level of overcollateralization has been 2% for the
entire period from May 2010 through July 2023. The 10th and 90th
percentiles are also typically 2%, although the 10th percentile has
occasionally fallen to as low as zero--notably, in the summer of
2011, briefly in Sept. 2012, and in the period from Sept. of 2022
through early Jan. of 2023--while the 90th percentile has
occasionally spiked to as high as 5%--specifically in Jan. 2017 and
again in Apr. of the same year.
\714\ See Viktoria Baklanova, Isaac Kuznits, Trevor Tatum,
Primer: Money Market Funds and the Repo Market (Feb. 18, 2021),
available at https://www.sec.gov/files/mmfs-and-the-repo-market-021721.pdf (``MMF Primer'').
\715\ See G-30 Report, supra note 5, at 13 (noting that minimum
margin requirements ``. . . would stop competitive pressures from
driving haircuts down (sometimes to zero), which reportedly has been
the case in recent years.'').
---------------------------------------------------------------------------

While positive haircuts protect the repo buyer, the bilaterally
cleared repo market generally does not feature the same level of
protection for the repo seller. Indeed, one of the main benefits of the
bilateral market to repo buyers is that it allows them to resell the
securities purchased in the start leg of the repo. As a result, repo
sellers are exposed to settlement risk and must manage that risk as
they see fit. In the triparty repo market, securities purchased as part
of a repo transaction remain in the custody of the clearing bank and
cannot be reused by the repo buyer except as collateral in another
triparty repurchase agreement, reducing settlement risk for the repo
seller.
Unlike bilaterally cleared and triparty repo the counterparties to
a centrally cleared repo transaction must post cash margin to the CCP
twice per day, as they do with trades in the cash market. Repo sellers
may be required to post more margin than repo buyers, similar to how in
the bilaterally cleared market repo sellers post margin through
haircuts while repo buyers do not.
6. Disruptions in the U.S. Treasury Securities Market
There have been significant disruptions in the U.S. Treasury
securities market in recent years. Although different in their scope
and magnitude, these events all generally involved dramatic increases
in market price volatility and/or sharp decreases in available
liquidity.\716\ U.S. Treasury securities are generally not information
sensitive in that their payoff is fixed in nominal terms. Moreover,
there is little evidence that information on inflation risk or
expectations could have driven the volatility observed in these
episodes, raising the possibility that the volatility originated in a
buy-sell imbalance, as opposed to fundamental factors. While a market
failure could be the origin of price volatility, the forward-looking
nature of markets can compound liquidity-driven price movements. The
fear of being unable to exit a position can lead to a ``rush to the
exits,'' leading to yet greater price swings. Because U.S. Treasury
securities are standardized, they generally benefit from a deep, ready
market for transactions. Investors count on the ability to move between
cash and U.S. Treasury securities seamlessly.\717\ This makes events
that reduce liquidity in these markets especially striking and
destabilizing to the overall market. Moreover, since the Proposal,
regulators and others have noted the persistence of illiquidity and the
mitigating effect of greater central clearing.\718\
---------------------------------------------------------------------------

\716\ See 2021 IAWG Report, supra note 4, for further discussion
of these and other disruptions. See also Remarks by Under Secretary
for Domestic finance Nellie Liang at the 2022 Treasury Market
Conference, available at https://home.treasury.gov/news/press-releases/jy1110. Under Secretary Liang points out that continued
liquidity concerns are linked to higher volatility since the COVID-
19 shock of Mar. 2020.
\717\ U.S. Treasury securities are often used as substitutes for
cash. There is anecdotal evidence that during Mar. 2020, some market
participants refused U.S. Treasury securities collateral in favor of
cash.
\718\ See Remarks by Under Secretary for Domestic Finance Nellie
Liang at the 2022 Treasury Market Conference available at https://home.treasury.gov/news/press-releases/jy1110, Enhancing The
Resilience of the U.S. Treasury Market: 2022 Staff Progress Report
(Nov 10, 2022), available at https://home.treasury.gov/system/files/136/2022-IAWG-Treasury-Report.pdf), and Darrel Duffie, Resilience
redux in the US Treasury market, Jackson Hole Symposium (Sept. 2,
2023), available at https://www.kansascityfed.org/Jackson%20Hole/documents/9780/JH-2023BW.pdf. See also Darrell Duffie, Michael
Fleming, Frank Keane, Claire Nelson, Or Shachar, and Peter Van
Tassel, B.6.aa, Internal SEC seminar (July 2023), available at
https://www.sec.gov/comments/s7-23-22/s72322-260739-614102.pdf.
---------------------------------------------------------------------------

a. COVID-19 Shock of March 2020
The market for U.S. Treasury securities experienced significant
disruptions in March 2020, characterized by a spike in volume, whose
origins may have been multiple but included high levels of selling by
foreign banks and by hedge funds.\719\ For example, hedge funds, one of
the principal sellers of U.S Treasury futures, hedge their short
futures position by establishing a long position in the cash market,
creating a ``cash-futures basis trade.'' \720\ The cash position of
this trade is often highly levered, using the repo market for
financing. In March, as the U.S. Treasury securities market came under
stress and as repo rates increased in some segments of the repo market,
the economics of the cash-futures basis trade worsened and various
funds found it necessary to unwind at least a portion of their
positions. This unwinding of positions resulted in more outright sales
of U.S. Treasury securities in the cash market, adding further stress
through a feedback loop.\721\
---------------------------------------------------------------------------

\719\ See SEC Staff Report on U.S. Credit Markets
Interconnectedness and the Effects of the COVID-19 Economic Shock
(Oct. 2020), available at https://www.sec.gov/files/US-Credit-Markets_COVID-19_Report.pdf.
\720\ See Ayelen Banegas, Phillip J. Monin, and Lubomir
Petrasek, Sizing hedge funds' Treasury market activities and
holdings (FEDS Notes Oct. 6, 2021), available at https://www.federalreserve.gov/econres/notes/feds-notes/sizing-hedge-funds-treasury-market-activities-and-holdings-20211006.html.
\721\ See supra note 719, at 4. In addition, a similar dynamic
was observed in the risk parity trades, where hedge funds lever up
(through the repo markets) lower volatility fixed-income positions
(e.g., government bonds) to create a risk-equalized portfolio across
asset classes. See also id.
---------------------------------------------------------------------------

During this period, bid-ask spreads increased by a factor of 5, and
market depth on inter-dealer brokers decreased by a factor of 10. The
price of 30-year U.S. Treasury securities fell by 10% in one two-day
period. Arbitrage relations appeared to break down throughout the
market.\722\ This may, as discussed above, have led to the winding down
of the cash-futures basis trade, for example, adding to further
stress.\723\ There also appeared to be large-scale selling from foreign
investors, including official institutions, to address their domestic
currency and liquidity needs.\724\
---------------------------------------------------------------------------

\722\ Duffie, supra note 27.
\723\ See generally Ayelen Banegas et al., supra note 720; see
also Daniel Barth & R. Jay Kahn, Hedge Funds and the Treasury Cash-
Futures Disconnect (Apr. 1, 2021), available at https://www.financialresearch.gov/working-papers/2021/04/01/hedge-funds-and-the-treasury-cash-futures-disconnect/; Mathias S. Kruttli, Phillip
J. Monin, Lubomir Petrasek, & Sumudu W. Watugala, Hedge Fund
Treasury Trading and Funding Fragility: Evidence from the COVID-19
Crisis (working paper Fin. and Econ. Disc. Series 2021-038), Fed.
Res. Bd (Apr. 2021), available at https://www.federalreserve.gov/econres/feds/files/2021038pap.pdf.
\724\ See Colin R. Weiss, Foreign Demand for U.S. Treasury
Securities during the Pandemic (FEDS Notes, Jan. 28, 2022),
available at https://www.federalreserve.gov/econres/notes/feds-notes/foreign-demand-for-us-treasury-securities-during-the-pandemic-20220128.htm.
---------------------------------------------------------------------------

Duffie and Liang and Parkinson, among others, have tied these
patterns to underlying U.S. Treasury securities market structure, in
which intermediation capacity may be reduced relative to the size of
the market and ultimate buyers and sellers may have difficulty locating
each other. These authors discuss ways in which central clearing could
have reduced these problems, mitigating the large price swings due to
illiquidity in the market just when it was most needed.\725\ One view
of central clearing is that it may facilitate all-to-all trading, thus
helping

[[Page 2791]]

ultimate buyers and sellers find each other.\726\ More buyers and
sellers of U.S. Treasury securities could potentially act as additional
sources of liquidity in a market with central clearing.
---------------------------------------------------------------------------

\725\ Duffie, supra note 27; Nellie Liang & Pat Parkinson,
Enhancing Liquidity of the U.S. Treasury Market Under Stress
(Hutchins Ctr. Working Paper No. 72, 2020), available at https://www.brookings.edu/wp-content/uploads/2020/12/WP72_Liang-Parkinson.pdf (``Liang & Parkinson'').
\726\ See Duffie, supra note 27.
---------------------------------------------------------------------------

b. September 2019 Repo Market Disruptions
The repo market experienced a substantial disruption starting
September 16, 2019, when overnight repo rates began to rise, and on
September 17, 2019, when the rise in repo rates accelerated
dramatically. During the episode, the Secured Overnight Financing Rate
(SOFR)--a measure of the average cost of overnight repo borrowing
(e.g., the implied cost of borrowing by selling overnight repo)--spiked
by 300 basis points to over 5% in the course of 2 days. There was also
a wide dispersion around this average; some trades occurred at rates as
high as 9%. On top of this, the spread between the 1st and 99th
percentile rates increased substantially from its average earlier in
2019 of approximately 25 basis points to approximately 675 basis points
during the disruption. The disruption spilled over into the other
markets, with the Effective Federal Funds Rate (EFFR) rising above the
Federal Reserve target by 5 basis points.
The disruption occurred amidst two events: first, a large
withdrawal of reserves from the banking system to service corporate tax
payments due September 16; and second, the settlement of U.S. Treasury
securities auctions. Altogether, the tax payments led approximately
$120 billion to flow away from bank reserves, bringing them down to
their lowest level in 5 years.\727\ Moreover, the auction settlement
raised the supply of U.S. Treasury securities outstanding, which was
accompanied by an increased demand for cash to fund purchases of these
securities. The need for cash reserves played a role in what appears to
be an unwillingness of banks to lend to one another at very high rates.
Less tangibly, market expectations could have played a role; it is
possible that the spike in rates could have been interpreted as a
signal for a future need of cash reserves, leading banks to conserve
cash regardless of what appeared to be strong economic incentives to do
otherwise.
---------------------------------------------------------------------------

\727\ See Sriya Anbil, Alyssa Anderson, and Zeynep Senyuz, What
Happened in Money Markets in September 2019? (FEDS Notes, Feb. 27,
2020), available at https://www.federalreserve.gov/econres/notes/feds-notes/what-happened-in-money-markets-in-september-2019-20200227.htm.
---------------------------------------------------------------------------

While the need for the banking system to replace reserves with cash
may be part of the explanation, in a well-operating market high rates
for overnight borrowing collateralized by U.S. Treasury securities
(i.e., the implied cost of borrowing by selling overnight repo) would
have attracted other market participants. Ultimately, as it did in
March 2020, the Federal Reserve injected reserves into the system--the
economic equivalent of lending to banks. The overnight repo operations
totaled $75 billion on September 17, 2019. Besides directly providing
cash, this perhaps signaled the Fed's willingness and ability to lend
as needed to restore rates to levels that would occur in the absence of
market frictions. In such a setting, a potential benefit of enhanced
clearing for U.S. Treasury repo and cash is its ability to reduce those
market frictions directly, without official sector intervention.
c. October 2014 Flash Rally
In March 2020 U.S. Treasury securities' prices fell, whereas in
September 2019 the rate for lending increased. Both events were
associated with an increase in the cost of borrowing (i.e., the implied
cost of borrowing by selling overnight repo). The events of October 15,
2014, were different in form: in this instance, yields on U.S. Treasury
bonds fell quickly and dramatically, leading to large increases in
prices, without any clear explanation. The intraday range for the 10-
year bond was 37 basis points, one of the largest on record, and far
outside the typical historical distribution.\728\ October 15, 2014,
featured the release of somewhat weaker-than-expected U.S. retail sales
data at 8:30 a.m. ET. While the data appeared to prompt the initial
decline in interest rates, the reaction was far larger than would have
been expected given the modest surprise in the data. Suggestive of some
connection is that the dollar amount of standing quotes in the central
limit order books on cash and futures trading platforms--a measure of
the quantity of liquidity that is commonly referred to as ``market
depth''--fell dramatically in the hour before the event window.
---------------------------------------------------------------------------

\728\ See generally Joint Staff Report, supra note 4.
---------------------------------------------------------------------------

A sudden rise in price does not at first appear as potentially
disruptive as a decline. However, it appears that levered market
participants had taken short positions in anticipation of an increase
in yields. Any further increase in price would have forced these
participants to cover their positions. Indeed, hedge funds became net
buyers of U.S. Treasury securities on the morning of October 15, 2014.
The decline in liquidity may have led to a further concern of an
inability to exit positions. In particular, although the share of
trading volume attributed to PTFs on October 15 does not stand out as
unusual relative to the prior period,\729\ PTFs significantly reduced
the dollar amounts of standing quotes in central limit order
books,\730\ leading to greater pressure on the system. This withdrawal
of liquidity appears to have been motivated by an attempt to manage
risk. Lastly, though broker-dealers increased their trading volume,
they provided less liquidity to the order books by widening their
spreads and in some cases withdrawing for brief periods from the offer
side of the book.\731\
---------------------------------------------------------------------------

\729\ See Joint Staff Report, supra note 4, at 21.
\730\ See 2021 IAWG Report, supra note 4, at 18.
\731\ See id.
---------------------------------------------------------------------------

This disruption showed that market liquidity provision had become
more short-term in nature, some liquidity providers were backed by less
capital, and liquidity was more vulnerable to shocks as a result of the
change in the composition of liquidity providers. In addition,
electronic trading permitted rapid increases in orders that removed
liquidity. These vulnerabilities are similar to ones observed during
the March 2020 events.\732\ As in the previously described episodes,
the price swings illustrate the apparent difficulty for outside capital
at accessing the market. Improved market functioning could have allowed
economic incentives to help stabilize the system: end-users of U.S.
Treasury securities could have reacted to the unusually high prices by
selling. However, such participants would have needed access to pricing
and to the ability to trade.
---------------------------------------------------------------------------

\732\ See id.
---------------------------------------------------------------------------

7. Affected Parties
a. Covered Clearing Agencies for U.S. Treasury Securities: FICC
Although the requirement to clear eligible secondary market
transactions would apply to all U.S. Treasury securities CCAs, FICC's
Government Securities Division, as noted previously, is the sole
provider of clearance and settlement services for U.S. Treasury
securities. FICC is a wholly owned subsidiary of The Depository Trust &
Clearing Corporation (DTCC); DTCC is a private corporation whose common
shares are owned by fee-paying participants in DTCC's clearing agency

[[Page 2792]]

subsidiaries, including FICC.\733\ In 2022 and 2021, FICC's total
clearing revenue was approximately $312.8 million and $310.0 million,
respectively, and its net income was approximately $4.6 million and
$13.4 million, respectively.\734\
---------------------------------------------------------------------------

\733\ See generally Notice of No Objection to Advance Notices,
Exchange Act Rel. No. 74142 (Jan. 27, 2015), 80 FR 5188 (Jan. 30,
2015) (not objecting to a proposal that DTCC's new common share
ownership formula will be based solely on fees paid to its
subsidiary clearing agencies).
\734\ FICC, Consolidated Financial Statements as of and for the
Years Ended Dec. 31, 2022 and 2021, available at https://www.dtcc.com/-/media/Files/Downloads/legal/financials/2023/DTCC-Annual-Financial-Statements-2022-and-2021.pdf.
---------------------------------------------------------------------------

The G-30 Report estimated that ``roughly 20 percent of commitments
to settle U.S. Treasury security trades are cleared through FICC.''
\735\ Although various analyses have noted the increased volume of
secondary market U.S. Treasury transactions that are not centrally
cleared,\736\ the dollar value of transactions FICC clears remains
substantial. In 2022, FICC's GSD processed $1.512 quadrillion in DVP
transactions of U.S. Government securities.\737\ In March 2020,
clearing dollar volume in U.S. Treasury securities at FICC rose ``to
over $6 trillion daily, an almost 43 percent increase over the usual
daily average of $4.2 trillion cleared [at that time].'' \738\
---------------------------------------------------------------------------

\735\ G-30 Report, supra note 5, at 11.
\736\ See, e.g., 2021 IAWG Report, supra note 4, at 5-6 (citing
TMPG White Paper); U.S. Department of the Treasury, A Financial
System That Creates Economic Opportunities Capital Markets (Oct.
2017), available at https://home.treasury.gov/system/files/136/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf (``2017 Treasury
Report''), at 81; Joint Staff Report, supra note 4, at 36-37.
\737\ Performance Dashboard, DTCC 2022 Annual Report, at 44,
available at https://www.dtcc.com/about/-/media/Files/Downloads/Annual-Report-2022/DTCC2022AR-PRINT.pdf. FICC's GSD also process
U.S. Government securities that are not U.S. Treasury securities but
the dollar amount processed of such securities is believed to be
nominal by comparison to that of U.S. Treasury securities.
\738\ DTCC May 2021 White Paper, supra note 307, at 3.
---------------------------------------------------------------------------

There are differences between the degree of central clearing in the
cash and the repo markets. Based on 2017 data, the TMPG estimated that
13 percent of cash U.S. Treasury securities transactions are centrally
cleared; 68 percent are bilaterally cleared; and 19 percent involve
hybrid clearing, in which only one leg of a transaction on an IDB
platform is centrally cleared.\739\ A Federal Reserve staff analysis of
primary dealer repo and reverse repo transactions during the first half
of 2022 found ``that approximately 20 percent of all repo and 30
percent of reverse repo is centrally cleared via FICC.'' \740\ Measured
by dollar volume, repos, according to DTCC, are the largest component
of the government fixed-income market.\741\ In mid-July 2021, according
to Finadium and based on DTCC data, FICC processed $1.15 trillion in
repo, or roughly 25 percent of the $4.4 trillion U.S. repo market at
that time.\742\ For all of 2022, DTCC reported that FICC processed $235
trillion through its GCF Repo Service.\743\
---------------------------------------------------------------------------

\739\ See 2021 IAWG Report, supra note 4, at 30; see also TMPG
White Paper, supra note 13, at 12.
\740\ See Sebastian Infante et al., supra note 75 (``Form FR2004
data only cover activities of primary dealers. Therefore, any
estimate based on that data is likely to underestimate the total
size of the repo market. Discussions with market participants
suggest that the nonprimary dealer's market share is smaller than
that attributed to the primary dealers, but growing.''). The authors
also show that all cleared bilateral repo and reverse repo have U.S.
Treasury securities and TIPS as collateral (the authors' Figure 4);
Viktoria Baklanova, Adam Copeland, and Rebecca McCaughrin, Reference
Guide to U.S. Repo and Securities Lending Markets, N.Y. Fed. Staff
Report No. 740, at 11 (rev. Dec. 2015), available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr740.pdf.
\741\ DTCC, A Guide to Clearance and Settlement, Chapter 8:
Settling Debt Instruments, available at https://www.dtcc.com/clearance-settlement-guide/#/chapterEight (last visited Dec. 12,
2023).
\742\ Finadium, Building Out Industry Data for New Industry
Needs 9 (2021), available at https://finadium.com/wp-content/pdfs/finadium-dtcc-building-out-repo-data.pdf.
\743\ DTCC 2022 Annual Report, supra note 737, at 44.
---------------------------------------------------------------------------

b. Direct Participants at U.S. Treasury Securities CCAs: FICC Netting
Members
The requirement to clear eligible secondary market transactions
would directly affect market participants that are direct participants
in a U.S. Treasury securities CCA, which currently means only direct
participants at FICC's GSD. FICC direct participants are also referred
to as FICC Netting Members. As previously discussed, FICC Netting
Members are the only FICC members eligible to become a counterparty to
FICC to a U.S. Treasury securities transaction, including repo and
reverse repo trades. As of August 14, 2023, FICC's GSD had 208 Netting
Members of which 192 were participants in FICC's repo netting
service.\744\ FICC Netting Members generally consist of bank-affiliated
dealers and registered broker-dealers. These dealers include all 24
financial institutions currently designated by the Federal Reserve Bank
of New York (N.Y. Fed) as ``primary dealers.'' \745\ In 2022, the
average daily trading dollar value in U.S. Treasury securities by
primary dealers was $614.3 billion.\746\ The relative significance of
dealer trading in the cash market for U.S. Treasury securities is shown
in Figure 8.
---------------------------------------------------------------------------

\744\ DTCC, FICC GSD Member Directory (Oct. 31, 2023), available
at https://www.dtcc.com/-/media/Files/Downloads/client-center/FICC/Mem-GOV-by-name.xlsx (107 Netting Members participated in FICC's GCF
service).
\745\ Primary dealers are counterparties to the N.Y. Fed in its
implementation of monetary policy and expected to participate
meaningfully in all U.S. Treasury securities auctions for new
issuances of U.S. Treasury securities. US Dept of the Treasury,
Primary Dealers, available at https://home.treasury.gov/policy-issues/financing-the-government/quarterly-refunding/primary-dealers.
For a current list of primary dealers see List of Primary Dealers,
Federal Reserve Bank of New York, available at https://www.newyorkfed.org/markets/primarydealers.
\746\ SIFMA, 2023 Capital Markets Fact Book, at 56 (July 2023)
available at https://www.sifma.org/wp-content/uploads/2022/07/2023-SIFMA-Capital-Markets-Factbook.pdf (SIMFA's term primary dealers
refers to N.Y. Fed prime brokers). Id. The dollar value of trading
in U.S. Treasury securities by primary dealers has a combined
average annual growth rate of 1.7% for the 10-year period ending in
2022.

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

[[Page 2793]]

[GRAPHIC] [TIFF OMITTED] TR16JA24.007

As previously discussed, the total notional transactions amount in
the repo market is larger than that of the cash U.S. Treasury
securities market. In 2021, average aggregate daily primary dealer
outstanding total repo positions were $4.3 trillion consisting of $2.5
trillion in repo (75% of which is collateralized by U.S. Treasury
securities) and $1.8 trillion in reverse repo (89% of which is
collateralized by U.S. Treasury securities).\747\ As of December 31,
2021, the repo market as a whole was valued at approximately $5.8
trillion.\748\ Although a large portion of this activity is cleared by
FICC, a large portion is also not centrally cleared. For 2021, DTCC
reported that ``FICC matches, nets, settles and risk manages repo
transactions valued at more than $3T daily.'' \749\ During the first
half of 2022, Federal Reserve staff estimated that a ``large fraction
of primary dealers' repo (38 percent) and reverse repo (60 percent)
activity is in the uncleared bilateral segment.'' \750\ See Figure 9.
Although these statistics include all collateral types, for the subset
of the repo market that includes a primary dealer on one side, the
Commission has more detailed data. As Figures 10 and 11 show, the vast
majority of uncleared bilateral and triparty primary dealer repo and
reverse repo collateral consists of U.S. Treasury securities (including
TIPS). The largest remaining components of repo (approximately 40
percent) and reverse repo activity (approximately 8 percent) are not
centrally cleared but settle on the triparty platform.\751\ This is
labeled ``Tri-Party (excluding GCF)'' in Figure 9, and the degree to
which Treasury collateral is used in these transactions is displayed in
Figure 11. The final and by far the smallest component of repo and
reverse repo activity (amounting to about 2% of activity) is triparty
repo using FICC's Sponsored GC service.\752\
---------------------------------------------------------------------------

\747\ SIFMA Research, US Repo Markets: A Chart Book, at 6, 7,
and 8 (Feb. 2022), available at https://www.sifma.org/wp-content/uploads/2022/02/SIFMA-Research-US-Repo-Markets-Chart-Book-2022.pdf.
Because these are figures for primary dealer repo and reverse repo,
they need not be equal. In the aggregate, however, repo must equal
reverse repo.
\748\ The Financial Accounts of the United States, L.207, line 1
(Federal Funds and Security Repurchase Agreements) available at
https://www.federalreserve.gov/releases/z1/20220310/html/l207.htm.
This number includes federal funds and security repurchase
agreements (for all collateral types). Federal funds outstanding on
Dec. 31, 2021, was $49B. Effective Federal Funds Rate, Federal
Reserve Bank of New York, available at https://www.newyorkfed.org/markets/reference-rates/effr. The comparable figures for Dec. 31,
2022, were $6.6T and $67B. The Financial Accounts of the United
States, L.207, line 1 (Federal Funds and Security Repurchase
Agreements), available at https://www.federalreserve.gov/releases/z1/20230608/html/l207.htm and Effective Federal Funds Rate, Federal
Reserve Bank of New York, available at https://www.newyorkfed.org/markets/reference-rates/effr.
\749\ DTCC 2021 Annual Report, supra note 737, at 32.
\750\ Sebastian Infante et al., supra note 75.
\751\ While the concentration among the top three dealers in the
U.S. Treasury securities (excluding Strips) tri-party repo market
ranged between 22% and 50% between 2011 and 2020, between Jan. 2021
and Nov. 2022, the percentage of the volume in this market
attributable to the top three dealers grew from 33.8 percent to
77.6% before falling to 67.7% by July 2023. NY Fed, Data &
Statistics, Visualization Tri-Party/GCF Repo, available at https://www.newyorkfed.org/data-and-statistics/data-visualization/tri-party-repo/-interactive/concentration.
\752\ Id.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P

[[Page 2794]]

[GRAPHIC] [TIFF OMITTED] TR16JA24.008

[GRAPHIC] [TIFF OMITTED] TR16JA24.009

[GRAPHIC] [TIFF OMITTED] TR16JA24.010

[[Page 2795]]

BILLING CODE 8011-01-C
c. Interdealer Brokers
Interdealer brokers \753\ and the trading platforms they operate
play a significant role in the markets for U.S. Treasury securities. As
previously discussed, an IDB will generally provide a trading facility
for multiple buyers and sellers for U.S. Treasury securities to enter
orders at specified prices and sizes and have these orders displayed
anonymously to all users. When a trade is executed, the IDB then books
two trades, with the IDB functioning as the principal to each
respective counterparty, thereby protecting the anonymity of each
party, but taking on credit risk from each of them. Although there is
no legal requirement for an IDB to be a FICC direct participant/Netting
Member, most IDBs are FICC Netting Members.\754\ Under FICC's existing
rules, if an IDB's customer in a U.S. Treasury security transaction is
not a FICC member, the IDB's transaction with that customer need not be
centrally cleared and may be bilaterally cleared. As discussed in the
Proposing Release and in parts II.A.1 and II.A.2.b.ii infra, each
transaction at an IDB is split into two pieces: a leg between the buyer
and the IDB and a leg between the IDB and the seller.\755\ If the buyer
or seller is a dealer, the respective leg is centrally cleared.
Transaction legs involving PTFs are generally not cleared and settled
bilaterally.
---------------------------------------------------------------------------

\753\ As noted previously, IDB is not used to encompass
platforms that provide voice-based or other non-anonymous methods of
bringing together buyers and sellers of U.S. Treasury securities.
IDB instead refers to electronic platforms providing anonymous
methods of bringing together buyers and sellers.
\754\ See generally TMPG White Paper, supra note 13. The TMPG
White Paper assumes throughout that IDBs are CCP direct members
(e.g., ``More specifically, the IDB platforms themselves and a
number of platform participants continue to clear and settle through
the CCP.'' Id. at 2).
\755\ See supra note 14, 87 FR at 64615.
---------------------------------------------------------------------------

TMPG estimates that ``roughly three-quarters of IDB trades clear
bilaterally.'' \756\ To help visualize the significance of the role
played by IDBs in the centrally cleared market, and given existing data
limitations, Table 3, adapted from a table prepared by the TMPG in
2019, presents five clearing and settlement case types that cover the
vast majority of secondary market cash trades. The table uses Federal
Reserve data collected from primary dealers in the first half of 2017
to estimate the daily volume (dollar and share percentage) attributable
to each clearing and settlement case type.
---------------------------------------------------------------------------

\756\ TMPG White Paper, supra note 13, at 2.

Table 3--Estimated Secondary Cash Market Primary Dealer Daily Trading Dollar (Billions) and Percentage Volume by
Clearing and Settlement Type
----------------------------------------------------------------------------------------------------------------
$ Volume Overall
Clearing and settlement type billions Non-IDB share IDB share percentage
----------------------------------------------------------------------------------------------------------------
Bilateral clearing, no IDB...................... $289 95% .............. 54.3
Central clearing, no IDB........................ 15 5% .............. 2.9
Central clearing, with IDB...................... 52 .............. 22.9% 9.8
Bilateral clearing, with IDB.................... 73 .............. 31.9% 13.6
Bilateral/central clearing, with IDB............ 103 .............. 45.3% 19.4
---------------------------------------------------------------
Totals:..................................... 531 $304 (57.2%) $228 (42.8%) 100
----------------------------------------------------------------------------------------------------------------
Source: TMPG White Paper, supra note 13, adapted from a table at p. 12.
Table 3 Notes: Figures are estimated using the Federal Reserves' Form FR2004 data for the first half of 2017 and
are based on the following assumptions: a) primary dealers account for all dealer activity, b) 5% of dealers'
trading not through an IDB is with another dealer, c) the shares of dealer and non-dealer activity in the IDB
market for coupon securities equal the weighted averages of the shares reported in the Oct. 15 report (that
is, 41.5% and 58.5%, respectively), d) only dealers trade bills, FRNs, and TIPS in the IDB market, and e) the
likelihood of dealer and non-dealers trading with one another in the IDB market solely reflects their shares
of overall volume. The table presents estimates because precise information is not available on the size of
the market or on how activity breaks down by the method of clearing and settlement.

d. Other Market Participants
As discussed previously, FICC netting members are generally
registered broker-dealers or banks. Some institutional participants
that are not FICC Netting Members/FICC direct participants are able to
centrally clear repos through FICC's Sponsored Service.\757\
---------------------------------------------------------------------------

\757\ FICC's Sponsored Member program also allows the submission
of cash transactions; however, as previously noted, the service is
generally used only for U.S. Treasury repo transactions at this
time.
---------------------------------------------------------------------------

In addition to Sponsored Members, various types of direct and
indirect market participants hold significant amounts of U.S. Treasury
securities and repo, and potentially purchase and sell U.S. Treasury
securities in the secondary cash and repo markets. To the extent that
these persons engage in secondary market transactions, we expect their
trading may be affected by increased central clearing resulting from
the adoption of the requirement to clear eligible secondary market
transactions.
Other key market participants, some of which are direct
participants and some of which are sponsored members that may be
affected by the rule include:
i. Broker-Dealers That Are Not Direct Participants/FICC Netting Members
Broker-dealers perform a number of functions in the U.S. securities
markets including making markets in securities, brokering securities
transactions, dealing securities, executing securities transactions,
clearing and settling securities transactions, and maintaining custody
of securities for investors. Some broker-dealers may perform multiple
functions whereas others may perform a single function.\758\
---------------------------------------------------------------------------

\758\ Using Form BD data from Sept. 2022, the Commission has
previously stated that 27% of Form BD filers are U.S. Government
Securities Brokers and 10% are U.S. Government Securities Dealers.
See Cybersecurity Risk Management Rule for Broker-Dealers, Clearing
Agencies, Major Security-Based Swap Participants, the Municipal
Securities Rulemaking Board, National Securities Associations,
National Securities Exchanges, Security-Based Swap Data
Repositories, Security-Based Swap Dealers, and Transfer Agents,
Exchange Act Release No. 97142 (Oct. 25, 2022) 87 FR 64610, at
64650-1.
---------------------------------------------------------------------------

Based on 2022 annual FOCUS filings, third quarter 2023 FOCUS
filings, and FICC list of netting members,\759\ there are 3,215 broker-
dealers that are not also FICC netting members. Broker-dealers that are
not FICC netting members are typically much smaller than those that
are. Average assets of all broker-dealers is approximately $2.4 billion
while the average of non-FICC netting member broker-dealers is
approximately $276 million.
---------------------------------------------------------------------------

\759\ See supra note 744.
---------------------------------------------------------------------------

ii. Hedge Funds, Family Offices, and Separately Managed Accounts
Hedge funds are active participants in the secondary market for
U.S. Treasury

[[Page 2796]]

securities and their trading activities may be a cause of price
movements in the U.S. Treasury securities market.\760\ Hedge funds can
use U.S. Treasury securities, for example, in order to borrow cash
(i.e., sell repo) to take leveraged positions in other markets, or to
execute trading strategies. As of December 31, 2022, approximately 21
percent of Form PF filers \761\ that are qualifying hedge funds
reported U.S. Treasury securities holdings totaling $1.70 trillion in
notional exposure in the cash market and $2.13 trillion in notional
exposure to repos.\762\
---------------------------------------------------------------------------

\760\ Ron Alquist & Ram Yamarthy, Hedge Funds and Treasury
Market Price Impact: Evidence from Direct Exposures (OFR working
paper 22-05, Aug. 23, 2022) (``find[ing] economically significant
and consistent evidence that changes in aggregate hedge fund
[Treasury] exposures are related to Treasury yield changes [and] . .
. that particular strategy groups and lower-levered hedge funds
display a larger estimated price impact on Treasuries.''), available
at https://www.financialresearch.gov/working-papers/files/OFRwp-22-05-hedge-funds-and-treasury-market-price-impact.pdf. See also note
720, supra.
\761\ Qualifying hedge funds refers to those hedge funds that
have a net asset value (individually or in combination with any
feeder funds, parallel funds and/or dependent parallel managed
accounts) of at least $500 million as of the last day of any month
in the fiscal quarter immediately preceding its most recently
completed fiscal quarter. See Form PF (Glossary of Terms). Although
the Proposal would cover any hedge fund, smaller funds' holdings are
not reflected in these statistics because of Form PF's minimum $150
million reporting threshold. An adviser must file Form PF if (1) it
is registered (or required to register) with the Commission as an
investment adviser, including if it also is registered (or required
to register) with CFTC as a commodity pool operator or commodity
trading adviser, (2) it manages one or more private funds, and (3)
the adviser and its related persons, collectively had at least $150
million in private fund assets under management as of the last day
of its most recently completed fiscal year. See Form PF General
Instruction No. 1, available at https://www.sec.gov/files/formpf.pdf.
\762\ Division of Investment Management Analytics Office,
Private Funds Statistics Fourth Calendar Quarter 2022, Table 46 at
39 (July 22, 2022), available at https://www.sec.gov/files/investment/private-funds-statistics-2022-q4-accessible.pdf.
---------------------------------------------------------------------------

Family offices are entities established by families to manage
family wealth.\763\ A recent survey of family offices \764\ found that
of 385 participating family offices around the world, almost half (46%)
are based in North America. Average family office AUM for North
American families was $1 billion.
---------------------------------------------------------------------------

\763\ ``Historically, most family offices have not been
registered as investment advisers under the Advisers Act because of
the `private adviser exemption' provided under the Advisers Act to
firms that advice fewer than fifteen clients and meet certain other
conditions.'' SEC Staff, Family Office: A Small Entity Compliance
Guide (Nov. 21, 2011), available at https://www.sec.gov/rules/final/2011/ia-3220-secg.htm.
\764\ Campden Wealth & The Royal Bank of Canada, The North
America Family Office Report 2021, available at https://www.rbcwealthmanagement.com/_assets/documents/cmp/the-north-america-family-office-report-2021-final-ua.pdf.
---------------------------------------------------------------------------

Similarly, Separately Managed Accounts (SMAs) are also portfolios
of assets managed by an investment adviser, usually targeted towards
institutional investors and wealthy individual investors. Because of
the end investor's risk tolerance, SMAs can also pursue high-risk,
leveraged strategies.
iii. Registered Investment Companies (RICs) Including Money Market
Funds, Other Mutual Funds, and ETFs
RICs, mainly money market funds, mutual funds, and ETFs, are large
holders of U.S. Treasury securities.\765\ At the end of the first
quarter of 2023, money market funds held $1.0 trillion of U.S. Treasury
securities ($185 billion in T-Bills and $856 billion in other U.S.
Treasury securities).\766\ Mutual funds held an additional $1.4
trillion of other U.S. Treasury securities ($14 billion of T-Bills and
$1.4 trillion of other U.S. Treasury securities) while exchange-traded
funds held an additional $452.4 billion in U.S. Treasury
securities.\767\ The degree to which these entities would be affected
depends on the extent to which their trading is likely to take place in
the secondary market.\768\
---------------------------------------------------------------------------

\765\ As of Mar. 2022, investment companies were the third
largest holder of U.S. Treasury securities holding just under $3.6
trillion. Viktoria Baklanova, Isaac Kuznits, Trevor Tatum, Money
Market Funds in the Treasury Market (Sept. 1, 2022), available at
https://www.sec.gov/files/mmfs-treasury-market-090122.pdf (``MMFs in
the Treasury Market''), at 3 (citing to Financial Accounts of the
United States as of Mar. 2022). The other large (over 5%) holders
are: ``other'' holders (including hedge funds) 30%, the Federal
Reserve (23 percent), pension funds (14%), and U.S. banks and state
and local governments (each holding 6%). See id. at 2 (figure 5).
\766\ Federal Reserve Statistical Release, Z.1 Financial
Accounts of the U.S, Flow of Funds, Balance Sheets, and Integrated
Macroeconomic Accounts, at 119 (L210 Treasury Securities--lines 42-
49) (``Financial Accounts of the U.S.''), available at https://www.federalreserve.gov/releases/z1/20220609/z1.pdf.
\767\ Id. at 119 (L210 Treasury Securities--lines 45-47 and 49).
Filings of Form N-MFP by money market funds show that, as of May 31,
2023, these funds invested approximately $2.8 trillion in Treasury
repos. In addition, mutual funds invested $27 billion in repurchase
agreements, including those backed by Treasury securities. See supra
note 118 and referencing text.
\768\ For example, an analysis of money market fund portfolios'
turnover of U.S. Treasury securities by the Commission staff
indicates only limited secondary market trading activity. Estimates
based on monthly filings of Form N-MFP suggest that, on average,
money market funds hold around 70% of U.S. Treasury securities to
the next month with around 6% of U.S. Treasury securities holdings
disposed of before maturity. The remaining approximately 23% of
holdings mature during the month. MMFs in the Treasury Market, supra
note 765, at 3. These estimates suggest that the final rule's effect
on money market fund cash market transactions in U.S. Treasury
securities will be very limited relative the final rule's effects on
money market funds' repo activities which could be more significant.
---------------------------------------------------------------------------

RICs are also active participants in the repo market with money
market funds being active cash investors in U.S. Treasury repo.
According to data filed with the Commission, money market funds'
investments in U.S. Treasury repo, both bilateral and triparty,
amounted to approximately $2.46 trillion in June 2023. Moreover, as
shown in Figure 12, money market fund U.S. Treasury repo volume has
grown from approximately $200 billion monthly in 2011 with the vast
majority of the most recent year's growth attributed to investments in
the Federal Reserve's repo facility.\769\
---------------------------------------------------------------------------

\769\ Id. at 4. The Commission understands the credit rating
agencies consider concentration of counterparty credit risk as one
factor in determining their rating of money market funds which may
drive money market funds to seek diversification of counterparties
for the repo transactions.

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

[[Page 2797]]

[GRAPHIC] [TIFF OMITTED] TR16JA24.011

For RICs, holdings of U.S. Treasury securities play an important
role in managing liquidity risk stemming from potential redemptions.
Given their highly liquid nature, U.S. Treasury securities can be used
to raise cash to meet redemptions. For example, a survey conducted by
an industry group showed that in the first quarter of 2020 mutual funds
had net sales of $128 billion in Treasury and agency bonds, mainly to
meet redemption requests at the onset of the Covid-19 pandemic.\770\
---------------------------------------------------------------------------

\770\ See Shelly Antoniewicz & Sean Collins, Setting the Record
Straight on Bond Mutual Funds' Sales of Treasuries, ICI Viewpoints
(Feb. 24, 2022), available at https://www.ici.org/viewpoints/22-view-bondfund-survey-2.
---------------------------------------------------------------------------

In addition to reliance on Treasury securities as sources of
liquidity, RICs use Treasury securities as another source of liquidity
by selling repo. Also, RICs accept Treasury securities as collateral in
their securities lending programs established as an additional source
of income for the fund shareholders. In July of 2023, the Commission
adopted amendments to certain rules that govern money market funds,
that among other things, increased daily and weekly liquid asset
minimums.\771\ As direct obligations of the U.S. Government, including
U.S. Treasury securities, are included in the definition of both daily
and weekly liquid assets,\772\ to the extent that money market funds
currently fall below the minimums, their holdings of U.S. Treasuries
may increase.
---------------------------------------------------------------------------

\771\ See Money Market Fund Reforms; Form PF Reporting
Requirements for Large Liquidity Fund Advisers; Technical Amendments
to Form N-CSR and Form N-1A, Investment Advisors Act Release No.
6344 (Aug. 3, 2023), 88 FR 51404 (``Money Market Reforms Adopting
Release'').
\772\ See supra note 771, at 51431.
---------------------------------------------------------------------------

iv. Principal Trading Firms (PTFs)
The role and importance of PTFs providing liquidity in the U.S.
Treasury securities market have been the subject of a number of
analyses and reports in recent years.\773\ For example, using FINRA's
Regulatory TRACE data in connection with a recent rulemaking proposal,
we identified 174 market participants who were active in the U.S.
Treasury securities market in July 2021 and were not members of
FINRA.^{774 775} We ``found that these participants accounted
for approximately 19 percent

[[Page 2798]]

of the aggregate U.S. Treasury security trading volume, with PTFs
representing the highest volumes of trading among these participants.''
\776\ We explained that in our analysis:
---------------------------------------------------------------------------

\773\ See, e.g., G-30 Report, supra note 5, at 1; Joint Staff
Report, supra note 4, at 3-4, 36, 55 (``PTFs now account for more
than half of the trading activity in the futures and electronically
brokered interdealer cash markets.''); Harkrader and Puglia FEDS
Notes, supra note 641; Doug Brain, Michiel De Pooter, Dobrislav
Dobrev, Michael Fleming, Pete Johansson, Collin Jones, Frank Keane,
Michael Puglia, Liza Reiderman, Tony Rodrigues, and Or Shachar,
Unlocking the Treasury Market Through TRACE (FEDS Notes, Sept. 28,
2018), available at https://www.federalreserve.gov/econres/notes/feds-notes/unlocking-the-treasury-market-through-trace-20180928.htm.
See also Peter Ryan and Robert Toomey, Improving Capacity and
Resiliency in US Treasury Markets: Part III (Nov. 15, 2021),
available at https://www.sifma.org/resources/news/improving-capacity-and-resiliency-in-us-treasury-markets-part-3/. (While in
the interdealer cash market, U.S. Treasury securities are often
cleared and settled through FICC, ``dealer trades with principal
trading firms (``PTFs'')--a very large share of this market--are
generally cleared bilaterally because most PTFs are not members of
the FICC.''). See also 2021 IAWG Report, supra note 4, at 21 (``on
February 25, 2021, a large shift in investor sentiment triggered
very high trading volumes [ ] that temporarily overwhelmed the
intermediation capacity of the Treasury market. Some market
participants observed that the stresses on February 25, 2021, were
exacerbated by lack of elasticity in liquidity supply resulting from
activity limits that IDB platforms impose on some firms, especially
PTFs that do not participate in central clearing.'').
\774\ Further Definition of ``As a Part of a Regular Business''
in the Definition of Dealer and Government Securities Dealer,
Exchange Act Rel. No. 94524 (Mar. 28, 2022), 87 FR 23054, 23072, and
23080 (Apr. 18, 2022) (``Because regulatory TRACE data pertaining to
Treasury securities reported by certain ATSs contains the identity
of non-FINRA member trading parties, we are able to analyze PTFs'
importance in the U.S. Treasury market during July 2021 and
summarize the number and type of market participants by monthly
trading volume . . . .''). ``Although FNRA membership is not
synonymous with dealer registration status, the Commission believes
that many of the market participants who are not FINRA members are
also likely not registered as government securities dealers.'' Id.
at 23072 n. 167.
\775\ In Aug. 2023, the SEC adopted amendments to an exemption
from the requirement for certain broker-dealers to join a national
securities association. The amendments will, among other effects,
enhance the oversight of participants in Treasury markets and the
transparency of the market by requiring certain broker-dealers
significantly involved in the proprietary trading of Treasury
securities to become FINRA members and report their Treasury
transactions to TRACE. See Exemption for Certain Exchange Members,
Exchange Act Release No. 98202 (Sept. 7, 2023), 88 FR 61850
(``Exemption for Certain Exchange Members Release'').
\776\ Id. at 23072.

PTFs had by far the highest volumes among identified non-FINRA
member participants in the U.S. Treasury market, and the largest
PTFs had trading volumes that were roughly comparable to the volumes
of the largest dealers. A Federal Reserve staff analysis found that
PTFs were particularly active in the interdealer segment of the U.S.
Treasury market in 2019, accounting for 61 percent of the volume on
[electronic] interdealer broker platforms. . . .\777\
---------------------------------------------------------------------------

\777\ Id. at 23080. Harkrader and Puglia FEDS Notes, supra note
641. See also Doug Brain et al. supra note 773. Harkrader and Puglia
used FINRA TRACE data on the trading volume shares of different
participant types on IDB platforms for nominal coupon securities
from April 1, 2019, to Dec. 31, 2019. They identified $191 billion
of average daily dollar volume on electronic/automated IDB platforms
during the period. They also noted data limitations, which they
estimated amounted to ``a very small fraction of total activity.''
Id.

Based on this Federal Reserve study and assuming that all PTFs are not
FICC members and that PTF trading on IDB electronic platforms during
the final three quarters 2019 was a reasonable proxy for the average
daily current volume of such trading today by PTFs, the requirement to
clear eligible secondary market transactions would subject as much as
approximately $116.51 billion per day in PTF trades on electronic/
automated IDBs to central clearing.\778\
---------------------------------------------------------------------------

\778\ Harkrader and Puglia FEDS Notes, supra note 641, at table
1 (61% of $191 billion = $116.51 billion).
---------------------------------------------------------------------------

v. State and Local Governments
According to the United States Census Bureau's 2017 Census of
Governments data, there were over 90,000 local governments in the
United States, including county, city, municipality, township, and
special purpose governments as well as nearly 13,000 independent school
district governments.\779\ These state and local governments are
significant holders of U.S. Treasury securities. As of March 2023,
state and local governments held approximately $1.6 trillion in U.S.
Treasury securities \780\ as part of their budgetary and short-term
investment duties.
---------------------------------------------------------------------------

\779\ 2017 Census of Governments--Organization, Table 2: Local
Governments by Type and State: 2017 & Table 9: Public School System
by Types of Organization and State: 2017, U.S. Census Bureau,
https://www.census.gov/data/tables/2017/econ/gus/2017-governments.html.
\780\ Financial Accounts of the U.S., supra note 766 (Line 19).
---------------------------------------------------------------------------

vi. Private Pensions Funds and Insurance Companies.
Insurance companies and pension funds also have significant
positions in U.S. Treasury securities. As of March 2023, private
pension funds and insurance companies are large holders of U.S.
Treasury securities, holding $479.3 billion and $405.9 billion
respectively.\781\
---------------------------------------------------------------------------

\781\ Id. (Lines 29, 32, and 35).
---------------------------------------------------------------------------

e. Triparty Agent: Bank of New York Mellon \782\
---------------------------------------------------------------------------

\782\ Paddrik et al., supra note 631(``The Federal Reserve
Board, through the Federal Reserve Bank of New York (FRBNY),
supervises triparty custodian banks and, on a mandatory basis
pursuant to its supervisory authority, collects transaction-level
data at the daily frequency.'').
---------------------------------------------------------------------------

Although triparty repo transactions are bilaterally negotiated,
they are settled through BNY Mellon, which currently plays a central
role in the triparty repo market as the sole triparty agent.\783\
Besides providing collateral valuation, margining, and management
services, BNY Mellon also provides back-office support to both parties
by settling transactions on its books and confirming that the terms of
the repo are met. Additionally, the clearing bank acts as custodian for
the securities held as collateral and allocates collateral to trades at
the close of the business day. As discussed previously, FICC recently
introduced the Sponsored GC Service that extends FICC's GCF repo
service to allow for the clearing of triparty repo.\784\
---------------------------------------------------------------------------

\783\ J.P. Morgan Chase previously served as a custodian in the
triparty space but largely exited the market in 2019. Id. at 2-3.
\784\ Exchange Act Release No. 92808 (Aug. 30, 2021), 86 FR
49580 (Sept. 3, 2021). Currently, the Bank of New York Mellon
operates the triparty platform that facilitates trades conducted via
the GCF Repo Service and Sponsored GC Service.
---------------------------------------------------------------------------

An expansion of central clearing under the requirement to clear
eligible secondary market transactions could affect BNY Mellon's
triparty business. It is, however, unclear whether increased central
clearing would increase or decrease the amount of repo traded that
makes use of triparty agent's services previously described.
f. Custodian Banks/Fedwire Securities Service (FSS)
Currently, custodian banks handle much of the trading activity for
long-only buy-side clients in the U.S. Treasury securities cash and
repo markets. When an asset buyer and seller engage bilaterally as
principals in a collateralized securities transaction, a repo for
example, a custodian bank will often provide various services to
support the transaction. Custodian services include transaction
settlement verification, verifying the amount of the relevant credit
exposure, calculating required initial and variation margin, and making
margin calls. In a triparty repo transaction that is not centrally
cleared, a custodian performs a clearing function by settling the
transaction on its own books without a corresponding transfer of
securities on the books of a central securities depository.\785\
---------------------------------------------------------------------------

\785\ The Clearing House, The Custody Services of Banks (July
2016), available at https://www.davispolk.com/sites/default/files/20160728_tch_white_paper_the_custody_services_of_banks.pdf.
---------------------------------------------------------------------------

FSS, operated by the Federal Reserve Bank system, provides
issuance, maintenance, transfer and settlement services for all
marketable U.S. Treasury securities to its 3,800 participants.\786\ For
example, FSS offers the ability to transfer securities and funds to
settle secondary-market trades, to facilitate the pledging of
collateral used to secure obligations, and to facilitate repo
transactions.\787\
---------------------------------------------------------------------------

\786\ See Fedwire Securities Service (``FSS brochure''),
FRBservices.org, https://www.frbservices.org/binaries/content/assets/crsocms/financial-services/securities/securities-product-sheet.pdf. The Federal Reserve Banks offer highly competitive
transaction, per-issue and monthly maintenance prices. Account
maintenance fees are waived for accounts holding only U.S. Treasury
securities and for certain accounts used to pledge securities to the
U.S. Treasury and Federal Reserve Banks. Fees for services are set
by the Federal Reserve Banks. See Fedwire Securities Service 2023
Fee Schedules, FRBservices.org, https://www.frbservices.org/resources/fees/securities-2023.
\787\ FSS brochure, supra note 786.
---------------------------------------------------------------------------

C. Analysis of Benefits, Costs, and Impact on Efficiency, Competition,
and Capital Formation

1. Benefits
The amendments being adopted will likely yield benefits associated
with increased levels of central clearing in the secondary market for
U.S. Treasury securities. The Commission previously has stated that
``the centralization of clearance and settlement activities at covered
clearing agencies allows market participants to reduce costs, increase
operational efficiency, and manage risks more effectively.'' \788\
These benefits could be particularly significant in times of market
stress, as CCPs will mitigate the potential for a single market
participant's failure to destabilize other market participants,
destabilize the financial system more broadly, and/or reduce the
effects of misinformation and rumors.\789\ A CCP also will address
concerns about counterparty risk by substituting the creditworthiness
and

[[Page 2799]]

liquidity of the CCP for the creditworthiness and liquidity of
counterparties.\790\ However, the Commission has also recognized that
this centralization of activity at clearing agencies makes risk
management at such entities a critical function.\791\
---------------------------------------------------------------------------

\788\ See CCA Standards Proposing Release, supra note 8, 79 FR
at 29587.
\789\ See, e.g., Liffe Order, supra note 7, 74 FR at 140.
\790\ Id.
\791\ Id.
---------------------------------------------------------------------------

Commenter(s) agreed that certain benefits of increased central
clearing--increasing liquidity, resilience, and intermediation
capacity--exist but disagree that these benefits have been
``sufficiently proven'' to outweigh the potential costs.\792\ As
discussed in part IV.A, supra, improvements to market resilience imply
potentially large expected benefits as the cost of financial market
crises can be high. As discussed in part IV.C.2, infra, the Commission
acknowledges the costs associated with the rule but believes that some
of the costs incurred by market participants are commensurate with the
risks and particular attributes of the market participants'
transactions. It further believes that the overall benefits of
increased clearing U.S. Treasury Securities transactions discussed
below, including improvements to market resiliency, justify the costs.
---------------------------------------------------------------------------

\792\ SIFMA/IIB Letter, supra note 37, at 1-2.
---------------------------------------------------------------------------

Bilateral clearing arrangements do not allow for multilateral
netting of obligations, which reduce end-of-day settlement
obligations.\793\ Larger gross settlement obligations, which increase
with leverage, increase operational risks and subsequently the
possibility of settlement fails. Central clearing of transactions nets
down gross exposures across participants, which reduces firms'
exposures while positions are open, and typically reduces the magnitude
of cash and securities flows required at settlement.\794\ These
reductions, particularly in cash and securities flow ``would reduce
liquidity risks associated with those settlements and counterparty
credit risks associated with failures to deliver on the contractual
settlement date,'' not only for CCP members but for the CCP
itself.\795\
---------------------------------------------------------------------------

\793\ See part IV.A supra for a discussion of central clearing
and the mitigation of clearance and settlement risks. However,
bilateral clearing does allow for balance sheet netting under
certain conditions and for margining of net positions that may
include multiple asset classes.
\794\ See 2021 IAWG Report, supra note 4, at 30.
\795\ See G-30 Report, supra note 5; see also PIFS Paper, supra
note 76 at 28-31.
---------------------------------------------------------------------------

It has been suggested that wider central clearing could have
lowered dealers' daily settlement obligations in the cash market by up
to 60 percent in the run-up to and aftermath of the March 2020 U.S.
Treasury securities market disruption and reduced settlement
obligations by up to 70 percent during the disruption itself.\796\ The
reduction in exposure is not limited to the cash market; it has been
estimated that the introduction of central clearing for dealer-to-
client repos would have reduced dealer exposures from U.S. Treasury
repos by over 80% (from $66.5 billion to $12.8 billion) in 2015.\797\
---------------------------------------------------------------------------

\796\ Id. See also Michael Fleming & Frank Keane, Netting
Efficiencies of Marketwide Central Clearing (Staff Report No. Staff
Report No. 964), Federal Reserve Bank Of New York (Apr. 2021)
(``Fleming & Keane (2021''), available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr964.pdf.
\797\ PIFS Paper, supra note 76, at 29 (citing OFFICE OF
FINANCIAL RESEARCH, Benefits and Risks of Central Clearing in the
Repo Market, 5-6 (Mar. 9, 2017) (``2017 OFR Report''), available at
https://www.financialresearch.gov/briefs/files/OFRBr_2017_04_CCP-for-Repos.pdf).
---------------------------------------------------------------------------

The benefits of multilateral netting flowing from central clearing
can improve market safety by lowering exposure to settlement
failures.\798\ Multilateral netting can also reduce the regulatory
capital required to support a given level of intermediation activity
\799\ and could also enhance capacity to make markets during normal
times and stress events because existing bank capital and leverage
requirements recognize the risk-reducing effects of multilateral
netting of trades that CCP clearing accomplishes.\800\ By reducing the
level of margin required to support a given total level of trading
activity, central clearing may reduce total risk to the system.
Financial crises are sometimes precipitated by margin calls following a
period of increased volatility. If a market participant holds
offsetting positions, then margin calls that might occur could be
avoided. Because financial markets are forward-looking, reducing the
anticipation of margin calls on other market participants can avoid
costly ``bank-run'' type dynamics.\801\
---------------------------------------------------------------------------

\798\ Duffie, supra note 27, at 15.
\799\ See part IV.A supra for an example of how multilateral
netting can reduce margin required to support a given level of
trading activity.
\800\ See 2021 IAWG Report, supra note 4, at 30; Liang &
Parkinson, supra note 725, at 9; Duffie, supra note 27, at 16-17. It
is important to note that this netting may offset any potentially
higher liquidity charges faced by major participants from clearing
at the CCP. See Duffie, supra note 27, at 17 (``To the contrary, the
netting of most purchases against sales at a CCP would lower the
overall liquidity requirements of dealers, assuming that dealers
continue to intermediate the market effectively.'').
\801\ See Menkveld and Vuillemey supra note 568.
---------------------------------------------------------------------------

Some benefits associated with capital reductions are particularly
relevant for overnight and term repo. In the case of financing activity
in U.S. Treasury securities market--U.S. Treasury repo--the entire
notional value of the position has to be recorded on a dealer's balance
sheet as soon as the start leg of the repo settles, and unless the
dealer faces the same legal counterparty with respect to an offsetting
financing trade of the same tenor, the dealer will not be able to net
such balance sheet impact against any other position. The grossing up
of the dealer's balance sheet in this manner can have implications with
respect to the amount of capital the dealer is required to reserve
against such activity. When transactions are cleared through a CCP,
dealers can offset their centrally cleared repo positions of the same
tenor, and thereby free up their capital to increase funding capacity
to the market.\802\ According to research that Finadium conducted among
repo dealers, netting can compress High Quality Liquid Asset (HQLA)
bilateral trading books by 60% to 80%.\803\
---------------------------------------------------------------------------

\802\ The positive impact on dealer's ability to increase
funding capacity will be offset, in part, by the direct and indirect
costs of central clearing. See id. and part IV.C.2 infra. One
commenter, although not supporting all aspects of the requirement to
clear eligible secondary market transaction, agreed that a clearing
mandate applied to bilateral repo transactions would be beneficial,
pointing to the balance sheet efficiency resulting from repo
clearing. See MFA Letter, supra note 81, at 13.
\803\ Finadium LLC, Netting Rules for Repo, Securities Lending
and Prime Brokerage (Sept. 2014), available at https://finadium.com/finadium-report-desc/netting-rules-for-repo-securities-lending-and-prime-brokerage/. Assets are considered to be HQLA if they can be
easily and immediately converted into cash at little or no loss of
value. The test of whether liquid assets are of ``high quality'' is
that, by way of sale or repo, their liquidity-generating capacity is
assumed to remain intact even in period of severe idiosyncratic and
market stress. See Liquidity Coverage Ratio Standards LCR30.2, LCR
30.3 (Basel Comm. On Banking Supervision 2019), available at https://www.bis.org/basel_framework/chapter/LCR/30.htm?tldate=20191231&inforce=20191215.
---------------------------------------------------------------------------

Cash and repo trades cleared and settled outside of a CCP may not
be subject to the same level of uniform and transparent risk management
associated with central clearing.\804\ By contrast, FICC is subject to
the Commission's risk management requirements addressing financial,
operational, and legal risk management, which include, among other
things, margin requirements commensurate with the risks and particular
attributes of each relevant product, portfolio, and market.\805\ As the
Commission believes that the amendments being adopted will incentivize
and facilitate additional central clearing in the U.S. Treasury
securities market, risk management should improve. To offset the risks
it faces as a central counterparty, the CCP requires its members to
post margin,

[[Page 2800]]

and the CCP actively monitors the positions its members hold. Moreover,
in the event that the posted margin is not enough to cover losses from
default, the CCP has a loss-sharing procedure that mutualizes loss
among its members.
---------------------------------------------------------------------------

\804\ See TMPG Repo White Paper, supra note 75.
\805\ G-30 Report, supra note 5, at 13; 17 CFR 240.17ad-
22(e)(6).
---------------------------------------------------------------------------

By lowering counterparty risk, central clearing also allows for the
``unbundling'' of counterparty risk from other characteristics of the
asset that is being traded. This unbundling makes the financial market
for Treasury securities more competitive.\806\
---------------------------------------------------------------------------

\806\ ``One of the conditions for a perfectly competitive market
is that [market participants] are happy to [buy or sell] from any of
the many [sellers or buyers] of the [asset]. No [buyer or seller] of
the [asset] has any particular advantage . . .'' David M. Kreps, ``A
Course in Microeconomic Theory'' Princeton University Press (1990),
at 264 (describing the conditions of a perfectly competitive
market.) When the transaction is novated to the CCP, market
participants substitute the default risk of the CCP for that of the
original counterparty.
---------------------------------------------------------------------------

The Commission also believes that these amendments will help avoid
a potential disorderly default by a member of any U.S. Treasury
securities CCA. Defaults in bilaterally settled transactions are likely
to be disorganized and subject to variable default management
techniques, often subject to bilaterally negotiated contracts with
potentially limited uniformity. Independent management of bilateral
credit risk creates uncertainty about the levels of exposure across
market participants and may make runs more likely; any loss stemming
from closing out the position of a defaulting counterparty is a loss to
the non-defaulting counterparty and hence a reduction in its capital in
many scenarios.\807\
---------------------------------------------------------------------------

\807\ See TMPG White Paper, supra note 13, at 32.
---------------------------------------------------------------------------

Increased use of central clearing should enhance regulatory
visibility in the critically important U.S. Treasury securities market.
Specifically, central clearing increases the transparency of settlement
risk to regulators and market participants and, in particular, allows
the CCP to identify concentrated positions and crowded trades,
adjusting margin requirements accordingly, which should help avoid
significant risk to the CCP and to the system as a whole.\808\
---------------------------------------------------------------------------

\808\ Duffie, supra note 27, at 15; DTCC October 2021 White
Paper, supra note 681, at 1; 2021 IAWG Report, supra note 4.
---------------------------------------------------------------------------

As discussed further below, the Commission is unable to quantify
certain economic benefits of these amendments. The Commission solicited
comment, including estimates and data from interested parties, that
would help inform the estimates of the economic effects of the
amendments but received only limited data, discussed further in part
IV.C.2.a infra, that could be used to improve these estimates.
a. U.S. Treasury Securities CCA Membership Requirements
The Commission is amending Rule 17ad-22(e)(18) to require any
covered clearing agency that provides central counterparty services for
transactions in U.S. Treasury securities to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to, as applicable, require that direct participants of a
covered clearing agency submit all eligible secondary market U.S.
Treasury securities transactions in which they enter for clearing at a
covered clearing agency.\809\ As previously explained in part II.A.2
supra, as proposed an eligible secondary market transaction in U.S.
Treasury securities was defined to include: (1) repurchase agreements
and reverse repurchase agreements in which one of the counterparties is
a direct participant; (2) any purchases and sales entered into by a
direct participant that is an interdealer broker, meaning if the direct
participant of the covered clearing agency brings together multiple
buyers and sellers using a trading facility (such as a limit order
book) and is a counterparty to both the buyer and seller in two
separate transactions; (3) any purchases and sales of U.S. Treasury
securities between a direct participant and a counterparty that is
either a registered broker-dealer, government securities dealer, or
government securities broker; a hedge fund; \810\ or an account at a
registered broker-dealer, government securities dealer, or government
securities broker where such account may borrow an amount in excess of
one-half of the net value of the account or may have gross notional
exposure of the transactions in the account that is more than twice the
net value of the account.\811\ However, any transaction (both cash
transactions and repos) where the counterparty to the direct
participant of the CCA is a central bank, sovereign entity,
international financial institution, or a natural person would be
excluded from the definition of an eligible secondary market
transaction.
---------------------------------------------------------------------------

\809\ See part II.A.1 supra.
\810\ For the purpose of the proposed rule, a hedge fund is
defined as any private fund (other than a securitized asset fund):
(a) with respect to which one or more investment advisers (or
related persons of investment advisers) may be paid a performance
fee or allocation calculated by taking into account unrealized gains
(other than a fee or allocation the calculation of which may take
into account unrealized gains solely for the purpose of reducing
such fee or allocation to reflect net unrealized losses); (b) that
may borrow an amount in excess of one-half of its net asset value
(including any committed capital) or may have gross notional
exposure in excess of twice its net asset value (including any
committed capital); or (c) that may sell securities or other assets
short or enter into similar transactions (other than for the purpose
of hedging currency exposure or managing duration). This definition
of a hedge fund is consistent with the Commission's definition of a
hedge fund in Form PF. See Proposing Release, supra note 14 at
64623.
\811\ Id.
---------------------------------------------------------------------------

In a change from the proposal, the Commission is modifying the
definition of an eligible secondary market transaction in Rule 17ad-
22(a) to conditionally exclude inter-affiliate transactions.\812\
Specifically, the Commission is excluding from that definition any
repurchase or reverse repurchase agreement collateralized by U.S.
Treasury securities entered into between a direct participant and an
affiliated counterparty, provided that the affiliated counterparty
submit for clearance and settlement all other repurchase or reverse
repurchase agreements collateralized by U.S. Treasury securities to
which the affiliated counterparty is a party.\813\
---------------------------------------------------------------------------

\812\ See part IV.B.3.b.v supra.
\813\ See part II.A.2.a supra.
---------------------------------------------------------------------------

As discussed in part II.A.2.a.vi, supra, inter-affiliate
transactions are used to transfer liquidity and risk within an
affiliated group. These transactions may serve different purposes,
including, but not limited to, providing U.S. Treasury securities for
delivery when an affiliate has taken a long or short position in U.S.
Treasury securities as a hedge against other exposures, allowing the
movement of U.S. Treasury securities to allow them to be posted as
margin on an affiliate's transaction, ensuring that U.S. Treasury
securities can serve as a liquidity buffer for an affiliated bank,\814\
or to meet liquidity composition targets. To get the U.S. Treasury
securities to the appropriate entity with an affiliated group, the
affiliate often enters into repos or reverse repos with a direct
participant of a U.S. Treasury securities CCA.
---------------------------------------------------------------------------

\814\ See supra note 238.
---------------------------------------------------------------------------

As discussed above, one commenter stated that requiring inter-
affiliate transactions to be centrally cleared would impose additional
costs with limited benefits.\815\ While the costs of clearing inter-
affiliate transactions may be similar to those of other transactions,
the Commission agrees with the commenter that the potential benefits of
clearing these transactions is likely to be less. For example, the
commenter noted that a direct participant's affiliate's credit risk is
already part of the group-wide financial risks to which the Treasury
CCP is exposed, and central clearing of inter-affiliate transactions is
unlikely to meaningfully impact the risk

[[Page 2801]]

profile.\816\ As discussed above, in certain circumstances, the
counterparty credit risk posed by inter-affiliate transactions may be
less than other transactions.\817\ However, affiliated entities are
separate legal entities and, generally, are not legally responsible for
each other's contractual obligations therefore while there may be a
benefit of reducing counterparty credit risk by centrally clearing such
transactions, the benefit is likely to be less.
---------------------------------------------------------------------------

\815\ SIFMA/IIB Letter, supra note 37, at 21-22.
\816\ Id.
\817\ See supra note 239.
---------------------------------------------------------------------------

In additional changes from the proposal and for the reasons
discussed above, the Commission is adding additional exclusions to the
definition of an eligible secondary market transaction for any
repurchase or reverse repurchase agreement collateralized by U.S.
Treasury securities in which one counterparty is a state or local
government, a covered clearing agency providing central counterparty
services, a derivatives clearing organization (see 7 U.S.C. 7a-1 and 17
CFR 39.3), or is regulated as a central counterparty in its home
jurisdiction.\818\ In the absence of the exclusion, these types of
entities may not be able to transact with netting members of a CCA,
reducing the available counterparties with which they could transact
and likely resulting in adverse impacts on the prices that are
available to them.
---------------------------------------------------------------------------

\818\ See part II.A.2.a supra.
---------------------------------------------------------------------------

The amendment to Rule 17ad-22(e)(18) will increase the fraction of
secondary market U.S. Treasury securities transactions required to be
submitted for clearing at a covered clearing agency. The Commission
believes that this should result in achieving the benefits associated
with an increased level of central clearing discussed in this section.
i. Scope of the Requirement To Clear Eligible Secondary Market
Transactions
A significant share of both cash and repo transactions in U.S.
Treasury securities, including those of direct participants in a
covered clearing agency, are not currently centrally cleared.\819\ The
Commission believes that covered clearing agency members not centrally
clearing cash or repo transactions in U.S. Treasury securities create
contagion risk to CCAs clearing and settling such transactions, as well
as to the market as a whole, and that this contagion risk can be
ameliorated by centrally clearing such transactions.
---------------------------------------------------------------------------

\819\ See DTCC May 2021 White Paper, supra note 307, at 5; 2021
IAWG Report, supra note 4, at 6.
---------------------------------------------------------------------------

Currently, FICC, the only U.S. Treasury securities CCA, requires
its direct participants to submit for central clearing their cash and
repo transactions in U.S. Treasury securities with other members.\820\
However, FICC's rules do not require its direct participants, such as
IDBs, to submit either cash or repo transactions \821\ with persons who
are not FICC members for central clearing.
---------------------------------------------------------------------------

\820\ FICC Rule 2A, section 7(e) (requirement that FICC Netting
Members submit to FICC all of their eligible trades with other
Netting Members); FICC Rule 18, section 2 (similar requirement with
regard to Repo transactions); cf. FICC Rule 3, section 8(e)
(providing clearing requirement for FICC IDB Members), supra note
19.
\821\ With regard to Sponsored GC Repos, as noted above, these
transactions can be secured with generic CUSIPs that include U.S.
Treasury securities, and with other generic CUSIPs that include
other securities, such as agency securities and mortgage backed
securities. Because the requirement to clear eligible secondary
market transactions is limited to eligible secondary market
transactions in U.S. Treasury securities, it would not apply to
Sponsored GC Repo generic CUSIPs that do not include U.S. Treasury
securities.
---------------------------------------------------------------------------

The expanded scope of the requirement to clear eligible secondary
market transactions should reduce instances of ``hybrid'' clearing,
where FICC lacks visibility on the bilaterally cleared component of a
trade. As discussed in the Proposing Release, trades cleared and
settled outside of a CCP may not be subject to the same level of risk
management associated with central clearing, which includes
requirements for margin determined by a publicly disclosed method that
applies objectively and uniformly to all members of the CCP, loss
mutualization, and liquidity risk management.\822\ The requirement to
clear eligible secondary market transactions should not only result in
the consistent and transparent application of risk management
requirements to trades that are now bilaterally cleared but also
increase the CCA's awareness of those trades, which it now lacks.\823\
---------------------------------------------------------------------------

\822\ See supra note 14, 87 FR at 64616; 2021 IAWG Report, supra
note 4, at 30; G-30 Report, supra note 5.
\823\ See supra note 369.
---------------------------------------------------------------------------

The definition of an eligible secondary market transaction applies
to all types of transactions that are of a type currently accepted for
clearing at a U.S. Treasury securities CCA; it does not impose a
requirement on a U.S. Treasury securities CCA to offer additional
products for clearing. One commenter specifically agreed that the
proposal should apply to the types of transactions that are eligible
for clearing at a U.S. Treasury securities CCA, as those eligibility
criteria evolve over time. The commenter stated that such an approach
would ensure that the requirement would not inadvertently give rise to
risk or undue costs by forcing into central clearing transaction types
that have not gone through a methodical risk analysis or for which the
costs may outweigh the benefits, while at the same time, it would allow
the requirement to evolve as U.S. Treasury securities CCAs, their
direct participants, and regulators identify transaction types that
would benefit from central clearing.\824\
---------------------------------------------------------------------------

\824\ DTCC/FICC Letter, supra note 33, at 12-13.
---------------------------------------------------------------------------

ii. Application of the Requirement To Clear Eligible Repo Transactions
The requirement to clear eligible secondary market transactions
requires that all direct participants of a U.S. Treasury securities CCA
submit for clearing all eligible secondary market transactions that are
repurchase agreements or reverse repurchase agreements. As discussed in
part IV.B.5 supra, risk management practices in the bilateral clearance
and settlement of repos are not uniform across market participants and
are less transparent than analogous practices under central
clearing.\825\ Many commenters supported the definition of an eligible
secondary market transaction as it relates to repo and reverse repo
transactions.\826\ These commenters encouraged a broad and
comprehensive definition to limit market fragmentation and avoidance of
central clearing.
---------------------------------------------------------------------------

\825\ TMPG Repo White Paper, supra note 75, at 1.
\826\ See supra note 81.
---------------------------------------------------------------------------

The benefits of central clearing--including the benefits of
netting--increase with the fraction of total volume of similar
transactions submitting for clearing at a CCP. Significant gaps persist
in the current coverage of transaction data in U.S. Treasury repo.\827\
The Commission understands that, among bilaterally settled repo,
approximately half was centrally cleared as of 2021.\828\ Centrally

[[Page 2802]]

cleared triparty repo is a relatively new service, and the proportion
may be smaller. Thus, despite the volume of centrally cleared repo
transactions as seen in Figure 10 above, and the development of
services to encompass more types of repo transactions at FICC, the
Commission understands the volume of repo not currently centrally
cleared to be substantial. The requirement that all U.S. Treasury CCA
members submit all eligible repurchase agreements for central clearing
would increase the fraction of total volume of such transactions
submitted for central clearing, realizing the benefits described above
in this section. In addition, because repo participants tend to be
sophisticated market players, the requirement for repo transactions
will cover a set of market participants many of whom will have built
most of the necessary processes and infrastructure to comply with the
rule.
---------------------------------------------------------------------------

\827\ 2021 IAWG Report, supra note 4, at 29. Some of the
benefits discussed here may be mitigated if central clearing of repo
were to occur at multiple CCPs (e.g., in there was an additional
registered clearing agency that accepted repo for clearing and in
the absence of an agreement between those registered clearing
agencies, the netting benefits may be less than those if there were
but a single clearing agency accepting repo for clearing).
\828\ Id. (``Non-centrally cleared bilateral repo represents a
significant portion of the Treasury market, roughly equal in size to
centrally cleared repo.'') (citing a 2015 pilot program by the U.S.
Treasury Department); see also TMPG Repo White Paper, supra note
804, at 1; Katy Burne, Future-Proofing the U.S. Treasury Market, BNY
Mellon Aerial View 7 (2021), available at https://www.bnymellon.com/content/dam/bnymellon/documents/pdf/aerial-view/future-proofing-the-us-treasury-market.pdf.coredownload.pdf (noting that 63% of repo
transactions remain non-centrally cleared according to Office of
Financial Research data as of Sept. 10, 2021).
---------------------------------------------------------------------------

One commenter noted an additional potential benefit to money market
funds (``MMFs'').\829\ The commenter stated that MMFs are only
permitted to execute repo transactions with counterparties that are
rated by one of the top rating agencies, a benefit typically accessible
to only larger participants due to the prohibitive cost of obtaining
and maintaining a rating from the top tier rating agencies. The
commenter stated that this limits the number of potential
counterparties with which MMFs can execute repo transactions, limiting
liquidity and pricing options available to the MMFs. If MMFs are able
to transact as sponsored members whose trades are centrally cleared and
are able to look through the initial counterparty to the credit
worthiness of the CCP itself, liquidity and pricing available to MMFs
is likely to improve.
---------------------------------------------------------------------------

\829\ Letter from the Independent Dealer & Trader Association,
at 10-11 (Sept. 1, 2023) (``IDTA Letter 2'').
---------------------------------------------------------------------------

Some commenters questioned the need for a requirement with respect
to repo, noting that the balance sheet netting efficiencies already
exist, providing a natural incentive to centrally clear such
transactions.\830\ The Commission agrees that centrally cleared repo
already benefits from favorable treatment on balance sheet, but
believes that a requirement to clear repo transactions would result in
more transactions being centrally cleared and, accordingly, additional
balance sheet efficiency and capacity to intermediate repo
transactions.\831\ Although FICC netting members may wish to increase
the fraction of their repo business that is centrally cleared in order
to take greater advantage of netting efficiencies, they are only able
to do so to the extent that their counterparties have taken the steps
necessary to access clearing. Requiring most repo transactions with a
FICC netting member on one side to be centrally cleared assures that
counterparties will have taken such steps. Thus, there would still be
benefits from the requirement, despite the currently existing balance
sheet treatment.
---------------------------------------------------------------------------

\830\ See supra note 84.
\831\ Duffie supra note 718, provides empirical evidence with
supporting theory that the current intermediation capacity of the
U.S. Treasury market impairs its resilience. Among the improvements
he discusses that could increase the market's intermediation
capacity under stress is broader central clearing. See Resilience
redux in the US Treasury market, supra note 718. See also Dealer
Capacity and US Treasury, presentation to SEC Staff (July 2023),
supra note 702.
---------------------------------------------------------------------------

The OFR published a 2023 report on an OFR pilot data collection of
non-centrally cleared bilateral repurchase agreement (``NCCBR'') trades
spanning nine dealers over three reporting dates in June 2022.\832\ Of
the four bilateral repo segments discussed (centrally cleared
transactions settled on the triparty platform, centrally cleared
transactions using the FICC DVP service, non-centrally cleared
transactions settled on the triparty platform, and NCCBR transactions),
the NCCBR segment is the largest of the four segments of the repo
market in terms of gross repo exposure by primary dealers.\833\ The
OFR' report uses the pilot data collection to answer the question of
why volume in this segment is so high despite the benefits of central
clearing, including the ability of dealers to net their repo positions
with one counterparty against reverse repo positions with another
counterparty for the purpose of calculating certain regulatory ratios,
thus reducing the balance sheet costs of participating in repo. The
report's authors estimate that over 60% of all Treasury trades in the
NCCBR market are naturally netted (matching repo and reverse repo with
the same counterparty and tenor, typically as part of a relative value
trade); however, they also show that substantial balance sheet netting
benefits could still result from the trades that are not naturally
netted if NCCBR trades were moved into central clearing.\834\
---------------------------------------------------------------------------

\832\ See Hempel et al. (2023), supra note 564.
\833\ Id.
\834\ Id.
---------------------------------------------------------------------------

Several commenters recommended excluding triparty repos from the
definition of an eligible secondary market transaction.\835\ Four of
these commenters suggested that the cost of including triparty repos
would outweigh the benefits.\836\ Several commenters argued that
including triparty repos would not significantly reduce the risks that
the proposal seeks to address because the current triparty market
infrastructure inherently mitigates the associated risks.\837\
Specifically, these commenters argue that credit risk in the triparty
market is mitigated by the triparty agent's provision of custodial,
collateral management, and settlement services.\838\ Moreover, one
commenter stated that the infrastructure underlying the triparty repo
market is robust and provides credit protections, operational
safeguards, and strict internal controls akin to central clearing.\839\
One commenter added that the triparty market is relatively safe from
credit risk because the triparty agent is subject to prudential
regulation.\840\ One commenter added that settlement risk in the
triparty market is nearly eliminated because collateral posted to the
triparty platform cannot generally be repledged outside the
platform.\841\ The commenter stated, therefore, that the only
significant source of settlement risk is the rare occurrence of a
counterparty's nonpayment of the repurchase price, which is generally
attributable to operational risk as opposed to credit risk.\842\
---------------------------------------------------------------------------

\835\ See supra note 85.
\836\ See MFA Letter, supra note 81, at 6, 14; SIFMA/IIB Letter,
supra note 37, at 20; ICI Letter, supra note 85, at 11; Federated
Letter, supra note 85, at 5.
\837\ See MFA Letter, supra note 81, at 14; SIFMA/AMG Letter,
supra note 35, at 11; ICI Letter, supra note 85, at 12, 22; Citadel
Letter, supra note 81, at 6; Federated Letter, supra note 85, at 5.
\838\ See id.
\839\ See ICI Letter, supra note 85, at 22.
\840\ See MFA Letter, supra note 81, at 14.
\841\ See Federated Letter, supra note 85, at 5.
\842\ See Federated Letter, supra note 85, at 5.
---------------------------------------------------------------------------

Despite supporting the exclusion of triparty repos from the
definition of an eligible secondary market transaction, one commenter
acknowledged that the triparty agent ``does not fulfill a CCP role--it
does not guarantee either counterparty's performance through novation
or otherwise and does not assume counterparty risk.'' \843\ The
Commission recognizes that the current triparty market infrastructure
incorporates credit protections, operational safeguards, and strict
internal controls. However, as discussed above, the triparty agent does
not fulfill a CCP role, and therefore, the Commission disagrees with
the contention that the current market infrastructure incorporates
controls akin to those available through central

[[Page 2803]]

clearing.\844\ Therefore, the benefits accruing to additional central
clearing using a U.S. Treasury securities CCA apply in varying degree
to triparty transactions as well.\845\
---------------------------------------------------------------------------

\843\ ICI Letter, supra note 85, at 33.
\844\ See supra part II.A.2.a supra.
\845\ Id.
---------------------------------------------------------------------------

In response to the commenter who stated that most risks are
eliminated because collateral cannot be posted outside the triparty
platform, the Commission disagrees. For example, significant risks
exist if concerns emerge regarding the financial condition of borrowers
in the triparty market.\846\ In such scenarios, even though collateral
stays within the triparty platform, the repo buyer could still face the
sudden default of a triparty repo counterparty.\847\ Moreover, the
Commission understands that settlement failures occur regularly and
tend to spike during market stress events.\848\ Even though not
considered a default, settlement failures create credit exposure to the
failing counterparty and market risk exposure with respect to the
relevant Treasuries.\849\ Furthermore, settlement failures may prevent
or make more costly the non-failing party's delivery of the relevant
Treasuries in respect of other transactions.
---------------------------------------------------------------------------

\846\ See 2013 Annual Report of the Financial Stability
Oversight Council, at 4, 12-13, 133-134, available at https://home.treasury.gov/system/files/261/FSOC-2013-Annual-Report.pdf;
Begalle et al., supra note 98 (discussing concern that stress caused
by a potential default of a triparty repo counterparty can lead to
either pre-default fire sales of assets by the counterparty or post-
default fire sales of collateral by the triparty repo investor and
the related financial stability concerns).
\847\ See SEC Division of Investment Management Guidance Update:
Counterparty Risk Management Practices with Respect to Tri-Party
Repurchase Agreements (July 2013), available at https://www.sec.gov/divisions/investment/guidance/im-guidance-2013-03.pdf.
\848\ See e.g., Adam Copeland, Antoine Martin, Michael Walker,
Repo Runs: Evidence from the Tri-Party Repo Market, N.Y. Fed Staff
Report No. 506, at 26-30, available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr506.pdf; Tobias Adrian,
Christopher R. Burke, and James J. McAndrews, The Federal Reserve's
Primary Dealer Credit Facility, 15 Fed. Res. Bank N.Y. Current
Issues in Econ. and Fin. 4, available at https://www.newyorkfed.org/medialibrary/media/research/current_issues/ci15-4.pdf; see also
Michael Fleming & Kenneth Garbade, Explaining Settlement Fails, 11
Fed. Res. Bank N.Y. Current Issues in Econ. and Fin. 1 (Sept. 2005),
available at https://www.newyorkfed.org/medialibrary/media/research/current_issues/ci11-9.pdf.
\849\ See Treasury Market Practice Group, U.S. Treasury
Securities Fails Charge Trading Practice (July 27, 2018), available
at https://www.newyorkfed.org/medialibrary/microsites/tmpg/files/TMPG-UST-fails-charge-trading-practice-FINAL-07-27-18.pdf.
---------------------------------------------------------------------------

One commenter stated that the Commission must address other aspects
of the Sponsored Service to better promote the objectives of central
clearing, with such issues including the treatment of the start leg of
the transaction, FICC's obligations to complete settlement of a
Sponsored Member's positions in the event of a Sponsoring Member's
default, and a Sponsored Member's ability to engage with FICC to
address issues arising from repo transactions that have been submitted
through sponsored clearing.\850\ The commenter stated that, within the
Sponsored Service, FICC does not novate the settlement of the start leg
of a repo transaction that is submitted for clearing between a
sponsoring Member and a sponsored Member, although it does novate the
end leg of the transaction, meaning that the counterparties continue to
be responsible for settlement outside of FICC and bear the risk of a
settlement fail vis a vis one another. The commenter also states that
the lack of central clearing for the start leg of repo transactions in
the Sponsored Service means that a requirement to clear eligible
secondary market transactions may not eliminate counterparty credit
risk issues to the extent the Commission anticipates, which, in turn,
means that the proposal may not increase competition or reduce spreads
as the Commission predicted in the Proposing Release.
---------------------------------------------------------------------------

\850\ ICI Letter, supra note 85, at 26-28.
---------------------------------------------------------------------------

The Commission understands that, contrary to transactions cleared
at FICC outside the Sponsored Service, FICC currently does not novate
the start legs of same-day settling Sponsored DVP Repos where the
Sponsored Member's pre-novation counterparty is its Sponsoring Member
(i.e., ``done-with'' Sponsored DVP Repo) or of Sponsored GC Repos.
However, the Commission does not believe that this failure to novate is
inconsistent with the definition of an eligible secondary market
transaction being adopted in this release.\851\ The Commission
acknowledges that settlement of the start leg occurring outside central
clearing could somewhat reduce the benefits of central clearing in this
limited instance, but the counterparty credit risk arising from the
start legs of such transactions are largely addressed by the fact that
they usually settle on a delivery-versus-payment basis between the
counterparties, meaning that the securities and funds are exchanged
simultaneously and resulting in less counterparty credit risk to
address. However, the Commission further understands that FICC has
stated that it is able to clear the start leg of any repo and currently
does clear the start leg of all repos between two direct participants,
the start leg of any Sponsored DVP repo where the Sponsored Member's
pre-novation counterparty is a third-party member of FICC (i.e.,
``done-away'' from the Sponsoring Member), and any Sponsored DVP Repo
where the start leg of such repo is scheduled to settle on some
business day in the future (i.e., forward-settling repos).\852\
---------------------------------------------------------------------------

\851\ See Part II.C.2.c, supra.
\852\ See FICC Rule 11, section 2, supra note 19; FICC Buyside
FAQ, supra note 169, at 2-3.
---------------------------------------------------------------------------

One commenter stated that neither the Sponsored Bilateral DVP
Service nor the Sponsored GC Repo Service compel FICC to complete the
settlement of a sponsored member's transactions in the event of a
sponsoring member's default, and that this approach is not consistent
with the Commission's assumption that central clearing increases the
likelihood of settlement.\853\ The Commission understands that this
ability to, potentially, terminate the Sponsored Member's transaction
in such circumstances arises from the fact that, within the Sponsored
Service, by design, the Sponsoring Member serves as the processing
agent for all movement of funds and securities for its Sponsored
Members, and FICC is not able to guarantee that an insolvent Sponsoring
Member, which may be subject to the control of another legal entity,
such as a bankruptcy trustee, would be able to continue processing such
transactions. This aspect of FICC's rules is consistent with how other
central counterparties have addressed the potential termination of
customer transactions in the event of their agent's default.\854\ As
discussed in Part II.B.2.c supra, the Commission does not believe that
the potential for FICC to terminate these transactions, in the unlikely
event of a Sponsoring Member default in which it is unable to work with
the controlling legal entity, means that the benefits in the Proposing
Release would not be, to a great extent, realized.
---------------------------------------------------------------------------

\853\ ICI Letter, supra note 85, at 27.
\854\ See supra note 438 and referencing paragraph.
---------------------------------------------------------------------------

iii. Application of the Requirement To Clear Eligible Secondary Market
Transactions to Purchases and Sales of U.S. Treasury Securities
As discussed above, 68 percent of cash market transactions in U.S.
Treasury securities are not centrally cleared, and another 19 percent
of such transactions are subject to so-called hybrid clearing.\855\ The
Commission has identified certain categories of purchases and sales of
U.S. Treasury securities that it believes should be part of the
requirement to clear eligible

[[Page 2804]]

secondary market transactions, i.e., for which U.S. Treasury securities
CCAs are obligated to impose membership rules to require clearing of
such transactions. The benefits of including these categories are
described below.
---------------------------------------------------------------------------

\855\ Proposing Release, supra note 14, at 64613.
---------------------------------------------------------------------------

As with repurchase transactions, the general benefits of central
clearing discussed in part IV.A supra become greater as the fraction of
total transaction volume that is centrally cleared increases. In other
words, there are positive externalities associated with broader central
clearing. However, unlike in the repo market, the Commission is not
requiring that all cash market transactions completed with a FICC
member be centrally cleared.\856\
---------------------------------------------------------------------------

\856\ The G-30 report recommends an approach to clearing all of
repo, and some cash trades. See generally G-30 Report, supra note 5.
---------------------------------------------------------------------------

Several commenters suggested that the scope of eligible secondary
market transactions in the cash market be broadened. One commenter
stated that the Commission should align the scope of the definition
with respect to cash transactions with the proposed scope for repos,
subject to certain limited exceptions for investors that trade de
minimis volumes. The commenter argued that the Commission's approach
with respect to cash transactions will increase costs for a specific
subset of market participants, thereby putting them at a competitive
disadvantage, while failing to deliver the envisaged market-wide
benefits associated with central clearing (i.e., it would materially
reduce the associated multilateral netting benefits, impair the risk
management practices of clearing agencies, and hinder the evolution in
trading protocols that can be expected from a market-wide clearing
requirement).\857\ For similar reasons, another commenter also stated
that the benefits of central clearing detailed ``will only materialize
if a market-wide mandate is implemented'' and supported defining the
scope of eligible secondary market transactions for cash transactions
as broadly as that proposed for repos.\858\ Another commenter stated
that limiting the scope of the cash clearing mandate would result in
unwarranted competitive disadvantages and related market distortions
for some types of investors, such as hedge funds, or some types of
trading platforms, such as anonymous trading facilities.\859\
---------------------------------------------------------------------------

\857\ Citadel Letter, supra note 81, at 5.
\858\ ARB et al. Letter, supra note 81, at 4 (stating that the
netting benefits associated with transitioning only proprietary
trading firm (``PTF'') transactions into central clearing are much
smaller, given the substantial netting that already occurs directly
with inter-dealer brokers (``IDBs''); the trading-related benefits
of central clearing will only accrue to market participants if their
transactions are covered by the proposed mandate; and that clearing
agency resiliency will be negatively impacted if only one segment of
the market is cleared).
\859\ MFA Letter, supra note 81, at 2.
---------------------------------------------------------------------------

The Commission proposed a targeted approach to clearing in the cash
market in the Proposing Release, limiting the clearing requirement to
specific types of entities transacting with members of a U.S. Treasury
securities CCA that pose certain risks when clearing cash market
treasury transactions bilaterally.\860\ As discussed in the Proposing
Release and discussed in part II.2.b supra, the Commission believed
that including within the scope of eligible transactions the cash
transactions of levered funds and hedge funds is more important than
those of other market participants that were not included in part
because the strategies employed by hedge funds ``can increase the
likelihood that the fund will experience stress or fail, and amplify
the effects on financial markets.'' \861\ The Commission is not
including purchases and sales of U.S. Treasury securities between a
direct participant and either a hedge fund or a levered account within
the definition of an eligible secondary market transaction in light of
questions raised by commenters regarding the inclusion of a hedge fund
and a leveraged account as proposed that merit further consideration,
and the Commission will continue to evaluate the issues raised to
determine if any further action is appropriate.\862\
---------------------------------------------------------------------------

\860\ See part II.A.2.b supra for discussion of the
justification for the scope as proposed.
\861\ Proposing Release, supra note 14 at 64623-4.
\862\ See part II.A.2.b.i supra.
---------------------------------------------------------------------------

In response to the comment that characterized a market-wide mandate
as a ``necessary condition'' for adoption of any mandate, the
Commission does not believe that all benefits of central clearing exist
only if the entire market is centrally cleared. The increased clearing
of cash transactions, targeted to address the differing risk profiles
of each market segment, would still bring the benefits of central
clearing to an important part of the cash market. As explained below,
cash and repo markets differ in important ways that suggest a broader
definition of eligible secondary market transactions for repo and a
less broad definition for cash transactions. Though there are linkages
across markets, segments of the Treasury market are distinct, and for
this reason, the Commission addresses the risks in each of these
categories separately in parts II.A.2.b.ii through iii supra.
The Commission understands the set of participants in U.S. Treasury
securities cash markets to be far broader and more heterogeneous than
in the repo markets. The cash market has many participants that trade
in relatively small amounts, whereas the market for repo is dominated
by larger, more sophisticated institutions. Although difficult to
quantify precisely, the number of participants is one or more orders of
magnitude greater in the cash market as compared with the repo market.
Because the benefits increase with the number and size of transactions,
whereas the costs have a large fixed component, extending the clearing
mandate to institutions that are market participants in repo markets
and a subset of the institutions that are participants in cash markets
should capture a large fraction of market activity, while also
capturing the most active market participants who may already have some
ability to connect with the clearing agency and experience with central
clearing.
a. IDB Transactions
The amendments being adopted require that all purchases and sales
of U.S. Treasury securities entered into by a direct participant of a
U.S. Treasury securities CCA and any counterparty, if the direct
participant of the CCA brings together multiple buyers and sellers
using a trading facility (such as a limit order book) and serves as a
counterparty to both the purchaser and seller in two separate
transactions executed on its platform, be subject to the requirement to
centrally clear eligible secondary market transactions. This
requirement encompasses the transactions of those entities serving as
IDBs in the U.S. Treasury securities market, in that it covers entities
that are standing in the middle of transactions between two
counterparties that execute a trade on the IDB's platform.\863\
---------------------------------------------------------------------------

\863\ See Proposing Release, supra note 14, at 64616 for further
discussion of IDBs and their role in the cash market for U.S.
Treasury securities.
---------------------------------------------------------------------------

The amendments being adopted will result in more central clearing
of IDB trades. FICC Member IDBs do not take directional positions on
the securities that trade on the IDB's platform. Consequently, a
requirement that FICC member IDBs centrally clear all of their trades
will give FICC better insight into the risk position of its clearing
members though the elimination of the hybrid clearing transactions
mentioned above.
In contrast to other FICC members, FICC members that are also IDBs
will be required to centrally clear all of their cash trades (and repo,
as described above). As described in the TMPG White Paper and in the
recent G-30

[[Page 2805]]

report,\864\ IDBs act as central nodes in the system, in effect serving
as clearing agencies without the regulatory structure of clearing
agency. Furthermore, the netting benefits to IDBs, as described in this
section are likely to be particularly high, because each transaction on
an IDB is matched by a transaction on the other side. IDBs are
sophisticated institutions that have experience managing the central
clearing of trades as they already centrally clear all trades with
other FICC members.
---------------------------------------------------------------------------

\864\ See generally G-30 Report, supra note 5.
---------------------------------------------------------------------------

The configuration of counterparty risk presented by hybrid clearing
allows FICC to manage the risks arising from the IDB-FICC member trade,
but FICC cannot manage the risks arising from the IDB's offsetting
trade with its non-FICC member counterparty and the potential
counterparty credit risk and settlement risk arising to the IDB from
that trade.\865\ Thus, the IDB is not able to net all of its positions
for clearing at FICC, and the IDB's positions appear to FICC to be
directional, which impacts the amount of margin that FICC collects for
the visible leg of the ``hybrid'' transaction. This lack of visibility
can increase risk during stress events, when margin requirements
usually increase. Thus, FICC is indirectly exposed to the IDB's non-
centrally cleared leg of the hybrid clearing transaction, but it lacks
the information to understand and manage its indirect exposure to this
transaction. As a result, in the event that the non-FICC counterparty
were to default to the IDB, causing stress to the IDB, that stress to
the IDB could be transmitted to the CCP and potentially to the system
as a whole.\866\ In particular, if the IDB's non-FICC counterparty
fails to settle a transaction that is subject to hybrid clearing, such
an IDB may not be able to settle the corresponding transaction that has
been cleared with FICC, which could lead the IDB to default. As part of
its existing default management procedures, FICC could seek to
mutualize its losses from the IDB's default, which could in turn
transmit stress to the market as a whole.
---------------------------------------------------------------------------

\865\ See, e.g., TMPG White Paper, supra note 13, at 22 (noting
that in a hybrid clearing arrangement, an ``IDB's rights and
obligations towards the CCP are not offset and therefore the IDB is
not in a net zero settlement position with respect to the CCP at
settlement date.'').
\866\ See DTCC May 2021 White Paper, supra note 307, at 5.
---------------------------------------------------------------------------

The Commission has previously stated that membership requirements
help to guard against defaults of any CCP member, as well to protect
the CCP and the financial system as a whole from the risk that one
member's default could cause others to default, potentially including
the CCP itself.\867\ Further, contagion stemming from a CCP member
default could be problematic for the system as a whole, even if the
health of the CCP is not implicated. This is so because the default
could cause others to back away from participating in the market. This
risk of decreased market participation could be particularly acute if
the defaulting participant were an IDB, whose withdrawal from the
market could jeopardize other market participants' ability to access
the market for on-the-run U.S. Treasury securities.\868\ And because
IDBs facilitate a significant proportion of trading in on-the-run U.S.
Treasury securities (that is, they form central nodes), such a
withdrawal could have significant consequences for the market as a
whole.\869\ The requirement to clear eligible secondary market
transactions should therefore help mitigate this risk by mandating that
a U.S. Treasury securities CCA ensure its IDB members clear both sides
of their transactions, thereby eliminating the various facets of
potential contagion risk posed by so-called hybrid clearing.
---------------------------------------------------------------------------

\867\ See CCA Standards Proposing Release, supra note 8.
\868\ TMPG White Paper, supra note 13, at 32.
\869\ See id.
---------------------------------------------------------------------------

Commenters generally supported the inclusion of IDB transactions in
the definition of an eligible secondary market transaction.\870\
Another commenter, although not supporting a requirement to clear
repos, stated that if such a requirement was adopted it should be
limited to IDBs and broker-dealers because (1) the counterparties to
such transactions are the most active participants in the Treasury repo
markets, thereby allowing the Commission to meaningfully increase
central clearing without applying a more categorical requirement, and
(2) because such transactions are more interconnected with the rest of
the market and have a higher possibility to transfer risk to outside
parties (including potentially a U.S. Treasury securities CCA).\871\
---------------------------------------------------------------------------

\870\ See AIMA Letter, supra note 81, at 7.
\871\ See SIFMA/IIB Letter, supra note 37, at 19-20.
---------------------------------------------------------------------------

However, certain commenters asserted that this aspect of the
definition would inappropriately disadvantage IDBs, with uncertain
benefits and potentially significant negative consequences that would
result if market participants shifted their trading activity away from
IDBs.\872\ Three commenters expressed concerns that including IDB
transactions in the definition of an eligible secondary market
transaction could draw trading activity away from IDBs, thereby
reducing market liquidity and market stability.\873\ The commenters
also noted that IDBs are anonymous platforms that currently support
all-to-all trading, which the Commission has recognized would improve
market structure and stability.\874\ The commenters argued that
including IDB transactions in the definition of an eligible secondary
market transaction could, therefore, hinder all-to-all trading.\875\
One of these commenters further argued that by discouraging market
participants from trading on IDBs, the requirement to clear eligible
secondary market transactions, as drafted, could limit the choices of
market participants with respect to trading venues.\876\
---------------------------------------------------------------------------

\872\ See ICI Letter, supra note 85, at 3, 11; MFA Letter, supra
note 81, at 19-21; see also Tradeweb Letter, supra note 81, at 3-4.
\873\ See ICI Letter, supra note 85, at 3, 11; MFA Letter, supra
note 81, at 20; Tradeweb Letter, supra note 81, at 3-4.
\874\ See id.
\875\ See id.
\876\ See MFA Letter, supra note 81, at 20.
---------------------------------------------------------------------------

The Commission disagrees with these commenters. The inclusion of
IDB transactions, along with other types of transactions, would not
necessarily lead to decreased liquidity and market stability or
negatively impact all-to-all trading in the U.S. Treasury market. The
benefits to market participants from trading on an IDBs, that is the
ability find counterparties and to trade anonymously are significant
and will continue even if such transactions are eligible secondary
market transactions, meaning that such transactions would incur the
costs associated with central clearing and described below.
Moreover, even in the event that some of these concerns materialize
from the inclusion of IDB transactions, the inclusion of IDB
transactions is justified as it would allow the U.S. Treasury
securities CCA to better risk manage ``hybrid'' transactions that are
currently not being submitted for central clearing. Specifically,
including IDB transactions in the definition of an eligible secondary
market transaction would address the potential for contagion risk
associated with hybrid clearing. As explained in the Proposing Release,
the configuration of counterparty risk presented by hybrid clearing
allows the U.S. Treasury securities CCA to manage the risks arising
from the IDB-CCA direct participant transaction, on the one hand, but
the U.S. Treasury securities CCA cannot manage the risks arising from
the IDB's offsetting transaction with its non-member counterparty and

[[Page 2806]]

the potential counterparty credit risk and settlement risk arising to
the IDB from that trade.\877\ Thus, under the current hybrid clearing
model, the U.S. Treasury securities CCA is indirectly exposed to the
IDB's non-centrally cleared transaction, but it lacks the ability to
risk manage its indirect exposure to this non-centrally cleared leg of
the transaction. Specifically, it does not know who the ultimate
counterparty of the transaction is and cannot collect margin on that
transaction. This, in turn, results in margin collection at the CCP
which is based upon only one transaction and has been calculated to
cover this seemingly directional position, as well as an inability to
net these offsetting transactions and provide the benefits of central
clearing. In particular, if the IDB's non-CCP member counterparty fails
to settle a transaction that is subject to hybrid clearing, such IDB
may not be able to settle the corresponding transaction that has been
cleared with the U.S. Treasury securities CCA due to a lack of
financial resources at the IDB, which could lead the IDB to
default.\878\ As part of its existing default management procedures,
the U.S. Treasury securities CCA could seek to mutualize its losses
from the IDB's default, which could in turn transmit stress to the
market as a whole.
---------------------------------------------------------------------------

\877\ See, e.g., TMPG White Paper, supra note 13, at 22 (noting
that in a hybrid clearing arrangement, an IDB's rights and
obligations to the CCP are not offset and the IDB is not in a net
zero settlement position with respect to the CCP at settlement
date). Thus, the IDB is not able to net all of its positions for
clearing at a U.S. Treasury securities CCA, and the IDB's positions
appear to the CCA to be directional, which impacts the amount of
margin that the CCA collects for the transaction.
\878\ See 2021 IAWG Report, supra note 4, at 31; See also DTCC
May 2021 White Paper, supra note 307.
---------------------------------------------------------------------------

As noted above, the Commission has previously stated that
membership requirements help to guard against defaults of any CCP
member, as well as to protect the CCP and the financial system as a
whole from the risk that one member's default could cause others to
default, potentially including the CCP itself.\879\ Further, contagion
stemming from a CCP member default could undermine confidence in the
financial system as a whole, even if the health of the CCP is not
implicated. This is because the default could cause others to back away
from participating in the market. This risk of decreased participation
could be particularly problematic if the defaulting participant was an
IDB, whose withdrawal from the market could impact other market
participants' ability to access the market for on-the-run U.S. Treasury
securities, approximately 49.7% of which trade on IDBs.\880\ Including
such transactions as eligible secondary market transactions would
therefore help protect against this risk by requiring that a U.S.
Treasury securities CCA ensure that direct participants who are IDBs
centrally clear both sides of their transactions, thereby eliminating
the various aspects of potential contagion risk posed by so-called
hybrid clearing.
---------------------------------------------------------------------------

\879\ See supra note 308.
\880\ TMPG White Paper, supra note 13, at 32; part IV.B.3 (Table
1) supra.
---------------------------------------------------------------------------

b. Other Cash Transactions
The Commission has identified additional categories of cash
transactions of U.S. Treasury securities to include in the membership
requirements for a U.S Treasury securities CCA that it believes will
provide the benefits of increased central clearing of U.S. Treasury
securities transactions described above.
The Commission is defining an eligible secondary market transaction
to include those cash purchase and sale transactions in which the
counterparty of the direct participant is a registered broker-dealer,
government securities broker, or dealer.\881\ These entities, by
definition, are engaged in the business of effecting transactions in
securities for the account of others (for brokers) or for their own
accounts (for dealers). Thus, these entities already are participating
in securities markets and have identified mechanisms to clear and
settle their transactions.\882\ More generally, many registered brokers
and dealers are familiar with transacting through introducing brokers
who pass their transactions to clearing brokers for clearing and
settlement.
---------------------------------------------------------------------------

\881\ 15 U.S.C. 78o(a) and 78o-5(a) (requirement to register)
and 78c(4), (5), (43), and (44) (definitions).
\882\ See, e.g., FICC Rules 3A, 8, 18, supra note 663 (providing
for prime brokerage and correspondent clearing and sponsored
membership); see also October 2021 White Paper, supra note 681, at
5-7.
---------------------------------------------------------------------------

In the Proposing Release, the Commission proposed to include in the
definition of eligible secondary market transaction any purchases and
sales of U.S. Treasury securities between a direct participant and a
counterparty that is: (i) a hedge fund, that is any private fund (other
than a securitized asset fund): (a) with respect to which one or more
investment advisers (or related persons of investment advisers) may be
paid a performance fee or allocation calculated by taking into account
unrealized gains (other than a fee or allocation the calculation of
which may take into account unrealized gains solely for the purpose of
reducing such fee or allocation to reflect net unrealized losses); (b)
that may borrow an amount in excess of one-half of its net asset value
(including any committed capital) or may have gross notional exposure
in excess of twice its net asset value (including any committed
capital); or (c) that may sell securities or other assets short or
enter into similar transactions (other than for the purpose of hedging
currency exposure or managing duration) (``hedge fund transactions''),
or (ii) an account at a registered broker-dealer, government securities
dealer, or government securities broker where such account may borrow
an amount in excess of one-half of the value of the account or may have
gross notional exposure of the transactions in the account that is more
than twice the value of the account (``leveraged account
transactions'').\883\
---------------------------------------------------------------------------

\883\ See part II.A.2.b supra.
---------------------------------------------------------------------------

Some commenters supported the proposed inclusion of transactions
with hedge funds within the definition of an eligible secondary market
transaction.\884\ However, other commenters asserted that transactions
with a hedge fund should not be within the definition of an eligible
secondary market transaction. Specifically, one commenter stated that
because of the nature of the definition, eligible secondary market
transactions would include those with firms that may (but in practice
might not actually) exceed the quantitative thresholds without regard
to the risks that these firms actually take on, or their investment
models and strategies. Further, the commenter stated that the
definition would not reflect any effort to assess whether any
particular fund or account actually imposes systemic risk, and would
instead treat the mere ability to obtain leverage as a source of
risk.\885\ Another commenter stated that there is no data to support
imposing a clearing requirement that targets just hedge funds and
leveraged accounts and expressed concern that a partial mandate may
result in some dealers choosing to offer liquidity only in a cleared
environment thereby reducing the liquidity available today to accounts
in the uncleared cash market.\886\ Another commenter stated that the
inclusion of hedge funds within the counterparties to an eligible
secondary market transaction would arbitrarily single out hedge funds'
cash Treasury transactions and would leave out other important market
participants' cash

[[Page 2807]]

Treasury transactions that also comprise a large segment of Treasury
market liquidity.\887\
---------------------------------------------------------------------------

\884\ See DTCC/FICC Letter, supra note 33; Better Markets
Letter, supra note 33; AFREF Letter, supra note 33.
\885\ See MFA Letter, supra note 81 at 19-20.
\886\ See SIFMA AMG Letter, supra note 35, at 11.
\887\ See AIMA Letter, supra note 81, at 7.
---------------------------------------------------------------------------

As the Commission stated in the Proposing Release, hedge funds
generally can engage in trading strategies that may pose heightened
risks of potential financial distress to their counterparties,
including those who are direct participants of a U.S. Treasury
securities CCA. The Commission previously has recognized that the
strategies employed by hedge funds ``can increase the likelihood that
the fund will experience stress or fail, and amplify the effects on
financial markets.'' \888\ The Commission also has stated that
significant hedge fund failures, resulting from their investment
positions or use of leverage or both, could result in material losses
at the financial institutions that lend to them if collateral securing
this lending is inadequate, and that these losses could have systemic
implications if they require these financial institutions to scale back
their lending efforts or other financing activities generally.\889\
---------------------------------------------------------------------------

\888\ See Form PF Proposing Release, supra note 279, 76 FR at
8073 (citing President's Working Group on Financial Markets, Hedge
Funds, Leverage, and the Lessons of Long Term Capital Management
(Apr. 1999), at 23).
\889\ Id. (also noting that the simultaneous failure of several
similarly positioned hedge funds could create contagion through the
financial markets if the failing funds had to liquidate their
investment positions at fire sale prices).
---------------------------------------------------------------------------

Similar to the risks posed to a U.S. Treasury securities CCA by
non-centrally cleared trades entered into by an IDB, non-centrally
cleared transactions entered into between hedge funds and direct
participants of the CCA could cause risks to the CCA in the event that
the hedge fund is not able to meet its obligations to the direct
participant, which could, in turn, create stress to the direct
participant and through to the CCA. Therefore, including the direct
participant's purchase and sale transactions with hedge funds within
the definition of an eligible secondary market transaction would have
reduced the potential for financial distress arising from the
transactions that could affect the direct participant and the U.S.
Treasury securities CCA. This aspect of the proposal would also have
resulted in consistent and transparent risk management being applied to
such transactions, as discussed further in part II.A.2.a supra.
However, in response to comments received and as discussed in part
II.A.2.b supra, the Commission is not adopting a definition of eligible
secondary market transaction in Rule 17ad-22(a) that includes these
transactions.\890\
---------------------------------------------------------------------------

\890\ Id.
---------------------------------------------------------------------------

iv. Exclusions From the Requirement To Clear Eligible Secondary Market
Transactions
The Commission is excluding certain otherwise eligible secondary
market transactions in U.S. Treasury securities from the requirement to
clear eligible secondary market transactions. Recognizing the
importance of U.S. Treasury securities not only to the financing of the
United States government, but also their central role in the
formulation and execution of monetary policy and other governmental
functions, the Commission is excluding from the requirement to clear
eligible secondary market transactions any otherwise eligible secondary
market transaction in U.S. Treasury securities between a direct
participant of a U.S. Treasury securities CCA and a central bank.\891\
For similar reasons, the Commission is also excluding from the
requirement to clear eligible secondary market transactions otherwise
eligible secondary market transactions in U.S. Treasury securities
between a direct participant of a U.S. Treasury securities CCA and a
sovereign entity or an international financial institution.\892\ In a
change from the proposal, and for the reasons given above, the
Commission is excluding from the requirement to clear eligible
secondary market transactions otherwise eligible secondary market
transactions in U.S. Treasury securities between a direct participant
of a U.S. Treasury securities CCA and either a state and local
government or a covered clearing agency providing central counterparty
services, a derivatives clearing organization (see 7 U.S.C. 7a-1 and 17
CFR 39.3), or is regulated as a central counterparty in its home
jurisdiction.\893\
---------------------------------------------------------------------------

\891\ See Proposing Release, supra note 14, at 64625 for a
discussion of the proposed definition of a central bank for the
purposes of the rule.
\892\ See id. for a discussion of the proposed definition of
sovereign entity and international financial institution.
\893\ See part II.A.2.a.vii supra and part II.A.2.a.iii supra.
---------------------------------------------------------------------------

One commenter recommended that the Commission exempt transactions
in U.S. Treasury securities between affiliates from any central
clearing requirement. The commenter stated that inter-affiliate
transactions are important to corporate groups, which may use them to
achieve efficient risk and capital allocation and obtain flexibility
for addressing customer demands.\894\ The commenter further stated that
requiring inter-affiliate transactions to be centrally cleared would
impose additional costs with limited benefits, for two reasons. First,
if an inter-affiliate transaction is part of a ``back-to-back
arrangement,'' meaning that the related external transaction between
the affiliated counterparty and a non-affiliated counterparty is not
centrally cleared, then subjecting the inter-affiliate transaction to a
central clearing requirement does nothing to reduce the contagion risk
presented by the non-affiliated counterparty. The commenter further
asserted that if that external transaction is already centrally
cleared, the contagion risk would already be addressed and requiring
the inter-affiliate transaction to be cleared would not create
additional benefits. Second, a direct participant's affiliate's credit
risk is already part of the group-wide financial risks to which the
Treasury CCP is exposed, and central clearing of inter-affiliate
transactions is unlikely to meaningfully impact the risk profile.\895\
---------------------------------------------------------------------------

\894\ SIFMA/IIB Letter, supra note 37, at 21-22.
\895\ Id.
---------------------------------------------------------------------------

The Commission agrees and in a change from the proposing release,
the Commission is conditionally excluding inter-affiliate repo.\896\
The Commission believes that, in certain circumstances, the
counterparty credit risk posed by inter-affiliate transactions may be
less than other transactions.\897\ However, the credit risk is not
eliminated because affiliated entities are separate legal entities and,
generally, are not legally responsible for each other's contractual
obligations. In the event that one or more affiliated entities becomes
insolvent, the affiliates, as separate legal entities, would be managed
as separate estates in a bankruptcy, with the trustee having a duty to
the creditors of the affiliate, not the affiliated family. Other
benefits of increased central clearing

[[Page 2808]]

such as consistent risk management and centralized default management
are likely to be less important for transactions within an affiliated
family. Therefore, the Commission believes the benefits of clearing
such transactions are likely less than those from similar transactions
with non-affiliates while the costs of doing so are likely similar.
---------------------------------------------------------------------------

\896\ See part II.A.2.a, supra. The Commission is conditioning
the availability of the exclusion for inter-affiliate transactions
on an obligation for the affiliated counterparty to submit its
eligible repo transactions for clearance and settlement. This
condition should help ensure that a direct participant cannot rely
upon an inter-affiliate transaction to avoid the requirement to
clear eligible secondary market transactions. If there were no such
condition, a direct participant could simply use inter-affiliate
transactions to move securities and funds to affiliates, and the
affiliate could then enter into external transactions with
counterparties which, if entered into with the direct participant,
would be eligible secondary market transactions.
\897\ See, e.g., Clearing Exemption for Swaps Between Certain
Affiliated Entities, 77 FR 50425, 50427 (Mar. 2012) (discussing the
internalization of counterparty risk on inter-affiliate swap
transactions as wholly owned members of the same corporate group,
but also discussing that similar benefits may not accrue for other
inter-affiliate swaps when the counterparties are not members of the
same group).
---------------------------------------------------------------------------

Although the Commission believes that the benefits of central
clearing are generally increasing in the fraction of total volume that
is centrally cleared, it also believes that the Federal Reserve System
should be free to choose the clearance and settlement mechanisms that
are most appropriate to effectuating its policy objectives.\898\
Further, the Commission believes that the exclusion should extend to
foreign central banks, sovereign entities and international financial
institutions for reasons of international comity.\899\ In light of
ongoing expectations that Federal Reserve Banks and agencies of the
Federal Government will not be subject to foreign regulatory
requirements in their transactions in the sovereign debt of other
nations, the Commission believes principles of international comity
counsel in favor of exempting foreign central banks, sovereign
authorities, and international institutions.
---------------------------------------------------------------------------

\898\ See Proposing Release, supra note 14, for a discussion of
the activities of Federal Reserve Bank of New York's open market
operations conducted at the direction of the Federal Open Market
Committee.
\899\ See id., for a discussion of the Commission's belief in
the principles of international comity.
---------------------------------------------------------------------------

The Commission is also excluding transactions between U.S. Treasury
CCA members and natural persons from the requirement to clear eligible
secondary market transactions. The Commission believes that natural
persons generally transact in small volumes and should not present
much, if any, contagion risk to a U.S. Treasury securities CCA and
therefore, the benefits discussed above are unlikely to be important
for these transactions. Commenters expressed support for these
exclusions.\900\
---------------------------------------------------------------------------

\900\ SIFMA/IIB Letter, supra note 37, at 20; CME Letter, supra
note 81.
---------------------------------------------------------------------------

Two commenters asked the Commission to adopt an exemption that
would allow FCMs to continue to engage in eligible secondary market
transactions in U.S. Treasury securities outside of central clearing,
and another commenter acknowledged the potential interaction between
the proposal and the regulatory framework governing FCMs.\901\ FCMs can
also be registered with the Commission as broker-dealers.\902\
Commenters expressed concern as to whether the account structure
provided by FICC would be consistent with the regulatory framework
governing FCMs.\903\ The Commission recognizes the apparent tension
between the rule amendments being adopted and the application of Rule
1.25(d)(2), as described in part II.A.2.a.iv, supra.
---------------------------------------------------------------------------

\901\ See supra note 200. See also part II.A.2.a.iv, supra, for
discussion of FCMs and the regulatory framework governing them.
\902\ One commenter states that the majority of FCMs are dually
registered as FCMs and broker-dealers. See FIA Letter, supra note
200, at 2.
\903\ See part II.A.2.a.iv, supra.
---------------------------------------------------------------------------

For the reasons discussed above in part II.A.2.a.iv, the Commission
does not believe that an exclusion for FCMs is necessary to accommodate
the relevant provisions of the CFTC Rules. Moreover, an exclusion for
FCMs would be inconsistent with the purpose of the rule which is to
help reduce contagion risk to the CCA and bring the benefits of central
clearing to more transactions involving U.S. Treasury securities,
particularly in light of their significance to the Treasury market.
b. Other Changes to Covered Clearing Agency Standards
The Commission believes that certain additional changes to its
Covered Clearing Agency Standards that apply only to U.S. Treasury
securities CCAs are warranted to facilitate additional clearing. Such
changes should help ensure that the U.S. Treasury securities CCA can
continue to manage the risks arising from more transactions from
additional indirect participants and to facilitate the increased use of
central clearing and the accompanying benefits. These changes, by
making central clearing more efficient for market participants, also
create incentives for greater use of central clearing.
i. Policies and Procedures Regarding Direct Participants' Transactions
The Commission is adopting Rule 17ad-22(e)(18)(iv)(B) that requires
a U.S. Treasury securities CCA establish, implement, maintain and
enforce written policies and procedures to identify and monitor its
direct participants' required submission of transactions for clearing,
including, at a minimum, addressing a direct participant's failure to
submit transactions. The Commission believes that such a requirement
should help ensure that a U.S. Treasury securities CCA adopts policies
and procedures directed at understanding whether and how its
participants comply with the policies that will be adopted as part of
the requirement to clear eligible secondary market transactions
requiring the submission of specified eligible secondary market
transactions for clearing. Without such policies and procedures, it
would be difficult for the CCA to assess if the direct participants are
complying with the requirement to clear eligible secondary market
transactions.
One commenter supported this aspect of the proposal.\904\ This
commenter anticipated that implementation of this aspect of the
proposal would be similar to implementation of other Covered Clearing
Agency Standards provisions that use that phrase.\905\ The commenter
stated that it expects a U.S. Treasury securities CCA would take steps
to remediate non-compliance on the part of its direct participants in a
manner consistent with the Covered Clearing Agency Standards and
breaches of the CCA's own rules.\906\
---------------------------------------------------------------------------

\904\ See FICC/DTCC Letter, supra note 33, at 21-22. See also
part II.A.4 supra for additional discussion.
\905\ Id.
\906\ Id.
---------------------------------------------------------------------------

ii. Netting and Margin Practices for House and Customer Accounts
The Commission is amending Rule 17ad-22(e)(6)(i) to require a U.S.
Treasury securities CCA to establish, implement, maintain and enforce
written policies and procedures reasonably designed to, as applicable,
calculate, collect, and hold margin amounts from a direct participant
for its proprietary U.S. Treasury securities positions, separately and
independently from margin calculated and collected from that direct
participant in connection with U.S. Treasury securities transactions by
an indirect participant that relies on the services provided by the
direct participant to access the covered clearing agency's payment,
clearing, or settlement facilities. As described further below, such
changes should allow a U.S. Treasury securities CCA to better
understand the source of potential risk arising from the U.S. Treasury
securities transactions it clears and potentially further incentivize
central clearing.
In practice, at FICC, clearing a U.S. Treasury securities
transaction between a direct participant and its customer, i.e., a
dealer to client trade, would not result in separate collection of
margin for the customer transaction. Except for transactions submitted
under the FICC sponsored member program,\907\ FICC margins the
transactions in the direct participant's (i.e., the dealer's) account
on a net basis, allowing any of the trades for the participant's own
accounts to net

[[Page 2809]]

against trades by the participant's customers.\908\
---------------------------------------------------------------------------

\907\ See DTCC October 2021 White Paper, supra note 681.
\908\ Id. at 5-6.
---------------------------------------------------------------------------

Under the amendments to Rule 17ad-22(e)(6)(i), a U.S. Treasury
securities CCA is required to establish, implement, maintain and
enforce written policies and procedures reasonably designed to, as
applicable, calculate margin amounts for all transactions that a direct
participant submits to the CCP on behalf of others, separately from the
margin that is calculated for transactions that the direct participant
submits on its own behalf. Such policies and procedures must also
provide that margin collateralizing customer positions be collected
separately from margin collateralizing a direct participant's
proprietary positions. Finally, the CCP will also be required to have
policies and procedures reasonably designed to, as applicable, ensure
that any margin held for customers or other indirect participants of a
member is held in an account separate from those of the direct
participant.
Because the amendments to Rule 17ad-22(e)(6)(i) require separating
positions in U.S. Treasury securities transactions of a direct
participant in a U.S. Treasury securities CCA from those of customers
or other indirect participants, the indirect participants' positions,
including those submitted outside of the sponsored member program, will
no longer be netted against the direct participant's positions. The
indirect participants' positions will be subject to the covered
clearing agency's risk management procedures, including collection of
margin specific to those transactions. These changes should allow a
U.S. Treasury securities CCA to better understand the source of
potential risk arising from the U.S. Treasury securities transactions
it clears. In addition, these changes should help avoid the risk of a
disorderly default in the event of a direct participant default, in
that FICC will be responsible for the central liquidation of the
defaulting participant's trades without directly impacting the trades
of the participant's customers or the margin posted for those trades.
Moreover, the amendments to Rule 17ad-22(e)(6)(i) should result in
dealer-to-customer trades gaining more benefits from central clearing.
Because margin for a direct participant's (i.e., a dealer's) trades
will be calculated, collected, and held separately and independently
from those of an indirect participant, such as a customer, the direct
participant's trades with the indirect participant can be netted
against the direct participant's position vis-[agrave]-vis other
dealers.\909\
---------------------------------------------------------------------------

\909\ See Marta Chaffee and Sam Schulhofer-Wohl, supra note 678,
at 3.
---------------------------------------------------------------------------

Holding margin amounts from a direct participant of a U.S Treasury
securities CCA separately and independently from those of an indirect
participant may reduce incentives for indirect participants to trade
excessively in times of high volatility.\910\ Such incentives exist
because the customers of a broker-dealer do not always bear the full
cost of settlement risk for their trades. Broker-dealers incur costs in
managing settlement risk with CCPs. Broker-dealers can recover the
average cost of risk management from their customers. However, if a
particular trade has above-average settlement risk, such as when market
prices are unusually volatile, it is difficult for broker-dealers to
pass along these higher costs to their customers because fees typically
depend on factors other than those such as market volatility that
impact settlement risk. Holding margin of indirect participants
separately from direct participants should reduce any such incentives
to trade more than they otherwise would if they bore the full cost of
settlement risk for their trades.
---------------------------------------------------------------------------

\910\ See Sam Schulhofer-Wohl, Externalities in Securities
Clearing and Settlement: Should Securities CCPs Clear Trades for
Everyone? (Fed. Res. Bank Chi. Working Paper No. 2021-02, 2021).
---------------------------------------------------------------------------

Commenters generally supported the proposed amendment to Rule 17ad-
22(e)(6)(i).\911\ However, commenters also raised several additional
issues with respect to the separation of house and customer margin that
are addressed in part II.B.1 supra. As discussed below,\912\ an
additional commenter stated that the proposed separation of house and
customer margin would negatively impact small and mid-size broker-
dealers who are disproportionately affected by FICC's Excess Capital
Premium (``ECP'') charge, which is a margin add-on that collects a
premium when a member's VaR charge exceeds the member's Net Capital,
net assets or equity capital (as applicable to that member based on its
type of regulation).\913\ As discussed in part II.B1 supra, the
commenter's concerns regarding the interplay between purported required
gross margining and the ECP charge rests on the assumption that gross
margin is required under the proposal, which, as discussed in the prior
paragraph, is not the case. In addition, FICC recently has indicated
that it intends to make available client clearing models that do not
require gross margin, consistent with its current offerings.\914\
---------------------------------------------------------------------------

\911\ See note 33 supra.
\912\ See part IV.C.3.b infra.
\913\ IDTA Letter, supra note 66, at 4; IDTA Letter 2, supra
note 829, at 7; see also FICC Rule 4, section 14, supra note 19.
\914\ See DTCC 2023 White Paper, supra note 107, at 6
(discussing that the proposal would allow the option to calculate
and collect margin associated with customer activity on a gross or
net basis depending on the client clearing model selected by the
member and stating that FICC would offer options via different
access models that would allow those parties to balance the benefits
of netting and segregation in different ways).
---------------------------------------------------------------------------

A commenter requested that the SEC encourage FICC to establish a
feature allowing (but not requiring) registered fund sponsored members
to support their obligations by having margin posted with FICC (``FICC
registered fund margin framework'') rather than by paying fees to the
sponsoring member.\915\ While the commenter noted that the Sponsored
Service under current FICC rules does not raise custody issues for
registered funds under the 1940 Act because registered funds are not
required to post margin to FICC, if a fund's margin were permitted to
be posted with FICC, that could raise custody issues for funds unless
such funds had relief from certain provisions of the 1940 Act.\916\ The
commenter stated that permitting registered funds' margin to be posted
with FICC could reduce costs for registered funds and facilitate their
use of cleared reverse repos and term repos.\917\ The Commission
understands that FICC's current rules for the Sponsored Service do not
require sponsored and sponsoring member margin to be calculated or held
separately implying that the sponsoring member is satisfying all FICC
margin requirements. Thus, current practice bundles trade execution and
clearing, including the posting of margin. As such, registered funds in
effect pay the costs associated with the posting of margin either
through fees or through inferior pricing. Enabling registered fund
margin to be posted at FICC creates the potential for unbundling these
activities, and for greater competition.
---------------------------------------------------------------------------

\915\ See supra note 125.
\916\ See part II.A.2.a.ii supra.
\917\ ICI Letter, supra note 85.
---------------------------------------------------------------------------

The Commission agrees that facilitating the ability for a
registered fund's margin to be posted at FICC as an alternative to the
sponsoring member satisfying all FICC margin requirements and passing
the cost of doing so through to the registered fund may lower the cost
of trading for the fund, and the Commission's five year position
discussed in part II.A.2.a.ii supra, will help facilitate the posting
of registered fund margin to satisfy a U.S. Treasury securities CCA's
margin deposit

[[Page 2810]]

requirements. The ability to separate the trade execution and clearing
services of sponsoring a registered fund's transactions with the CCA
from the posting margin may facilitate done-away trading and enhance
the ability of smaller CCA netting members to become sponsoring members
or expand the capacity of sponsoring members in the Sponsored Service.
iii. Facilitating Access to U.S. Treasury Securities CCAs
The various access models currently available to access central
clearing in the U.S. Treasury securities market may not meet the needs
of the many different types of market participants who transact in U.S.
Treasury securities with the direct members of a U.S. Treasury
Securities CCA. The additional provision to Rule 17ad-22(e)(18)(iv)(C)
requires a U.S. Treasury securities CCA to establish, implement,
maintain and enforce certain written policies and procedures regarding
access to clearance and settlement services, which, while not
prescribing specific methods of access, is intended to ensure that all
U.S. Treasury security CCAs have appropriate means to facilitate access
to clearance and settlement services in a manner suited to the needs of
market participants, including indirect participants.
Some market participants have commented on the current practice of
tying clearing services to trading under the sponsored clearing
model.\918\ Under this model, the decision to clear the trades of an
indirect participant appears to be contingent on that indirect
participant trading with the direct participant sponsoring the indirect
member.\919\ If the indirect participant is a competitor of the
sponsoring direct participant and the direct participant has discretion
on which trades to clear, the indirect participant may have difficulty
accessing clearing. The rule requires the U.S. Treasury securities CCA
to ensure appropriate means to facilitate access; for some current
indirect participants this may imply direct membership (with a
potential change in membership criteria); alternatively, requiring
something similar to a ``done-away'' clearing model may be another
means of facilitating clearing.
---------------------------------------------------------------------------

\918\ See Futures Industry Association Principal Traders Group,
Clearing a Path to a More Resilient Treasury Market, at 10 (July
2021), available at https://www.fia.org/sites/default/files/2021-07/FIA-PTG_Paper_Resilient%20Treasury%20Market_FINAL.pdf (``FIA-PTG
Whitepaper'').
\919\ See id. at 7.
---------------------------------------------------------------------------

Other considerations relate to the services available through the
sponsored clearing model. For example, buy-side participants, currently
engage in both triparty and bilateral repo, across multiple tenors
(both overnight and long term), and on either side (selling or buying)
of the transaction. At present, it appears that FICC direct members may
be able to decline to submit a trade with counterparties who are not
FICC direct members for central clearing at their discretion.\920\ Thus
some indirect participants who are unable to enter into a similar
transaction using a different FICC direct member who is willing to
submit the trade for central clearing would not be able to access
central clearing under the current practice. The rule requires FICC to
create new policies and procedures to facilitate access to clearing for
these participants.
---------------------------------------------------------------------------

\920\ See part IV.B.3 supra.
---------------------------------------------------------------------------

One commenter opposed the inclusion of registered funds because the
current clearing framework is not sufficiently developed to support
such a central clearing requirement.\921\ The commenter identified
several issues to be addressed prior to adopting such a requirement,
including improvements to the Sponsored Service and develop a ``done
away'' model (see part II.B.2 supra for additional discussion of the
issues raised by this commenter).
---------------------------------------------------------------------------

\921\ ICI Letter, supra note 85.
---------------------------------------------------------------------------

In addition, the Rule 17ad-22(e)(18)(iv)(C) requires the CCA's
written policies and procedures be annually reviewed by the CCA's board
of directors to ensure that the CCA has appropriate means to facilitate
access to clearance and settlement services of all eligible secondary
market transactions in U.S. Treasury securities, including those of
indirect participants. This review should help ensure that such
policies regarding access to clearance and settlement services,
including for indirect participants, are reviewed annually by the U.S.
Treasury securities CCA's board of directors. The annual review ensures
that such policies and procedures be reviewed periodically and
potentially updated to address any changes in market conditions.
c. Amendments to Rules 15c3-3 and 15c3-3a
The rules and rule amendments being adopted and that are discussed
above could cause a substantial increase in the margin broker-dealers
must post to a U.S. Treasury securities CCA resulting from their
customers' cleared U.S. Treasury securities positions. Currently, Rules
15c3-3 and 15c3-3a do not permit broker-dealers to include a debit in
the customer reserve formula equal to the amount of margin required and
on deposit at a U.S. Treasury securities CCA. This is because no U.S.
Treasury securities CCA has implemented rules and practices designed to
segregate customer margin and limit it to being used solely to cover
obligations of the broker-dealer's customers. Therefore, increases in
the amount of margin required to be deposited at a U.S. Treasury
securities CCA as a result of the requirement to clear eligible
secondary market transactions would result in corresponding increases
in the need to use broker-dealers' cash and securities to meet these
requirements.
The amendment to Rule 15c3-3a permits, under certain conditions,
margin required and on deposit at a U.S. Treasury securities CCA to be
included as a debit item in the customer reserve formula. This new
debit item will offset credit items in the Rule 15c3-3a formula and,
thereby, free up resources that could be used to meet the margin
requirements of a U.S. Treasury securities CCA. The amendment allows a
customer's broker to use customer funds to meet margin requirements at
the CCP generated by the customer's trades, lowering the cost of
providing clearing services.
As discussed further below, we expect these changes to allow more
efficient use of margin for cleared trades relative to the baseline.
This change, alone, could create incentives for greater use of central
clearing, and thus could promote the benefits described in previous
sections.
Overall, commenters supported the proposal to permit this debit
item.\922\ One commenter stated that the practical effect of this
change would be to allow broker-dealers to use margin collected from
customers to satisfy margin requirements associated with such
customers' transactions, rather than using proprietary funds to finance
customer margin as is the case today, and expressed its support for
this amendment because it will free up broker-dealer resources by
reducing the amount of proprietary funds needed to finance customer
margin and therefore lower the cost of clearing, while continuing to
protect customer funds.\923\ Another commenter stated that this change
would reduce the costs of centrally clearing U.S. Treasury securities
transactions and thus incentivize more central clearing of such
transactions.\924\
---------------------------------------------------------------------------

\922\ See supra note 446.
\923\ See MFA Letter, supra note 81, at 10.
\924\ See SIFMA/IIB Letter, supra note 37, at 12.

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

[[Page 2811]]

2. Costs
The Commission has, where practicable, attempted to quantify the
economic effects it expects may result from the amendments and new
rules that it is adopting. In some cases, however, data needed to
quantify these economic effects is not currently available or depends
on the particular changes made to the U.S. Treasury securities CCA
policies and procedures. As noted below, in the Proposing Release the
Commission was unable to quantify certain economic effects and
solicited comment, including estimates and data from interested
parties, which could help inform the estimates of the economic effects
of the new rules and amendments.
Significant costs of central clearing for market participants may
include: (i) initial margin requirements (which in practice are held as
``clearing fund'' at FICC and subject to loss mutualization and the
attendant adverse capital implications); (ii) clearing fees; (iii)
obligations with respect to FICC's capped contingency liquidity
facility (``CCLF''); (iv) the operational build necessary to access
central clearing (either as a direct participant or as an indirect
participant); and (v) legal costs and time associated with onboarding
customers for indirect central clearing, including, e.g., the need for
Sponsoring Members to file UCC financing statements with respect to
Sponsored Members under the Sponsored Member program. These costs are
discussed in more detail below. Not all costs are expected to be borne
by all participants and may depend on rules of the clearing agency.
One commenter stated that the increased costs of centrally clearing
U.S. Treasury security transactions may reduce liquidity and diversity
in the Treasury market if firms reduce activity, leave the market, or
if barriers to entry are too high, given the significant costs of
clearing for market participants.\925\ The commenter identified several
types of costs, including initial margin requirements, clearing fees,
obligations with respect to FICC's CCLF, the operational build
necessary to access central clearing either as a direct or indirect
participant, and legal costs and time associated with onboarding
customers for indirect central clearing, including, e.g., the need for
Sponsoring Members to file UCC financing statements with respect to
Sponsored Members under the Sponsored Member program. The commenter
stated that the impact of these costs would be disproportionately felt
by small and mid-sized participants in the U.S. Treasury market, and
that they would reduce diversity in the market and further increase
concentration among market participants (which may increase systemic
risk) if such participants leave the market.\926\
---------------------------------------------------------------------------

\925\ See SIFMA/IIB Letter, supra note 37.
\926\ See SIFMA/IIB Letter, supra note 37, at 8.
---------------------------------------------------------------------------

Increased transaction costs will, all else equal, reduce the
expected return of a particular investment. If this were the only
effect then the risk/return tradeoff would worsen and transaction
volume could fall and liquidity deteriorate. However, central clearing
also provides numerous benefits described above, including a possible
decrease in transaction costs.\927\ Many of these benefits could be
expected to particularly benefit small and mid-sized participants, for
example the reduction in counterparty credit risk that can result from
central clearing may particularly benefit smaller market participants.
---------------------------------------------------------------------------

\927\ See part IV.C.1 supra.
---------------------------------------------------------------------------

Commenters mentioned the potential concentration risk that would
arise because of the requirement to clear eligible secondary market
transactions, specifically because only one covered clearing agency
currently provides such services. One commenter stated that
concentrating such significant levels of settlement, operational,
liquidity and credit risk in one institution means that were there
operational or liquidity stress at FICC, widespread dysfunction in the
Treasury markets could result.\928\ One commenter agreed that the
existence of one covered clearing agency serving the U.S. Treasury
market is highly problematic as it creates enormous concentration risk
for market participants, and highlighted that, given the importance of
the U.S. Treasury market to the overall global economy, there needs to
be a compelling reason for increasing the concentration of cleared
trading activity in a single clearing house particularly when there is
no alternative or fallback venue should the clearing house experience a
disruption to its operations or more significantly were to fail.\929\
---------------------------------------------------------------------------

\928\ See SIFMA/IIB Letter, supra note 37, at 10.
\929\ SIFMA/AMG Letter, supra note 37, at 9.
---------------------------------------------------------------------------

The Commission also recognizes the risks associated with increased
centralization of clearance and settlement activities. In particular,
the Commission has previously noted that ``[w]hile providing benefits
to market participants, the concentration of these activities at a
covered clearing agency implicitly exposes market participants to the
risks faced by covered clearing agencies themselves, making risk
management at covered clearing agencies a key element of systemic risk
mitigation.'' \930\
---------------------------------------------------------------------------

\930\ See CCA Standards Proposing Release, supra note 8, 79 FR
at 29587.
---------------------------------------------------------------------------

As discussed previously, currently only FICC provides CCP services
for U.S. Treasury securities transactions, including outright cash
transactions and repos.\931\ Were FICC unable to provide its CCP
services for any reason then this could have a broad and severe impact
on the overall U.S. economy. The FSOC recognized this when it
designated FICC as a systemically important financial market utility in
2012,\932\ which subjects it to heightened risk management requirements
and additional regulatory supervision, by both its primary regulator
and the Board of Governors.\933\ In addition, FICC is subject to the
Covered Clearing Agency Standards, which address the various types of
risk that FICC faces as a CCP, including settlement, operational,
liquidity, and credit risk. FICC also must meet its obligations under
both Section 19(b) of the Exchange Act, as a self-regulatory
organization, and Title VIII of the Dodd-Frank Act. The Commission
believes that this overall supervisory framework, including the Covered
Clearing Agency Standards, should help ensure that FICC continues to be
subject to robust supervision and oversight and to be able to manage
the risks presented to it, even those arising from increased Treasury
clearing.
---------------------------------------------------------------------------

\931\ See Proposing Release, supra note 14 at 64612. See also
part II.A.1.b supra.
\932\ See supra note 369.
\933\ Id. at 119. The Commission previously stated that Congress
has recognized in the Clearing Supervision Act that the operation of
multilateral payment, clearing or settlement activities may reduce
risks for clearing participants and the broader financial system,
while also creating new risks that require multilateral payment,
clearing or settlement activities to be well-designed and operated
in a safe and sound manner. The Clearing Supervision Act is
designed, in part, to create a regulatory framework to help deal
with such risk management issues, which is generally consistent with
the Exchange Act requirement that clearing agencies organize
themselves in a manner to facilitate prompt and accurate clearance
and settlement, safeguard securities and funds and protect
investors. See CCA Standards Proposing Release, supra note 8, 76 FR
at 14474; see also 12 U.S.C. 5462(9), 5463(a)(2).
---------------------------------------------------------------------------

a. Costs to FICC and Its Members of the Requirement To Clear Eligible
Secondary Market Transactions
The Commission believes that many of the direct costs of the rules
and amendments it is adopting to the U.S. Treasury securities CCA are a
result of new policies and procedures requirements, the costs of which
are likely to be modest. This is because all

[[Page 2812]]

but one of these amendments and rules require the CCA to make certain
changes to its policies and procedures. The other amends Rule 15c3-3a
to permit margin required and on deposit at a U.S. Treasury securities
CCA to be included as a debit item in the customer reserve formula for
broker-dealers, subject to the conditions discussed above. As discussed
above, the amendments to Rule 15c3-3a require several conditions to be
met, including that the U.S. Treasury securities CCA calculate a
separate margin amount for each customer on a gross basis.\934\
Comments submitted by the single current U.S. Treasury securities CCA
acknowledged that it would need to make documentation, operational,
organizational, and systems changes in order to comply with the
proposal.\935\
---------------------------------------------------------------------------

\934\ See part II.C.2.c supra.
\935\ See DTCC/FICC Letter, supra note 33, at v. Although DTCC/
FICC acknowledged there would be required system and other changes,
it did not provide any estimate of the costs of such changes.
---------------------------------------------------------------------------

Rule 17ad-22(e)(18)(iv) requires a U.S. Treasury securities CCA to
establish, implement, maintain and enforce written policies and
procedures, as discussed above.\936\ Because policies and procedures
regarding the clearing of all eligible secondary market transactions
entered into by a direct participant in a U.S. Treasury securities CCA
are not currently required under existing Rule 17ad-22, the Commission
believes that Rule 17ad-22(e)(18)(iv) may require a covered clearing
agency to make substantial changes to its policies and procedures. The
rule amendment contains similar provisions to existing FICC rules but
will also impose additional requirements that do not appear in existing
Rule 17ad-22. As a result, the Commission believes that a U.S. Treasury
securities CCA will incur burdens of reviewing and updating existing
policies and procedures in order to comply with the provisions of Rule
17ad-22(e)(18)(iv) and, in some cases, may need to create new policies
and procedures.\937\
---------------------------------------------------------------------------

\936\ See part II.A.4 supra for a discussion of the requirement
that a U.S. Treasury securities CCA establish, implement, maintain
and enforce written policies and procedures reasonably designed to,
as applicable, identify and monitor its direct participants'
required submission of transactions for clearing, including, at a
minimum, addressing a direct participant's failure to submit
transactions. See part II.B.2 supra for a discussion of the
requirement that U.S. Treasury securities CCA establish, implement,
maintain and enforce written policies and procedures reasonably
designed to, as applicable, ensure that it has appropriate means to
facilitate access to clearance and settlement services of all
eligible secondary market transactions in U.S. Treasury securities,
including those of indirect participants, which policies and
procedures the U.S. Treasury securities CCA's board of directors
reviews annually.
\937\ See part IV.C.2.c.ii, infra.
---------------------------------------------------------------------------

The Commission estimates that U.S. Treasury securities CCAs will
incur an aggregate one-time direct cost of approximately $207,000 to
create new policies and procedures.^{938 939} The rule also
requires ongoing monitoring and compliance activities with respect to
the written policies and procedures created in response to the rule.
The Commission estimates that the ongoing activities required by Rule
17ad-22(e)(18)(iv) impose an aggregate ongoing cost on covered clearing
agencies of approximately $61,000 per year.\940\
---------------------------------------------------------------------------

\938\ To monetize the internal costs, the Commission staff used
data from SIFMA publications, modified by Commission staff to
account for an 1800 hour work-year and multiplied by 5.35
(professionals) or 2.93 (office) to account for bonuses, firm size,
employee benefits and overhead. See SIFMA, Management and
Professional Earnings in the Security Industry--2013 (Oct. 7, 2013);
SIFMA, Office Salaries in the Securities Industry--2013 (Oct. 7,
2013). These figures have been adjusted for inflation using data
published by the Bureau of Labor Statistics.
\939\ This figure was calculated as follows: Assistant General
Counsel for 40 hours (at $518 per hour) + Compliance Attorney for 80
hours (at $406 per hour) + Computer Operations Manager for 20 hours
(at $490 per hour) + Senior Risk Management Specialist for 40 hours
(at $397 per hour) + Business Risk Analyst for 80 hours (at $305 per
hour) = $103,280 x 2 respondent clearing agencies = $206,560. See
part V.A infra.
\940\ This figure was calculated as follows: Compliance Attorney
for 25 hours (at $406 per hour) + Business Risk Analyst for 40 hours
(at $305 per hour) + Senior Risk Management Specialist for 20 hours
(at $397 per hour) = $30,290 x 2 respondent clearing agencies =
$60,580. See part V.A infra.
---------------------------------------------------------------------------

i. Costs Attendant to an Increase in CCLF
The new rules and amendments being adopted will likely result in a
significant increase in the volume of U.S. Treasury securities
transactions submitted to clearing. The G-30 has reported that FICC
differs qualitatively from other CCPs in that counterparty credit risks
are relatively small but liquidity risks in the event of member
defaults could be extraordinarily large.\941\ This is because net long
positions generate liquidity obligations for FICC since, in the event
of a member default, FICC would have to deliver cash in order to
complete settlement of such positions with non-defaulting parties.
Increased clearing volume of cash and repo transactions as a result of
the rule could increase FICC's credit and liquidity exposure to its
largest participant family, including those participants acting as
sponsors of non-members.\942\ FICC is obligated by Commission rule to
maintain liquidity resources to settle all obligations of its largest
participant family, in the event of default.\943\ These resources
include the CCLF in which Members will be required to hold and fund
their deliveries to an insolvent clearing member up to a predetermined
cap by entering into repo transactions with FICC until it completes the
associated close-out. This facility allows clearing members to
effectively manage their potential financing requirements with
predetermined caps.\944\
---------------------------------------------------------------------------

\941\ G-30 Report, supra note 5, at 14.
\942\ Participant family means that if a participant directly,
or indirectly through one or more intermediaries, controls, is
controlled by, or is under common control with, another participant
then the affiliated participants shall be collectively deemed to be
a single participant family. See Rule 17ad-22(a).
\943\ See part IV.B.3 supra.
\944\ FICC Disclosure Framework 2021 at 88, available at https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/FICC_Disclosure_Framework.pdf.
---------------------------------------------------------------------------

As reported in the CPMI-IOSCO disclosure by FICC for Q2 of 2023,
the combined liquidity commitment by clearing members to the FICC's
CCLF was $86.3 billion for all repos and cash trades of U.S. Treasury
and Agency securities. Since the inception of the CCLF in 2018, the
CCLF has ranged in size from $82.5B to $108B.\945\ Commitments by bank-
affiliated dealers to the CCLF count against regulatory liquidity
requirements, including the Liquidity Coverage Ratio (LCR).\946\
Dealers affiliated with banks may satisfy their CCLF obligations using
a guarantee from that affiliated bank but dealers not affiliated with
banks may incur costs to obtain commitments to meet CCLF liquidity
requirements. FICC states that when examining the impact of the rule
amendments being adopted, its findings are inconclusive about the
potential impact of the incremental indirect participant Treasury
volume on FICC's liquidity needs or its CCLF.\947\
---------------------------------------------------------------------------

\945\ See part IV.B.3 supra.
\946\ LCR is calculated as the ratio of High-Quality Liquid
Assets (HQLA) divided by estimated total net cash outflow during a
30-day stress period. Because commitments by bank-affiliated dealers
to the CCLF would increase the denominator of the ratio, a bank-
affiliated dealer would have to increase HQLA to reach a required
level of LCR.
\947\ See DTCC 2023 White Paper, supra note 107, at 3, 19.
---------------------------------------------------------------------------

The size and cost of a firm's liquidity plan is tied not only to
its own exposure at FICC, but also to the maximum exposure of the
largest systemically important financial institution (``SIFI'') banks.
One commenter stated that its members have reduced their portfolios as
part of their CCLF liquidity plans.\948\ At the same time, SIFIs have
increased the size of their portfolios, and

[[Page 2813]]

correspondingly, the very risk that the CCLF was designed to
reduce.\949\
---------------------------------------------------------------------------

\948\ IDTA Letter, supra note 66, at 8-9.
\949\ Id.
---------------------------------------------------------------------------

ii. Costs of the Requirement To Clear Eligible Secondary Market
Transactions in Terms of Increased Margining for Existing FICC Members
As discussed above, the Commission recognizes that these amendments
could cause an increase in the margin clearing members must post to a
U.S. Treasury securities CCA resulting from the additional transactions
that will be submitted for clearing as a result of these amendments.
Although various SRO margin rules provide for the collection of margin
for certain transactions in U.S. Treasury securities, the Commission
understands that transactions between dealers and institutional
customers are subject to a variable ``good-faith'' margin standard,
which the Commission understands--based on its supervisory experience--
can often result in fewer financial resources collected for margin
exposures than those that would be collected if a CCP margin model,
like the one used at FICC, were used.\950\ Mitigating the potential for
higher margin requirements for transactions submitted for clearing at a
U.S. Treasury securities CCA is the benefit of netting that results
from additional centrally cleared transactions.\951\ As described in
part IV.C.1 supra, this mitigant is likely to be especially significant
in the case of IDB members. Also, potentially substantially mitigating
the costs for clearing members is the ability for broker-dealers to
include a debit in the customer reserve formula equal to the amount of
margin required and on deposit at a U.S. Treasury securities CCA, as
described in part II.C supra.
---------------------------------------------------------------------------

\950\ See supra note 27.
\951\ See part IV.C.1 supra for a discussion of the benefits of
multilateral netting expected to result from higher volumes of
centrally cleared transactions.
---------------------------------------------------------------------------

Based on a survey of its members, FICC estimates that incremental
indirect participant Treasury volume could result in a corresponding
increase in Value at Risk (VaR) margin of approximately $26.6 billion
across the FICC/GSD membership.^{952 953} Netting members'
required fund deposits to the clearing fund are primarily driven by a
VaR charge; however, other margin charges may be collected when
applicable.\954\ The cost to the netting members of the additional
required fund deposits estimated by FICC is likely be less than this
for three reasons. First, the definition of an eligible secondary
market transaction with respect to cash transactions that is being
adopted is narrower than that which was proposed and on which FICC's
estimates were based. Second, some fraction of the additional secondary
market transactions that will be centrally cleared due to the new rules
that would otherwise have been cleared bilaterally would also have been
subject to margin requirements. Finally, since margin is only posted
pending settlement, the cost to the posting entity is the opportunity
cost of the funds.
---------------------------------------------------------------------------

\952\ See DTCC 2023 White Paper, supra note 107, at 3, 16. FICC
estimates that, in aggregate, there will be an incremental $500
billion of indirect participant Treasury repo activity, $520 billion
of indirect participant Treasury reverse repo activity and $605
billion of indirect participant Treasury cash activity that could be
submitted to FICC under the Proposing Release if it were adopted.
The increase in margin is based on this estimate of increased
central clearing activity. The estimates assume that all incremental
indirect participant volume clears through one of FICC's client
clearing models that calculate margin on a gross basis. The
estimates could decrease if the activity were cleared through one of
FICC's client clearing models that calculate margin on a net basis.
See also note 377, supra, regarding margin methodologies. BNY Mellon
estimates as much as $370 billion in additional Treasury cash
activity and $2.8 trillion in additional Treasury repo and reverse
repo activity that could be submitted to FICC although they note
that exemptions could reduce these amounts. See BNY Mellon,
Reassembly Required: Central Clearing could Reshape the U.S.
Treasury Market (November 2023), available at https://www.bnymellon.com/us/en/insights/all-insights/central-clearing-us-treasury-market.html.
\953\ There is uncertainty among market participants about how
much additional margin would have to be collected by FICC. For
example, in an article in the Financial Times' Alphaville, an
analyst at Barclays is quoted as estimating the additional margin
could be $45 billion. Bryce Elder, Repo reform is a $2tn mystery
wrapped in an enigma of dodgy data, FT Alphaville (Oct.13, 2023),
available at https://www.ft.com/content/518cbd3b-b1ed-4c3e-bd5e-9ac5bee99d9f. The discussion concluding that the cost to netting
members of the additional required fund deposits estimated by FICC
applies to this alternative estimate as well.
\954\ See DTCC, F.A.Q. FICC--Risk Management, available at
https://www.dtcc.com/USTclearing/-/media/Files/Downloads/Microsites/Treasury-Clearing/FICC-Risk-Management-FAQ.pdf (last visited Dec.
11, 2023).
---------------------------------------------------------------------------

One commenter, on behalf of its broker-dealer members, stated that
there is a transaction cost difference between current bilateral trades
that are cleared using the triparty platform and an identical
transaction that must be centrally cleared.\955\ The commenter further
noted that this cost across a volume of trades is borne by clients of
broker-dealers. The commenter stated that while the actual costs may
vary across its membership, its members are currently paying about
$3.00 per transaction settled on the triparty platform and bilaterally
cleared over $7.00 for a similar tri-party transaction that was
centrally cleared through FICC. The commenter stated that this is
because FICC imposes intraday and end-of-day position management
charges, among other charges, making it materially cost prohibitive to
transact with FICC and thereby increasing the cost of trading to the
end customer. Besides the direct impact of these costs, which could
limit trading, costs of central clearing may incentivize non-direct
participants of a Treasury CCP to look for ways to trade away from
direct participants in order to not have to centrally clear Treasury
transactions, negatively affecting both liquidity and competition.
---------------------------------------------------------------------------

\955\ IDTA Letter, supra note 66, at 4.
---------------------------------------------------------------------------

Several commenters discussed facilitating cross-margining of
indirect participants' transactions in U.S. Treasury securities with
those in U.S. Treasury futures as a method to lower costs of trading
and thereby incentivize additional clearing.\956\ One commenter stated
that cross-margining would lower costs for market participants by
allowing them to apply margin across positions submitted for clearing
through various clearinghouses. The commenter stated that this would
ensure that a market participant can post margin adequate to support
its positions without having to post margin in excess of regulatory
requirements due to an inability to apply margin across platforms.\957\
As discussed above, other commenters made additional suggestions
lowering costs by creating additional cross margining
opportunities.\958\ The current cross-margining agreement between FICC
and CME is part of the GSD rulebook, and any changes to it have to be
filed with the Commission pursuant to Section 19(b) of the Exchange
Act. The Commission agrees that cross-margining can be beneficial to
market participants.\959\ Rules requiring segregation of client margin
should facilitate cross-margining. If such cross-margining were
adopted, some costs of clearing would be mitigated.
---------------------------------------------------------------------------

\956\ MFA Letter at 11; SIFMA/IIB Letter, supra note 37, at 13;
SIFMA AMG Letter at 8.
\957\ MFA Letter at 11.
\958\ See part II.A.1.0 supra.
\959\ Id.
---------------------------------------------------------------------------

One commenter stated that central clearing can have procyclical
effects in times of market stress due to the margin requirements of
clearing agencies, further reducing liquidity when it is most
needed.\960\ The commenter stated that, depending on the applicable
margin models, clearing can be procyclical in times of market turmoil,
as increased margin requirements (including intraday and ad hoc calls)
drive demand for liquid assets, which,

[[Page 2814]]

in turn, increases the scarcity of those assets and further drives
market stress. The commenter described FICC's rules as allowing FICC to
demand, at any time in its discretion, additional margin from its
members in times of market volatility, including through intraday
calls, to safeguard the clearing infrastructure.\961\
---------------------------------------------------------------------------

\960\ SIFMA/IIB Letter, supra note 37, at 9.
\961\ Id.
---------------------------------------------------------------------------

The Commission acknowledges that, in times of market stress, margin
calls may increase to address the ongoing market volatility. This is by
design, as margin models are built to be responsive to current market
conditions. The Commission has specifically required that CCAs have the
authority and operational capacity to make intraday margin calls in
defined circumstances.\962\ This ability is important to the CCA's
ability to manage the risk and cover the credit exposures that its
participants may bring to the CCA. When considering a CCA's authority
with respect to intraday margin, the Commission may consider its
potential procyclicality.\963\ In addition, the Commission may consider
the transparency of the margin model, such that market participants can
understand when the CCA may make margin calls.\964\ In addition to the
FICC rules cited by the commenter, FICC has provided additional
transparency regarding how it determines the need for intraday margin
calls, including the specific criteria that it uses to assess the
need.\965\ FICC is also subject to Rule 17ad-22(e)(23), which requires
certain levels of public disclosure regarding FICC's margin methodology
and the costs of participating in FICC, as discussed further in part
II.B.2 supra. The Commission's ongoing consideration of the role and
function of intraday margin calls, as well as market participants'
ability to understand such calls, obviates the need for separate study
in connection with this proposal.\966\
---------------------------------------------------------------------------

\962\ 17 CFR 240.17ad-22(e)(6)(ii).
\963\ See, e.g., Self-Regulatory Organizations; Fixed Income
Clearing Corporation; Order Approving a Proposed Rule Change to
Modify the Calculation of the MBSD VaR Floor to Incorporate a
Minimum Margin Amount, Exchange Act Release No. 92303, at 32 (June
30, 2021) (discussing commenter's concern regarding potential
procyclical nature of a margin methodology change); Self-Regulatory
Organizations; The Options Clearing Corporation; Order Granting
Approval of Proposed Rule Change Concerning The Options Clearing
Corporation's Margin Methodology for Incorporating Variations in
Implied Volatility, Exchange Act Release No. 95319, at 3 (July 19,
2022) (referencing the impact of a change to margin methodology on
procyclicality of margin).
\964\ See, e.g., Self-Regulatory Organizations; National
Securities Clearing Corporation; Order Approving a Proposed Rule
Change to Enhance National Securities Clearing Corporation's
Haircut-Based Volatility Charge Applicable to Illiquid Securities
and UITs and Make Certain Other Changes to Procedure XV, Exchange
Act Release No. 34-90502, at 56-59 (Nov. 24, 2020) (discussing
commenter's concerns regarding transparency of change to margin
methodology).
\965\ See Self-Regulatory Organizations; Fixed Income Clearing
Corporation; Notice of Filing of Proposed Rule Changes to the
Required Fund Deposit Calculation in the Government Securities
Division Rulebook, Exchange Act Release No. 82588 (Jan. 26, 2018)
(identifying the following specific parameter breaks: (i) a dollar
threshold that evaluates whether a Netting Member's Intraday VaR
Charge equals or exceeds a set dollar amount (then set at
$1,000,000) when compared to the VaR Charge that was included in the
most recently collected Required Fund Deposit including, any
subsequently collected Intraday Supplemental Fund Deposit; (ii) a
percentage threshold, that evaluates whether the Intraday VaR Charge
equals or exceeds a percentage increase (then set at 100%) of the
VaR Charge that was included in the most recently collected Required
Fund Deposit including, if applicable, any subsequently collected
Intraday Supplemental Fund Deposit; (iii) the coverage target, that
evaluates whether a Netting Member is experiencing backtesting
results below the 99% confidence level). FICC has updated this
information via Important Notices to its participants. See, e.g.,
Important Notice GOV1244-22, GSD Intraday Supplemental Fund Deposit
Parameter Change (Apr. 11, 2022), available at https://www.dtcc.com/-/media/Files/pdf/2022/4/11/GOV1244-22.pdf (raising the coverage
target).
\966\ See also Proposed Rule, Covered Clearing Agency Resilience
and Recovery and Wind-Down Plans, Exchange Act Release No. 97516
(May 17, 2023), 88 FR 34708 (May 30, 2023) (proposing additional
requirements with respect to intraday margin that CCAs require
intraday monitoring of their exposures and specifying particular
circumstances in which the CCA should make intraday margin calls).
---------------------------------------------------------------------------

iii. Other Costs
Several commenters raised additional issues related to costs or
limitations on benefits of the new rules and amendments. One commenter
explained that registered funds' access to the Treasury repo market
could be restricted by the number or willingness of the FICC netting
members to provide sponsoring services, with attending negative effect
on the market liquidity.\967\
---------------------------------------------------------------------------

\967\ ICI Letter, supra note 85, at 30-31.
---------------------------------------------------------------------------

Commenters have raised concerns that increases in demand for the
Sponsored Service may put pressure on existing sponsoring members and
reduce their ability or willingness to onboard additional clients. Such
outcomes may result in these market participants not being able to
trade with some of the largest banks and broker dealers who are direct
members of FICC unless they are able to access clearing using an
alternative clearing model, reducing the number of potential
counterparties, possibly raising trading costs. Demand for sponsored
access to clearing could also drive up the price of providing such
services and provide an incentive for new competitors to enter the
market for providing sponsored clearing services. Alternatively, it is
possible that as part of review of its access models and related
policies and procedures required by Rule 17ad-22(e)(18)(iv)(C), that
FICC may modify its access models in a way that results in improved
access for market participants who otherwise be so affected. Another
commenter explained the impact of the ECP charge in conjunction with
FICC's Sponsored Service, stating that ``the combination of gross
margining and ECP currently in use under the Sponsored Model, and what
is prescribed in the Proposed Rule, effectively prevents smaller and
middle market broker dealers from materially participating in the
Treasury market.\968\
---------------------------------------------------------------------------

\968\ IDTA Letter, supra note 66, at 5. This commenter's stated
concern regards the interplay between the ECP and gross margining
and rests on the assumption that gross margining is required by the
rule which is not the case. See supra part II.B.1. However, the ECP
in its current form may impact the willingness of small and middle
market broker dealers from sponsoring additional market
participants.
---------------------------------------------------------------------------

However, another commenter explained that, in addition to the
Sponsored Service, the U.S. Treasury securities CCA offers a variety of
way to access central clearing for indirect participants.\969\ For
example, FICC's Prime Brokerage Clearing and Correspondent Clearing
models currently support clearing of transactions between indirect
participants although, at present, these models are rarely used.\970\
As stated in the Proposing Release, the Commission continues to believe
that the U.S. Treasury securities CCA generally should consider a wide
variety of appropriate means to facilitate access to clearance and
settlement services of all eligible secondary market transactions in
U.S. Treasury securities, including those of indirect participants. In
view of the critical services it provides, the U.S. Treasury securities
CCA generally should seek to provide access in as flexible a means as
possible, consistent with its responsibility to provide sound risk
management and comply with other provisions of the Exchange Act, the
Covered Clearing Agency Standards, and other applicable regulatory
requirements.
---------------------------------------------------------------------------

\969\ DTCC Letter, supra note 33, at 18-21.
\970\ Id. at 20.
---------------------------------------------------------------------------

b. Costs to Non-Members of a U.S Treasury Securities CCA as a Result of
the Requirement To Clear Eligible Secondary Market Transactions
The requirement to clear eligible secondary market transactions
requires that all repo transactions with a direct participant be
centrally cleared and that

[[Page 2815]]

certain cash transactions with a direct participant to be centrally
cleared. The costs incurred by non-members of a U.S. Treasury
securities CCA to comply with this requirement will depend on the
policies and procedures developed by the CCA, as discussed in parts
IV.C.2.a supra and IV.C.2.d infra.
As stated above, the Commission believes that these amendments will
increase central clearing in the U.S Treasury securities market.
Transactions that are not currently submitted for central clearing but
would be under the amendments being adopted will be subject to certain
transaction, position, and other fees as determined by the U.S.
Treasury securities CCA.\971\
---------------------------------------------------------------------------

\971\ The fee structure for FICC is described in its rulebook.
See FICC Rules, supra note 19, at 307.
---------------------------------------------------------------------------

Market participants who enter into eligible secondary market
transactions with members of U.S. Treasury securities CCAs who do not
have access to clearing may incur costs related to establishing the
required relationships with a clearing member in order to submit the
eligible transactions for clearing. These market participants may also
incur additional costs related to the submission and management of
margin. It is possible that such market participants may seek
alternative counterparties that are not U.S. Treasury securities CCA
members in order to avoid incurring these costs.
As discussed in the baseline, the majority of repo and cash
transactions in the dealer-to-customer segment are not centrally
cleared. This differentiates the U.S. Treasury securities market from
the markets for swaps and for futures. There is currently some clearing
of customer repo; the majority of this clearing is ``done-with''--the
clearing broker and the counterparty are one and the same. However, in
the swaps and futures markets, and in the equities market, clearing is
``done-away''--meaning that the clearing broker may be other than the
trading counterparty. Market participants have identified costs with
the done-with model. Market participants in the secondary market for
U.S Treasury securities that will be required to be centrally cleared
could incur direct costs for arranging clearing-related legal
agreements with every potential counterparty. Depending on the customer
there may be a large number of such arrangements.
There are indirect costs arising when a trading counterparty is a
competitor. For example, the pricing and offering of clearing services
may be determined by forces other than the costs and benefits of the
clearing relationship itself, such as the degree of competition between
the counterparties. Other economic arrangements facilitating customer
clearing are possible and may develop, as in other markets.\972\ One
such arrangement is direct CCA membership. However, for smaller
entities, CCA membership may not be economically viable, and for some
entities, legal requirements may prevent direct membership. Another
possibility is seeking out counterparties other than CCA members. The
``done away'' structure of clearing has worked effectively in other
markets, and, if it were to develop so that all market participants
with demand could trade using the ``done-away'' structure, would
significantly mitigate these costs.
---------------------------------------------------------------------------

\972\ See FIA-PTG Whitepaper, supra note 918 (for a description
of different client clearing models).
---------------------------------------------------------------------------

Some participants may not currently post margin for cash clearing
and may be now required to do so, depending on the form the clearing
relationship takes. There may be costs associated with the transfer of
margin. An institutional investor self-managing its account would
instruct its custodian to post margin with the CCA on the execution
date, and post a transaction in its internal accounting system showing
the movement of margin. The day after trade execution, the investor
would oversee the return of margin from FICC, with an attendant mark of
a transaction on the investor's internal accounting system. Similar
steps would occur for an institutional investor trading through an
investment adviser, though in this case the adviser might instruct the
custodian and mark the transaction, depending on whether the adviser
has custody. The institutional investor might also pay a wire fee
associated with the transfer of margin.
Besides the costs of developing new contracts with counterparties
to support central clearing, there will also be a cost to non-CCA
members associated with margin, to the extent that more margin is
required than in a bilateral agreement. This cost of margining is
analogous to that borne by CCA members and is discussed further above.
As a result of the rule, a potential cost to money market fund
participants that face FICC as a counterparty is that the funds' credit
ratings could be affected if FICC becomes a substantially large
counterparty of these participants, which could be interpreted by
credit models and ratings methodologies as a heightened concentration
risk factor. As concentration risk in a CCP is typically not viewed in
the same way as concentration risk with a bilateral trading party,
credit rating agencies may quickly adapt their methods to distinguish
the CCA from a conventional counterparty. In the absence of such
changes at credit rating agencies, money market fund participants may
find it necessary to either alter their investment strategies to
substitute purchases of Treasury securities for repo or to enter into
repo transactions with entities that are not direct members of a
Treasury securities CCA.
As discussed above, increased demand for the Sponsored Service and
the existence of compliance and capital costs for sponsoring members
may limit the ability of some market participants to access clearing
through the Sponsored Service. Unless these market participants are
able to access clearing through alternative clearing models, they may
be unable to trade repo with some of the largest banks and broker
dealers who are direct members of FICC, reducing the number of
potential counterparties, and possibly resulting in inferior pricing
for such market participants. Alternatively, it is possible that as
part of review of its access models and related policies and procedures
required by Rule 17ad-22(e)(18)(iv)(C), that FICC may modify its access
models in a way that results in improved access for market participants
who otherwise be so affected.
One commenter argued that including triparty repos in the
definition of an eligible secondary market transaction would likely
impair the cash and collateral management processes of hedge funds and
alternative asset managers.\973\ Specifically, the commenter suggested
that such firms currently conduct same-day bilateral transactions that
they would not be able to conduct with a direct participant of a U.S.
Treasury securities CCA required to centrally clear its repo
transactions.\974\
---------------------------------------------------------------------------

\973\ See MFA Letter at 17.
\974\ See id.
---------------------------------------------------------------------------

The Commission disagrees with this commenter. In its supervisory
capacity, the Commission is aware that registered funds, hedge funds,
and alternative asset managers currently conduct centrally cleared
triparty repo transactions. For example, the Commission is aware that
numerous hedge funds conduct such same-day transactions as sponsored
members of FICC. Therefore, the existing operational infrastructure
supports centrally cleared triparty repo transactions.
As discussed above, two commenters asked the Commission to adopt an
exemption that would allow FCMs to continue to engage in eligible
secondary

[[Page 2816]]

market transactions in U.S. Treasury securities outside of central
clearing.\975\ For the reasons discussed above in part II.A.2.a.iv
supra, the Commission is not excluding repo transactions between FICC
netting members and FCMs from the definition of eligible secondary
market transactions. However, the Commission recognizes that the
tension between the rules governing FCMs and the rule amendments being
adopted may raise costs for FCMs if it restricts the choice of models
that can be used to access central clearing or reduces the number of
potential counterparties. For example, one of the commenters explained
that FCMs are permitted to invest customer funds in certain securities
determined by the CFTC to be ``consistent with the objectives of
preserving capital and maintaining liquidity.'' \976\ The commenter
stated that permitted investments include, among other things, U.S.
Treasury securities, and investments with U.S. Treasury securities may
be made by either direct purchase or sale or by entering into repo
transactions.\977\ The commenter further explained that, for repo
transactions, an FCM's ``permitted counterparties are limited to a bank
. . . , securities broker-dealer, or government securities dealer
registered with the [Commission],'' and a clearing agency is not a
permitted counterparty.\978\ If an FCM is unable to clear repo
transactions then it would not be able to trade with FICC netting
members, reducing the number of potential counterparties available to
it.
---------------------------------------------------------------------------

\975\ See supra note 901 and referencing text.
\976\ FIA Letter, supra note 200, at 4-5 (discussing 17 CFR
1.25(b)).
\977\ FIA Letter, supra note 200, at 4-5 (discussing 17 CFR
1.25(a)).
\978\ FIA Letter, supra note 200, at 5 (discussing 17 CFR
1.25(d)(2))).
---------------------------------------------------------------------------

c. Other Changes to Covered Clearing Agency Standards
i. Netting and Margin Practices for House and Customer Accounts
The amendments to Rule 17ad-22(e)(6)(i) require a U.S. Treasury
securities CCA to establish, implement, maintain and enforce written
policies and procedures reasonably designed to, as applicable,
calculate, collect, and hold margin amounts from a direct participant
for its proprietary U.S. Treasury securities positions, separately and
independently from margin calculated and collected from that direct
participant in connection with U.S. Treasury securities transactions by
an indirect participant that relies on the services provided by the
direct participant to access the covered clearing agency's payment,
clearing, or settlement facilities.\979\ The amendments to Rule 17ad-
22(e)(6)(i) contain similar provisions to existing FICC rules,
specifically with respect to its Sponsored Member program, but also
impose additional requirements that do not appear in existing Rule
17ad-22. As a result, the Commission believes that a U.S. Treasury
securities CCA will incur burdens of reviewing and updating existing
policies and procedures in order to comply with the amendments to Rule
17ad-22(e)(6) and, in some cases, may need to create new policies and
procedures.\980\
---------------------------------------------------------------------------

\979\ See part II.B.1 supra.
\980\ For general information and statistics regarding the
Sponsored Service, see DTCC, Sponsored Service, supra note 669. The
Sponsored Service also allows the submission of cash transactions;
however, at this time, the service is generally used only for U.S.
Treasury repo transactions.
---------------------------------------------------------------------------

The Commission estimates that U.S. Treasury securities CCAs will
incur an aggregate one-time cost of approximately $106,850 to create
new policies and procedures.\981\ The amendments to the rule also
require ongoing monitoring and compliance activities with respect to
the written policies and procedures created in response to the rule.
The Commission estimates that the ongoing activities required by the
amendments to Rule 17ad-22(e)(6) will impose an aggregate ongoing cost
on covered clearing agencies of approximately $60,580 per year.\982\
---------------------------------------------------------------------------

\981\ This figure was calculated as follows: Assistant General
Counsel for 20 hours (at $518 per hour) + Compliance Attorney for 40
hours (at $406 per hour) + Computer Operations Manager for 12 hours
(at $490 per hour) + Senior Programmer for 20 hours (at $368 per
hour) + Senior Risk Management Specialist for 25 hours (at $397 per
hour) + Senior Business Analyst for 12 hours (at $305 per hour) =
$53,425 x 2 respondent clearing agencies = $106,850. See part V.B
infra.
\982\ This figure was calculated as follows: Compliance Attorney
for 25 hours (at $406 per hour) + Business Risk Analyst for 40 hours
(at $305 per hour) + Senior Risk Management Specialist for 20 hours
(at $397 per hour) = $30,290 x 2 respondent clearing agencies =
$60,580. See part V.B infra.
---------------------------------------------------------------------------

ii. Facilitating Access to U.S. Treasury Securities CCAs
Rule 17ad-22(e)(18)(iv)(C) requires a U.S. Treasury securities CCA
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to, as applicable, ensure that it has
appropriate means to facilitate access to clearance and settlement
services of all eligible secondary market transactions in U.S. Treasury
securities, including those of indirect participants, which policies
and procedures the U.S. Treasury securities CCA's board of directors
reviews annually.
The rule requires a U.S. Treasury securities CCA to establish,
implement, maintain and enforce written policies and procedures. The
Commission believes that a respondent U.S. Treasury securities CCA will
incur burdens of reviewing and updating existing policies and
procedures and will need to create new policies and procedures in order
to comply with the provisions of Rule 17ad-22(e)(18)(iv)(C). These
costs are included in the costs of creating new policies and procedures
associated with Rule 17ad-22(e) discussed above.
Commenters generally supported the Commission's attention to the
need for appropriate access to the U.S. Treasury securities CCA, and
several commenters specifically agreed that the Commission should not
prescribe any particular model. One commenter stated that the commenter
``fully agree[s] with the Commission that flexibility and an open-
access approach are critical to facilitating access to clearing. [ ],
dictating a single model of clearing would close off clearing to many
market participants, force indirect participants to bear additional
clearing costs, increase concentration, reduce competition, and
negatively impact market liquidity.'' \983\ In addition, another
commenter supported the proposal to rely on the clearing agencies to
develop the model and infrastructure and that clearing agencies should
have flexibility to innovate in this area. This commenter also noted
many market stakeholders may prefer an agency model or some form of
limited membership with a clearing agency.\984\
---------------------------------------------------------------------------

\983\ FICC/DTCC Letter, supra note 33, at 18.
\984\ ICE Letter, supra note 85, at 3.
---------------------------------------------------------------------------

Another commenter stated that the Commission should encourage FICC
to improve the existing Sponsored Service in several ways: (1) to
further develop a ``give up'' structure to facilitate best execution
(and accommodate ``done-away'' trades), noting that FICC's prime
broker/correspondent clearing infrastructure could be leveraged to
develop a give up model outside of prime brokerage (which would need to
provide for standardized documentation that facilitates additions and
deletions of approved brokers, agreed-upon terms for rejection of
trades by a sponsoring member and centralized storage of delegations);
and (2) to add a feature permitting (but not requiring) sponsored
members to directly support their obligations to FICC through margin
posting rather than by paying fees to the sponsoring member reflecting
the cost of

[[Page 2817]]

its clearing fund contributions.\985\ As stated in the Proposing
Release, the Commission believes that U.S. Treasury securities CCAs
should continue to develop access models that would best serve the
needs of market participants, and the Commission encourages such CCAs
to take all appropriate steps to accommodate ``done-away'' trades. The
Commission would consider any proposals in this regard consistent with
its obligations under Section 19 of the Exchange Act.
---------------------------------------------------------------------------

\985\ ICI Letter, supra note 85.
---------------------------------------------------------------------------

d. Amendments to Rules 15c3-3 and 15c3-3a
The amendment to Rule 15c3-3a permits, under certain conditions,
margin required and on deposit at a U.S. Treasury securities CCA to be
included as a debit item in the customer reserve formula. This new
debit item offset credit items in the Rule 15c3-3a formula and,
thereby, free up resources that could be used to meet the margin
requirements of a U.S. Treasury securities CCA. The amendment allows a
customer's broker to use customer funds to meet margin requirements at
the CCP generated by the customer's trades, lowering the cost of
providing clearing services. Broker-dealers may incur costs from
updating procedures and systems to be able to use customer funds to
meet customer margin requirements. However, the amended rule does not
require that the broker-dealer does so.
Overall, commenters supported the proposal to permit this debit
item.\986\ Commenters stated that the proposed amendments would make
clearing more efficient and free up resources that could be used to
meet the CCA's margin requirements, while continuing to protect
customer funds.\987\ Commenters also stated that the proposal would
incentivize central clearing.\988\ A commenter stated that the proposal
would extend to margin held at a U.S. Treasury securities CCA the same
treatment as margin posted to other clearing organizations.\989\ As a
result, this commenter stated that the proposal would facilitate
greater access to clearing and eliminate an undue burden on
competition. Another commenter--in supporting the proposal--stated that
it does not make sense that margin cannot be freely rehypothecated from
a customer through a broker-dealer to a U.S. Treasury securities CCA
without the broker-dealer receiving a beneficial adjustment as part of
its customer reserve formula calculation.\990\ For greater and more
efficient client clearing, another commenter encouraged the Commission
to adopt this proposal irrespective of whether the requirement to clear
eligible secondary market transactions is adopted.\991\
---------------------------------------------------------------------------

\986\ See AIMA Letter, supra note 81; CME Letter, supra note 81;
DTCC/FICC Letter, supra note 33; ICE Letter, supra note 33; MFA
Letter, supra note 81; ISDA Letter, supra note 391; SIFMA AMG
Letter, supra note 35.
\987\ See AIMA Letter, supra note 81; MFA Letter, supra note 81;
SIFMA/IIB Letter supra note 37.
\988\ See CME Letter, supra note 81; SIFMA AMG Letter, supra
note 35.
\989\ See DTCC/FICC Letter, supra note 33.
\990\ See SIFMA AMG Letter, supra note 35.
\991\ See ISDA Letter, supra note 391.
---------------------------------------------------------------------------

One commenter sought clarification that the conditions of Rule
15c3-3 would not preclude a U.S. Treasury securities CCA from entering
into a repurchase transaction involving customer cash margin, so long
as the purchased securities under such repurchase transaction consist
of U.S. Treasury securities held in a segregated account for the
benefit of customers and satisfy certain other requirements.\992\ The
commenter provided a summary of potential protections that could be put
in place to ensure that--if a U.S. Treasury securities CCA uses cash in
the broker-dealer's segregated account for liquidity purposes--the cash
would be protected through collateral comprising U.S. Treasury
securities deposited into the account and other measures.\993\ As
discussed in part II.C.4.iii, supra the Commission would need to review
a more detailed plan for how the cash will be used and customers
protected before taking any action on the commenter's request. The
Commission acknowledges that the degree to which costs that are
incurred in order to maintain sufficient qualifying liquid resources
are directly born by various participants depends in part on the use of
customer margin as a qualifying liquid resource.\994\
---------------------------------------------------------------------------

\992\ DTCC/FICC Letter II, supra note 503. See also part
II.C.4.iii, supra for additional discussion of the issue raised by
this comment letter.
\993\ Id.
\994\ One such source is FICC's CCLF. See part IV.B.4, supra and
part IV.C.2.a.i, supra. See also supra note 688, and referencing
text regarding the Commission's requiring FICC to hold qualifying
liquid resources sufficient to meet a cover-1 standard.
---------------------------------------------------------------------------

e. Other Costs
One commenter stated that the Commission should consider that ``the
sheer number and complexity of the Proposals, when considered in their
totality, if adopted, would impose staggering aggregate costs, as well
as unprecedented operational and other practical challenges.'' \995\
But, consistent with its long-standing practice, the Commission's
economic analysis in each adopting release considers the incremental
benefits and costs for the specific rule--that is the benefits and
costs stemming from that rule compared to the baseline. In doing so,
the Commission acknowledges that in some cases resource limitations can
lead to higher compliance costs when the compliance period of the rule
being considered overlaps with the compliance period of other rules. In
determining compliance periods, the Commission considers the benefits
of the rules as well as the costs of delayed compliance periods and
potential overlapping compliance periods.
---------------------------------------------------------------------------

\995\ MFA Letter 2, supra note 600, at 3; see ICI Letter 2,
supra note 600, at 3 (stating that the Commission should consider
``practical realities such as the implementation timelines as well
as operational and compliance requirements'').
---------------------------------------------------------------------------

In this regard, some commenters mentioned the proposals which
culminated in the recent adoptions of the May 2023 SEC Form PF Amending
Release, the Beneficial Ownership Amending Release, the Private Fund
Advisers Adopting Release, the Rule 10c-1a Adopting Release, the Short
Position Reporting Adopting Release, and the Securitizations Conflicts
Adopting Release.\996\ The Commission acknowledges that there are
compliance periods for certain requirements of these rules that overlap
in time with the final rule, which may impose costs on resource
constrained entities affected by multiple rules.\997\
---------------------------------------------------------------------------

\996\ See supra note 600. As stated above, commenters also
specifically suggested the Commission consider potential overlapping
compliance costs between the final rule and certain proposing
releases. See supra note 608. These proposals have not been adopted
and thus have not been considered as part of the baseline here. To
the extent those proposals are adopted in the future, the baseline
in those subsequent rulemakings will reflect the regulatory
landscape that is current at that time.
\997\ See supra notes 602 to 607 (summarizing compliance dates).
---------------------------------------------------------------------------

However, the Commission does not think these increased costs from
overlapping compliance periods will be significant for several reasons.
First, the number of market participants who directly or indirectly
engage in eligible secondary market transactions in Treasury securities
that will be subject to the final rule and who will be subject to one
or more of the other recently adopted rules could be limited based on
whether those participants' activities fall within the scope of the
other rules.\998\ Second, for the reasons

[[Page 2818]]

discussed above, we have adopted a phased approach to implementation
and compliance based on input from commenters.\999\ Further, all of the
other rules have long compliance periods, which is expected to
facilitate planning, preparation and investment and thereby limit the
cost of overlapping compliance periods.\1000\ Third, commenters'
concerns about the costs of overlapping compliance periods were raised
in response to the proposal and as discussed above, we have taken steps
to reduce costs of the final rule.\1001\
---------------------------------------------------------------------------

\998\ The Rule 10c-1a Adopting Release will require only persons
who agree to a covered securities loan to report that activity. The
Short Position Reporting Adopting Release will require only
institutional investment managers that meet or exceed certain
reporting thresholds to report short position and short activity
data for equity securities. And the Securitizations Conflicts
Adopting Release will affect only certain entities--and their
affiliates and subsidiaries--that participate in securitization
transactions. See supra notes 605 to 607. In addition, FICC will not
be affected by any of the six rules identified by commenters.
\999\ See part III supra.
\1000\ See supra notes 602 to 607.
\1001\ The final rule mitigates costs relative to the proposal
in the following ways. First, the scope of the definition of
eligible secondary market transaction in Rule 17ad-22(a) has been
revised to exclude repos by other clearing organizations, repos by
state and local governments, and inter-affiliate repos. Second, the
scope of the definition of eligible secondary market transaction has
been modified to no longer include cash transactions by hedge funds
and leveraged accounts. Third, the Commission is modifying paragraph
(a) of Note H to Rule 15c3-3a to permit ``qualified customer
securities'' to be used to meet the customer position margin
requirement in addition to cash and U.S. Treasury securities.
Finally, to reduce operational burdens on broker-dealers, the
Commission is removing the proposed requirement to return excess
collateral within one business day that was part of fifth rule set--
identified in paragraph (b)(2)(v) of proposed Note H.
---------------------------------------------------------------------------

3. Effect on Efficiency, Competition, and Capital Formation
a. Efficiency
i. Price Transparency
As mentioned in part IV.B supra, the majority of trading in on-the-
run U.S. Treasury securities in the interdealer market occurs on
electronic platforms operated by IDBs that bring together buyers and
sellers anonymously using order books or other trading facilities
supported by advanced electronic trading technology. These platforms
are usually run independently in the sense that there is no centralized
market for price discovery or even a ``single virtual market with
multiple points of entry''.\1002\ As a result, pre-trade transparency
is suboptimal: quotations and prices coming from and going to an IDB
may be distributed unevenly to market participants who have a
relationship with that IDB. Efficiency, which measures the degree to
which prices can quickly respond to relevant information, is impaired
because of this market fragmentation; some areas of the market may not
reflect information passed on by prices in other sectors. Central
clearing can promote price discovery in several ways: first, the
clearing agency itself becomes a source of data; \1003\ and second, the
accessibility of central clearing could promote all-to-all trading as
previously mentioned in part II.A.1 supra, which should reduce the
obstacles to information flow that come from fragmentation.\1004\
---------------------------------------------------------------------------

\1002\ Maureen O'Hara and Mao Ye, Is Market Fragmentation
Harming Market Quality?, 100 J. Fin. Econ. 459 (2011).
\1003\ FIA-PTG Whitepaper, supra note 918.
\1004\ See supra note 31.
---------------------------------------------------------------------------

ii. Operational and Balance Sheet Efficiency
Greater use of central clearing could also increase the operational
efficiency of trading U.S. Treasury securities. Central clearing
replaces a complex web of bilateral clearing relationships with a
single relationship to the CCP. In that sense, the complex network of
relationships that a market participant may have for bilaterally
clearing U.S. Treasury securities would shrink, with attendant
reductions in paperwork, administrative costs, and operational risk.
Central clearing also enhances balance sheet efficiency, allowing
firms to put capital to more productive uses. The amendments to Rule
15c3-3a permit, under certain conditions, margin required and on
deposit at a U.S. Treasury securities CCA to be included as a debit
item in the customer reserve formula. This new debit item offset credit
items in the Rule 15c3-3a formula and, thereby, free up resources that
could be used to meet the margin requirements of a U.S. Treasury
securities CCA. The amendment allows a customer's broker to use
customer funds to meet margin requirements at the CCP generated by the
customer's trades, lowering the cost of providing clearing services.
Though these lower costs may or may not be fully passed on to
customers, in a competitive environment the Commission expects that at
least some of these savings will pass through to customers.
b. Competition
With respect to the market for execution of U.S. Treasury
securities by broker-dealers, increased central clearing can enhance
the ability of smaller participants to compete with incumbent
dealers.\1005\ Similarly, decreased counterparty credit risk--and
potentially lower costs for intermediation--could result in narrower
spreads, thereby enhancing market quality.\1006\ While estimating this
quantitatively is difficult, research has demonstrated lower costs
associated with central clearing in other settings.\1007\ Moreover,
increased accessibility of central clearing in U.S. Treasury securities
markets could support all-to-all trading, which should further improve
competitive pricing, market structure and resiliency.\1008\
---------------------------------------------------------------------------

\1005\ See G-30 Report, supra note 5, at 13.
\1006\ Id.
\1007\ See Y.C. Loon & Z.K. Zhong, The Impact of Central
Clearing on Counterparty Risk, Liquidity, and Trading: Evidence From
the Credit Default Swap Market, 112 J. Fin. Econ. 91 (2014).
\1008\ See 2021 IAWG Report, supra note 4, at 30; Duffie, supra
note 27, at 16; G-30 Report, supra note 5, at 13.
---------------------------------------------------------------------------

Commenters suggest that costs of clearing may be disproportionately
felt by small and mid-size participants in the Treasury market.\1009\
An additional commenter stated that the proposed separation of house
and customer margin would negatively impact small and mid-size broker-
dealers who are disproportionately affected by FICC's Excess Capital
Premium (``ECP'') charge, which is a margin add-on that collects a
premium when a member's VaR charge exceeds the member's Net Capital,
net assets or equity capital (as applicable to that member based on its
type of regulation).\1010\ The commenter explained the impact of the
ECP charge in conjunction with FICC's Sponsored Service, stating that
``the combination of gross margining and ECP currently in use under the
Sponsored Model, and what is prescribed in the Proposed Rule,
effectively prevents smaller and middle market broker dealers from
materially participating in the Treasury market.\1011\ The commenter
states that the ultimate effect of the ECP charge is exacerbated when
customer/institutional counterparty margin is included in the
calculation, and the surcharge prevents smaller independent broker-
dealers from sponsoring institutional counterparties/customers.\1012\
The commenter's concerns regarding the interplay between purported
required gross margining and the ECP charge rests on the assumption
that gross margin is required under the proposal, which, as discussed
in part II.B.1 supra, is not the case.\1013\ With respect to the

[[Page 2819]]

ECP charge on its own, the Commission is not taking any action with
respect to the ECP charge as part of adopting these new requirements.
The ECP charge is part of FICC's existing rulebook, which is an SRO
rule, and any change to that rulebook would be made pursuant to the
proposed rule change process under Section 19(b).\1014\
---------------------------------------------------------------------------

\1009\ Letter from Evan Gerhard, President and CEO of ASL
Capital Markets (Dec. 23, 2022) and letter from SIA Partners (Aug.
31, 2023) at 22 (``SIA Partners 2'').
\1010\ IDTA Letter, supra note 66, at 4; see also FICC Rule 4,
section 14, supra note 19.
\1011\ IDTA Letter, supra note 66, at 5.
\1012\ IDTA Letter, supra note 66, at 5.
\1013\ The rule does require that a proprietary position not be
netted against a customer position. This could enhance competition
because dealers with customers are no longer advantaged relative to
those without. It enhances the unbundling of clearing and trading
services described in part IV.C.1 supra.
\1014\ Exchange Act Section 19(b); see also Section 19(c).
---------------------------------------------------------------------------

While the rule does not require gross margining of customers, the
rule does require members to clear additional transactions relative to
the baseline. Because the dominant clearing model is the sponsored
model, and because the sponsored model does use gross margining, which
implicates the ECP, the Commission acknowledges the commenter's
concerns regarding possible competitive effects on the Treasury market.
Specifically, the existence of the ECP links the costs of sponsorship
with the capital of the entity, and hence sponsorship is more
economical for some than for others. Because current market practice is
to bundle execution with clearing, some entities may face additional
hurdles in trade execution in that it may be uneconomical for them to
serve as sponsoring members for a large dollar value of trades.
There are two factors that mitigate any potential impact of the ECP
on competitiveness. First, there are alternatives to the sponsored
clearing model that do not require gross margining. The commenter cites
one such model, and notes ambiguity as to whether this model can indeed
be used by independent dealers.\1015\ The Commission acknowledges the
commenter's concern but notes that FICC recently has indicated that it
intends to make available client clearing models that do not require
gross margin, consistent with its current offerings.\1016\ Second, the
amendments to Rule 15c3-3a, which permit margin required and on deposit
at a U.S. Treasury securities CCA to be included as a debit item in the
customer reserve formula makes it economical for dealers to post margin
on behalf of their customers. This may encourage the development of
clearing models that are based on counterparty risk, rather than the
capital of the trading entity. In a second letter, the same commenter
advocates for a common margining regime for FICC, where members
participating in the MBSD, GSD, or the CME are accounted for properly
in terms of offsetting positions \1017\ and while that subject is not
within the scope of this release, permitting rehypothecation of margin
may have directionally similar effects.
---------------------------------------------------------------------------

\1015\ See IDTA Letter, supra note 66, at 7.
\1016\ See DTCC 2023 White Paper, supra note 107, at 6
(discussing that the proposal would allow the option to calculate
and collect margin associated with customer activity on a gross or
net basis depending on the client clearing model selected by the
member and stating that FICC would offer options via different
access models that would allow those parties to balance the benefits
of netting and segregation in different ways).
\1017\ IDTA Letter 2, supra note 829, at 2.
---------------------------------------------------------------------------

With respect to the market for U.S. Treasury securities clearing
services, currently there is a single provider of central clearing. The
amendments will likely engender indirect costs associated with
increased levels of central clearing in the secondary market for U.S.
Treasury securities. Generally, the economic characteristics of a
financial market infrastructure (``FMI''), including clearing agencies,
include specialization, economies of scale, barriers to entry, and a
limited number of competitors.^{1018 1019} The Commission noted
in its proposal of rules applicable to covered clearing agencies that
such characteristics, coupled with the particulars of an FMI's legal
mandate, could result in market power, leading to lower levels of
service, higher prices, and under-investment in risk management
systems.\1020\ Market power may also affect the allocation of benefits
and costs flowing from these new rules and amendments that are being
adopted, namely the extent to which these benefits and costs are passed
through by FICC to participants.\1021\ The centralization of clearing
activities for a particular class of transaction in a single clearing
agency may also result in a reduction in its incentives to innovate and
to invest in the development of appropriate risk management practices
on an ongoing basis.
---------------------------------------------------------------------------

\1018\ See Comm. on Payment and Settlement Sys. and Tech. Comm.
Int'l Org. Sec. Comms, Principles for Financial Market
Infrastructures (Apr. 16, 2012), available at https://www.bis.org/cpmi/publ/d101a.pdf.
\1019\ See generally Nadia Linciano et al., The Clearing and
Settlement Industry: Structure Competition and Regulatory Issues
(Italian Secs. & Exch. Comm'n Research Paper 58, May 2005),
available at https://www.ssrn.com/abstract=777508 (concluding in
part that the core services offered by the clearance and settlement
industry tend toward natural monopolies because the industry can be
characterized as a network industry, where consumers buy systems
rather than single goods, consumption externalities exist, costs
lock-in consumers once they choose a system, and production improves
with economies of scale).
\1020\ See CCA Standards Proposing Release, supra note 8. See
also ICE Letter, supra note 31, at 2.
\1021\ For a discussion of cost pass-through, including when
there lacks competition, see for example, RBB Econ., Cost pass-
through: theory, measurement and policy implications, A Report
prepared for the Office of Fair Trading (2014), available at https://www.gov.uk/government/publications/cost-pass-through-theory-measurement-and-policy-implications.
---------------------------------------------------------------------------

Finally, the scope of the rule does not preclude members of FICC
from strategically renouncing membership if they assess that the
benefits of maintaining their ability to trade without centrally
clearing their trades exceed their costs of surrendering their
membership with the CCA. If this scenario materializes for a number of
FICC members, then there will be costs to the overall market. Those
costs could be the product of a smaller number of clearing members
competing in the market for clearing services. Costs could also
manifest themselves as increased risk from non-centrally cleared
transactions and a reduction in the margin, operational and capital
efficiencies related to central clearing. Further, if the number of
clearing members falls, then the exposure of FICC to its largest
clearing member could increase resulting in additional increases in the
required size of the CCLF.
In addition, as stated above, some commenters requested the
Commission consider interactions between the economic effects of the
proposed rule and other recent Commission rules, as well as practical
realities such as implementation timelines.\1022\ As discussed above,
the Commission acknowledges that overlapping compliance periods may in
some cases increase costs. This may be particularly true for smaller
entities with more limited compliance resources. This effect can
negatively impact competition because these entities may be less able
to absorb or pass on these additional costs, making it more difficult
for them to remain in business or compete. However, we have mitigated
the overall costs of the final rules relative to the proposal.\1023\
Moreover, all of the other rules have long compliance periods to
facilitate planning, preparation and investment, thereby mitigating the
cost to smaller entities of overlapping compliance periods.\1024\ We
therefore do not expect the risk of negative competitive effects from
increased compliance costs from simultaneous compliance periods to be
significant.
---------------------------------------------------------------------------

\1022\ See parts IV.B, supra.
\1023\ See supra note 1003.
\1024\ See supra notes 604 to 607.
---------------------------------------------------------------------------

c. Capital Formation
The new rule and amendments may encourage private-sector capital
formation. U.S. Treasury securities form a benchmark for fixed income
and even equity rates of return, and the new rule could lower the cost
of capital for

[[Page 2820]]

private-sector issuers.\1025\ If the yield required by investors to
hold U.S. Treasury securities reflects, in part, the risks associated
with the buying and selling of U.S. Treasury securities, and increased
central clearing of these transactions lowers those risks, then the new
rule may put downward pressure on required yields.
---------------------------------------------------------------------------

\1025\ Standard textbook treatments of finance use the U.S.
Treasury rate of return as a benchmark in computing the cost of
capital for private companies. The link between interest rates of
government debt and corporate debt is a long-standing feature of the
financial landscape. See, e.g., Benjamin Friedman, Implications of
Government Deficits for Interest Rates, Equity Returns, and
Corporate Financing, Fin. Corp. Cap. Form. (1986). See also
Philippon, The Bond Market's Q, Q. J. Econ. (Aug. 2009) (noting a
link between the level of interest rates and investment).
---------------------------------------------------------------------------

Research has shown that investors value both the safety and
liquidity of U.S. Treasury securities. Because prices in the primary
market both reflect and are driven by prices in the secondary market,
liquidity could be one of the factors translating into lower rates of
borrowing costs for U.S. taxpayers.\1026\
---------------------------------------------------------------------------

\1026\ See Arvind Krishnamurthy & Annette Vissing-Jorgensen, The
Aggregate Demand for Treasury Debt, 120 J. Pol. Econ. (Apr. 2012).
---------------------------------------------------------------------------

D. Reasonable Alternatives

1. Require U.S. Treasury Securities CCAs To Have Policies and
Procedures Requiring Only IDB Clearing Members To Submit U.S. Treasury
Securities Cash Trades With Non-Members for Central Clearing
In the Proposing Release, the Commission considered the alternative
of narrowing the scope of the requirement to clear eligible secondary
market transactions as it pertains to cash transactions in the
secondary market for U.S. Treasury securities. The narrower definition
of eligible secondary market transaction contemplated in this
alternative included (1) a repurchase or reverse repurchase agreement
collateralized by U.S. Treasury securities, in which one of the
counterparties is a direct participant; or (2) a purchase or sale
between a direct participant and any counterparty, if the direct
participant of the covered clearing agency (A) brings together multiple
buyers and sellers using a trading facility (such as a limit order
book) and (B) is a counterparty to both the buyer and seller in two
separate transactions.\1027\ This alternative differs from the proposal
by omitting from the definition of eligible transactions those cash
transactions between a direct participant and a registered broker-
dealer, government securities broker, government securities dealer,
hedge fund, or account at a registered broker-dealer, government
securities dealer, or government securities broker where such account
may borrow an amount in excess of one-half of its net assets or may
have gross notional exposure in excess of twice its net assets.\1028\
---------------------------------------------------------------------------

\1027\ See Proposing Release. Such direct participants are
referred to in this section and the alternatives below as ``IDBs''.
\1028\ See Proposing Release, supra note 14, 88 FR at 64663; see
also id. at 64622 for a discussion of cash transactions included in
the definition of eligible transactions.
---------------------------------------------------------------------------

Several commenters supported the Commission's proposal overall,
including the cash clearing requirement.\1029\ By contrast, other
commenters opposed cash clearing generally.\1030\ Other commenters
suggested that the scope of eligible secondary market transactions in
the cash market be broadened.\1031\
---------------------------------------------------------------------------

\1029\ AFREF Letter, supra note 33, at 2; Better Markets Letter,
supra note 33, at 2, 6-8.
\1030\ See part II.A.2.b supra for a discussion of comments
received regarding cash clearing.
\1031\ Id.
---------------------------------------------------------------------------

As discussed in the proposing release, the benefits arising from
cash clearing for IDB members are particularly high. Hybrid clearing
creates unique issues for FICC because FICC is able to manage the risks
arising from the IDB-FICC member trade, but it lacks any knowledge of
the IDB's offsetting trade with its other counterparty and the
potential exposure arising to the IDB from that trade, leaving the IDB,
from FICC's perspective, as apparently having a directional exposure
despite the non-centrally cleared trade that would leave the IDB
flat.\1032\ This lack of knowledge could prevent FICC from ``accurately
identifying, measuring and managing its direct and indirect
counterparty risk exposure and can affect its decision-making,'' \1033\
which in turn potentially increases the likelihood that a default of an
IDB member could in turn harm the CCP or the system as a whole. As
stated in the Proposing Release, the Commission has previously stated
that membership requirements help to guard against defaults of any CCP
member, as well to protect the CCP and the financial system as a whole
from the risk that one member's default could cause others to default,
potentially including the CCP itself. Further, contagion stemming from
a CCP member default could be problematic for the system as a whole,
even if the health of the CCP is not implicated. The default could
cause others to back away from participating in the market,
particularly if the defaulting participant was an IDB, whose withdrawal
from the market could jeopardize other market participants' ability to
access the market for U.S. Treasury securities.\1034\
---------------------------------------------------------------------------

\1032\ See TMPG White Paper, supra note 13 at 22 (noting that in
a hybrid clearing arrangement, an ``IDB's rights and obligations
vis-a-vis the CCP are not offset and therefore the IDB is not in a
net zero settlement position with respect to the CCP at settlement
date.'').
\1033\ See TMPG White Paper, supra note 13, at 27.
\1034\ See TMPG White Paper, supra note 13, at 32.
---------------------------------------------------------------------------

This alternative would, with a more limited scope, move a large
portion of secondary market transactions in U.S. Treasury securities
that are not currently centrally cleared into central clearing.\1035\
The degree of central clearing would still allow for a partial picture
of concentrated positions to the clearing agency. That said, there
would be a limited benefit in terms of operational and balance sheet
efficiency, and the benefits other than those specifically related to
the IDB would be greatly reduced. Specifically, the reduced scope of
this alternative would not capture types of participants that are
usually leveraged such as hedge funds.
---------------------------------------------------------------------------

\1035\ Id.
---------------------------------------------------------------------------

As discussed in part II.A.2.b supra, the Commission is not
including transactions with hedge funds and leveraged accounts in the
definition of eligible transactions. The definition of eligible
secondary market transaction in Rule 17ad-22(a) is being adopted as
proposed with respect to IDB transactions and transactions that involve
a purchase or sale between a direct participant and a registered
broker-dealer, government securities broker, or government securities
dealer. Including these transactions within the scope of eligible
transactions increases the benefits discussed above associated with an
increased proportion of transactions being centrally cleared.\1036\
However, as discussed above, the costs associated with including these
transactions within the scope of eligible transactions may be less than
those transactions not included by this alternative.\1037\
---------------------------------------------------------------------------

\1036\ See Proposing Release, supra note 14, and part IV.A,
supra of this release for a discussion of the benefits associated
with increased central clearing.
\1037\ See Proposing Release, supra note 14, at 64665 for a
discussion of the familiarity of many registered brokers with
methods of central clearing of U.S. Treasury securities
transactions. See also Id at 64669 for a discussion of the costs to
non-FICC members, including the entities included within this
alternative, of the requirement to clear eligible secondary market
transactions.

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

[[Page 2821]]

2. Require U.S. Treasury Securities CCAs To Have Policies and
Procedures Requiring the Submission of All Repurchase Agreements
Without Requirements for the Submission of Cash Transactions
In the Proposing Release, the Commission considered excluding the
cash U.S. Treasury securities market from the proposed rule, and
instead only requiring that covered clearing agencies have policies and
procedures reasonably designed to require that direct participants of
the covered clearing agency submit for central clearing all
transactions in U.S. Treasury repo transactions into which it
enters.\1038\
---------------------------------------------------------------------------

\1038\ See Proposing Release, supra note 14.
---------------------------------------------------------------------------

Several commenters supported the Commission's proposal overall,
including the cash clearing requirement.\1039\ By contrast, other
commenters opposed cash clearing generally.\1040\
---------------------------------------------------------------------------

\1039\ AFREF Letter, supra note 33, at 2; Better Markets Letter,
supra note 33, at 2, 6-8.
\1040\ See part II.A.2.b supra for a discussion of comments
received regarding cash clearing.
---------------------------------------------------------------------------

The Commission understands that there is a likely benefit of
additional balance sheet capacity that flows from clearing repo
transactions in U.S. Treasury securities that might not occur with the
clearing of cash transactions. Multilateral netting can reduce the
amount of balance sheet capacity required for intermediation of repo
and could enhance dealer capacity to make markets during normal times
and stress events, because existing bank capital and leverage
requirements recognize the risk-reducing effects of multilateral
netting of trades that CCP clearing accomplishes.\1041\
---------------------------------------------------------------------------

\1041\ See 2021 IAWG Report, supra note 4; Liang & Parkinson,
supra note 725, at 9; Duffie, supra note 27, at 16-17.
---------------------------------------------------------------------------

The upfront costs of adjusting to the rule would be lower under
this alternative than under the current proposal, as a result of a
smaller number of participants and activities in scope and also the
current level of interconnectedness among those participants. As
previously mentioned, the number of participants in the U.S. Treasury
repo market is significantly smaller than the number of participants in
the cash market and is composed of sophisticated investors who have
already incurred the costs of building the ability to novate
transactions to the CCP. Infrastructure for Sponsored Clearing already
exists, so processing changes should be less than in other more
comprehensive alternatives and costs would be concentrated on the
implementation of similar agreements at a larger scale.
Nevertheless, excluding the cash U.S. Treasury securities market
from the rule would omit the largest sector of the U.S. Treasury
market, both in terms of activity and number of participants. This
alternative would yield smaller benefits in the areas of financial
stability, risk visibility, margin offset efficiencies, and capital
requirement reductions. The Commission believes that, given the scale-
intensive nature of clearing, there are economies of scale that can
only be realized when a larger number of financial market participants
clear their U.S. Treasury securities cash trades.
3. Include All Cash Transactions Within the Scope of Eligible Secondary
Market Transactions With Exceptions for Central Banks, Sovereign
Entities, International Financial Institutions, and Natural Persons
In the Proposing Release, the Commission considered requiring
covered clearing agencies to have policies and procedures reasonably
designed to require that direct participants of the covered clearing
agency submit for central clearing all cash and repo transactions in
U.S. Treasury securities into which they enter, except for natural
persons, central banks, sovereign entities and international finance
institutions. This policy option would include cash transactions
between direct participants of a U.S. Treasury securities CCA and any
counterparty except for those that fall within one of the
aforementioned exceptions.\1042\ Several commenters opposed cash
clearing generally.\1043\
---------------------------------------------------------------------------

\1042\ See Proposing Release, supra note 14.
\1043\ See part II.A.2.b supra for a discussion of comments
received regarding cash clearing.
---------------------------------------------------------------------------

This alternative would capture more of the potential benefits and
positive externalities that result from increased central clearing,
more closely resembling the assumptions and estimated benefits of
Fleming and Keane's calculations on clearing benefits.\1044\ By virtue
of requiring all repo and most cash transactions to be centrally
cleared, the alternative goes the furthest in solving the underlying
collective action problem whereby some participants may find it optimal
to not participate in central clearing, reducing the benefits that may
accrue to the market as a whole.
---------------------------------------------------------------------------

\1044\ Fleming & Keane (2021), supra note 796.
---------------------------------------------------------------------------

Several commenters suggested that the scope of eligible secondary
market transactions in the cash market be broadened. One commenter
stated that the Commission should align the scope of the definition
with respect to cash transactions with the proposed scope for repos,
subject to certain limited exceptions for investors that trade de
minimis volumes. The commenter argued that the Commission's approach
with respect to cash transactions will increase costs for a specific
subset of market participants, thereby putting them at a competitive
disadvantage, while failing to deliver the envisaged market-wide
benefits associated with central clearing (i.e., it would materially
reduce the associated multilateral netting benefits, impair the risk
management practices of clearing agencies, and hinder the evolution in
trading protocols that can be expected from a market-wide clearing
requirement).\1045\ For similar reasons, another commenter also stated
that the benefits of central clearing detailed will only materialize if
``a market-wide mandate is implemented'' and supported defining the
scope of eligible secondary market transactions for cash transactions
as broadly as that proposed for repos.\1046\ Another commenter stated
that limiting the scope of the cash clearing mandate would result in
unwarranted competitive disadvantages and related market distortions
for some types of investors, such as hedge funds, or some types of
trading platforms, such as anonymous trading facilities.\1047\ An
additional commenter stated that the proposed definition leaves out
other important market participants' cash Treasury transactions that
also comprise a large segment of Treasury market liquidity, and that
the Commission should require other market participants' cash Treasury
transactions in which a direct participant is involved to be cleared,
so that the benefits of central clearing that the Commission cites will
accrue throughout the broader cash Treasury market.\1048\ In addition,
another commenter acknowledged the benefits of a comprehensive clearing
requirement, but acknowledged the need for a pragmatic approach and
supported the Commission's proposed requirements as a reasonable
foundation

[[Page 2822]]

to begin mandatory central clearing in this market.\1049\
---------------------------------------------------------------------------

\1045\ Citadel Letter, supra note 81, at 5.
\1046\ ARB et al. Letter, supra note 81, at 4 (stating that the
netting benefits associated with transitioning only proprietary
trading firm (``PTF'') transactions into central clearing are much
smaller, given the substantial netting that already occurs directly
with inter-dealer brokers (``IDBs''); the trading-related benefits
of central clearing will only accrue to market participants if their
transactions are covered by the proposed mandate; and that clearing
agency resiliency will be negatively impacted if only one segment of
the market is cleared).
\1047\ MFA Letter, supra note 81, at 2.
\1048\ AIMA Letter, supra note 81, at 7.
\1049\ GTS Letter, supra note 81, at 3-5.
---------------------------------------------------------------------------

As discussed above, the benefits of clearing are scale-dependent,
so that a more comprehensive clearing directive would result in larger
positive externalities (e.g., lower contagion risk, less financial
network complexity) and larger economies of scale (e.g., larger margin
offsets) for the U.S. Treasury securities market. Another benefit of
this alternative would be an enhanced ability of FICC (and, by
extension, regulatory agencies) to observe the dynamics and manage the
risks in the U.S. Treasury securities markets.
Nevertheless, there are compelling reasons for the exclusions that
the proposal makes for a specific sample of market participants. Buy-
side participants in the U.S. Treasury securities markets that do not
take on any leverage, or take less than one-half their assets in
leverage, such as the majority of bond mutual funds, typically have
lower daily turnover. As a result of their lower turnover and
subsequent lower volume, they typically do not have the existing
infrastructure to readily connect to the CCP, making their up-front
costs significantly higher than for other participants. This implies
that the costs of subjecting these participants to the requirement to
clear eligible secondary market transactions are likely higher than
those of participants included in the proposal and the benefits
smaller.
4. Require U.S. Treasury Securities CCAs To Change CCA Access
Provisions and Netting and Margin Practices for House and Customer
Accounts and Rule 15c3-3
In the Proposing Release the Commission considered, as an
alternative to the policy choices it proposed, only amending Rules
15c3-3, 17ad-22(e)(6)(i), and 17ad-22(e)(18)(iv)(C).\1050\ This
alternative would not include a requirement to clear eligible secondary
market transactions, as set forth in Proposed Rule 17ad-
22(e)(18)(iv)(A) and (B).\1051\
---------------------------------------------------------------------------

\1050\ See Proposing Release, supra note 14.
\1051\ Id.
---------------------------------------------------------------------------

Overall, commenters supported the proposed amendments to Rule 15c3-
3a.\1052\ For increased and more efficient client clearing, another
commenter encouraged the Commission to adopt this proposal irrespective
of whether the Commission adopts the requirement to clear eligible
secondary market transactions, as set forth in Proposed Rule 17ad-
22(e)(18)(iv)(A) and (B).\1053\
---------------------------------------------------------------------------

\1052\ See AIMA Letter, supra note 81, at 8; CME Letter, supra
note 81, at 4; DTCC/FICC Letter, supra note 33, at 28-29; ICE
Letter, supra note 33, at 3; MFA Letter, supra note 81, at 10; ISDA
Letter, supra note 391, at 2; SIFMA AMG Letter, supra note 35, at 8.
See part II.C supra for a discussion of comments received.
\1053\ See ISDA Letter, supra note 391, at 2.
---------------------------------------------------------------------------

This alternative would require a U.S. Treasury securities CCA to
establish, implement, maintain and enforce certain written policies and
procedures that would be reasonably designed to, as applicable,
calculate, collect, and hold margin amounts from a direct participant
for its proprietary U.S. Treasury securities positions separately and
independently from margin that would be held for an indirect
participant. Specifically, the requirement to separately and
independently hold an indirect participant's margin would apply to
margin calculated by and collected from a direct participant in
connection with its U.S. Treasury securities transactions with an
indirect participant that relies on the direct participant's services
to access the covered clearing agency's payment, clearing, or
settlement facilities.
The alternative would also include changes to 17ad-
22(e)(18)(iv)(C), directing FICC to, as more fully described above,
have policies and procedures, to be annually reviewed by its board of
directors, to have appropriate means to facilitate access to clearing
all eligible secondary market transactions in U.S. Treasury securities.
This alternative would also include changes to Rule 15c3-3a, to permit
margin required and on deposit at a U.S. Treasury securities CCA to be
included as a debit item in the customer reserve formula, subject to
the conditions discussed below. This new debit item would offset credit
items in the Rule 15c3-3a formula and, thereby, free up resources that
could be used to meet the margin requirements of a U.S. Treasury
securities CCA. The new debit item would be reported on a newly created
Item 15 of the Rule 15c3-3a reserve formula.
As discussed in part IV.C.2.b supra, the proposed amendments to
Rule 17ad-22(e)(6)(i) should produce benefits for dealer-to-customer
trades. Because margin for a direct participant's (i.e., a dealer's)
trades that have been novated to the CCP would be calculated,
collected, and held separately and independently from those of an
indirect participant, such as a customer, the direct participant's
trades with the indirect participant that have been novated to the CCP
would be able to be netted against the direct participant's position
with other dealers. Such netting is not currently available. In
summary, the Commission expects changes in the customer reserve formula
and expanded margin offset possibilities to allow more efficient use of
margin for cleared trades relative to current market practice.
As discussed in part II.A.1.a supra, commenters identified several
methods by which the Commission could or should incentivize additional
central clearing without adopting a requirement to clear eligible
secondary market transactions. One of the methods commenters identified
was to adopt Rule 15c3-3 discussed in part II.C infra as a method to
incentivize additional central clearing.\1054\ As discussed in part
II.5 supra the Commission agrees that the methods identified by the
commenters could incentivize and facilitate additional central
clearing. The Commission therefore is adopting the amendments to Rule
15c3-3, the requirement to segregate house and customer margin, and the
need to ensure access to central clearing, as discussed in parts II.C,
II.B.1, and II.B.2 supra respectively. The Commission does not believe
that these changes should be made without also requiring that U.S.
Treasury securities CCAs obligate their direct participants to submit
eligible secondary market transactions for clearing. Merely
incentivizing and facilitating greater central clearing, as opposed to
requiring central clearing, would not sufficiently address the current
risks to U.S. Treasury securities CCAs. Therefore, for the reasons
discussed in part II.2.a and b, the requirement to clear is also
necessary.
---------------------------------------------------------------------------

\1054\ See supra note 344.
---------------------------------------------------------------------------

V. Paperwork Reduction Act

A. Proposed Changes to Covered Clearing Agency Standards

As discussed in the Proposing Release,\1055\ the amendments to Rule
17ad-22(e) contain ``collection of information'' requirements within
the meaning of the Paperwork Reduction Act of 1995 (``PRA'').\1056\ The
Commission submitted the proposed collections of information to the
Office of Management and Budget (``OMB'') for review in accordance with
the PRA. The title of the information collection for Rule 17ad-22(e) is
``Clearing Agency Standards for Operation and Governance'' (OMB Control
No. 3235-0695). The amendments to Rule 17ad-22(e) add two new
information collections, titled ``17ad-22(e)(6)

[[Page 2823]]

(Treasury Clearing)'' and ``17ad-22(e)(18) (Treasury Clearing),''
respectively, to OMB Control No. 3235-0695. An agency may not conduct
or sponsor, and a person is not required to respond to, a collection of
information unless it displays a currently valid OMB control number.
---------------------------------------------------------------------------

\1055\ Proposing Release, supra note 14, 87 FR at 64675-77.
\1056\ See 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

Respondents under this rule are Treasury securities CCAs, of which
there is currently one. The Commission anticipates that one additional
entity may seek to register as a clearing agency to provide CCP
services for Treasury securities in the next three years, and so for
purposes of this rulemaking the Commission has assumed two respondents.
As described above in parts II.A and B supra, the Commission is
adopting the amendments to Rules 17ad-22(e)(6) and (e)(18) as proposed,
and the Commission has received no comments on the burden estimates
provided in the Proposing Release. Accordingly, the Commission is not
adjusting the burden estimates from the Proposing Release, except with
respect to minor changes to correct mathematical errors, as described
more fully below.
1. Amendment to Rule 17ad-22(e)(6)
The purpose of this collection of information is to enable a
covered clearing agency for Treasury securities to better understand
and manage the risks presented by transactions that a direct
participant may submit on behalf of its customer, i.e., an indirect
participant which relies upon the direct participant to access the
covered clearing agency. The collection is mandatory. To the extent
that the Commission receives confidential information pursuant to this
collection of information, such information would be kept confidential
subject to the provisions of applicable law.\1057\
---------------------------------------------------------------------------

\1057\ See, e.g., 5 U.S.C. 552. Exemption 4 of the Freedom of
Information Act provides an exemption for trade secrets and
commercial or financial information obtained from a person and
privileged or confidential. See 5 U.S.C. 552(b)(4). Exemption 8 of
the Freedom of Information Act provides an exemption for matters
that are contained in or related to examination, operating, or
condition reports prepared by, on behalf of, or for the use of an
agency responsible for the regulation or supervision of financial
institutions. See 5 U.S.C. 552(b)(8).
---------------------------------------------------------------------------

The amendment to Rule 17ad-22(e)(6) requires a Treasury securities
CCA to establish, implement, maintain and enforce written policies and
procedures. The amendment contains similar provisions to existing FICC
rules, specifically with respect to its Sponsored Member program, but
also imposes additional requirements that did not previously appear in
Rule 17ad-22. As a result, the Commission believes that a respondent
Treasury securities CCA will incur burdens of reviewing and updating
existing policies and procedures in order to comply with the amendment
to Rule 17ad-22(e)(6) and, in some cases, may need to create new
policies and procedures.\1058\ The Commission believes that the PRA
burdens for the amendment to Rule 17ad-22(e)(6) may require a
respondent clearing agency to make substantial changes to its policies
and procedures. Based on the similar policies and procedures
requirements and the corresponding burden estimates previously made by
the Commission for several rules in the Covered Clearing Agency
Standards where the Commission anticipated similar burdens,\1059\ the
Commission estimates that the amendment to Rule 17ad-22(e)(6) would
impose on each respondent Treasury securities CCA an initial burden of
129 hours in the first year.\1060\
---------------------------------------------------------------------------

\1058\ See Proposing Release, supra note 14, 87 FR at 64622
(discussing existing FICC rules for sponsored member program).
\1059\ See CCA Standards Adopting Release, supra note 10, 81 FR
at 70895-97 (discussing Rules 17ad-22(e)(13), (15), and (18)).
Although the rule amendment is with respect to Rule 17ad-22(e)(6),
the Commission believes that these Rules present the best overall
comparison to the rule amendment, in light of the nature of the
changes needed to implement the rule amendment here and what was
proposed in the Covered Clearing Agency Standards.
\1060\ This figure was calculated as follows: (Assistant General
Counsel for 20 hours) + (Compliance Attorney for 40 hours) +
(Computer Operations Manager for 12 hours) + (Senior Programmer for
20 hours) + (Senior Risk Management Specialist for 25 hours) +
(Senior Business Analyst for 12 hours) = 129 hours x 2 respondent
clearing agencies = 258 hours.
---------------------------------------------------------------------------

In addition, the amendment to Rule 17ad-22(e)(6) imposes ongoing
burdens on a respondent Treasury securities CCA. The amended rule
requires ongoing monitoring and compliance activities with respect to
the written policies and procedures created in response to the amended
rule. Based on the similar reporting requirements and the corresponding
burden estimates previously made by the Commission for several rules in
the Covered Clearing Agency Standards where the Commission anticipated
similar burdens,\1061\ the Commission estimates that the ongoing
activities required by the amendment to Rule 17ad-22(e)(6) would impose
an ongoing burden of 85 hours per year (including the first
year).\1062\ Therefore, the aggregate ongoing industry burden
associated with the amendments to Rule 17ad-22(e)(6) for the two
respondents is approximately 170 hours per year.\1063\
---------------------------------------------------------------------------

\1061\ See CCA Standards Adopting Release, supra note 10, 81 FR
at 70893 and 70895-96 (discussing Rules 17ad-22(e)(6) and (13)).
\1062\ This figure was calculated as follows: (Compliance
Attorney for 25 hours + Business Risk Analyst for 40 hours + Senior
Risk Management Specialist for 20 hours) = 85 hours x 2 respondent
clearing agencies = 170 ongoing burden hours. (This figure is a
corrected version from that in the 2022 Proposing Release, which
contained a calculation error in the chart that overstated the
estimated burden by 6 hours per respondent, and another calculation
error in the accompanying footnote that understated the estimated
burden by 5 hours per respondent. See Proposing Release, supra note
14, 87 FR at 64675, footnote 505 and accompanying text.)
\1063\ This figure was calculated as follows: 85 hours x 2
respondent clearing agencies = 170 hours.

--------------------------------------------------------------------------------------------------------------------------------------------------------
Initial burden Aggregate Ongoing burden Aggregate
Name of information collection Type of burden Number of per entity initial burden per entity ongoing burden
respondents (hours) (hours) (hours) (hours)
--------------------------------------------------------------------------------------------------------------------------------------------------------
17ad-22(e)(6) (Treasury Clearing)...... Recordkeeping............ 2 129 258 \a\ 85 \b\ 170
--------------------------------------------------------------------------------------------------------------------------------------------------------
\a\ See supra note 963.
\b\ See id.

2. Amendment to Rule 17ad-22(e)(18)(iv)
The purpose of the collection of information under Rule 17ad-
22(e)(18)(iv) is to enable a U.S. Treasury securities CCA to ensure
that its direct participants submit for clearance and settlement, as a
requirement of membership in the CCA, all eligible secondary market
transactions in U.S. Treasury securities to the U.S. Treasury
securities CCA to which the direct participants are a counterparty.
This should, in turn, help ensure that the risk presented by the
eligible secondary market transactions of that direct participant that
are not centrally cleared would not be transmitted to the U.S. Treasury
securities CCA, and to enable the CCA to identify and manage the risks
posed by those transactions that are currently not submitted for
central clearing. In addition, the purpose of this rule is to ensure
that the U.S. Treasury

[[Page 2824]]

securities CCA adopts policies and procedures to identify and monitor
its direct participants' submission of transactions for clearance and
settlement, including how the CCA would address a failure to submit
transactions that are required to be submitted. Finally, the purpose of
the rule is to ensure that the CCA has appropriate means to facilitate
access to clearance and settlement services of all eligible secondary
market transactions in U.S. Treasury securities, including those of
indirect participants, which policies and procedures the board of
directors of such covered clearing agency reviews annually.
This additional collection is mandatory. To the extent that the
Commission receives confidential information pursuant to this
collection of information, such information would be kept confidential
subject to the provisions of applicable law.\1064\
---------------------------------------------------------------------------

\1064\ See, e.g., 5 U.S.C. 552 et seq. Exemption 4 of the
Freedom of Information Act provides an exemption for trade secrets
and commercial or financial information obtained from a person and
privileged or confidential. See 5 U.S.C. 552(b)(4). Exemption 8 of
the Freedom of Information Act provides an exemption for matters
that are contained in or related to examination, operating, or
condition reports prepared by, on behalf of, or for the use of an
agency responsible for the regulation or supervision of financial
institutions. See 5 U.S.C. 552(b)(8).
---------------------------------------------------------------------------

The amendment to Rule 17ad-22(e)(18)(iv) requires a U.S. Treasury
securities CCA to establish, implement, maintain and enforce written
policies and procedures, as discussed above. Because such policies and
procedures are not currently required under existing Rule 17ad-22, the
Commission believes that the estimated PRA burdens for the amendment to
Rule 17ad-22(e)(18)(iv) would be significant and may require a
respondent clearing agency to make substantial changes to its policies
and procedures. The amendment contains similar provisions to existing
rules, but also imposes additional requirements that did not previously
appear in Rule 17ad-22.\1065\ As a result, the Commission believes that
a respondent U.S. Treasury securities CCA would incur burdens of
reviewing and updating existing policies and procedures in order to
comply with the provisions of amended Rule 17ad-22(e)(18)(iv) and, in
some cases, may need to create new policies and procedures. Based on
the similar policies and procedures requirements and the corresponding
burden estimates previously made by the Commission for several rules in
the Covered Clearing Agency Standards where the Commission anticipated
similar burdens,\1066\ the Commission estimates that the amendment to
Rule 17ad-22(e)(18)(iv) would impose on each respondent Treasury
securities CCA an initial burden of 260 hours in the first year.\1067\
---------------------------------------------------------------------------

\1065\ See Proposing Release, supra note 14, 87 FR n.34 and
accompanying text (discussing current FICC rules).
\1066\ See CCA Standards Adopting Release, supra note 10, 81 FR
at 70895-97 (discussing Rules 17ad-22(e)(13), (15), and (18)). The
Commission believes that these Rules present the best comparison to
the rule amendment, in light of the nature of the rule amendment.
Although the rule amendment is with respect to Rule 17ad-22(e)(18),
the Commission believes that considering additional rules in the
Covered Clearing Agency Standards is reasonable in light of the
nature of the rule amendment and the changes necessary to establish
and implement the requirements of the rule amendment, as compared to
the current Commission rules and U.S. Treasury securities CCA rules.
\1067\ This figure was calculated as follows: Assistant General
Counsel for 40 hours + Compliance Attorney for 80 hours + Computer
Operations Manager for 20 hours + Senior Risk Management Specialist
for 40 hours + Business Risk Analyst for 80 hours = 260 hours x 2
respondent clearing agencies = 520 hours.
---------------------------------------------------------------------------

In addition, the amendment to Rule 17ad-22(e)(18)(iv) imposes
ongoing burdens on a respondent Treasury securities CCA. The amended
rule requires ongoing monitoring and compliance activities with respect
to the written policies and procedures created in response to the
amendment. Based on the similar reporting requirements and the
corresponding burden estimates previously made by the Commission for
several rules in the Covered Clearing Agency Standards where the
Commission anticipated similar burdens,\1068\ the Commission estimates
that the ongoing activities required by the amendment to Rule 17ad-
22(e)(18)(iv) would impose an ongoing burden of 85 hours per year
(including the first year).\1069\ Therefore, the aggregate ongoing
industry burden associated with the amendment to Rule 17ad-
22(e)(18)(iv) for the two respondents is approximately 170 hours per
year.\1070\
---------------------------------------------------------------------------

\1068\ See supra note above (discussing relevant aspects of the
Covered Clearing Agency Standards).
\1069\ This figure was calculated as follows: (Compliance
Attorney for 25 hours + Business Risk Analyst for 40 hours + Senior
Risk Management Specialist for 20 hours) = 85 ongoing burden hours
per year.
\1070\ This figure was calculated as follows: 85 hours x 2
respondent clearing agencies = 170 hours.

--------------------------------------------------------------------------------------------------------------------------------------------------------
Initial burden Aggregate Ongoing burden Aggregated
Name of information collection Type of burden Number of per entity initial burden per entity ongoing burden
respondents (hours) (hours) (hours) (hours)
--------------------------------------------------------------------------------------------------------------------------------------------------------
17ad-22(e)(18) (Treasury Clearing)..... Recordkeeping............ 2 260 520 \a\ 85 170
--------------------------------------------------------------------------------------------------------------------------------------------------------
\a\ This figure is a corrected version from that in the 2022 Proposing Release, which contained an error in the calculation that understated the
estimated burden by 5 hours. See Proposing Release, supra note 13, 87 FR 64675.

B. Broker-Dealers

The final rule amendment to Rule 15c3-3a does not require a new
collection of information on the part of any entities subject to these
rules. Accordingly, the requirements imposed by the PRA are not
applicable to this rule.

VI. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') requires the Commission,
in promulgating rules, to consider the impact of those rules on small
entities.\1071\ Section 603(a) of the Administrative Procedure
Act,\1072\ as amended by the RFA, generally requires the Commission to
undertake a final regulatory flexibility analysis of all proposed rules
to determine the impact of such rulemaking on ``small entities.''
\1073\ Section 605(b) of the RFA states that this requirement shall not
apply to any proposed rule which, if adopted, would not have a
significant economic impact on a substantial number of small
entities.\1074\ In the Proposing Release, the Commission certified that
the proposed amendments to Rules 17ad-22 and 15c3-3a would not have a
significant economic impact on a substantial number of small entities
for purposes of the RFA. The Proposing Release solicited comment on the
certification. The Commission received no comments on this
certification.
---------------------------------------------------------------------------

\1071\ See 5 U.S.C. 601 et seq.
\1072\ 5 U.S.C. 603(a).
\1073\ Section 601(b) of the RFA permits agencies to formulate
their own definitions of ``small entities.'' See 5 U.S.C. 601(b).
The Commission has adopted definitions for the term ``small entity''
for the purposes of rulemaking in accordance with the RFA. These
definitions, as relevant to this rulemaking, are set forth in 17 CFR
240.0-10.
\1074\ See 5 U.S.C. 605(b).
---------------------------------------------------------------------------

A. Clearing Agencies

The amendments to Rule 17ad-22 would apply to covered clearing
agencies, which would include

[[Page 2825]]

registered clearing agencies that provide the services of a central
counterparty or central securities depository.\1075\ For the purposes
of Commission rulemaking and as applicable to the proposed amendments
to Rule 17ad-22, a small entity includes, when used with reference to a
clearing agency, a clearing agency that (i) compared, cleared, and
settled less than $500 million in securities transactions during the
preceding fiscal year, (ii) had less than $200 million of funds and
securities in its custody or control at all times during the preceding
fiscal year (or at any time that it has been in business, if shorter),
and (iii) is not affiliated with any person (other than a natural
person) that is not a small business or small organization.\1076\
---------------------------------------------------------------------------

\1075\ 17 CFR 240.17ad-22(a)(5).
\1076\ See 17 CFR 240.0-10(d).
---------------------------------------------------------------------------

Based on the Commission's existing information about the clearing
agencies currently registered with the Commission, the Commission
believes that such entities exceed the thresholds defining ``small
entities'' set out above. While other clearing agencies may emerge and
seek to register as clearing agencies, the Commission does not believe
that any such entities would be ``small entities'' as defined in
Exchange Act Rule 0-10.\1077\ In any case, clearing agencies can only
become subject to the new requirements under Rule 17ad-22(e) should
they meet the definition of a covered clearing agency, as described
above. Accordingly, the Commission believes that any such registered
clearing agencies will exceed the thresholds for ``small entities'' set
forth in Exchange Act Rule 0-10.
---------------------------------------------------------------------------

\1077\ See 17 CFR 240.0-10(d). The Commission based this
determination on its review of public sources of financial
information about registered clearing agencies and lifecycle event
service providers for OTC derivatives.
---------------------------------------------------------------------------

B. Broker-Dealers

For purposes of Commission rulemaking in connection with the RFA, a
small entity includes a broker-dealer that: (1) had total capital (net
worth plus subordinated liabilities) of less than $500,000 on the date
in the prior fiscal year as of which its audited financial statements
were prepared pursuant to Rule 17a-5(d) under the Exchange Act, or, if
not required to file such statements, a broker-dealer with total
capital (net worth plus subordinated liabilities) of less than $500,000
on the last day of the preceding fiscal year (or in the time that it
has been in business, if shorter); and (2) is not affiliated with any
person (other than a natural person) that is not a small business or
small organization.\1078\ Under the standards adopted by the Small
Business Administration, small entities in the finance and insurance
industry include the following: (1) for entities in credit
intermediation and related activities, firms with $175 million or less
in assets; (2) for non-depository credit intermediation and certain
other activities, firms with $7 million or less in annual receipts; (3)
for entities in financial investments and related activities, firms
with $7 million or less in annual receipts; (4) for insurance carriers
and entities in related activities, firms with $7 million or less in
annual receipts; and (5) for funds, trusts, and other financial
vehicles, firms with $7 million or less in annual receipts.
---------------------------------------------------------------------------

\1078\ See 17 CFR 240.0-10(c).
---------------------------------------------------------------------------

The final rule amendment to Rule 15c3-3a would permit margin
required and on deposit with covered clearing agencies for U.S.
Treasury securities to be included by broker-dealers as a debit in the
reserve formulas for accounts of customers and proprietary accounts of
broker-dealers, subject to certain conditions. Only carrying broker-
dealers will be impacted by the final rule amendment. This is because
only carrying broker-dealers are required to maintain a customer or PAB
reserve account and may collect customer margin.
Based on FOCUS Report data, the Commission estimates that as of
June 30, 2023, there were approximately 772 broker-dealers that were
``small'' for the purposes of Rule 0-10. Of these, the Commission
estimates that there are less than ten broker-dealers that are carrying
broker-dealers (i.e., can carry customer or PAB margin accounts and
extend credit). However, based on June 30, 2023, FOCUS Report data,
none of these small carrying broker-dealers carried debit balances.
This means that any ``small'' carrying firms are not extending margin
credit to their customers, and therefore, the final rule amendment
likely would not apply to them. Therefore, while the Commission
believes that some small broker-dealers could be affected by the final
amendment, the amendment will not have a significant impact on a
substantial number of small broker-dealers.

C. Certification

For the reasons described above, the Commission certifies that the
final amendments to Rules 17ad-22 and 15c3-3a would not have a
significant economic impact on a substantial number of small entities
for purposes of the RFA.

VII. Other Matters

If any of the provisions of these rules, or the application thereof
to any person or circumstance, is held to be invalid, such invalidity
shall not affect other provisions or application of such provisions to
other persons or circumstances that can be given effect without the
invalid provision or application.
Pursuant to the Congressional Review Act,\1079\ the Office of
Information and Regulatory Affairs has designated these rules as a
``major rule,'' as defined by 5 U.S.C. 804(2).
---------------------------------------------------------------------------

\1079\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

Statutory Authority

The Commission is amending Rule 17ad-22 under the Commission's
rulemaking authority set forth in section 17A of the Exchange Act, 15
U.S.C. 78q-1, and section 805 of the Clearing Supervision Act, 15
U.S.C. 5464 respectively. Pursuant to the Exchange Act, 15 U.S.C. 78a
et seq., and particularly, sections 15 and 23(a) (15 U.S.C. 78o and
78w(a)), thereof, the Commission is amending Sec. 240.15c3-3a under
the Exchange Act.

List of Subjects in 17 CFR Part 240

Reporting and recordkeeping requirements, Securities.

Text of Amendments

In accordance with the foregoing, title 17, chapter II of the Code
of Federal Regulations is amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934

0
1. The general authority citation for part 240 continues to read, and
the sectional authority for Sec. 240.17ad-22 is revised to read, as
follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 78ll, 78mm,
80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq.,
and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350;
Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-106,
sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
Section 240.15c3-3a is also issued under Pub. L. 111-203, Sec.
939, 939A, 124. Stat. 1376 (2010) (15 U.S.C. 78c, 15 U.S.C. 78o-7
note).
* * * * *
Section 240.17ad-22 is also issued under 12 U.S.C. 5461 et seq.
* * * * *

[[Page 2826]]

0
2. Revise and republish Sec. 240.15c3-3a to read as follows:

Sec. 240.15c3-3a Exhibit A--Formula for determination of customer and
PAB account reserve requirements of brokers and dealers under Sec.
240.15c3-3.

------------------------------------------------------------------------
Credits Debits
------------------------------------------------------------------------
1. Free credit balances and other credit XXX ..........
balances in customers' security accounts. (See
Note A)........................................
2. Monies borrowed collateralized by securities XXX ..........
carried for the accounts of customers (See Note
B).............................................
3. Monies payable against customers' securities XXX ..........
loaned (See Note C)............................
4. Customers' securities failed to receive (See XXX
Note D)........................................
5. Credit balances in firm accounts which are XXX ..........
attributable to principal sales to customers...
6. Market value of stock dividends, stock splits XXX ..........
and similar distributions receivable
outstanding over 30 calendar days..............
7. Market value of short security count XXX ..........
differences over 30 calendar days old..........
8. Market value of short securities and credits XXX ..........
(not to be offset by longs or by debits) in all
suspense accounts over 30 calendar days........
9. Market value of securities which are in XXX ..........
transfer in excess of 40 calendar days and have
not been confirmed to be in transfer by the
transfer agent or the issuer during the 40 days
10. Debit balances in customers' cash and margin .......... XXX
accounts excluding unsecured accounts and
accounts doubtful of collection. (See Note E)..
11. Securities borrowed to effectuate short .......... XXX
sales by customers and securities borrowed to
make delivery on customers' securities failed
to deliver.....................................
12. Failed to deliver of customers' securities .......... XXX
not older than 30 calendar days................
13. Margin required and on deposit with the .......... XXX
Options Clearing Corporation for all option
contracts written or purchased in customer
accounts. (See Note F).........................
14. Margin required and on deposit with a .......... XXX
clearing agency registered with the Commission
under section 17A of the Act (15 U.S.C. 78q-1)
or a derivatives clearing organization
registered with the Commodity Futures Trading
Commission under section 5b of the Commodity
Exchange Act (7 U.S.C. 7a-1) related to the
following types of positions written, purchased
or sold in customer accounts: (1) security
futures products and (2) futures contracts (and
options thereon) carried in a securities
account pursuant to an SRO portfolio margining
rule (See Note G)..............................
15. Margin required and on deposit with a .......... XXX
clearing agency registered with the Commission
under section 17A of the Act (15 U.S.C. 78q-1)
resulting from the following types of
transactions in U.S. Treasury securities in
customer accounts that have been cleared,
settled, and novated by the clearing agency:
(1) purchases and sales of U.S. Treasury
securities; and (2) U.S. Treasury securities
repurchase and reverse repurchase agreements
(See Note H)...................................
-----------------------
Total credits............................... .......... ..........
Total debits................................ .......... ..........
-----------------------
16. Excess of total credits (sum of items 1-9) .......... XXX
over total debits (sum of items 10-15) required
to be on deposit in the ``Reserve Bank
Account'' (Sec. 240.15c3-3(e)). If the
computation is made monthly as permitted by
this section, the deposit must be not less than
105 percent of the excess of total credits over
total debits...................................
------------------------------------------------------------------------

Notes Regarding the Customer Reserve Bank Account Computation

Note A. Item 1 must include all outstanding drafts payable to
customers which have been applied against free credit balances or
other credit balances and must also include checks drawn in excess
of bank balances per the records of the broker or dealer.
Note B. Item 2 must include the amount of options-related or
security futures product-related Letters of Credit obtained by a
member of a registered clearing agency or a derivatives clearing
organization which are collateralized by customers' securities, to
the extent of the member's margin requirement at the registered
clearing agency or derivatives clearing organization. Item 2 must
also include the amount of Letters of Credit which are
collateralized by customers' securities and related to other futures
contracts (and options thereon) carried in a securities account
pursuant to an SRO portfolio margining rule. Item 2 must include the
market value of customers' securities on deposit at a ``qualified
clearing agency'' as defined in Note H below.
Note C. Item 3 must include in addition to monies payable
against customers' securities loaned the amount by which the market
value of securities loaned exceeds the collateral value received
from the lending of such securities.
Note D. Item 4 must include in addition to customers' securities
failed to receive the amount by which the market value of securities
failed to receive and outstanding more than thirty (30) calendar
days exceeds their contract value.
Note E. (1) Debit balances in margin accounts must be reduced by
the amount by which a specific security (other than an exempted
security) which is collateral for margin accounts exceeds in
aggregate value 15 percent of the aggregate value of all securities
which collateralize all margin accounts receivable; provided,
however, the required reduction must not be in excess of the amounts
of the debit balance required to be excluded because of this
concentration rule. A specified security is deemed to be collateral
for a margin account only to the extent it represents in value not
more than 140 percent of the customer debit balance in a margin
account.
(2) Debit balances in special omnibus accounts, maintained in
compliance with the requirements of Section 7(f) of Regulation T (12
CFR 220.7(f)) or similar accounts carried on behalf of another
broker or dealer, must be reduced by any deficits in such accounts
(or if a credit, such credit must be increased) less any calls for
margin, mark to the market, or other required deposits which are
outstanding five business days or less.
(3) Debit balances in customers' cash and margin accounts
included in the formula under Item 10 must be reduced by an amount
equal to 1 percent of their aggregate value.
(4) Debit balances in cash and margin accounts of household
members and other persons related to principals of a broker or
dealer and debit balances in cash and margin accounts of affiliated
persons of a broker or dealer must be excluded from the Reserve
Formula, unless the broker or dealer can demonstrate that such debit
balances are directly related to credit items in the formula.
(5) Debit balances in margin accounts (other than omnibus
accounts) must be reduced by the amount by which any single
customer's debit balance exceeds 25 percent (to the extent such
amount is greater than $50,000) of the broker-dealer's tentative net
capital (i.e., net capital prior to securities haircuts) unless the
broker or dealer can demonstrate that the debit balance is directly
related to credit items in the Reserve Formula. Related accounts
(e.g., the separate accounts of an individual, accounts under common
control or subject to cross guarantees) will be deemed to be a
single customer's accounts for purposes of this provision. If the
registered national securities exchange or the registered national
securities association having responsibility for

[[Page 2827]]

examining the broker or dealer (``designated examining authority'')
is satisfied, after taking into account the circumstances of the
concentrated account including the quality, diversity, and
marketability of the collateral securing the debit balances or
margin accounts subject to this provision, that the concentration of
debit balances is appropriate, then such designated examining
authority may grant a partial or plenary exception from this
provision. The debit balance may be included in the reserve formula
computation for five business days from the day the request is made.
(6) Debit balances in joint accounts, custodian accounts,
participation in hedge funds or limited partnerships or similar type
accounts or arrangements that include both assets of a person or
persons who would be excluded from the definition of customer
(``noncustomer'') and assets of a person or persons who would be
included in the definition of customer must be included in the
Reserve Formula in the following manner: if the percentage ownership
of the non-customer is less than 5 percent then the entire debit
balance shall be included in the formula; if such percentage
ownership is between 5 percent and 50 percent then the portion of
the debit balance attributable to the non-customer must be excluded
from the formula unless the broker or dealer can demonstrate that
the debit balance is directly related to credit items in the
formula; or if such percentage ownership is greater than 50 percent,
then the entire debit balance must be excluded from the formula
unless the broker or dealer can demonstrate that the debit balance
is directly related to credit items in the formula.
Note F. Item 13 must include the amount of margin required and
on deposit with the Options Clearing Corporation to the extent such
margin is represented by cash, proprietary qualified securities and
letters of credit collateralized by customers' securities.
Note G. (a) Item 14 must include the amount of margin required
and on deposit with a clearing agency registered with the Commission
under section 17A of the Act (15 U.S.C. 78q-1) or a derivatives
clearing organization registered with the Commodity Futures Trading
Commission under section 5b of the Commodity Exchange Act (7 U.S.C.
7a-1) for customer accounts to the extent that the margin is
represented by cash, proprietary qualified securities, and letters
of credit collateralized by customers' securities.
(b) Item 14 will apply only if the broker or dealer has the
margin related to security futures products, or futures (and options
thereon) carried in a securities account pursuant to an approved SRO
portfolio margining program on deposit with:
(1) A registered clearing agency or derivatives clearing
organization that:
(i) Maintains security deposits from clearing members in
connection with regulated options or futures transactions and
assessment power over member firms that equal a combined total of at
least $2 billion, at least $500 million of which must be in the form
of security deposits. For the purposes of this Note G, the term
``security deposits'' refers to a general fund, other than margin
deposits or their equivalent, that consists of cash or securities
held by a registered clearing agency or derivative clearing
organization; or
(ii) Maintains at least $3 billion in margin deposits; or
(iii) Does not meet the requirements of paragraphs (b)(1)(i)
through (b)(1)(iii) of this Note G, if the Commission has
determined, upon a written request for exemption by or for the
benefit of the broker or dealer, that the broker or dealer may
utilize such a registered clearing agency or derivatives clearing
organization. The Commission may, in its sole discretion, grant such
an exemption subject to such conditions as are appropriate under the
circumstances, if the Commission determines that such conditional or
unconditional exemption is necessary or appropriate in the public
interest, and is consistent with the protection of investors; and
(2) A registered clearing agency or derivatives clearing
organization that, if it holds funds or securities deposited as
margin for security futures products or futures in a portfolio
margin account in a bank, as defined in section 3(a)(6) of the Act
(15 U.S.C. 78c(a)(6)), obtains and preserves written notification
from the bank at which it holds such funds and securities or at
which such funds and securities are held on its behalf. The written
notification will state that all funds and/or securities deposited
with the bank as margin (including customer security futures
products and futures in a portfolio margin account), or held by the
bank and pledged to such registered clearing agency or derivatives
clearing agency as margin, are being held by the bank for the
exclusive benefit of clearing members of the registered clearing
agency or derivatives clearing organization (subject to the interest
of such registered clearing agency or derivatives clearing
organization therein), and are being kept separate from any other
accounts maintained by the registered clearing agency or derivatives
clearing organization with the bank. The written notification also
will provide that such funds and/or securities will at no time be
used directly or indirectly as security for a loan to the registered
clearing agency or derivatives clearing organization by the bank,
and will be subject to no right, charge, security interest, lien, or
claim of any kind in favor of the bank or any person claiming
through the bank. This provision, however, will not prohibit a
registered clearing agency or derivatives clearing organization from
pledging customer funds or securities as collateral to a bank for
any purpose that the rules of the Commission or the registered
clearing agency or derivatives clearing organization otherwise
permit; and
(3) A registered clearing agency or derivatives clearing
organization establishes, documents, and maintains:
(i) Safeguards in the handling, transfer, and delivery of cash
and securities;
(ii) Fidelity bond coverage for its employees and agents who
handle customer funds or securities. In the case of agents of a
registered clearing agency or derivatives clearing organization, the
agent may provide the fidelity bond coverage; and
(iii) Provisions for periodic examination by independent public
accountants; and
(iv) A derivatives clearing organization that, if it is not
otherwise registered with the Commission, has provided the
Commission with a written undertaking, in a form acceptable to the
Commission, executed by a duly authorized person at the derivatives
clearing organization, to the effect that, with respect to the
clearance and settlement of the customer security futures products
and futures in a portfolio margin account of the broker or dealer,
the derivatives clearing organization will permit the Commission to
examine the books and records of the derivatives clearing
organization for compliance with the requirements set forth in Sec.
240.15c3-3a, Note G (b)(1) through (3).
(c) Item 14 will apply only if a broker or dealer determines, at
least annually, that the registered clearing agency or derivatives
clearing organization with which the broker or dealer has on deposit
margin related to securities future products or futures in a
portfolio margin account meets the conditions of this Note G.
Note H. (a) Item 15 must include the amount of margin required
and on deposit with a clearing agency registered with the Commission
under section 17A of the Act (15 U.S.C. 78q-1) that clears, settles,
and novates transactions in U.S. Treasury securities (``qualified
clearing agency'') to the extent that the margin is:
(1) In the form of cash, U.S. Treasury securities, or qualified
customer securities; and
(2) Being used to margin U.S. Treasury securities positions of
the customers of the broker or dealer that are cleared, settled, and
novated by the qualified clearing agency.
(b) Item 15 will apply only if the cash and securities required
and on deposit at the qualified clearing agency:
(1)(i) Are cash owed by the broker or dealer to the customer of
the broker or dealer that was delivered by the broker or dealer to
the qualified clearing agency to meet a margin requirement resulting
from that customer's U.S. Treasury securities positions cleared,
settled, and novated at the qualified clearing agency and not for
any other customer's or the broker's or dealer's U.S. Treasury
securities positions cleared, settled, and novated at the qualified
clearing agency;
(ii) U.S. Treasury securities or qualified customer securities
held in custody by the broker or dealer for the customer of the
broker or dealer that were delivered by the broker or dealer to the
qualified clearing agency to meet a margin requirement resulting
from that customer's U.S. Treasury securities positions cleared,
settled, and novated at the qualified clearing agency and not for
any other customer's or the broker's or dealer's U.S. Treasury
securities positions cleared, settled, and novated at the qualified
clearing agency; or
(iii) U.S. Treasury securities owned by the broker or dealer
that were delivered by the broker or dealer to the qualified
clearing agency to meet a margin requirement resulting from a
customer's U.S. Treasury securities positions cleared, settled, and
novated at the qualified clearing agency under the following
conditions:
(A) The broker or dealer did not owe to the customer or hold in
custody for the customer

[[Page 2828]]

sufficient cash, U.S. Treasury securities, and/or qualified customer
securities to meet a margin requirement resulting from that
customer's U.S. Treasury securities positions cleared, settled, and
novated at the qualified clearing agency at the time the margin
requirement arose;
(B) The broker or dealer calls for the customer to deliver a
sufficient amount of cash, U.S. Treasury securities, and/or
qualified customer securities to meet the margin requirement on the
day the margin requirement arose; and
(C) The broker or dealer receives a sufficient amount of cash,
U.S. Treasury securities, and/or qualified customer securities to
meet the margin requirement by the close of the next business day
after the margin requirement arose.
(2) Are treated in accordance with rules of the qualified
clearing agency that impose the following requirements and the
qualified clearing agency and broker or dealer are in compliance
with the requirements of the rules (as applicable):
(i) Rules requiring the qualified clearing agency to calculate a
separate margin amount for each customer of the broker or dealer and
the broker or dealer to deliver that amount of margin for each
customer on a gross basis;
(ii) Rules limiting the qualified clearing agency from investing
cash delivered by the broker or dealer to margin U.S. Treasury
security transactions of the customers of the broker or dealer or
cash realized through using U.S. Treasury securities delivered by
the broker or dealer for that purpose in any asset other than U.S.
Treasury securities with a maturity of one year or less;
(iii) Rules requiring that the cash, U.S. Treasury securities,
and qualified customer securities used to margin the U.S. Treasury
securities positions of the customers of the broker or dealer be
held in an account of the broker or dealer at the qualified clearing
agency that is segregated from any other account of the broker or
dealer at the qualified clearing agency and that is:
(A) Used exclusively to clear, settle, novate, and margin U.S.
Treasury securities transactions of the customers of the broker or
dealer;
(B) Designated ``Special Clearing Account for the Exclusive
Benefit of the Customers of [name of broker or dealer]'';
(C) Subject to a written notice of the qualified clearing agency
provided to and retained by the broker or dealer that the cash, U.S.
Treasury securities, and qualified customer securities in the
account are being held by the qualified clearing agency for the
exclusive benefit of the customers of the broker or dealer in
accordance with the regulations of the Commission and are being kept
separate from any other accounts maintained by the broker or dealer
or any other clearing member at the qualified clearing agency; and
(D) Subject to a written contract between the broker or dealer
and the qualified clearing agency which provides that the cash, U.S.
Treasury securities, and qualified customer securities in the
account are not available to cover claims arising from the broker or
dealer or any other clearing member defaulting on an obligation to
the qualified clearing agency or subject to any other right, charge,
security interest, lien, or claim of any kind in favor of the
qualified clearing agency or any person claiming through the
qualified clearing agency, except a right, charge, security
interest, lien, or claim resulting from a cleared U.S. Treasury
securities transaction of a customer of the broker or dealer
effected in the account;
(iv) Rules requiring the qualified clearing agency to hold the
customer cash, U.S. Treasury securities, and qualified customer
securities used to margin the U.S. Treasury securities positions of
the customers of the broker or dealer itself or in an account of the
clearing agency at a U.S. Federal Reserve Bank or a ``bank,'' as
that term is defined in section 3(a)(6) of the Act (15 U.S.C.
78c(a)(6)), that is insured by the Federal Deposit Insurance
Corporation, and that the account at the U.S. Federal Reserve Bank
or bank must be:
(A) Segregated from any other account of the qualified clearing
agency or any other person at the U.S. Federal Reserve Bank or bank
and used exclusively to hold cash, U.S. Treasury securities, and
qualified customer securities to meet current margin requirements of
the qualified clearing agency resulting from positions in U.S.
Treasury securities of the customers of the broker or dealer members
of the qualified clearing agency;
(B) Subject to a written notice of the U.S. Federal Reserve Bank
or bank provided to and retained by the qualified clearing agency
that the cash, U.S. Treasury securities, and qualified customer
securities in the account are being held by the U.S. Federal Reserve
Bank or bank pursuant to Sec. 240.15c3-3 and are being kept
separate from any other accounts maintained by the qualified
clearing agency or any other person at the U.S. Federal Reserve Bank
or bank; and
(C) Subject to a written contract between the qualified clearing
agency and the U.S. Federal Reserve Bank or bank which provides that
the cash, U.S. Treasury securities, and qualified customer
securities in the account are subject to no right, charge, security
interest, lien, or claim of any kind in favor of the U.S. Federal
Reserve Bank or bank or any person claiming through the U.S. Federal
Reserve Bank or bank; and
(v) Rules requiring systems, controls, policies, and procedures
to return cash, U.S. Treasury securities, and qualified customer
securities to the broker or dealer that are no longer needed to meet
a current margin requirement resulting from positions in U.S.
Treasury securities of the customers of the broker or dealer; and
(3) The Commission has approved rules of the qualified clearing
agency that meet the conditions of this Note H and has published
(and not subsequently withdrawn) a notice that brokers or dealers
may include a debit in the customer reserve formula when depositing
cash, U.S. Treasury securities, and/or qualified customer securities
to meet a margin requirement of the qualified clearing agency
resulting from positions in U.S. Treasury securities of the
customers of the broker or dealer.
(c) As used in this Note H, the term ``qualified customer
securities'' means the securities of a customer of the broker or
dealer (other than U.S. Treasury securities) that are held in
custody by the broker or dealer for the customer and that under the
rules of the qualified clearing agency are eligible to be used to
margin U.S. Treasury securities positions of the customer that are
cleared, settled, and novated by the qualified clearing agency.

Notes Regarding the PAB Reserve Bank Account Computation

Note 1. Broker-dealers should use the formula in Exhibit A for
the purposes of computing the PAB reserve requirement, except that
references to ``accounts,'' ``customer accounts, or ``customers''
will be treated as references to PAB accounts.
Note 2. Any credit (including a credit applied to reduce a
debit) that is included in the computation required by Sec.
240.15c3-3 with respect to customer accounts (the ``customer reserve
computation'') may not be included as a credit in the computation
required by Sec. 240.15c3-3 with respect to PAB accounts (the ``PAB
reserve computation'').
Note 3. Note E(1) to Sec. 240.15c3-3a does not apply to the PAB
reserve computation.
Note 4. Note E(3) to Sec. 240.15c3-3a which reduces debit
balances by 1 percent does not apply to the PAB reserve computation.
Note 5. Interest receivable, floor brokerage, and commissions
receivable of another broker or dealer from the broker or dealer
(excluding clearing deposits) that are otherwise allowable assets
under Sec. 240.15c3-1 need not be included in the PAB reserve
computation, provided the amounts have been clearly identified as
payables on the books of the broker or dealer. Commissions
receivable and other receivables of another broker or dealer from
the broker or dealer that are otherwise non-allowable assets under
Sec. 240.15c3-1 and clearing deposits of another broker or dealer
may be included as ``credit balances'' for purposes of the PAB
reserve computation, provided the commissions receivable and other
receivables are subject to immediate cash payment to the other
broker or dealer and the clearing deposit is subject to payment
within 30 days.
Note 6. Credits included in the PAB reserve computation that
result from the use of securities held for a PAB account (``PAB
securities'') that are pledged to meet intra-day margin calls in a
cross-margin account established between the Options Clearing
Corporation and any regulated derivatives clearing organization may
be reduced to the extent that the excess margin held by the other
clearing corporation in the cross-margin relationship is used the
following business day to replace the PAB securities that were
previously pledged. In addition, balances resulting from a portfolio
margin account that are segregated pursuant to Commodity Futures
Trading Commission regulations need not be included in the PAB
Reserve Bank Account computation.
Note 7. Deposits received prior to a transaction pending
settlement which are $5 million or greater for any single
transaction or $10 million in aggregate may be excluded as credits
from the PAB reserve computation if such balances are placed and
maintained in a separate PAB Reserve Bank Account by

[[Page 2829]]

12 p.m. Eastern Time on the following business day. Thereafter, the
money representing any such deposits may be withdrawn to complete
the related transactions without performing a new PAB reserve
computation.
Note 8. A credit balance resulting from a PAB reserve
computation may be reduced by the amount that items representing
such credits are swept into money market funds or mutual funds of an
investment company registered under the Investment Company Act of
1940 on or prior to 10 a.m. Eastern Time on the deposit date
provided that the credits swept into any such fund are not subject
to any right, charge, security interest, lien, or claim of any kind
in favor of the investment company or the broker or dealer. Any
credits that have been swept into money market funds or mutual funds
must be maintained in the name of a particular broker or for the
benefit of another broker.
Note 9. Clearing deposits required to be maintained at
registered clearing agencies may be included as debits in the PAB
reserve computation to the extent the percentage of the deposit,
which is based upon the clearing agency's aggregate deposit
requirements (e.g., dollar trading volume), that relates to the
proprietary business of other brokers and dealers can be identified.
However, Note H to Item 15 of Sec. 240.15c3-3a applies with respect
to margin delivered to a U.S. Treasury securities clearing agency.
Note 10. A broker or dealer that clears PAB accounts through an
affiliate or third party clearing broker must include these PAB
account balances and the omnibus PAB account balance in its PAB
reserve computation.

0
3. Redesignate Sec. 240.17Ad-22 as Sec. 240.17ad-22 and amend newly
redesignated Sec. 240.17ad-22 by:
0
a. In paragraph (a):
0
i. Removing the designations for paragraphs (a)(1) through (19) and
placing the paragraphs alphabetical order, and
0
ii. Adding in alphabetical order definitions for ``Affiliated
counterparty'', ``Central bank'', ``Eligible secondary market
transaction'', ``International financial institution'', ``State or
local government'', ``Sovereign entity'', and ``U.S. Treasury
security''.
0
b. Revising paragraphs (e)(6)(i) and (18).
The revisions and additions read as follows:

Sec. 240.17ad-22 Standards for clearing agencies.

(a) * * *
Affiliated counterparty means any counterparty which meets the
following criteria:
(i) The counterparty is either a bank (as defined in 15 U.S.C.
78c(6)), broker (as defined in 15 U.S.C. 78c(4)), dealer (as defined in
15 U.S.C. 78c(5)), or futures commission merchant (as defined in 7
U.S.C. 1a(28)), or any entity regulated as a bank, broker, dealer, or
futures commission merchant in its home jurisdiction;
(ii) The counterparty holds, directly or indirectly, a majority
ownership interest in the direct participant, or the direct
participant, directly or indirectly, holds a majority ownership
interest in the counterparty, or a third party, directly or indirectly,
holds a majority ownership interest in both the direct participant and
the counterparty; and
(iii) The counterparty, direct participant, or third party
referenced in paragraph (ii) of this definition as holding the majority
ownership interest would be required to report its financial statements
on a consolidated basis under U.S. Generally Accepted Accounting
Principles or International Financial Reporting Standards, and such
consolidated financial statements include the financial results of the
majority-owned party or of both majority-owned parties.
* * * * *
Central bank means a reserve bank or monetary authority of a
central government (including the Board of Governors of the Federal
Reserve System or any of the Federal Reserve Banks) and the Bank for
International Settlements.
* * * * *
Eligible secondary market transaction refers to a secondary market
transaction in U.S. Treasury securities of a type accepted for clearing
by a registered covered clearing agency that is:
(i) A repurchase or reverse repurchase agreement collateralized by
U.S. Treasury securities, in which one of the counterparties is a
direct participant; or
(ii) A purchase or sale, between a direct participant and:
(A) Any counterparty, if the direct participant of the covered
clearing agency brings together multiple buyers and sellers using a
trading facility (such as a limit order book) and is a counterparty to
both the buyer and seller in two separate transactions; or
(B) Registered broker-dealer, government securities broker, or
government securities dealer; except that:
(iii) Any purchase or sale transaction in U.S. Treasury securities
or repurchase or reverse repurchase agreement collateralized by U.S.
Treasury securities in which one counterparty is a central bank, a
sovereign entity, an international financial institution, or a natural
person shall be excluded from the definition set forth in this section
of an eligible secondary market transaction;
(iv) Any repurchase or reverse repurchase agreement collateralized
by U.S. Treasury securities in which one counterparty is a covered
clearing agency providing central counterparty services or a
derivatives clearing organization (see 7 U.S.C. 7a-1 and 17 CFR 39.3),
or is regulated as a central counterparty in its home jurisdiction,
shall be excluded from the definition set forth in this section of an
eligible secondary market transaction;
(v) Any repurchase or reverse repurchase agreement collateralized
by U.S. Treasury securities in which one counterparty is a state or
local government shall be excluded from the definition set forth in
this section of an eligible secondary market transaction;
(vi) Any repurchase or reverse repurchase agreement collateralized
by U.S. Treasury securities entered into between a direct participant
and an affiliated counterparty shall be excluded from the definition
set forth in this section of an eligible secondary market transaction,
provided that the affiliated counterparty submit for clearance and
settlement all other repurchase or reverse repurchase agreements
collateralized by U.S. Treasury securities to which the affiliate is a
party.
* * * * *
International financial institution means the African Development
Bank; African Development Fund; Asian Development Bank; Banco
Centroamericano de Integraci[oacute]n Econ[oacute]mica; Bank for
Economic Cooperation and Development in the Middle East and North
Africa; Caribbean Development Bank; Corporaci[oacute]n Andina de
Fomento; Council of Europe Development Bank; European Bank for
Reconstruction and Development; European Investment Bank; European
Investment Fund; European Stability Mechanism; Inter-American
Development Bank; Inter-American Investment Corporation; International
Bank for Reconstruction and Development; International Development
Association; International Finance Corporation; International Monetary
Fund; Islamic Development Bank; Multilateral Investment Guarantee
Agency; Nordic Investment Bank; North American Development Bank; and
any other entity that provides financing for national or regional
development in which the U.S. Government is a shareholder or
contributing member.
* * * * *
Sovereign entity means a central government (including the U.S.
Government), or an agency, department, or ministry of a central
government.
* * * * *

[[Page 2830]]

State or local government means a state or any political
subdivision thereof, or an agency or instrumentality of a State or any
political subdivision thereof, but shall not include any pension or
retirement plan established and maintained by a State, its political
subdivisions, or any agency or instrumentality of a State or its
political subdivisions, for the benefit of its employees.
* * * * *
U.S. Treasury security means any security issued by the U.S.
Department of the Treasury.
* * * * *
(e) * * *
(6) * * *
(i) Considers, and produces margin levels commensurate with, the
risks and particular attributes of each relevant product, portfolio,
and market, and, if the covered clearing agency provides central
counterparty services for U.S. Treasury securities, calculates,
collects, and holds margin amounts from a direct participant for its
proprietary positions in Treasury securities separately and
independently from margin calculated and collected from that direct
participant in connection with U.S. Treasury securities transactions by
an indirect participant that relies on the services provided by the
direct participant to access the covered clearing agency's payment,
clearing, or settlement facilities;
* * * * *
(18) Establish objective, risk-based, and publicly disclosed
criteria for participation, which:
(i) Permit fair and open access by direct and, where relevant,
indirect participants and other financial market utilities;
(ii) Require participants to have sufficient financial resources
and robust operational capacity to meet obligations arising from
participation in the clearing agency;
(iii) Monitor compliance with such participation requirements on an
ongoing basis; and
(iv) When the covered clearing agency provides central counterparty
services for transactions in U.S. Treasury securities,
(A) Require that any direct participant of such covered clearing
agency submit for clearance and settlement all of the eligible
secondary market transactions to which such direct participant is a
counterparty;
(B) Identify and monitor its direct participants' submission of
transactions for clearing as required in paragraph (e)(18)(iv)(A) of
this section, including how the covered clearing agency would address a
failure to submit transactions in accordance with paragraph
(e)(18)(iv)(A) of this section; and
(C) Ensure that it has appropriate means to facilitate access to
clearance and settlement services of all eligible secondary market
transactions in U.S. Treasury securities, including those of indirect
participants, which policies and procedures the board of directors of
such covered clearing agency reviews annually.
* * * * *

By the Commission.

Dated: December 13, 2023.
J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2023-27860 Filed 1-12-24; 8:45 am]
BILLING CODE 8011-01-P

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.