Notice2021-17075
Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of Filing of Advance Notice to Establish the Securities Financing Transaction Clearing Service and Make Other Changes
Primary source
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Published
August 12, 2021
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 86 Issue 153 (Thursday, August 12, 2021)</title>
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[Federal Register Volume 86, Number 153 (Thursday, August 12, 2021)]
[Notices]
[Pages 44530-44571]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2021-17075]
[[Page 44529]]
Vol. 86
Thursday,
No. 153
August 12, 2021
Part III
Securities and Exchange Commission
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Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Filing of Advance Notice To Establish the
Securities Financing Transaction Clearing Service and Make Other
Changes; Notice
Federal Register / Vol. 86 , No. 153 / Thursday, August 12, 2021 /
Notices
[[Page 44530]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-92568; File No. SR-NSCC-2021-803]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Filing of Advance Notice to Establish the
Securities Financing Transaction Clearing Service and Make Other
Changes
August 5, 2021.
Pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act entitled the Payment,
Clearing, and Settlement Supervision Act of 2010 (``Clearing
Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the Securities
Exchange Act of 1934 (``Act''),\2\ notice is hereby given that on July
22, 2021, National Securities Clearing Corporation (``NSCC'') filed
with the Securities and Exchange Commission (``Commission'') the
advance notice as described in Items I, II and III below, which Items
have been prepared by the clearing agency.\3\ The Commission is
publishing this notice to solicit comments on the advance notice from
interested persons.
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\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(1)(i).
\3\ NSCC filed this advance notice as a proposed rule change
(SR-NSCC-2021-010) with the Commission pursuant to Section 19(b)(1)
of the Act, 15 U.S.C. 78s(b)(1), and Rule 19b-4 thereunder, 17 CFR
240.19b-4. A copy of the proposed rule change is available at <a href="http://www.dtcc.com/legal/sec-rule-filings.aspx">http://www.dtcc.com/legal/sec-rule-filings.aspx</a>.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance
Notice
This advance notice consists of proposed modifications to the NSCC
Rules & Procedures (``Rules'') \4\ that would (i) establish new
membership categories and requirements for sponsoring members and
sponsored members whereby existing Members would be permitted to
sponsor certain institutional firms into membership, (ii) establish a
new membership category and requirements for agent clearing members
whereby existing Members would be permitted to submit, on behalf of
their customers, transactions to NSCC for novation, (iii) establish the
securities financing transaction clearing service (``Securities
Financing Transaction Clearing Service'' or ``SFT Clearing Service'')
to make central clearing available at NSCC for equity securities
financing transactions, which are, broadly speaking, transactions where
the parties exchange equity securities against cash and simultaneously
agree to exchange the same securities and cash, plus or minus a rate
payment, on a future date (collectively, ``Securities Financing
Transactions'' or ``SFTs''), and (iv) make other amendments and
clarifications to the Rules, as described in greater detail below.
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\4\ Capitalized terms not defined herein are defined in the
Rules, available at http://www.dtcc.com/~/media/Files/Downloads/
legal/rules/nscc_rules.pdf.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Advance Notice
In its filing with the Commission, the clearing agency included
statements concerning the purpose of and basis for the Advance Notice
and discussed any comments it received on the Advance Notice. The text
of these statements may be examined at the places specified in Item IV
below. The clearing agency has prepared summaries, set forth in
sections A and B below, of the most significant aspects of such
statements.
(A) Clearing Agency's Statement on Comments on the Advance Notice
Received From Members, Participants, or Others
NSCC reviewed the proposal with various Members and market
participants (e.g., agent lenders, brokers, matching service providers,
and books and records service providers) in order to benefit from their
expertise and industry knowledge. Written comments relating to this
proposal have not been received from Members or any other person. If
any written comments are received, they will be publicly filed as an
Exhibit 2 to this filing, as required by Form 19b-4 and the General
Instructions thereto.
Persons submitting comments are cautioned that, according to
Section IV (Solicitation of Comments) of the Exhibit 1A in the General
Instructions to Form 19b-4, the Commission does not edit personal
identifying information from comment submissions. Commenters should
submit only information that they wish to make available publicly,
including their name, email address, and any other identifying
information.
All prospective commenters should follow the Commission's
instructions on how to submit comments, available at <a href="https://www.sec.gov/regulatory-actions/how-to-submit-comments">https://www.sec.gov/regulatory-actions/how-to-submit-comments</a>. General
questions regarding the rule filing process or logistical questions
regarding this filing should be directed to the Main Office of the
Commission's Division of Trading and Markets at
<a href="/cdn-cgi/l/email-protection#deaaacbfbab7b0b9bfb0bab3bfacb5bbaaad9eadbbbdf0b9b1a8"><span class="__cf_email__" data-cfemail="90e4e2f1f4f9fef7f1fef4fdf1e2fbf5e4e3d0e3f5f3bef7ffe6">[email protected]</span></a> or 202-551-5777.
NSCC reserves the right not to respond to any comments received.
(B) Advance Notice Filed Pursuant to Section 806(e) of the Clearing
Supervision Act
Nature of the Proposed Change
The purpose of this proposed rule change is to (i) establish new
membership categories and requirements for sponsoring members and
sponsored members whereby existing Members would be permitted to
sponsor certain institutional firms into membership, (ii) establish a
new membership category and requirements for agent clearing members
whereby existing Members would be permitted to submit, on behalf of
their customers, transactions to NSCC for novation, (iii) establish the
SFT Clearing Service to make central clearing available at NSCC for
SFTs, and (iv) make other amendments and clarifications to the Rules,
as described in greater detail below.
(i) Background
NSCC is proposing to introduce central clearing for SFTs, which
are, broadly speaking, securities lending transactions where parties
exchange equity securities against cash and simultaneously agree to
exchange the same securities and cash, plus or minus a rate payment, on
a future date. In particular, the proposed SFT Clearing Service would
expand central clearing at NSCC to include SFTs with a one Business Day
term (i.e., overnight SFTs) in eligible equity securities that are
entered into by Members, institutional firms that are sponsored into
NSCC by a Sponsoring Member (as defined below and in the proposed rule
change), or Agent Clearing Members (as defined below and in the
proposed rule change) on behalf of Customers (as defined below and in
the proposed rule change), as applicable.
SFTs involve the owner of securities (typically a registered
investment company, pension plan, sovereign wealth fund or other
institutional firm) transferring those securities temporarily to a
borrower (typically a hedge fund). SFTs are often facilitated and
intermediated by broker-dealers and agent lenders (i.e., custodial
banks or other institutions that lend out securities as agent on behalf
of institutional firms). In return for the lent securities, the
borrower transfers collateral, and a net rate payment is typically
transferred to either the lender or the borrower that reflects the
liquidity of the lent securities, as well as interest on any cash
collateral.\5\ NSCC
[[Page 44531]]
understands that SFTs provide liquidity to markets and facilitates the
ability of market participants to make delivery on short-sales, and
thereby avoid failures to deliver, ``naked'' shorts, and similar
situations. On a typical Business Day, The Depository Trust Company
(``DTC''), an NSCC affiliate, processes deliver orders related to
securities lending transactions on securities having a value of
approximately $150 billion.
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\5\ This rate payment is typically calculated in a manner
similar to interest on the principal balance of a loan and accrues
on a daily basis. As a result, the rate payment is typically
calculated as the product of a specified balance (typically the
amount of cash collateral unless the collateral consists of
securities) and a specified rate (reflecting both the liquidity of
the securities and the ability of the lender to re-use the cash
collateral), divided by 360 or a similar day count fraction.
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Capital Efficiency Opportunities
The Basel III \6\ capital and leverage requirements, as implemented
by the U.S. banking regulators, constrain the ability of agent lenders
and brokers to intermediate and facilitate SFTs.\7\ NSCC believes
central clearing of SFTs would be able to address these constraints,
which may otherwise impair market participants' ability to engage in
SFTs.
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\6\ Basel III is an internationally agreed set of measures
developed by the Basel Committee on Banking Supervision in response
to the financial crisis of 2007-2009.
\7\ See, e.g., 12 CFR part 3 (Office of the Comptroller of the
Currency--Capital Adequacy Standards); 12 CFR part 217 (Federal
Reserve--Capital Adequacy of Bank Holding Companies, Savings and
Loan Holding Companies, and State Member Banks); 12 CFR part 252,
subpart Q (Single Counterparty Credit Limits); 12 CFR part 324
(Federal Deposit Insurance Corporation--Capital Adequacy of FDIC-
Supervised Institutions).
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For example, NSCC believes it is uniquely positioned to create
balance sheet netting opportunities for market participants (i.e., the
ability to offset cash payables and receivables versus NSCC) by
becoming the legal counterparty to both pre-novation counterparties to
an SFT through novation. Specifically, market participants that borrow
securities through NSCC and then onward lend those securities, or other
securities, to another NSCC Member through the proposed SFT Clearing
Service may have the ability to net down the cash collateral return
obligations and entitlements related to such SFTs. By contrast, for
bilateral SFTs, market participants may be required to record those
payables and receivables on their balance sheets on a gross (rather
than netted) basis. A netted balance sheet can create significant
capital benefits for market participants because it can reduce the
amount of regulatory capital they must hold against SFTs under the U.S.
``supplementary leverage ratio'' and other capital requirements that
favor a netted balance sheet.\8\
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\8\ See 12 CFR 217.10(c)(4)(ii)(E)-(F).
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In addition, under Basel III, bank holding companies that have
broker-dealer subsidiary borrowers are required to reserve capital
against their exposures to institutional firm lenders of securities in
relation to the cash collateral posted by such borrowers. Those capital
requirements can vary depending on the credit profile of the
institutional firm lender, and generally are well in excess of those
applied to exposures to qualifying central counterparties, such as
NSCC.\9\ The counterparty risk weight of a qualifying central
counterparty, like NSCC, is 2%,\10\ which may result in considerable
capital savings to these bank holding companies, to the extent they
participate in central clearing.
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\9\ See 12 CFR 217.32 and 217.37 generally.
\10\ See 12 CFR 217.35(c)(3).
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Moreover, agent lending banks and bank holding company parents of
broker-dealer borrowers that participate in central clearing could
receive beneficial treatment under the single counterparty credit
limits, which exempt exposures to qualifying central
counterparties.\11\
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\11\ See 12 CFR 252.77(a)(3).
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In light of the potential for central clearing to alleviate the
aforementioned capital constraints otherwise applicable to bilateral
SFTs, NSCC believes that central clearing of SFTs may increase the
capacity of market participants to engage in SFTs.\12\
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\12\ Members should discuss this matter with their accounting
and regulatory capital experts.
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Fire Sale Risk Mitigation
In addition to creating capital efficiency opportunities for market
participants, NSCC believes that broadening the scope of central
clearing at NSCC to SFTs would also reduce the potential for market
disruption from fire sales.
In the case of securities lending transactions, the primary risk of
fire sales \13\ relates to the reinvestment of cash collateral by
institutional firms that are the lenders in securities lending
transactions. Those institutional firms will typically reinvest the
cash collateral they receive from the borrower into other securities.
If the borrower of the securities thereafter defaults, the
institutional firm lenders generally need to quickly liquidate the
securities representing the reinvestment in order to raise cash to
purchase the originally lent security. A substantial number of
disconnected and competing liquidations by multiple lenders can create
fire sale conditions for the securities being liquidated, which can
harm not only the institutional firm lenders by potentially lowering
the amount of cash they can raise in the sale of such securities, but
also create market losses for all holders of such securities.\14\
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\13\ Fire sale risk is the risk of rapid sales of assets in
large amounts that temporarily depress market prices of such assets
and create financial instability.
\14\ See Financial Stability Board, Strengthening Oversight and
Regulation of Shadow Banking: Policy Framework for Addressing Shadow
Banking Risks in Securities Lending and Repos, at 5 (August 29,
2013) available at <a href="https://www.fsb.org/wp-content/uploads/r_130829b.pdf?page_moved=1">https://www.fsb.org/wp-content/uploads/r_130829b.pdf?page_moved=1</a>. See also United States Securities and
Exchange Commission: Securities Lending and Short Sale Roundtable
Transcript (September 29, 2009), Former Chairman Schapiro's Remarks,
at 2-3, available at <a href="https://www.sec.gov/news/openmeetings/2009/roundtable-transcript-092909.pdf">https://www.sec.gov/news/openmeetings/2009/roundtable-transcript-092909.pdf</a>.
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Moreover, if an institutional firm lender should default and fail
to return the cash collateral back to its borrowers, the borrowers
would typically be looking to liquidate the borrowed securities in
order to make themselves whole for the cash collateral they delivered
to the institutional firm lender. Competing and disconnected sales of
such securities could similarly create fire sale conditions and not
only harm the borrowers to the extent the value of the securities
decline, but also create market losses for all holders of the borrowed
securities.
NSCC believes that broadening the scope of central clearing at NSCC
to SFTs would reduce the potential for market disruption from fire
sales for a number of reasons. First, in the event of a default, NSCC
would conduct a centralized, orderly liquidation of the defaulter's SFT
Positions (as defined below and in the proposed rule change). Such an
organized liquidation should result in substantially less price
depreciation and market disruption than multiple independent non-
defaulting parties racing against one another to liquidate the
positions. Second, NSCC would only need to liquidate the defaulter's
net positions. By contrast, in the context of a default by a broker-
dealer intermediary that runs a matched book in the bilateral
securities market, both the ultimate lender and the ultimate borrower
need to liquidate the defaulter's gross positions. Limiting the
positions that need to be liquidated to the defaulter's net positions
should reduce the volume of required sales activity, which in turn
should limit the price and market impact of the close-out of the
defaulter's positions. Lastly, NSCC would use its risk management
resources to provide confidence to market participants that they will
receive back their cash or securities, as
[[Page 44532]]
applicable, which should limit the propensity for market participants
to seek to unwind their transactions in a stressed market scenario.
Liquidity Drain Risk Mitigation
Liquidity risk may also arise if, in the context of a stressed
market scenario, borrowers or lenders concerned about their
counterparties' creditworthiness seek to unwind their securities
lending transactions and obtain the return of their cash collateral or
securities. This occurred to a certain extent in 2008, when borrowers
began demanding to return borrowed securities in exchange for the cash
collateral the borrowers had posted to institutional firm lenders.\15\
These ``runs'' may require institutional firm lenders to quickly sell
off securities that are the subject of their cash reinvestments to
raise cash to return to the borrowers, thereby also creating potential
fire sale conditions with respect to the reinvestment securities, as
described above. Similarly, borrowers may need to purchase or re-borrow
securities in stressed market conditions, leading to potentially
significant losses.
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\15\ See, e.g., id.
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NSCC believes that having SFTs be centrally cleared by NSCC would
lower the risk of a liquidity drain in a stress scenario. Specifically,
NSCC believes that having it clear SFT activity would provide
confidence to borrowers and lenders that they will receive back their
cash or securities and thereby lessen parties' inclination to rush to
unwind their transactions in a stressed market scenario.
Addition of New Membership Categories for Institutional Firm SFT
Activity
When evaluating the opportunity to expand its cleared offerings to
SFTs, NSCC engaged in extensive discussions with numerous market
participants, including agent lenders, brokers, institutional firms,
and critical third parties, such as matching service providers and
books and records service providers. NSCC also organized several
industry working groups to discuss the possibility of clearing SFTs.
Each constituency has a unique perspective on the proposed SFT Clearing
Service. By capturing their differing viewpoints in the design, NSCC
has sought to ensure that the proposed SFT Clearing Service would
reflect their needs and facilitate industry adoption of the proposed
SFT Clearing Service.
There was a considerable amount of discussion between NSCC and
market participants regarding the appropriate model(s) through which
institutional firms should access central clearing. Some market
participants expressed interest in allowing Members to sponsor
institutional firms into NSCC membership in a manner similar to that
provided for under the sponsoring member/sponsored member program at
the Government Securities Division (``GSD'') of Fixed Income Clearing
Corporation (``FICC''), an NSCC affiliate (``FICC's Sponsoring Member/
Sponsored Member Program'').\16\ Under FICC's Sponsoring Member/
Sponsored Member Program, sponsoring members may submit to FICC
transactions entered into on a principal-to-principal basis between the
sponsoring member and the sponsored member.\17\ On the other hand,
certain other market participants, including in particular certain
agent lending banks, requested that the central clearing service
accommodate agent-style trading (i.e., where the agent lender enters
into the transaction on behalf of the institutional firm, rather than
as principal counterparty). As NSCC understands it, agent-style trading
is the way such agent lenders are typically approved to transact in
securities lending transactions on behalf of their institutional firm
clients today.\18\
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\16\ See Rule 3A (Sponsoring Members and Sponsored Members) of
the FICC GSD Rulebook (``GSD Rules''), available at http://dtcc.com/
~media/Files/Downloads/legal/rules/ficc_gov_rules.pdf.
\17\ FICC's Sponsoring Member/Sponsored Member Program also
allows sponsoring members to submit to FICC transactions entered
into between a sponsored member and a third-party netting member.
However, based on feedback from market participants, NSCC has
decided to address this type of trading via the proposed agent
clearing model for SFT.
\18\ In addition, certain other agent lenders who are not
themselves banks or broker-dealers (and so are not eligible to
become Members of NSCC) preferred a model where the institutional
firm client becomes the direct member of NSCC with no obligations
running between the agent lender and the clearing agency.
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NSCC considered all of this input, as well as the recent
experiences of FICC in expanding the suite of both transactions and
participants eligible for FICC's Sponsoring Member/Sponsored Member
Program,\19\ and ultimately decided to incorporate both the sponsoring/
sponsored membership type (to facilitate principal style trading for
institutional firms and their sponsoring members) as well as the Agent
Clearing Member membership type (to facilitate agent-style trading by
agent lenders on behalf of institutional firm clients) into the
proposed SFT Clearing Service.\20\ NSCC expects these proposed new
membership types would help expand access to central clearing for
institutional firms and facilitate industry adoption of the proposed
SFT Clearing Service.
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\19\ See Securities Exchange Act Release Nos. 80563 (May 1,
2017), 82 FR 21284 (May 5, 2017) (SR-FICC-2017-003) (Expand the
types of entities that are eligible to participate in FICC as
Sponsored Members), 85470 (March 29, 2019), 84 FR 13328 (April 4,
2019) (SR-FICC-2018-013) (Expand Sponsoring Member Eligibility in
the GSD Rulebook), and 88262 (February 21, 2020), 85 FR 11401
(February 27, 2020) (SR-FICC-2019-007) (Close-Out and Funds-Only
Settlement Processes Associated with the Sponsoring Member/Sponsored
Member Service).
\20\ NSCC decided at this time not to incorporate a direct model
for institutional firm clearing into the proposed SFT Clearing
Service because in its experience with a similar model in FICC (the
CCIT Service), the requirements that a clearing agency, such as
NSCC, would be required to apply to an institutional firm that
participated as a direct member (e.g., Clearing Fund and loss
allocation) would, as a general matter, not likely be compatible
with the regulatory requirements and investment guidelines
applicable to many of the regulated institutional firms that NSCC
anticipates would be interested in participating in the proposed SFT
Clearing Service.
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The proposed SFT Clearing Service would also allow for the
submission of broker-to-broker activity as well as client-to-client
activity (credit intermediated by Sponsoring Members and/or Agent
Clearing Members) into the NSCC system.
(ii) Key Parameters of the Proposed SFT Clearing Service
Overnight SFTs
NSCC is proposing central clearing for SFTs with a one Business Day
term (i.e., overnight SFTs) in eligible equity securities that are
entered into by Members, institutional firms that are sponsored into
NSCC by Sponsoring Members, or Agent Clearing Members on behalf of
customers. NSCC has determined that overnight term SFTs with a daily
pair off option are more appropriate for the proposed SFT Clearing
Service than open transactions with mark-to-market collections. This is
because, as NSCC understands it, open transactions are not eligible for
balance sheet netting given they do not have a scheduled off-leg/
settlement date. As described above, the proposed SFT Clearing Service
is designed to offer both balance sheet netting and capital efficiency
opportunities to market participants. NSCC therefore finds it
appropriate to make overnight term SFTs with a scheduled date for Final
Settlement (as defined below and in the proposed rule change) of the
next Business Day, rather than open transactions, eligible for central
clearing through the proposed SFT Clearing Service.
For example, assume that a Transferor (as defined below and in the
proposed rule change) and Transferee (as defined below and in the
proposed rule change)
[[Page 44533]]
enter into an SFT pursuant to which: (i) In the Initial Settlement (as
defined below and in the proposed rule change) on Monday, the
Transferor will transfer 100 shares of security X to the Transferee
against $100 per share; and (ii) in the Final Settlement on Tuesday,
the Transferee will transfer 100 shares of security X to the Transferor
against $100 per share. After the Initial Settlement occurs on Monday,
the Final Settlement of the SFT is novated to NSCC. In the Final
Settlement on Tuesday, the Transferee will return 100 shares of
security X to the Transferor for $100 per share. The Rate Payment (as
defined below and in the proposed rule change) would be passed by NSCC
as between the Transferor and Transferee on Tuesday as part of NSCC's
end-of-day final money settlement process.
SFT Counterparties
The proposed SFT Clearing Service would only be available for SFTs
entered into between (i) a Member and another Member, (ii) a Sponsoring
Member and its Sponsored Member (as defined below and in the proposed
rule change), and (iii) an Agent Clearing Member acting on behalf of a
Customer and either (x) a Member or (y) the same or another Agent
Clearing Member acting on behalf of a Customer. As used in the Rules,
``Member'' includes full-service NSCC clearing members, but not
Sponsored Members.\21\ In addition, as proposed, the only SFTs entered
into by Sponsored Members that would be eligible for novation to NSCC
would be SFTs between the Sponsored Member and its Sponsoring
Member.\22\
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\21\ As defined in Rule 1 (Definitions and Descriptions), the
term ``Member'' means any Person specified in Section 2.(i) of Rule
2 who has qualified pursuant to the provisions of Rule 2A. As such,
the term ``Member'' does not include a Sponsored Member. Supra note
4.
\22\ See Section 5 of proposed Rule 56, which provides that a
Sponsoring Member shall be permitted to submit to NSCC SFTs between
itself and its Sponsored Members.
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Approved SFT Submitters
Consistent with the manner in which NSCC accepts cash market
transactions, SFTs would be required to be submitted to NSCC on a
locked-in/matched basis by an Approved SFT Submitter (as defined below
and in the proposed rule change) in accordance with the communication
links, formats, timeframes and deadlines established by NSCC for such
purpose. Approved SFT Submitters would be selected by the SFT Members
(as defined below and in the proposed rule change), subject to NSCC's
approval. An Approved SFT Submitter could either be a Member or a
third-party vendor. SFTs submitted to NSCC by an Approved SFT Submitter
would be valid and binding obligations of each SFT Member designated by
the Approved SFT Submitter as a party thereto.
Eligible Equity Securities and Per Share Price Minimum
NSCC will maintain eligibility criteria for the securities that may
underlie an SFT that NSCC will accept for novation. Consistent with
NSCC's general approach to eligibility for securities, the eligibility
criteria would not be a rule, but a separate document maintained by
NSCC and available to Members. It is currently contemplated that
eligible securities for SFTs in the proposed SFT Clearing Service will
be limited to CNS-eligible securities.
In light of the fact that central clearing of SFTs would be a new
service for NSCC, and market participants would be able to elect which
of their eligible SFTs to novate to NSCC (i.e., central clearing of
SFTs would not be mandatory for Members), NSCC is not able to
anticipate at this time the size and composition of the SFT portfolios
that would be novated to NSCC. Due to this lack of history, NSCC would,
as an initial matter, provide proposed SFT Clearing Service for only
those SFTs where the underlying securities are CNS-eligible equity
securities that have a per share price of $5 or more. NSCC selected $5
as the per share price minimum for underlying equity securities that
could be the subject of a novated SFT because $5 is a common share
price minimum adopted in brokerage margin eligibility schedules.
This proposed share price limitation would be implemented
systemically by NSCC as one of the eligibility criteria for determining
whether an equity security is eligible to be the subject of a novated
SFT (rather than as a rule), and such per share price limitation could
be modified by NSCC \23\ at a later date after NSCC gains more
experience with the nature of the SFT portfolios submitted for
clearing. In addition, if the share price of underlying securities of
an SFT that has already been novated to NSCC falls below $5, such SFT
would continue to be novated to NSCC, but the Required SFT Deposit (as
defined below and in the proposed rule change) for the affected Members
would include an amount equal to 100% of the market value of such
underlying securities until such time as the per share price of the
underlying securities equals or exceeds $5.
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\23\ The per share price limitation could be modified by NSCC
without any regulatory filings; however, any change in the per share
price limitation would be announced by NSCC via an Important Notice
posted to its website.
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Cash Collateral
Consistent with the cash market transactions NSCC clears today
where cash is used to satisfy Members' purchase obligations in eligible
securities, cash would likewise be the only eligible form of collateral
for novated SFTs under the proposed SFT Clearing Service.\24\ More
specifically, NSCC would limit the SFTs that it is willing to novate to
SFTs that have SFT Cash (as defined below and in the proposed rule
change) equal to or greater than 100% market value of the lent
securities, and would not novate any obligations to return collateral
consisting of securities.\25\
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\24\ This is referred to as ``SFT Cash'' in the proposed rule
text.
\25\ See Section 5(a) of proposed Rule 56 and the definition of
``Securities Financing Transaction''.
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NSCC would novate the Final Settlement obligations of an SFT as of
the time the Initial Settlement of such SFT is completed, unless the
SFT is a Bilaterally Initiated SFT (as defined below and in the
proposed rule change) or a Sponsored Member Transaction (as defined
below and in the proposed rule change), in which case novation of the
Final Settlement obligations would occur upon NSCC reporting to the
Approved SFT Submitter that the SFT has been validated and novated to
NSCC.
As described above, each SFT would be collateralized by cash equal
to no less than 100% of the market value of the lent securities. In
addition, in order to address regulatory and investment guideline
requirements applicable to certain institutional firms,\26\ a Member
would be permitted (but not required) to transfer an additional cash
haircut above 100% (e.g., 102%) to such institutional firms, i.e.,
Independent Amount SFT Cash (as defined below and in the proposed rule
change), as part of the Initial Settlement of the SFT. The Sponsoring
Member or Agent Clearing Member, as applicable, that receives the
Independent Amount SFT Cash in the Initial Settlement would also
receive a commensurate Clearing Fund call, i.e., an Independent Amount
SFT Cash Deposit Requirement (as
[[Page 44534]]
defined below and in the proposed rule change), from NSCC to reflect
the value received by such Member above the market price of the equity
security lent. NSCC's novation of Final Settlement obligations related
to Independent Amount SFT Cash would be tied to the time the Sponsoring
Member or Agent Clearing Member, as applicable, satisfies the related
Independent Amount SFT Cash Deposit Requirement in cash.
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\26\ As an example, a registered investment company that lends
securities through an agent may be required under Section 17(f) of
the Investment Company Act of 1940 and Rule 17f-2 thereunder to
collect cash collateral equal to no less than 102% of the market
value of the lent securities. See, e.g., The Adams Express Company,
SEC No-Action Letter (Oct. 8, 1984). Other institutional firms may
be subject to similar requirements under their established
investment guidelines or applicable rules, regulations or guidance.
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RVP/DVP Settlement at DTC
The Final Settlement obligations of each SFT, other than a
Sponsored Member Transaction, that is novated to NSCC would settle
receive-versus-payment/delivery-versus-payment (``RVP/DVP'') at
DTC.\27\ SFT deliver orders would be processed in accordance with DTC's
rules and procedures, including provisions relating to risk controls.
DTC would accept delivery instructions for an SFT from NSCC, as agent
for DTC participants that are SFT Members.\28\
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\27\ As described below, the Final Settlement and other
obligations of each Sponsored Member Transaction would, at the
direction of NSCC, settle on the books and records of the relevant
Sponsoring Member.
\28\ On July 22, 2021, DTC submitted a proposed rule change to
provide DTC participants that are also NSCC Members with settlement
services in connection with NSCC's proposed SFT Clearing Service.
See SR-DTC-2021-014, which was filed with the Commission but has not
yet been published in the Federal Register. A copy of this proposed
rule change is available at <a href="http://www.dtcc.com/legal/sec-rule-filings.aspx">http://www.dtcc.com/legal/sec-rule-filings.aspx</a>.
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Pre-novation counterparties to an SFT that is due to settle may
elect to pair off (i.e., offset) the Final Settlement obligations of
such SFT against the Initial Settlement obligations of a new SFT
between the same parties on the same securities. NSCC believes that
such offsets would minimize the operational burden of settling
overnight obligations. NSCC would calculate and process the difference
in cash collateral between the paired off SFTs, i.e., Price
Differential (as defined below and in the proposed rule change). Price
Differential would also be processed in accordance with DTC rules and
procedures, including provisions relating to risk controls. DTC would
accept Price Differential payment orders for an SFT from NSCC, as agent
for DTC participants that are SFT Members.
Settlement of the Rate Payment obligations and payment obligations
arising from certain mandatory corporate actions and cash dividends
would be processed as part of NSCC's end-of-day final money settlement
process.
As an example of an SFT with a full pair off (i.e., offset), assume
that a Transferor and Transferee enter into an SFT pursuant to which:
(i) In the Initial Settlement on Monday, the Transferor will transfer
100 shares of security X to the Transferee against $100 per share; and
(ii) in the Final Settlement on Tuesday, the Transferee will transfer
100 shares of security X to the Transferor against $100 per share.
After the Initial Settlement occurs on Monday, the Final Settlement of
the SFT is novated to NSCC. At the end of day on Monday, the share
price of security X is $99 per share. On Tuesday, the Approved SFT
Submitter, on behalf of the Transferor and the Transferee, instructs
NSCC to pair off the parties' Final Settlement obligations on the
Settling SFT (as defined below and in the proposed rule change) with a
Linked SFT (as defined below and in the proposed rule change) pursuant
to which (i) in the Initial Settlement on Tuesday, the Transferor will
transfer 100 shares of security X to the Transferee against $99 per
share; and (ii) in the Final Settlement on Wednesday, the Transferee
will transfer 100 shares of security X to the Transferor against $99
per share. NSCC would, on Tuesday, collect $1 per share in Price
Differential from the Transferor and pay $1 per share in Price
Differential to the Transferee in connection with the pair off. In
addition, the Rate Payment for the Settling SFT would be passed by NSCC
as between the Transferor and Transferee on Tuesday as part of NSCC's
end-of-day final money settlement process. In the Final Settlement on
Wednesday, the Transferee will return 100 shares of security X to the
Transferor for $99 per share. The Rate Payment for the Linked SFT would
be passed by NSCC as between the Transferor and Transferee on Wednesday
as part of NSCC's end-of-day final money settlement process.
As an example of an SFT with a partial pair off (i.e., offset),
assume that a Transferor and Transferee enter into an SFT pursuant to
which: (i) in the Initial Settlement on Monday, the Transferor will
transfer 100 shares of security X to the Transferee against $100 per
share; and (ii) in the Final Settlement on Tuesday, the Transferee will
transfer 100 shares of security X to the Transferor against $100 per
share. After the Initial Settlement occurs on Monday, the Final
Settlement of the SFT is novated to NSCC. At the end of day on Monday,
the share price of security X is $99 per share. On Tuesday, the
Approved SFT Submitter, on behalf of the Transferor and the Transferee,
instructs NSCC to partially pair off the parties' Final Settlement
obligations on the Settling SFT with a Linked SFT pursuant to which (i)
in the Initial Settlement on Tuesday, the Transferor will transfer 25
shares of security X to the Transferee against $99 per share; and (ii)
in the Final Settlement on Wednesday, the Transferee will transfer 25
shares of security X to the Transferor against $99 per share. In the
Final Settlement on Tuesday for the remaining Settling SFT, the
Transferee will return 75 shares of security X to the Transferor for
$100 per share. NSCC would, on Tuesday, collect $1 per share in Price
Differential from the Transferor and pay $1 per share in Price
Differential to the Transferee in relation to the shares subject to
pair off (i.e., 25 shares of security X). In addition, the Rate Payment
for the Settling SFT (i.e., 100 shares of security X) would be passed
by NSCC as between the Transferor and Transferee on Tuesday as part of
NSCC's end-of-day final money settlement process. In the Final
Settlement on Wednesday for the Linked SFT, the Transferee will return
25 shares of security X to the Transferor for $99 per share. The Rate
Payment on the Linked SFT (i.e., 25 shares of security X) would be
passed by NSCC as between the Transferor and Transferee on Wednesday as
part of NSCC's end-of-day final money settlement process.
Buy-In, Recall and Accelerated Settlement
It is occasionally the case in the securities lending market that a
borrower is solvent and able to satisfy its general obligations as they
become due but unable to deliver the lent securities to the lender
within the timeline requested by the lender. The contractual remedy
that has developed in the bilateral securities lending market for these
situations is a ``buy-in.'' Under this remedy, the lender may purchase
securities equivalent to the borrowed securities in the market and
charge the borrower for the cost of this purchase. This serves to
benefit the lender because it allows the lender to recover the
securities within its required timeline, and it benefits the borrower
by avoiding a situation in which the borrower's failure to perform
under a single transaction results in an event of default and close-out
of all of its securities lending transactions (and potentially other
positions through a cross-default). Similarly, in the bilateral space,
securities borrowers may have the need to accelerate settlement of
securities lending transactions if they lose a ``permitted purpose''
for such loans under Regulation T. The proposed SFT Clearing Service
would seek to retain the buy-in and acceleration
[[Page 44535]]
mechanisms, as they ensure the smooth functioning of securities markets
without causing unnecessary and disorderly defaults or regulatory
violations.\29\
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\29\ NSCC does not believe retaining the buy-in and acceleration
mechanisms would undermine novation because NSCC would remain the
obligor and obligee in respect of the Final Settlement, Rate
Payment, and Distribution Payment (as defined below and in the
proposed rule change) entitlements and obligations. These mechanisms
simply affect the timing and manner in which those obligations are
discharged.
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Consistent with their rights under industry-standard documentation
for bilateral SFTs, as proposed, Transferors would have the right to
submit a Recall Notice (as defined below and in the proposed rule
change) to NSCC in respect of a novated SFT for which Final Settlement
obligations have not yet been satisfied. If the Transferee does not
return the lent securities by the Recall Date (as defined below and in
the proposed rule change) specified in such notice, and the Transferor
would be eligible to Buy-In (as defined below and in the proposed rule
change), in accordance with such timeframes and deadlines as
established by NSCC for such purpose, such securities.
For example, assume that a Transferor and Transferee enter into an
SFT pursuant to which: (i) In the Initial Settlement on Monday, the
Transferor will transfer 100 shares of security X to the Transferee
against $100 per share; and (ii) in the Final Settlement on Tuesday,
the Transferee will transfer 100 shares of security X to the Transferor
against $100 per share. After the Initial Settlement occurs on Monday,
the Final Settlement of the SFT is novated to NSCC. At the end of day
on Monday, the share price of security X is $99 per share. On Tuesday,
the Approved SFT Submitter, on behalf of the Transferor and the
Transferee, instructs NSCC to pair off (i.e., offset) the parties'
Final Settlement obligations on the Settling SFT with a Linked SFT
pursuant to which (i) in the Initial Settlement on Tuesday, the
Transferor will transfer 100 shares of security X to the Transferee
against $99 per share; and (ii) in the Final Settlement on Wednesday,
the Transferee will transfer 100 shares of security X to the Transferor
against $99 per share. NSCC would, on Tuesday, collect $1 per share in
Price Differential from the Transferor and pay $1 per share in Price
Differential to the Transferee in connection with the pair off. In
addition, the Rate Payment for the Settling SFT would be passed by NSCC
as between the Transferor and Transferee on Tuesday as part of NSCC's
end-of-day final money settlement process.
Later in the day on Tuesday, the Transferor determines it now needs
100 shares of security X back in its inventory, and so the Approved SFT
Submitter submits a Recall Notice to NSCC, prior to the deadline
established by NSCC, on behalf of the Transferor for 100 shares of
security X with a Recall Date of Thursday. At the end of day on
Tuesday, the share price of security X is $98 per share. Upon receipt
of the Recall Notice, the SFT would be treated as a Non-Returned SFT
(as defined below and in the proposed rule change) by NSCC pursuant to
Section 9(e) of proposed Rule 56 (Securities Financing Transaction
Clearing Service). Accordingly, pursuant to Section 9(a) of proposed
Rule 56, the Final Settlement Date (as defined below and in the
proposed rule change) of the SFT would be rescheduled to Thursday, and
NSCC would, on Wednesday collect $1 per share in Price Differential
from the Transferor and pay $1 per share in Price Differential to the
Transferee on the Non-Returned SFT. The Rate Payment for the Non-
Returned SFT would also be passed by NSCC as between the Transferor and
Transferee on Wednesday as part of NSCC's end-of-day final money
settlement process.
Assume further that the Transferee does not transfer the 100 shares
of security X on Wednesday and that the end of day price of security X
on Wednesday is $97 per share. On Thursday, NSCC would again collect $1
per share in Price Differential from the Transferor and pay $1 per
share in Price Differential to the Transferee on the Non-Returned SFT.
The Rate Payment for the Non-Returned SFT would also be passed by NSCC
as between the Transferor and Transferee on Thursday as part of NSCC's
end-of-day final money settlement process. In addition, since the
Recall Notice specified Thursday as the Recall Date, the Transferor
would be entitled to purchase (or deem itself to have purchased) 100
shares of security X in accordance with the provisions of Section 9(b)
of proposed Rule 56. Assuming that the Transferor paid a price of $95
per share for security X and submitted a written notice to NSCC of its
Buy-In Costs (as defined below and in the proposed rule change) on
Thursday, the Transferor would owe NSCC a Buy-In Amount (as defined
below and in the proposed rule change) of $2 per share ($100 per share
of SFT Cash received by the Transferor at the Initial Settlement of the
SFT, less the $95 per share Buy-In Costs of the Transferor, minus $3
per share Price Differential paid by the Transferor to NSCC), and such
Buy-In Amount would be debited by NSCC from the Transferor and credited
to the Transferee as part of NSCC's end-of-day final money settlement
process on Friday.
Similarly, consistent with their rights under industry-standard
documentation for bilateral SFTs, Transferees would have the right to
accelerate the scheduled Final Settlement of a novated SFT through
notice from the Approved SFT Submitter to NSCC of such accelerated
settlement.
For example, assume that a Transferor and Transferee enter into an
SFT pursuant to which: (i) In the Initial Settlement on Monday, the
Transferor will transfer 100 shares of security X to the Transferee
against $100 per share; and (ii) in the Final Settlement on Tuesday,
the Transferee will transfer 100 shares of security X to the Transferor
against $100 per share. After the Initial Settlement occurs on Monday,
the Final Settlement of the SFT is novated to NSCC. At the end of day
on Monday, the share price of security X is $99 per share. On Tuesday,
the Approved SFT Submitter, on behalf of the Transferor and the
Transferee, instructs NSCC to net the parties' Final Settlement
obligations on the Settling SFT with a Linked SFT pursuant to which (i)
in the Initial Settlement on Tuesday, the Transferor will transfer 100
shares of security X to the Transferee against $99 per share; and (ii)
in the Final Settlement on Wednesday, the Transferee will transfer 100
shares of security X to the Transferor against $99 per share. NSCC
would, on Tuesday, collect $1 per share in Price Differential from the
Transferor and pay $1 per share in Price Differential to the Transferee
in connection with the pair off. Later in the day on Tuesday, the
Transferee loses permitted purpose under Regulation T for the borrowing
of 100 shares of security X. Therefore, pursuant to Section 11 of
proposed Rule 56 (Securities Financing Transaction Clearing Service),
the Approved SFT Submitter submits a notice to NSCC on behalf of the
Transferee to accelerate the Final Settlement of the Linked SFT to
Tuesday. The Transferee then on Tuesday returns 100 shares of security
X to NSCC for $99 per share, and NSCC returns 100 shares of security X
to the Transferor for $99 per share. The Rate Payment would be passed
by NSCC for the Settling SFT as between the Transferor and Transferee
on Tuesday as part of NSCC's end-of-day final money settlement process.
[[Page 44536]]
Risk Management of SFT Positions
Under the proposal, NSCC is requiring a deposit to the Clearing
Fund \30\ for SFT Positions, i.e., Required SFT Deposit. From a market
risk standpoint, SFT activity would be risk managed by NSCC in a manner
consistent with Members' CNS positions but would be margined
independently of the Member's other positions,\31\ and a Required SFT
Deposit would be collected by NSCC for all SFT activity of an SFT
Member, subject to a $250,000 minimum deposit.\32\ Specifically, NSCC
is proposing to calculate an SFT Member's Required SFT Deposit by
applying the sections of Procedure XV (Clearing Fund Formula and Other
Matters) specified in Section 12 of proposed Rule 56 (i.e., Sections
I.(A)(1)(a), (b), (d), (f), (g), (h) of Procedure XV as well as the
additional Clearing Fund formula in Section I.(B)(5) (Intraday Mark-to-
Market Charge) of Procedure XV as such sections apply to CNS
Transactions, and the additional Clearing Fund formula in Sections
I.(B)(1) (Additional Deposits for Members on the Watch List); (2)
(Excess Capital Premium), (3) (Backtesting Charge), (4) (Bank Holiday
Charge); Minimum Clearing Fund and Additional Deposit Requirements in
Sections II.(A)1(a)-(b), II.(B), II.(C); as well as Section III
(Collateral Value of Eligible Clearing Fund Securities) of Procedure
XV, as such sections apply to Members). Furthermore, NSCC would require
an additional Required SFT Deposit for Non-Returned SFTs that is
intended to mirror the premium charged for CNS Fails Positions. NSCC
would also apply the Independent Amount SFT Cash Deposit Requirement
for SFTs that have Incremental Additional Independent Amount SFT Cash.
NSCC is also proposing that, for the purpose of applying Section
I.(A)(1)(h) of Procedure XV (Margin Liquidity Adjustment (``MLA'')
charge), SFT Positions shall be netted with Net Unsettled
Positions.\33\
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\30\ As currently defined in Rule 1 (Definitions and
Descriptions), the term ``Clearing Fund'' means the fund created
pursuant to Rule 4. Supra note 4.
\31\ NSCC is not proposing at this time to portfolio margin a
Member's SFT Positions with any CNS positions of the Member. NSCC
may reconsider this position after it obtains a reasonable amount of
experience observing the nature and volume of SFT activity submitted
by Members to NSCC for novation through the proposed SFT Clearing
Service.
\32\ This $250,000 minimum deposit is a requirement that is
separate from NSCC's proposed change to a Member's minimum (non-SFT)
Clearing Fund deposit requirement, although it is designed to be
consistent with such proposed change. See Securities Exchange Act
Release No. 91809 (May 10, 2021), 86 FR 26588 (May 14, 2021) (SR-
NSCC-2021-005).
\33\ ``Net Unsettled Positions'' include a Member's net of
unsettled Regular Way, When-Issued and When-Distributed pending
positions (i.e., net positions that have not yet passed Settlement
Date) and fail positions (i.e., net positions that did not settle on
Settlement Date). See Procedure XV, supra note 4.
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Consistent with the manner in which clearing fund requirements are
satisfied by members of FICC for their cleared securities financing
transactions, NSCC would require that (i) a minimum of 40% of an SFT
Member's Required SFT Deposit consist of a combination of cash and
Eligible Clearing Fund Treasury Securities and (ii) the lesser of
$5,000,000 or 10% of an SFT Member's Required SFT Deposit (but not less
than $250,000) \34\ consist of cash.\35\ NSCC would also have the
discretion to require an SFT Member to post its Required SFT Deposit in
proportion of cash higher than would otherwise be required as described
above. NSCC's determination to impose any such requirement would be
made in view of market conditions and other financial and operational
capabilities of the relevant SFT Member. For example, as proposed in
Section 12 of Rule 56, if NSCC had specific concerns about a particular
SFT Member's financial or operational capabilities, but NSCC had not
yet come to the determination that ceasing to act for the SFT Member
would be appropriate (but could potentially become appropriate within
the near term), NSCC may request that a greater portion of the SFT
Member's Required SFT Deposit to the Clearing Fund be in the form of
cash in order to simplify any potential close-out liquidation required
in the event of that SFT Member's default. Separately, pursuant to
Section II.(A)1(a) of Procedure XV, if an SFT Member's deposit of
Eligible Clearing Fund Agency Securities or Eligible Clearing Fund
Mortgage-Backed Securities is in excess of 25% of the SFT Member's
Required Fund Deposit, NSCC would subject the deposit to an additional
haircut.
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\34\ This $250,000 minimum cash deposit requirement is designed
to be consistent with NSCC's proposed change to the minimum amount
of cash that must be used to satisfy a Member's (non-SFT) Clearing
Fund deposit requirement. See Securities Exchange Act Release No.
91809 (May 10, 2021), 86 FR 26588 (May 14, 2021) (SR-NSCC-2021-005).
NSCC believes a $250,000 minimum cash deposit would serve to
strengthen NSCC's liquidity resources. Cash may also be easier to
access upon a Member's default, further reducing the risk of losses
and using non-defaulting Member's securities or funds, or NSCC
funds.
\35\ These requirements are designed to be consistent with FICC
GSD's clearing fund requirements of its members given that NSCC
anticipates that there would be considerable overlap between the
membership of FICC GSD that participate in FICC for purposes of
clearing their securities financing transaction activity (including
in particular sponsored repo activity) and the Members that would
elect to participate in the proposed SFT Clearing Service.
Specifically, FICC GSD Rule 4, Section 3 requires (i) a minimum of
40 percent of a member's required fund deposit to be in the form of
cash and/or eligible clearing fund treasury securities and (ii) the
lesser of $5,000,000 or 10 percent of the required fund deposit,
with a minimum of $100,000, be made and maintained in cash. See Rule
4 (Clearing Fund and Loss Allocation) of the FICC GSD Rulebook,
supra note 16
.
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The Sponsoring Member Required Fund Deposits (as defined below and
in the proposed rule change) and Agent Clearing Member Required Fund
Deposits (as defined below and in the proposed rule change) would each
be calculated on a gross basis, and no offsets for netting of positions
as between different Sponsored Members or different Customers,\36\ as
applicable, would be permitted. This is to ensure that NSCC's
volatility-based Clearing Fund deposit requirements represent the sum
of each individual institutional firm's activity.
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\36\ See Section 7(c) of proposed Rule 2C and Section 6(c) of
proposed 2D.
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As proposed, the SFT Clearing Service would mitigate NSCC's
liquidity risk associated with satisfaction of Final Settlement
obligations owing to non-defaulting SFT Members on novated SFTs in the
event of an SFT Member default by providing for satisfaction of such
Final Settlement obligations to occur in accordance with the normal
settlement cycle for the purchase or sale of securities, as
applicable.\37\ NSCC would accordingly be able to satisfy such Final
Settlement obligations through market action (if necessary) rather than
through its own liquidity resources. More specifically, NSCC would be
able to sell the securities lent by a Defaulting SFT Member (as defined
below and in the proposed rule change) and/or purchase the securities
borrowed by a Defaulting SFT Member and use the proceeds of such sales
and/or the securities purchased to satisfy the Defaulting SFT Member's
Final Settlement obligations to non-defaulting SFT Members. In the
absence of this provision, NSCC would need to rely exclusively on its
liquidity resources to satisfy Final Settlement obligations owing to
non-defaulting SFT Members, since it would not receive the proceeds of
any market action to liquidate the Defaulting SFT Member's SFT
Positions until after Final Settlement obligations were due.
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\37\ See proposed Rule 56, Section 14(b)(viii).
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The proposal would also provide that NSCC could further delay its
[[Page 44537]]
satisfaction of Final Settlement obligations to non-defaulting SFT
Members beyond the normal settlement cycle for the purchase or sale of
securities to the extent NSCC determines that taking market action to
close-out some or all of the defaulted SFT Member's novated SFT
Positions would create a disorderly market in the relevant SFT
Securities.\38\ For example, to the extent that market action is
required by NSCC to close-out the positions of a Defaulting SFT Member,
and selling out or buying in (as applicable) the entire quantity of
securities would move the market and create disorder, NSCC would adhere
to pre-determined market volume limits as set forth in NSCC's internal
procedures and execute its hedging strategy in order to meet its
default management objectives. In such a situation, non-defaulting SFT
Members would not be able to effect a recall or an associated buy-in,
since such market activity would exacerbate the disorderly conditions
that NSCC's delay is designed to prevent, nor would non-defaulting SFT
Members otherwise be able to or accelerate the delayed Final Settlement
obligations, as any such acceleration would frustrate the purpose of
the delay, i.e., to avoid creating a disorderly market in the relevant
SFT Securities.
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\38\ Id.
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However, in any case, until NSCC has satisfied the Final Settlement
obligations owing to non-defaulting SFT Members, NSCC would continue
paying to and receiving from non-defaulting SFT Members the applicable
Price Differential (i.e., the change in market value of the relevant
securities) with respect to their novated SFTs.\39\ By continuing to
process these Price Differential payments until Final Settlement
occurs, NSCC would ensure that non-defaulting SFT Members are kept in
the same position as if the Defaulting SFT Member had not defaulted and
the pre-novation counterparties had instead agreed to roll the SFTs. To
the extent NSCC is required to pay a Price Differential to a non-
defaulting SFT Member, NSCC would rely on the NSCC Clearing Fund,
including the Required SFT Deposit, in order to cover the liquidity
need associated with any such Price Differential obligation.\40\ In
addition, NSCC would anticipate being in regular communication with the
non-defaulting SFT Members as to the timing of the satisfaction of any
Final Settlement obligations related to a defaulting SFT Member.
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\39\ See proposed Rule 56, Section 14(b)(ix).
\40\ For example, assume that a Transferor and Transferee enter
into an SFT pursuant to which: (i) In the Initial Settlement on
Monday, the Transferor will transfer 100 shares of security X to the
Transferee against $100 per share; and (ii) in the Final Settlement
on Tuesday, the Transferee will transfer 100 shares of security X to
the Transferor against $100 per share. Assume further that at
midnight on Monday, NSCC ceases to act for the Transferor.
On Tuesday, NSCC executes a sale of 100 shares of security X for
$99 per share. In accordance with the regular way settlement cycle
for purchases and sales of equity securities, this sale will settle
on Thursday.
Pursuant to Section 14(b)(viii) of proposed Rule 56 (Securities
Financing Transaction Clearing Service), NSCC would likewise settle
the Final Settlement obligations of the defaulting Transferor's SFT
with the non-defaulting Transferee on Thursday.
Assume further that the end-of-day price of security X on
Tuesday is $99 per share. On Wednesday, NSCC would pay $1 per share
in Price Differential to the non-defaulting Transferee pursuant to
Section 14(b)(ix) of proposed Rule 56. Assume further that the end-
of-day price of security X on Wednesday is $98 per share.
On Thursday, NSCC would pay an additional $1 per share in Price
Differential to the non-defaulting Transferee pursuant to Section
14(b)(ix) of proposed Rule 56. The Transferee would then return 100
shares of security X to NSCC and receive $98 per share (i.e., the
current market price for security X) from NSCC. As such, the non-
defaulting Transferee would be made whole by NSCC for the $100 per
share it transferred in the Initial Settlement of the Defaulted-
Related SFT (as defined below and in the proposed rule change) since
NSCC would have transferred to it $98 per share in Final Settlement
plus an additional $2 per share in Price Differential.
NSCC would incur a net loss of $1 per share in this example
since it would have sold security X for $99 per share and paid the
non-defaulting Transferee a total of $100 per share (i.e., $98 per
share in Final Settlement proceeds plus $2 per share in Price
Differential). NSCC would be entitled to deduct this amount from the
defaulted Transferor's Clearing Fund deposits (including its SFT
Deposit).
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(iii) Sponsoring Members and Sponsored Members
NSCC is proposing a sponsored membership program to allow Members
to play the role of pre-novation counterparty and credit intermediary
for their institutional firm clients in clearing.
NSCC has modeled a number of the aspects of the proposed sponsored
member program, including the eligibility criteria and many of the risk
management requirements, on FICC's Sponsoring Member/Sponsored Member
Program. FICC's Sponsoring Member/Sponsored Member Program allows an
FICC Netting Member to sponsor an entity that satisfies certain
requirements and submit to FICC for novation certain securities
transactions between the Netting Member and the sponsored entity. These
securities transactions generally include the off-leg of repurchase
transactions on U.S. government or agency securities or straight
purchase and sales of such securities. Such transactions present
similar risk management, legal, accounting, and operation
considerations to SFTs, as both involve an obligation of a sponsored
member and a sponsoring member to exchange cash against securities.
Since 2005, FICC has worked with its members to improve its Sponsoring
Member/Sponsored Member Program to address these considerations. Based
on feedback from Members and its own internal assessments, NSCC
believes that leveraging the provisions of FICC's Sponsoring Member/
Sponsored Member program and the learning over the past decade and a
half would allow NSCC to provide a sponsored member program that has a
solid risk management, accounting, legal and operational foundation.
Sponsoring Members
Under the proposal, all Members would be eligible to apply to
become Sponsoring Members in NSCC, subject to credit criteria that are
designed to be substantially similar to those applicable to category 2
sponsoring members in FICC's Sponsoring Member/Sponsored Member Program
for the reasons described above in Item II(B)(iii) ``Sponsoring Members
and Sponsored Members.'' \41\ A Member whose
[[Page 44538]]
application to become a Sponsoring Member has been approved by the
Board of Directors or NSCC, as applicable, pursuant to proposed Rule 2C
(``Sponsoring Member'') would be permitted to sponsor their
institutional firm clients into membership as Sponsored Members. Such
Sponsoring Members would then be able to facilitate their institutional
firm clients' cleared activity via two back-to-back principal SFTs,
i.e., client-to-Sponsoring Member and Sponsoring Member-to-broker (or
to another institutional firm client that the Sponsoring Member has
sponsored into membership), and each of such transactions would be
eligible for novation to NSCC.
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\41\ If a Member is a Registered Broker-Dealer, then such Member
would only be eligible to apply to become a Sponsoring Member if it
satisfies the credit criteria in proposed Rule 2C (Sponsoring
Members and Sponsored Members) (i.e., if it has (i) Net Worth of at
least $25 million and (ii) excess net capital over the minimum net
capital requirement imposed by the SEC (or such higher minimum
capital requirement imposed by the Member's designated examining
authority) of at least $10 million). Such credit criteria are
comparable to the credit criteria applicable to category 2
sponsoring members that are registered broker-dealers in FICC's
Sponsoring Member/Sponsored Member Program. A Sponsoring Member
applicant would be viewed and surveilled as the credit counterparty
to NSCC in respect to its Sponsored Member Sub-Account(s) (as
defined below and in the proposed rule change) in light of its
responsibility to NSCC as the processing agent and unconditional
guarantor of its Sponsored Members' performance to NSCC.
In addition, NSCC may require that a Person be a Member for a
time period deemed necessary by NSCC before that Person may be
considered to become a Sponsoring Member. This requirement may be
imposed by NSCC on a new Member that has yet to demonstrate a track
record of financial responsibility and operational capability.
Furthermore, as proposed, the application of a Member to be a
Sponsoring Member at NSCC that is an Agent Clearing Member or an
existing FICC sponsoring member would not be required to be approved
by the NSCC Board of Directors. NSCC believes this approach to Board
of Director's approval for Sponsoring Members is appropriate in
light of the fact that the critical components of the FICC
sponsoring member application as well as the NSCC Sponsoring Member
and Agent Clearing Member applications and the criteria that the
respective boards assess when determining whether to admit a Member
in such respective capacities are substantially similar.
Nonetheless, NSCC would apply the same rigorous counterparty credit
review process to any Member applying to be a Sponsoring Member at
NSCC, whether or not the Member is an existing FICC sponsoring
member.
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Consistent with the requirements applicable to sponsoring members
in FICC's Sponsoring Member/Sponsored Member Program for the reasons
described above in Item II(B)(iii) ``Sponsoring Members and Sponsored
Members,'' a Sponsoring Member would be responsible for (i) submitting
data on its Sponsored Members' SFTs to NSCC or appointing a third-party
Approved SFT Submitter to do so, (ii) posting to NSCC all of the
Clearing Fund associated with the SFT activity of its Sponsored
Members, which would be calculated on a gross basis (i.e., SFT activity
would not be netted across Sponsored Members for Clearing Fund
purposes), (iii) providing an unconditional guaranty to NSCC for its
Sponsored Members' Final Settlement and other obligations to NSCC, and
(iv) covering any default loss allocable to its Sponsored Members (in
addition to its own default loss allocation as a Member).
Specifically, as proposed, a Sponsoring Member would be permitted
to submit to NSCC for novation Sponsored Member Transactions, subject
to an activity limit designed to be substantially similar to that
applicable to category 2 sponsoring members in FICC's Sponsoring
Member/Sponsored Member Program for the reasons described above in Item
II(B)(iii) ``Sponsoring Members and Sponsored Members.'' Under the
proposal, if the sum of the Volatility Charges (as defined below and in
the proposed rule change) applicable to a Sponsoring Member's Sponsored
Member Sub-Accounts (as defined below and in the proposed rule change)
and its other accounts at NSCC exceeds its Net Member Capital (as
defined below and in the proposed rule change), the Sponsoring Member
would not be permitted to submit activity into its Sponsored Member
Sub-Accounts, unless otherwise determined by NSCC in order to promote
orderly settlement. As defined in Section 5 of proposed Rule 2C,
Sponsored Member Transactions are SFTs between a Sponsoring Member and
its Sponsored Members.
The Sponsoring Member would establish one or more accounts at NSCC
for its Sponsored Members' positions arising from such Sponsored Member
Transactions, i.e., Sponsored Member Sub-Accounts, which would be
separate from the Sponsoring Member's proprietary accounts. For
operational and administrative purposes, NSCC would interact solely
with the Sponsoring Member as agent of its Sponsored Members.
Sponsoring Members would be responsible for providing NSCC with a
Sponsoring Member Guaranty (as defined below and in the proposed rule
change) whereby the Sponsoring Member guarantees to NSCC the payment
and performance by its Sponsored Members of their obligations under the
Sponsored Member Transactions submitted by the Sponsoring Member for
novation. Although Sponsored Members are principally liable to NSCC for
their own settlement obligations under such transactions in accordance
with the Rules, the Sponsoring Member Guaranty requires the Sponsoring
Member to satisfy those settlement obligations on behalf of a Sponsored
Member if the Sponsored Member defaults and fails perform its
settlement obligations.
In addition, a Sponsoring Member would be responsible for posting
to NSCC all of the Clearing Fund associated with the Sponsored Member
Transactions (which would not be netted across Sponsored Members for
Clearing Fund purposes) and covering any default loss allocable to its
Sponsored Members, as well as its own default loss allocation as a
Member.\42\
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\42\ The following example illustrates how loss allocation would
occur with respect to Sponsoring Members and Sponsored Members:
Assume NSCC incurs a $100 million aggregate loss from a Defaulting
Member Event. In addition, assume that the Corporate Contribution
amount that NSCC would first apply to any loss from a Defaulting
Member Event is $25 million. This means NSCC would allocate the
remaining $75 million losses (i.e., $100 million minus $25 million)
to Members pursuant to Section 4 of Rule 4 (Clearing Fund),
including Sponsored Member Sub-Accounts as if each were a Member. If
the allocated losses to a Sponsoring Member's Sponsored Member Sub-
Accounts is $1 million and the allocated losses to its Sponsoring
Member in its capacity as a Member is $2 million, the Sponsoring
Member would be responsible for a total of $3 million loss
allocation ($1 million for its Sponsored Member Sub-Account loss
allocation amount and $2 million for its own default loss allocation
as a Member).
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As proposed, consistent with FICC's Sponsoring Member/Sponsored
Member Program for the reasons described above in Item II(B)(iii)
``Sponsoring Members and Sponsored Members,'' NSCC would also provide a
mechanism by which a Sponsoring Member may cause the termination and
liquidation of a Sponsored Member's positions arising from Sponsored
Member Transactions between the Sponsoring Member and such Sponsored
Member that have been novated to NSCC.\43\
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\43\ See Section 14 of proposed Rule 2C (Sponsoring Members and
Sponsored Members).
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Sponsored Members
Consistent with the requirements applicable to sponsored members in
FICC's Sponsoring Member/Sponsored Member Program for the reasons
described above in Item II(B)(iii) ``Sponsoring Members and Sponsored
Members,'' any Person that has been approved by NSCC to be sponsored
into membership by a Sponsoring Member pursuant to proposed Rule 2C
(``Sponsored Member'') would be required to be either a ``qualified
institutional buyer'' as defined by Rule 144A\44\ under the Securities
Act of 1933, as amended (``Securities Act''),\45\ or a legal entity
that, although not organized as an entity specifically listed in
paragraph (a)(1)(i)(H) of Rule 144A under the Securities Act, satisfies
the financial requirements necessary to be a ``qualified institutional
buyer'' as specified in that paragraph.
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\44\ 17 CFR 230.144A.
\45\ 15 U.S.C. 77a et seq.
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(iv) Agent Clearing Members and Customers
NSCC is proposing an agent clearing membership designed to allow
Members to play the role of agent and credit intermediary for their
institutional firm clients in clearing. This membership type is being
proposed in response to the request of certain market participants,
including in particular certain agent lending banks, that the proposed
SFT Clearing Service accommodate agent-style trading (i.e., where the
agent lender enters into the transactions on behalf of its
institutional firm clients with a third-party market participant,
rather than acting as its institutional firm clients' principal pre-
novation counterparty). Agent-style trading is the manner in which such
agent lenders are typically approved to transact in securities lending
transactions on behalf of their institutional firm clients. Under the
[[Page 44539]]
proposal, a Member that enters into transactions on behalf of its
institutional firm clients in accordance with the provisions of
proposed Rule 2D (``Agent Clearing Member'') would be permitted to
submit SFTs executed by it (as agent on behalf of its institutional
firm clients, with each such client referred to as a ``Customer'') with
a Member participating in the proposed SFT Clearing Service (which
could include a Member acting in a proprietary capacity within the
proposed SFT Clearing Service as well as an Agent Clearing Member).
All Members would be eligible to apply to become Agent Clearing
Members in NSCC, subject to credit criteria that are substantially
similar to those applicable to Sponsoring Members as well as category 2
sponsoring members in FICC's Sponsoring Member/Sponsored Member
Program.\46\
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\46\ If a Member is a Registered Broker-Dealer, then such Member
would only be eligible to apply to become an Agent Clearing Member
if it satisfies the credit criteria in proposed Rule 2D (i.e., if it
has (i) Net Worth of at least $25 million and (ii) excess net
capital over the minimum net capital requirement imposed by the SEC
(or such higher minimum capital requirement imposed by the Member's
designated examining authority) of at least $10 million). Such
credit criteria are comparable to the credit criteria applicable to
sponsoring members that are registered broker-dealers in FICC's
Sponsoring Member/Sponsored Member Program. Similar to the review of
a Sponsoring Member applicant, an Agent Clearing Member applicant
would also be viewed and surveilled as the credit counterparty to
NSCC in light of its role as the Member with respect to its Agent
Clearing Member Customer Omnibus Account(s).
In addition, NSCC may require a Person be a Member for a time
period deemed necessary by NSCC before that Person may be considered
to become an Agent Clearing Member. This requirement may be imposed
by NSCC on a new Member that has yet to demonstrate a track record
of financial responsibility and operational capability.
Furthermore, as proposed, the application of a Member to be an
Agent Clearing Member at NSCC that is a Sponsoring Member or an
existing FICC sponsoring member would not be required to be approved
by the NSCC Board of Directors. NSCC believes this approach to the
Board of Director's approval for Agent Clearing Members is
appropriate in light of the fact that the critical components of the
FICC sponsoring member application as well as the NSCC Sponsoring
Member and Agent Clearing Member applications and the criteria that
the respective boards assess when determining whether to admit a
Member in such respective capacities are substantially similar.
Nonetheless, NSCC would apply the same rigorous counterparty credit
review process to any Member applying to be an Agent Clearing Member
at NSCC, whether or not the Member is an existing FICC sponsoring
member.
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Under the proposal, the requirements to be imposed on Agent
Clearing Members would largely mirror those imposed on Sponsoring
Members. However, NSCC is not proposing to impose the same types of
requirements on an Agent Clearing Member's Customers as it does on
Sponsored Members because a Customer would not be a direct member of
NSCC.
Specifically, as proposed, an Agent Clearing Member would be
permitted to submit to NSCC for novation Agent Clearing Member
Transactions (as defined below and in the proposed rule change), on
behalf of one or more of its Customers, subject to an activity limit.
Specifically, under the proposal, if the sum of the Volatility Charges
applicable to an Agent Clearing Member's Agent Clearing Member Customer
Omnibus Account(s) (as defined below and in the proposed rule change)
and its other accounts at NSCC exceeds its Net Member Capital, the
Agent Clearing Member would not be permitted to submit activity into
its Agent Clearing Member Customer Omnibus Account(s), unless otherwise
determined by NSCC in order to promote orderly settlement. As defined
in Section 4 of proposed Rule 2D, Agent Clearing Member Transactions
are SFTs that an Agent Clearing Member submits to NSCC on behalf of one
or more Customers.
The Agent Clearing Member would establish one or more accounts at
NSCC for its Customers' positions, i.e., an Agent Clearing Member
Customer Omnibus Account, that would be in the name of the Agent
Clearing Member for the benefit of its Customers; however, each Agent
Clearing Member Customer Omnibus Account may only contain activity
where the Agent Clearing Member is acting as Transferor on behalf of
its Customers, or as Transferee on behalf of its Customers, but not
both (i.e., activity would not be netted across Customers for Clearing
Fund purposes). Under the proposal, the Agent Clearing Member would act
solely as agent of its Customers in connection with the clearing of
Agent Clearing Member Transactions; however, the Agent Clearing Member
would remain fully liable for the performance of all obligations to
NSCC arising in connection with Agent Clearing Member Transactions.
In addition, as proposed under the sponsoring/sponsored membership
model, the Agent Clearing Member would be responsible for posting to
NSCC all of the Clearing Fund associated with the activity of its
Customers and covering any default loss allocable to its Customers, as
well as its own default loss allocation as a Member; \47\ however,
unlike a Sponsoring Member, an Agent Clearing Member would not be
required to provide an unconditional guaranty to NSCC for its
Customer's obligations. This is because, as described above, the Agent
Clearing Member would be fully liable for all obligations of its
Customers under the Agent Clearing Member Transactions that it
submitted to NSCC as the Member.
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\47\ The following example illustrates how loss allocation would
occur with respect to Agent Clearing Members: Assume NSCC incurs a
$100 million aggregate loss from a Defaulting Member Event. In
addition, assume that the Corporate Contribution amount that NSCC
would first apply to any loss from a Defaulting Member Event is $25
million. This means NSCC would allocate the remaining $75 million
losses (i.e., $100 million minus $25 million) to Members pursuant to
Section 4 of Rule 4 (Clearing Fund), including Agent Clearing Member
Customer Omnibus Accounts as if each were a Member. If the allocated
losses to an Agent Clearing Member's Agent Clearing Member Customer
Omnibus Account is $1 million and the allocated losses to the Agent
Clearing Member in its capacity as a Member is $2 million, the Agent
Clearing Member would be responsible for a total of $3 million loss
allocation ($1 million for its Agent Clearing Member Customer
Omnibus Account loss allocation amount and $2 million for its own
default loss allocation as a Member).
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As proposed, NSCC would also provide a mechanism by which an Agent
Clearing Member may, upon a default of a Customer and consent of NSCC,
transfer Agent Clearing Member Transactions of the Customer established
in one or more of the Agent Clearing Member's Agent Clearing Member
Customer Omnibus Accounts from such Agent Clearing Member Customer
Omnibus Accounts to the Agent Clearing Member's proprietary account at
NSCC as a Member.\48\
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\48\ See Section 11 of proposed Rule 2D (Agent Clearing
Members).
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(v) Sponsoring Member/Sponsored Member vs. Agent Clearing Member/
Customers
The direct costs of central clearing (i.e., Clearing Fund, loss
allocation, fees and performance on behalf of an institutional firm
clients) would be largely equivalent as between what NSCC proposes to
apply to a Sponsoring Member and what NSCC proposes to apply to an
Agent Clearing Member. Likewise, the capital costs to Sponsoring
Members and Agent Clearing Members of intermediating institutional firm
activity as between the two buy-side clearing models would be largely
equivalent. That being said, because Sponsoring Members would be
required to ensure that (i) each of their clients separately onboards
with NSCC as a Sponsored Member (which NSCC understands is generally
required from an accounting perspective in order for the Sponsoring
Member to net on its balance sheet its SFTs with Sponsored Members
against the Sponsoring Member's other NSCC-cleared SFTs),\49\ (ii) each
of their client's SFTs is individually submitted to NSCC for
[[Page 44540]]
clearing, and (iii) each Sponsored Member continues to remain in
compliance with the financial standards applicable to Sponsored Members
throughout the course of its membership, Sponsoring Members may incur
more legal, onboarding, operational and ongoing administrative costs
than Agent Clearing Members with respect to their institutional firm
clearing activity.
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\49\ Supra note 11.
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However, the sponsoring/sponsored membership model allows for
principal-style trading between a Sponsoring Member and its Sponsored
Member where the Sponsoring Member and Sponsored Member are pre-
novation counterparties, which would generally create the opportunity
for a Sponsoring Member to make an economic spread between its trade
with its Sponsored Member and its offsetting trades with other NSCC
Members or Sponsored Members. The opportunity for such economic spread
and the ability of a Sponsoring Member to achieve balance sheet netting
and capital efficiency on such trading activity through the novation of
SFTs to NSCC could, for some market participants, offset the indirect
additional costs associated with acting as a Sponsoring Member, rather
than acting as an Agent Clearing Member.
On the other hand, as NSCC understands it, for some market
participants, particularly agent lenders, their business models are not
typically predicated on principal-style trading. Rather, these agency
businesses typically charge fees for their services (rather than taking
economic spreads) and their business models and their agreed upon
investment guidelines with their institutional firm customers may only
permit agented (rather than principal-style) trading for securities
lending transactions. So, for such market participants, participating
in clearing at NSCC as an Agent Clearing Member may be a better fit for
their overall business model.
From the perspective of an institutional firm client, the costs of
clearing that may be passed through to it by its intermediary
(depending on their commercial arrangements) would be largely
equivalent. That said, some institutional firms that engage in
securities lending may be prohibited from acting as Sponsored Members
and engaging in principal-style trading with their intermediary in
clearing for regulatory and/or investment guideline reasons. For those
institutional firms, being able to transact SFTs as a Customer within
an Agent Clearing Member Customer Omnibus Account would offer them a
means to access central clearing that would otherwise not be available
to them if the sponsoring/sponsored membership model were the only
model available for buy-side clearing.
(vi) Proposed Rule Changes
(A) Proposed Rule 2C--Sponsoring Members and Sponsored Members
NSCC is proposing to add Rule 2C, entitled ``Sponsoring Members and
Sponsored Members.'' This new rule would govern the proposed sponsored
membership and would be comprised of 14 sections, each of which is
described below.
Proposed Rule 2C, Section 1 (General)
Section 1 of proposed Rule 2C would be a general provision
regarding the Rules applicable to Sponsoring Members and Sponsored
Members.
Section 1 of proposed Rule 2C would provide that NSCC will permit
the establishment of a sponsored membership relationship between a
Member that is approved as a Sponsoring Member and one or more Persons
that are accepted by NSCC as Sponsored Members of that particular
Sponsoring Member. Section 1 of proposed Rule 2C would further provide
that the rights, liabilities and obligations of Sponsoring Members and
Sponsored Members shall be governed by proposed Rule 2C, and that
references to the term ``Member'' in other Rules would not apply to
Sponsoring Members and to Sponsored Members, in their respective
capacities as such, unless specifically noted as such in proposed Rule
2C or in such other Rules.
Section 1 of proposed Rule 2C would also provide that a Sponsoring
Member shall continue to have all of the rights, liabilities and
obligations as set forth in the Rules and in any agreement between it
and NSCC pertaining to its status as a Member, and such rights,
liabilities and obligations shall be separate from its rights,
liabilities and obligations as a Sponsoring Member except as
contemplated under Sections 7, 8 and 9 of proposed Rule 2C and under
the Sponsoring Member Guaranty.
Proposed Rule 2C, Section 2 (Qualifications of Sponsoring Members, the
Application Process and Continuance Standards)
Section 2 of proposed Rule 2C would establish the eligibility
requirements for Members that wish to become Sponsoring Members, the
membership application process that would be required of each Member to
become a Sponsoring Member, the on-going membership requirements that
would apply to Sponsoring Members, as well as the requirements
regarding a Sponsoring Member's election to voluntarily terminate its
membership.
Under Section 2(a) of proposed Rule 2C, any Member would be
eligible to apply to become a Sponsoring Member; however, if a Member
is a Registered Broker-Dealer, such Member would only be permitted to
apply to become a Sponsoring Member if it has (1) Net Worth (as defined
below and in the proposed rule change) of at least $25 million and (2)
excess net capital over the minimum net capital requirement imposed by
the Commission (or such higher minimum capital requirement imposed by
the Member's designated examining authority) of at least $10
million.\50\ In connection therewith, NSCC is proposing ``Net Worth''
to mean, as of a particular date, the amount equal to the excess of the
assets of a Person over the liabilities of such Person, computed in
accordance with generally accepted accounting principles, and for
Registered Broker-Dealers, Net Worth shall include liabilities that are
subordinated to the claims of creditors pursuant to a satisfactory
subordination agreement, as defined in Appendix D to Rule 15c3-1 of the
Act.\51\ As proposed, NSCC may require that a Person be a Member for a
certain time period before that Person may be considered to become a
Sponsoring Member.
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\50\ NSCC is proposing these financial minimums for Registered
Broker-Dealer Sponsoring Member applicants to reflect the additional
responsibility that the applicant would undertake as a Sponsoring
Member. These financial minimums are determined based on NSCC's
assessment of the minimum capital that would be necessary for a
broker-dealer to conduct meaningful level of NSCC-cleared activity
while serving as a credit counterparty in respect of others' trades.
In its assessment, NSCC considered various factors, such as the
amount of a Registered Broker-Dealer Member's capital and its impact
on such Member's financial responsibility and operational
capability, comparability with the financial requirements of other
clearing agencies, and the desire to strike a balance between credit
risk mitigation and member accessibility. For the reasons described
above in Item II(B)(iii) ``Sponsoring Members and Sponsored
Members,'' these financial minimums are also designed to be
consistent with the requirements applicable to registered broker/
dealers that are sponsoring members in FICC's Sponsoring Member/
Sponsored Member Program.
\51\ 17 CFR 240.15c3-1d.
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Section 2(b) of proposed Rule 2C would provide that each Member
applicant to become a Sponsoring Member would be required to provide an
application and other information requested by NSCC. Sponsoring Member
applications shall first be reviewed by NSCC and would require the
Board of Directors' approval, unless the Member applicant is already an
Agent Clearing Member under proposed Rule 2D or a
[[Page 44541]]
sponsoring member of FICC.\52\ NSCC believes this approach to the Board
of Director's approval for Sponsoring Members is appropriate in light
of the fact that the critical components of the FICC sponsoring member
application as well as the NSCC Sponsoring Member and Agent Clearing
Member applications and the criteria that the respective boards assess
when determining whether to admit a Member in such respective
capacities are substantially similar.
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\52\ It is NSCC's understanding that FICC is evaluating a change
to the GSD Rules to provide that the application of an FICC
sponsoring member applicant that is already an NSCC Sponsoring
Member or Agent Clearing Member would not require approval of FICC's
board of directors.
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Under Section 2(c) of proposed Rule 2C, if the Sponsoring Member
application is denied, such denial would be handled in accordance with
Section 1 of Rule 2A (Initial Membership Requirements).
As proposed in Section 2(d) of proposed Rule 2C, NSCC may impose
additional financial requirements on a Sponsoring Member applicant
based upon the level of the anticipated positions and obligations of
such applicant, the anticipated risk associated with the volume and
types of transaction such applicant proposes to process through NSCC as
a Sponsoring Member and the overall financial condition of such
applicant. Under the proposal, with respect to an application of a
Member to become a Sponsoring Member that requires the Board of
Directors' approval, the Board of Directors shall also approve any
increased financial requirements imposed by NSCC in connection with the
approval of the application, and NSCC would thereafter regularly review
such Sponsoring Member regarding its compliance with the increased
financial requirements.\53\
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\53\ If the increased financial requirements are imposed in
connection with a Sponsoring Member application that does not
require the Board of Directors' approval, the increased financial
requirements would not be subject to the Board of Directors'
approval. Nonetheless, once a Sponsoring Member application is
approved with increased financial requirements, NSCC would
thereafter regularly review such Sponsoring Member regarding its
continued adherence to such increased financial requirements as well
as determine whether such increased financial requirements are still
appropriate. If the Sponsoring Member is unable to adhere to the
increased financial requirements, the Board of Directors may,
pursuant to Section 10 of proposed Rule 2C, suspend, prohibit or
limit the Sponsoring Member's access to NSCC's services.
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In addition, under Section 2(e) of proposed Rule 2C, NSCC may
require each Sponsoring Member or any Sponsoring Member applicant to
furnish adequate assurances of such Sponsoring Member or Sponsoring
Member applicant's financial responsibility and operational capability
within the meaning of Rule 15 (Assurances of Financial Responsibility
and Operational Capability), as NSCC may at any time or from time to
time deem necessary or advisable in order to protect NSCC, its
participants, creditors or investors, to safeguard securities and funds
in the custody or control of NSCC and for which NSCC is responsible, or
to promote the prompt and accurate clearance, settlement and processing
of securities transactions.\54\
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\54\ As an example, NSCC may require a Sponsoring Member or a
Sponsoring Member applicant to furnish adequate assurances of such
Sponsoring Member or Sponsoring Member applicant's financial
responsibility and operational capability if NSCC has concerns about
such Sponsoring Member or Sponsoring Member applicant's overall
financial health or credit rating.
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Section 2(f) of proposed Rule 2C would provide that each Member
whose Sponsoring Member application is approved would sign and deliver
to NSCC (i) an agreement between NSCC and the Member and specifies the
terms and conditions deemed by NSCC to be necessary in order to protect
itself and its participants (``Sponsoring Member Agreement''), (ii) a
guaranty, in the form and substance acceptable to NSCC, whereby the
Member, in its capacity as a Sponsoring Member, guarantees to NSCC the
payment and performance by its Sponsored Members of their obligations
under the Rules in respect of the Sponsoring Member's Sponsored Member
Sub-Accounts, including, without limitation all of the settlement
obligations of its Sponsored Members in respect of such Sponsored
Member Sub-Accounts (``Sponsoring Member Guaranty''), and a related
legal opinion in a form satisfactory to NSCC. In addition, Section 2(f)
of proposed Rule 2C would provide that nothing in the Rules shall
prohibit a Sponsoring Member from seeking reimbursement from a
Sponsored Member for payments made by the Sponsoring Member (whether
pursuant to the Sponsoring Member Guaranty, out of Clearing Fund
deposits or otherwise) with respect to obligations as to which the
Sponsored Member is a principal obligor under the Rules, or as
otherwise may be agreed by the Sponsored Member and Sponsoring Member.
Section 2(g) of proposed Rule 2C would provide that each Sponsoring
Member shall submit to NSCC, within the timeframes and in the formats
required by NSCC, the reports and information that all Members are
required to submit regardless of type of Member and the reports and
information required to be submitted for its respective type of Member,
all pursuant to Section 2 of Rule 2B (Ongoing Membership Requirements
and Monitoring) and, if applicable, Addendum O (Admission of Non-US
Entities as Direct NSCC Members).
Section 2(h) of proposed Rule 2C would provide that a Sponsoring
Member's books and records, insofar as they relate to the Sponsored
Member Transactions submitted to NSCC, shall be open to the inspection
of the duly authorized representatives of NSCC to the same extent
provided in Rule 2A (Initial Membership Requirements) for other
Members.
Section 2(i) of proposed Rule 2C would provide that a Sponsoring
Member shall promptly inform NSCC, both orally and in writing, if it is
no longer in compliance with the relevant standards and qualifications
for applying to become a Sponsoring Member set forth in the proposed
Rule 2C. Notification must take place immediately and in no event later
than 2 Business Days from the date on which the Sponsoring Member first
learns of its non-compliance. As proposed, NSCC would assess a fine in
accordance with the Fine Schedule in Addendum P against any Sponsoring
Member that fails to so notify NSCC.\55\ If the Sponsoring Member fails
to remain in compliance with the relevant standards and qualifications,
NSCC would, if necessary, undertake appropriate action to determine the
status of the Sponsoring Member and its continued eligibility as such.
In addition, NSCC may review the financial responsibility and
operational capability of the Sponsoring Member, and otherwise require
from the Sponsoring Member additional reports of its financial or
operational condition at such intervals and in such detail as NSCC
shall determine. In addition, if NSCC has reason to believe that a
Sponsoring Member may fail to comply with any of the Rules applicable
to Sponsoring Members, it may require the Sponsoring Member to provide
it, within such timeframe, and in such detail, and pursuant to such
manner as NSCC shall determine, with assurances in writing of a
credible nature that the Sponsoring Member shall not, in fact, violate
any of the Rules.
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\55\ See Addendum P (Fine Schedule), supra note 4.
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Section 2(j) of proposed Rule 2C would provide that in the event
that a Sponsoring Member fails to remain in compliance with the
relevant requirements of the Rules, the Sponsoring Member Agreement or
the
[[Page 44542]]
Sponsoring Member Guaranty, NSCC shall have the right to cease to act
for the Sponsoring Member in its capacity as a Sponsoring Member
pursuant to Section 10 of proposed Rule 2C, unless the Sponsoring
Member requests that such action not be taken and NSCC determines that,
depending upon the specific circumstances and the record of the
Sponsoring Member, it is appropriate instead to establish for such
Sponsoring Member a time period, which shall be determined by NSCC and
which shall be no longer than 30 calendar days unless otherwise
determined by NSCC, during which the Sponsoring Member must resume
compliance with such requirements. As proposed, in the event that the
Sponsoring Member is unable to satisfy such requirements within the
time period specified by NSCC, NSCC shall, pursuant to the Rules, cease
to act for the Sponsoring Member in its capacity as a Sponsoring Member
pursuant to Section 10 of the proposed Rule 2C.
Section 2(k) of proposed Rule 2C would provide that if the sum of
the Volatility Charges applicable to a Sponsoring Member's Sponsored
Member Sub-Accounts and its other accounts at NSCC exceeds its Net
Member Capital (as defined below and in the proposed rule change), the
Sponsoring Member shall not be permitted to submit activity into its
Sponsored Member Sub-Accounts, unless otherwise determined by NSCC in
order to promote orderly settlement.\56\ As proposed, ``Volatility
Charge'' would mean, in respect to a Member, the amount of its Required
Fund Deposit calculated by NSCC by applying Sections I.(A)(1)(a)(i)-
(iv) of Procedure XV (Clearing Fund Formula and Other Matters); ``Net
Member Capital'' would mean Net Capital (as defined below and in the
proposed rule change), net assets or equity capital, as applicable to a
Member, based on the type of regulation, and in particular the capital
requirements, to which the Member is subject; and ``Net Capital'' would
mean, as of a particular date, the amount equal to the net capital of a
Registered Broker-Dealer as defined in Rule 15c3-1(c)(2) of the
Act,\57\ or any successor rule or regulation thereto.
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\56\ NSCC selected the Volatility Charges and Net Member Capital
as the criteria for purposes of establishing the activity limit for
Sponsoring Members. This is because a Sponsoring Member's total
Volatility Charges being in excess of its Net Member Capital is an
important indicator that the Sponsoring Member's financial
resources, as measured by its Net Capital, net assets or equity
capital, may be insufficient to meet the largest component of its
Required Fund Deposit (i.e., Volatility Charges).
\57\ 17 CFR 240.15c3-1(c)(2).
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Section 2(l) of proposed Rule 2C would provide that a Sponsoring
Member may voluntarily elect to terminate its status as a Sponsoring
Member, with respect to all Sponsored Members or with respect to one or
more Sponsored Members from time to time, by providing NSCC with a
written notice from a Sponsoring Member to NSCC that the Sponsoring
Member is voluntarily electing to terminate its status as a Sponsoring
Member with respect to all of its Sponsored Members or with respect to
one or more of its Sponsored Members (``Sponsoring Member Voluntary
Termination Notice''). The Sponsoring Member shall specify in the
Sponsoring Member Voluntary Termination Notice the Sponsored Member(s)
in respect of which the Sponsoring Member is terminating its status
(the ``Former Sponsored Members'') and a desired date for such
termination, which date shall not be prior to the scheduled Final
Settlement Date of any remaining obligation owed by the Sponsoring
Member to NSCC with respect to the Former Sponsored Members as of the
time such Sponsoring Member Voluntary Termination Notice is submitted
to NSCC, unless otherwise approved by NSCC.
Section 2(l) of proposed Rule 2C would also provide that such
termination would not be effective until accepted by NSCC, which shall
be no later than 10 Business Days after the receipt of the Sponsoring
Member Voluntary Termination Notice from such Sponsoring Member. NSCC's
acceptance shall be evidenced by a notice to NSCC's participants
announcing the termination of the Sponsoring Member's status as such
with respect to the Former Sponsored Members and the date on which the
termination of the Sponsoring Member's status as a Sponsoring Member
becomes effective (``Sponsoring Member Termination Date''). As
proposed, after the close of business on the Sponsoring Member
Termination Date, the Sponsoring Member shall no longer be eligible to
submit Sponsored Member Transactions on behalf of the Former Sponsored
Members, and each Former Sponsored Member shall cease to be a Sponsored
Member unless it is the Sponsored Member of another Sponsoring Member.
If any Sponsored Member Transactions is submitted to NSCC by the
Sponsoring Member on behalf of a Former Sponsored Member that is
scheduled to settle after the Sponsoring Member Termination Date, such
Sponsoring Member's Sponsoring Member Voluntary Termination Notice
would be deemed void, and the Sponsoring Member would remain subject to
the proposed Rule 2C as if it had not given such Sponsoring Member
Voluntary Termination Notice.
Section 2(m) of proposed Rule 2C would provide that a Sponsoring
Member's voluntary termination of its status as such, in whole or in
part, shall not affect its obligations to NSCC, or the rights of NSCC,
including under the Sponsoring Member Guaranty, with respect to
Sponsored Member Transactions submitted to NSCC before the applicable
Sponsoring Member Termination Date. Any such Sponsored Member
Transactions that have been novated to NSCC shall continue to be
processed by NSCC. The return of the Sponsoring Member's Clearing Fund
deposit shall be governed by Section 7 of Rule 4 (Clearing Fund). If an
Event Period were to occur after a Sponsoring Member has submitted the
Sponsoring Member Voluntary Termination Notice but on or prior to the
Sponsoring Member Termination Date, in order for the Sponsoring Member
to benefit from its Loss Allocation Cap pursuant to Section 4 of Rule
4, the Sponsoring Member would need to comply with the provisions of
Section 6 of Rule 4 and submit a Loss Allocation Withdrawal Notice,
which notice, upon submission, shall supersede and void any pending
Sponsoring Member Voluntary Termination Notice previously submitted by
the Sponsoring Member.
Section 2(n) of proposed Rule 2C would provide that any non-public
information furnished to NSCC pursuant to proposed Rule 2C shall be
held in confidence as may be required under the laws, rules and
regulations applicable to NSCC that relate to the confidentiality of
records. Section 2(n) would also provide that each Sponsoring Member
shall maintain DTCC Confidential Information in confidence to the same
extent and using the same means it uses to protect its own confidential
information, but no less than a reasonable standard of care, and shall
not use DTCC Confidential Information or disclose DTCC Confidential
Information to any third party except as necessary to perform such
Sponsoring Member's obligations under the Rules or as otherwise
required by applicable law. Section 2(n) would further provide that
each Sponsoring Member acknowledges that a breach of its
confidentiality obligations under the Rules may result in serious and
irreparable harm to NSCC and/or DTCC for which there is no adequate
remedy at law. In addition, Section 2(n) would provide that in the
event of such a breach by the Sponsoring Member,
[[Page 44543]]
NSCC and/or DTCC shall be entitled to seek any temporary or permanent
injunctive or other equitable relief in addition to any monetary
damages thereunder.\58\
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\58\ Section 2(n) of proposed Rule 2C is designed to be
consistent with NSCC's proposed change to revise certain provisions
in the Rules relating to the confidentiality of information
furnished by participants. See Securities Exchange Act Release No.
92334 (July 7, 2021), 86 FR 36815 (July 13, 2021) (SR-NSCC-2021-
007).
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Proposed Rule 2C, Section 3 (Qualifications of Sponsored Members,
Approval Process and Continuance Standards)
Section 3 of proposed Rule 2C would establish the eligibility
requirements for Sponsored Members, the membership application process
that would be required of each Sponsored Member, the on-going
membership requirements that would apply to Sponsored Members, as well
as the requirements regarding a Sponsored Member's election to
voluntarily terminate its membership.
Section 3(a) of proposed Rule 2C would provide that a Person shall
be eligible to apply to become a Sponsored Member if: (x) It is
sponsored into membership by a Sponsoring Member, and (y) it (1) is a
``qualified institutional buyer'' as defined by Rule 144A \59\ under
the Securities Act,\60\ or (2) is a legal entity that, although not
organized as an entity specifically listed in paragraph (a)(1)(i)(H) of
Rule 144A under the Securities Act, satisfies the financial
requirements necessary to be a ``qualified institutional buyer'' as
specified in that paragraph. NSCC would have the right to rely on the
representation provided by the Sponsoring Member regarding satisfaction
of (y).
---------------------------------------------------------------------------
\59\ 17 CFR 230.144A.
\60\ 15 U.S.C. 77a et seq.
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Section 3(b) of proposed Rule 2C would provide that each time that
a Sponsoring Member wishes to sponsor a Person into membership, it
shall provide NSCC with the representation referred to in Section 3(a)
of proposed Rule 2C, as well as any additional information in such form
as may be prescribed by NSCC. NSCC shall approve or disapprove Persons
as Sponsored Members. If NSCC denies the request of a Sponsoring Member
to add a Person as a Sponsored Member, such denial shall be handled in
the same manner as set forth in Section 1 of Rule 2A (Initial
Membership Requirements) with respect to membership applications except
that the written statement referred to therein shall be provided to
both the Sponsoring Member and the Person seeking to become a Sponsored
Member.
Section 3(c) of proposed Rule 2C would provide that each Person to
become a Sponsored Member shall sign and deliver to NSCC an agreement
whereby the Person shall agree to any terms and conditions deemed by
NSCC to be necessary in order to protect itself and its participants
(the ``Sponsored Member Agreement''). Each Person to become a Sponsored
Member that shall be an FFI Member must be FATCA Compliant.
Section 3(d) of proposed Rule 2C would provide that a Sponsored
Member shall immediately inform its Sponsoring Member, both orally and
in writing, if the Sponsored Member is no longer in compliance with the
requirements of Section 3(a) of proposed Rule 2C. A Sponsoring Member
shall promptly inform NSCC, both orally and in writing, if a Sponsored
Member is no longer in compliance with the requirements of Section 3(a)
of proposed Rule 2C. Notification to NSCC by the Sponsoring Member must
take place within one (1) Business Day from the date on which the
Sponsoring Member first learns of the Sponsored Member's non-
compliance. NSCC would assess a fine in accordance with the Fine
Schedule in Addendum P against any Sponsoring Member that fails to so
notify NSCC.\61\
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\61\ See Addendum P (Fine Schedule), supra note 4.
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Section 3(e) of proposed Rule 2C would provide that a Sponsored
Member may voluntarily elect to terminate its membership by providing
NSCC with a written notice from the Sponsored Member to NSCC that the
Sponsored Member is voluntarily electing to terminate its membership
(``Sponsored Member Voluntary Termination Notice''). The Sponsored
Member shall specify in the Sponsored Member Voluntary Termination
Notice a desired date for the termination, which date shall not be
prior to the scheduled Final Settlement Date of any remaining
obligation owed by the Sponsored Member to NSCC as of the time such
Sponsored Member Voluntary Termination Notice is submitted to NSCC,
unless otherwise approved by NSCC.
In addition, Section 3(e) of proposed Rule 2C would provide that
such termination would not be effective until accepted by NSCC, which
shall be no later than 10 Business Days after the receipt of the
Sponsored Member Voluntary Termination Notice from such Sponsored
Member. NSCC's acceptance shall be evidenced by a notice to NSCC's
participants announcing the termination of the Sponsored Member and the
date on which the termination of the Sponsored Member becomes effective
(``Sponsored Member Termination Date''). After the close of business on
the Sponsored Member Termination Date, the relevant Sponsoring Member
shall no longer be eligible to submit Sponsored Member Transactions on
behalf of the Sponsored Member. If any Sponsored Member Transaction is
submitted to NSCC by the relevant Sponsoring Member on behalf of the
Sponsored Member that is scheduled to settle after the Sponsored Member
Termination Date, such Sponsored Member's Sponsored Member Voluntary
Termination Notice would be deemed void, and the Sponsored Member would
remain subject to the proposed Rule 2C as if it had not given such
Sponsored Member Voluntary Termination Notice.
Section 3(f) of proposed Rule 2C would provide that a Sponsored
Member's voluntary termination shall not affect its obligations to
NSCC, or the rights of NSCC, including under the Sponsoring Member
Guaranty, with respect to Sponsored Member Transactions submitted to
NSCC before the Sponsored Member Termination Date, and the Sponsoring
Member Guaranty shall remain in effect to cover all outstanding
obligations of the Sponsored Member to NSCC that are within the scope
of such Sponsoring Member Guaranty.
Proposed Rule 2C, Section 4 (Compliance With Laws)
Section 4 of proposed Rule 2C would provide that each Sponsoring
Member and Sponsored Member shall comply in all material respects with
all applicable laws, including applicable laws relating to securities,
taxation and money laundering, as well as global sanctions laws, in
connection with the use of NSCC's services.
Proposed Rule 2C, Section 5 (Sponsored Member Transactions)
Section 5 of proposed Rule 2C would provide that a Sponsoring
Member shall be permitted to submit to NSCC SFTs between itself and its
Sponsored Members (``Sponsored Member Transactions'') in accordance
with proposed Rule 56, as described below. Section 5 of proposed Rule
2C would further provide that NSCC directs each Sponsored Member and
Sponsoring Member to settle all Final Settlement, Rate Payment, Price
Differential, and other securities delivery and payment obligations
arising under a Sponsored Member Transaction that has been
[[Page 44544]]
novated to NSCC by causing the relevant cash and securities to be
transferred to the Transferor or Transferee, as applicable, on the
books and records of the Sponsoring Member, and each Sponsored Member
and Sponsoring Member agrees that any such transfer shall satisfy
NSCC's corresponding obligation with respect to such Sponsored Member
Transaction.
Proposed Rule 2C, Section 6 (Sponsoring Member Agent Obligations)
Section 6 of proposed Rule 2C would provide that a Sponsored Member
shall appoint its Sponsoring Member to act as agent with respect to the
Sponsored Member's satisfaction of its settlement obligations arising
under Sponsored Member Transactions between the Sponsored Member and
the Sponsoring Member and for performing all functions and receiving
reports and information set forth in the Rules. NSCC's provision of
such reports and information to the Sponsoring Member shall constitute
satisfaction of any obligation of NSCC to provide such reports and
information to the affected Sponsored Members. As proposed,
notwithstanding the foregoing and any other activities the Sponsoring
Member may perform in its capacity as agent for Sponsored Members, each
Sponsored Member shall be obligated as principal to NSCC with respect
to all settlement obligations under the Rules, and the Sponsoring
Member shall not be a principal under the Rules with respect to
settlement obligations of its Sponsored Members.
Proposed Rule 2C, Section 7 (Clearing Fund Obligations)
Section 7 of proposed Rule 2C would set forth the Clearing Fund
obligations.
Section 7(a) of proposed Rule 2C would provide that NSCC shall
maintain a ledger maintained on the books and records of NSCC for a
Sponsoring Member that reflects the outstanding SFTs that a Sponsoring
Member enters into in respect of a Sponsored Member and that have been
novated to NSCC, the SFT Positions or SFT Cash associated with those
transactions and any debits or credits of cash associated with such
transactions effected pursuant to Rule 12 (Settlement) (each a
``Sponsored Member Sub-Account''). Each Sponsoring Member shall make
and maintain so long as such Member is a Sponsoring Member a deposit to
the Clearing Fund as a Required Fund Deposit to support the activity in
its Sponsored Member Sub-Accounts (the ``Sponsoring Member Required
Fund Deposit''). Deposits to the Clearing Fund would be held by NSCC or
its designated agents, to be applied as provided in the Rules.
Section 7(b) of proposed Rule 2C would provide that, in the
ordinary course, for purposes of satisfying the Sponsoring Member's
Clearing Fund requirements under the Rules for its Member activity, its
Sponsoring Member activity, and, to the extent applicable, its Agent
Clearing Member activity, the Sponsoring Member's proprietary accounts,
its Sponsored Member Sub-Accounts, and its Agent Clearing Member
Customer Omnibus Account(s), if any, shall be treated separately, as if
they were accounts of separate entities. Notwithstanding the previous
sentence, however, NSCC may, in its sole discretion, at any time and
without prior notice to the Sponsoring Member (but being obligated to
give notice to the Sponsoring Member as soon as possible thereafter)
and whether or not the Sponsoring Member or any of its Sponsored
Members is in default of its obligations to NSCC, treat the Sponsoring
Member's accounts as a single account for the purpose of applying
Clearing Fund deposits; apply Clearing Fund deposits made by the
Sponsoring Member with respect to any account as necessary to ensure
that the Sponsoring Member meets all of its obligations to NSCC under
any other account(s); and otherwise exercise all rights to offset and
net against the Clearing Fund deposits any net obligations among any or
all of the accounts, whether or not any other Person is deemed to have
any interest in such account.\62\
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\62\ NSCC believes it unlikely that it would exercise this
authority, as the Clearing Fund deposits associated with each
Sponsored Member Sub-Account, Agent Clearing Member Customer Omnibus
Account and proprietary account of a Sponsoring Member are designed
to be sufficient to cover the obligations of such account or sub-
account. However, if a Sponsoring Member defaults or fails to
perform and the Clearing Fund deposits associated with a given
account or sub-account of such Sponsoring Member are not sufficient
to discharge the Sponsoring Member's obligations in relation to such
account or sub-account, NSCC would look to the Clearing Fund
deposits related to the Sponsoring Member's other accounts or sub-
accounts. For example, if NSCC ceased to act for a Sponsoring Member
and the close-out of the SFT Positions established in the Sponsoring
Member's Sponsored Member Sub-Accounts resulted in a loss to NSCC in
excess of the Clearing Fund previously posted by the Sponsoring
Member in relation to such SFT Positions, NSCC may apply to the
excess any other Clearing Fund deposits posted by the Sponsoring
Member to NSCC, such as Clearing Fund posted in connection with the
proprietary positions of the Sponsoring Member. Similarly, if a
Sponsoring Member failed to perform under the Sponsoring Member
Guaranty outside the context of a cease-to-act situation and the
Clearing Fund previously posted by the Sponsoring Member in relation
to the SFT Positions established in the Sponsoring Member's
Sponsored Member Sub-Accounts was not sufficient to satisfy the
obligations under the Sponsoring Member Guaranty, NSCC may apply to
the remainder any other Clearing Fund deposits posted by the
Sponsoring Member to NSCC.
NSCC believes this is appropriate because the Clearing Fund
deposits of a Sponsoring Member are the proprietary assets of the
Sponsoring Member, and NSCC generally has the right to apply the
Clearing Fund deposits of a Member to any of the Member's
obligations to NSCC, regardless of whether those were the
obligations that generated the Clearing Fund deposit requirement.
NSCC therefore believes that, consistent with the FICC Sponsoring
Member/Sponsored Member Program for the reasons described above in
Item II(B)(iii) ``Sponsoring Members and Sponsored Members,'' a
Sponsoring Member's Clearing Fund deposits should be available to
satisfy any of the Sponsoring Member's guaranty or other obligations
to NSCC.
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Section 7(c) of proposed Rule 2C would provide that the Sponsoring
Member Required Fund Deposit for each Sponsored Member Sub-Account
shall be calculated separately based on the Sponsored Member
Transactions in such Sponsored Member Sub-Account, and the Sponsoring
Member shall, as principal, be required to satisfy the Sponsoring
Member Required Fund Deposit for each of the Sponsoring Member's
Sponsored Member Sub-Accounts.
Section 7(d) of proposed Rule 2C would provide that Sections 1, 2,
4, 5, 6, 7, 8, 9, 10, 11 and 12 of Rule 4 (Clearing Fund) shall apply
to the Sponsoring Member Required Fund Deposit with respect to
obligations of a Sponsoring Member under the Rules, including its
obligations arising under the Sponsored Member Sub-Accounts, and the
obligations of a Sponsoring Member under its Sponsoring Member Guaranty
to the same extent as such sections apply to any Required Fund Deposit
and any other obligations of a Member. For purposes of Section 1 of
Rule 4, obligations and liabilities of a Member to NSCC that shall be
secured shall include, without limitation, a Member's obligations as a
Sponsoring Member under the Rules, including, without limitation, any
obligation of any such Sponsoring Member to provide the Sponsoring
Member Required Fund Deposit, such Sponsoring Member's obligations
arising under the Sponsored Member Sub-Accounts of such Sponsoring
Member and such Sponsoring Member's obligations under its Sponsoring
Member Guaranty.
Section 7(e) of proposed Rule 2C would provide that a Sponsoring
Member shall be subject to such fines as may be imposed in accordance
with the Rules for any late satisfaction of a Clearing Fund deficiency
call.
[[Page 44545]]
Proposed Rule 2C, Section 8 (Right of Offset)
Section 8 of proposed Rule 2C would provide that in the ordinary
course, with respect to satisfaction of any Sponsored Member's
obligations under the Rules, the Sponsoring Member's Sponsored Member
Sub-Accounts, the Sponsoring Member's proprietary accounts, and the
Sponsoring Member's Agent Clearing Member Customer Omnibus Accounts, if
any, at NSCC shall be treated separately, as if they were accounts of
separate entities. Notwithstanding the previous sentence, however, NSCC
may, in its sole discretion, at any time any obligation of the
Sponsoring Member arises under the Sponsoring Member Guaranty to pay or
perform thereunder with respect to any Sponsored Member, exercise a
right of offset and net any such obligation of the Sponsoring Member
under its Sponsoring Member Guaranty against any obligations of NSCC to
the Sponsoring Member in respect of such Sponsoring Member's
proprietary accounts at NSCC.\63\ NSCC would generally anticipate
exercising this right if, upon a Sponsoring Member default, the
Sponsoring Member owed an amount under the Sponsoring Member Guaranty
and was owed an amount by NSCC in relation to the Sponsoring Member's
proprietary or other obligations.
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\63\ NSCC believes the most likely circumstance in which it
would exercise this authority would be in the context of a
Sponsoring Member default. If, in such circumstance, NSCC realizes a
profit in closing out the positions associated with a proprietary
account of the Sponsoring Member, but incurs a loss in closing out
the positions associated with the Sponsored Member Sub-Accounts of
the Sponsoring Member, it would offset its obligation to turn over
to the Sponsoring Member the gains in relation to the Sponsoring
Member's proprietary account against the obligations of the
Sponsoring Member under the Sponsoring Member Guaranty.
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Proposed Rule 2C, Section 9 (Loss Allocation Obligations)
Section 9 of proposed Rule 2C would establish loss allocation
obligations under the sponsored membership model.
Section 9(a) of proposed Rule 2C would provide that Sponsored
Members shall not be obligated for allocations, pursuant to Rule 4
(Clearing Fund), of loss or liability incurred by NSCC. To the extent
that a loss or liability is determined by NSCC to arise in connection
with Sponsored Member Transactions (i.e., in connection with the
insolvency or default of a Sponsoring Member), the Sponsored Members
shall not be responsible for or considered in the loss allocation
calculation, but rather such loss shall be allocated to other Members
in accordance with the principles set forth in Section 4 of Rule 4.
Section 9(b) of proposed Rule 2C would provide that, to the extent
NSCC incurs a loss or liability from a Defaulting Member Event or a
Declared Non-Default Loss Event and a loss allocation obligation
arises, that would be the responsibility of a Sponsored Member Sub-
Account as if the Sponsored Member Sub-Account were a Member, NSCC
shall calculate such loss allocation obligation as if the affected
Sponsored Member were subject to such allocations pursuant to Section 4
of Rule 4, but the Sponsoring Member shall be responsible for
satisfying such obligations.
Section 9(c) of proposed Rule 2C would provide that the entire
amount of the Required Fund Deposit associated with the Sponsoring
Member's proprietary accounts at NSCC and the entire amount of the
Sponsoring Member Required Fund Deposit may be used to satisfy any
amount allocated against a Sponsoring Member, whether in its capacity
as a Member, a Sponsoring Member, or otherwise. With respect to an
obligation to make payment due to any loss allocation amounts assessed
on a Sponsoring Member pursuant to Section 9(b) of proposed Rule 2C,
the Sponsoring Member may instead elect to terminate its membership in
NSCC pursuant to Section 6 of Rule 4 and thereby benefit from its Loss
Allocation Cap pursuant to Section 4 of Rule 4; however, for the
purpose of determining the Loss Allocation Cap for such Sponsoring
Member, its Required Fund Deposit shall be the sum of its Required Fund
Deposits associated with its proprietary accounts at NSCC (including
its proprietary SFT Account (as defined below and in the proposed rule
change) pursuant to proposed Rule 56), its Sponsoring Member Required
Fund Deposit, and its Agent Clearing Member Required Fund Deposits, if
any, for each of its Agent Clearing Member Customer Omnibus Accounts.
Proposed Rule 2C, Section 10 (Restrictions on Access to Services by a
Sponsoring Member)
Section 10 of proposed Rule 2C would establish the rights of NSCC
to restrict a Sponsoring Member's access to NSCC's services.
Section 10(a) of proposed Rule 2C would provide that the Board of
Directors may at any time, upon NSCC providing notice to a Sponsoring
Member pursuant to Section 5 of Rule 45 (Notices), suspend a Sponsoring
Member in its capacity as a Sponsoring Member from any service provided
by NSCC either with respect to a particular transaction or transactions
or with respect to transactions generally or prohibit or limit such
Sponsoring Member's access to services offered by NSCC in the event
that one or more of the factors set forth in Section 1 of Rule 46
(Restrictions on Access to Services) is present with respect to the
Sponsoring Member.
Section 10(b) of proposed Rule 2C would provide that Rule 46 shall
apply with respect to a Sponsoring Member in the same way as it applies
to Members, including the Board of Directors' right to summarily
suspend the Sponsoring Member and to cease to act for such Sponsoring
Member. As under Rule 46, the Board of Directors would need to make the
determination of whether to suspend, prohibit or limit a Sponsoring
Member's access to services offered by NSCC on the basis of the factors
set forth in that rule.
Section 10(c) of proposed Rule 2C would provide that if NSCC ceases
to act for a Sponsoring Member in its capacity as a Sponsoring Member,
Section 14 of proposed Rule 56 shall apply and NSCC shall decline to
accept or process data from the Sponsoring Member on Sponsored Member
Transactions and NSCC shall cease to act for all of the Sponsored
Members of the affected Sponsoring Member (unless such Sponsored
Members are also Sponsored Members of other Sponsoring Members).
Section 10(c) would also provide that if NSCC suspends, prohibits or
limits a Sponsoring Member in its capacity as a Sponsoring Member with
respect to such Sponsoring Member's access to services offered by NSCC,
NSCC shall decline to accept or process data from the Sponsoring Member
on Sponsored Member Transactions and shall suspend the Sponsored
Members of the affected Sponsoring Member (unless they are also
Sponsored Members of other Sponsoring Members) for so long as NSCC is
suspending, prohibiting or limiting the Sponsoring Member. Any
Sponsored Member Transactions which have been novated to NSCC shall
continue to be processed by NSCC. In addition, Section 10(c) would
provide that NSCC, in in sole discretion, shall determine whether to
close-out the affected Sponsored Member Transactions or permit the
Sponsored Members to complete their settlement.
This is different from how NSCC would treat Agent Clearing Member
Transactions of an Agent Clearing Member under Section 9 of proposed
Rule 2D if NSCC ceased to act for the Agent Clearing Member.
Specifically,
[[Page 44546]]
for Agent Clearing Member Transactions, as proposed, NSCC would close-
out any Agent Clearing Member Transactions which have been novated to
NSCC; however, with respect to Sponsored Member Transactions,
consistent with FICC's Sponsoring Member/Sponsored Member Program for
the reasons described above in Item II(B)(iii) ``Sponsoring Members and
Sponsored Members,'' NSCC would have the option to either terminate or
settle a Sponsored Member's novated positions after ceasing to act for
the Sponsoring Member. NSCC would have the practical and legal
capability to make such an election because each Sponsored Member would
be a limited-purpose member of NSCC. Accordingly, NSCC would have the
requisite information about each of the Sponsored Member's novated
positions (by virtue of each Sponsored Member's novated portfolio
represented as a different sub-account of the Sponsoring Member (i.e.,
Sponsored Member Sub-Account) on the books and records of NSCC) to make
such an election. By contrast, an Agent Clearing Member's Customers
would not be limited-purpose members of NSCC nor would NSCC know which
transactions within an Agent Clearing Member Customer Omnibus Account
belong to which Customers. As such, NSCC would not be able to
separately terminate or complete settlement with respect to Customers'
novated positions.
Proposed Rule 2C, Section 11 (Restrictions on Access to Services by a
Sponsored Member)
Section 11 of proposed Rule 2C would establish the rights of NSCC
to restrict a Sponsored Member's access to NSCC's services.
Section 11(a) of proposed Rule 2C would provide that the Board of
Directors may at any time upon NSCC providing notice to a Sponsored
Member and its Sponsoring Member pursuant to Section 5 of Rule 45
(Notices), suspend a Sponsored Member from any service provided by NSCC
either with respect to a particular transaction or transactions or with
respect to transactions generally, or prohibit or limit such Sponsored
Member with respect to access to services offered by NSCC in the event
that one or more of the factors set forth in Section 1 of Rule 46
(Restrictions on Access to Services) is present with respect to the
Sponsored Member.
Section 11(b) of proposed Rule 2C would provide that Rule 46 shall
apply with respect to a Sponsored Member in the same way as it applies
to Members, including the Board of Directors' right to summarily
suspend a Sponsored Member and to cease to act for such Sponsored
Member. As under Rule 46, the Board of Directors would need to make the
determination of whether to suspend, prohibit or limit a Sponsored
Member's access to services offered by NSCC on the basis of the factors
set forth in that rule.
Section 11(c) of proposed Rule 2C would provide that if NSCC ceases
to act for a Sponsored Member, Section 14 of proposed Rule 56 shall
apply.
Section 11(d) of proposed Rule 2C would provide that NSCC shall
cease to act for a Sponsored Member that is no longer in compliance
with the requirements of Section 3(a) of proposed Rule 2C.
Proposed Rule 2C, Section 12 (Insolvency of a Sponsoring Member)
Section 12(a) of proposed Rule 2C would provide that a Sponsoring
Member shall be obligated to immediately notify NSCC that (a) it fails,
or is unable, to perform its contracts or obligations or (b) it is
insolvent, as required by Section 1 of Rule 20 (Insolvency) for other
Members. A Sponsoring Member shall be treated by NSCC in all respects
as insolvent under the same circumstances set forth in Section 2 of
Rule 20 for other Members. Section 3 of Rule 20 shall apply, in the
same manner in which such section applies to other Members, in the case
where NSCC treats a Sponsoring Member as insolvent.
Section 12(b) of proposed Rule 2C would provide that in the event
that NSCC determines to treat a Sponsoring Member as insolvent pursuant
to Rule 20 (Insolvency), NSCC shall have the right to cease to act for
the insolvent Sponsoring Member pursuant to Section 10 of the proposed
Rule 2C. If NSCC ceases to act for the insolvent Sponsoring Member,
NSCC shall decline to accept or process data from the Sponsoring
Member, including Sponsored Member Transactions, and NSCC shall
terminate the membership of all of the insolvent Sponsoring Member's
Sponsored Members unless they are the Sponsored Members of another
Sponsoring Member. Any Sponsored Member Transactions which have been
novated to NSCC shall continue to be processed by NSCC. NSCC, in its
sole discretion, shall determine whether to close-out the affected
Sponsored Member Transactions and/or permit the Sponsored Members to
complete their settlement. This is different from how NSCC would treat
Agent Clearing Member Transactions. As described above, NSCC would
close-out any Agent Clearing Member Transactions which have been
novated to NSCC. However, with respect to Sponsored Member
Transactions, consistent with FICC's Sponsoring Member/Sponsored Member
Program for the reasons described above in Item II(B)(iii) ``Sponsoring
Members and Sponsored Members,'' NSCC would have the option to either
terminate or settle a Sponsored Member's novated positions after
ceasing to act for the Sponsoring Member. This is because NSCC would
have the practical and legal capability to make such an election
because each Sponsored Member would be a limited-purpose member of
NSCC. Accordingly, NSCC would have the requisite information about each
of the Sponsored Member's novated positions (by virtue of each
Sponsored Member's novated portfolio represented as a different sub-
account of the Sponsoring Member (i.e., Sponsored Member Sub-Account)
on the books and records of NSCC) to make such an election. By
contrast, an Agent Clearing Member's Customers would not be limited-
purpose members of NSCC nor would NSCC know which transactions within
an Agent Clearing Member Customer Omnibus Account belong to which
Customers. As such, NSCC would not be able to separately terminate or
complete settlement with respect to Customers' novated positions.
Proposed Rule 2C, Section 13 (Insolvency of a Sponsored Member)
Section 13 of proposed Rule 2C would establish NSCC's rights in the
event of an insolvency of a Sponsored Member.
Section 13(a) of proposed Rule 2C would provide that a Sponsored
Member and its Sponsoring Member (to the extent it has knowledge
thereof) shall be obligated to immediately notify NSCC that the
Sponsored Member is insolvent or that the Sponsored Member would be
unable to perform any of its material contracts, obligations or
agreements in the same manner as required by Section 1 of Rule 20
(Insolvency) for other Members. For purposes of Section 13 of proposed
Rule 2C, a Sponsoring Member shall be deemed to have knowledge that a
Sponsored Member is insolvent or would be unable to perform on any of
its material contracts, obligations or agreements if one or more duly
authorized representatives of the Sponsoring Member, in its capacity as
such, has knowledge of such matters. A Sponsored Member shall be
treated by NSCC in all respects as insolvent under the same
circumstances set forth in Section 2 of Rule 20 for other Members.
Section 3 of Rule 20 shall apply, in the same manner in which such
section
[[Page 44547]]
applies to other Members, in the case where NSCC treats a Sponsored
Member as insolvent.
Section 13(b) of proposed Rule 2C would provide that in the event
that NSCC determines to treat a Sponsored Member as insolvent pursuant
to Rule 20 (Insolvency), NSCC shall have the right to cease to act for
the insolvent Sponsored Member pursuant to Section 11 of the proposed
Rule 2C. If NSCC ceases to act for the insolvent Sponsored Member,
Section 14 of proposed Rule 56 shall apply with respect to the close-
out of the insolvent Sponsored Member's Sponsored Member Transactions.
Proposed Rule 2C, Section 14 (Liquidation of Sponsored Member and
Related Sponsoring Member Positions)
Section 14 of proposed Rule 2C would provide a mechanism by which a
Sponsoring Member may cause the termination and liquidation of a
Sponsored Member's positions arising from Sponsored Member Transactions
between the Sponsoring Member and its Sponsored Member that have been
novated to NSCC. Specifically, in the event (i) the Sponsoring Member
triggers the termination of a Sponsored Member's positions or (ii) NSCC
ceases to act for the Sponsored Member and the Sponsoring Member does
not continue to perform the obligations of the Sponsored Member, both
the Sponsored Member's positions and the Sponsoring Member's
corresponding positions arising from the Sponsored Member Transactions
between the Sponsoring Member and the Sponsored Member would be
terminated. Thereupon, the Sponsoring Member would calculate a net
liquidation value of such terminated positions, which liquidation value
would be paid either to or by the Sponsored Member by or to the
Sponsoring Member. NSCC would not, as a practical matter, be involved
in such settlement and would not need to take any market action because
the termination of the Sponsored Member's positions and the
corresponding Sponsoring Member's positions would leave NSCC flat.
Additionally, the Sponsoring Member would indemnify NSCC for any claim
by a Sponsored Member arising out of the Sponsoring Member's
calculation of the net liquidation value.
Section 14(a) of proposed Rule 2C would specify the scope of
positions to which Section 14 of proposed Rule 2C applies. It would
state that Section 14 only applies with respect to the liquidation of
positions resulting from Sponsored Member Transactions that have been
novated to NSCC.
Section 14(a) of proposed Rule 2C would further state that such
section would only apply if (i) a Sponsoring Member is a Defaulting
Member and NSCC has not ceased to act for the Sponsoring Member and
(ii) a Corporation Default has not occurred. This is because, as
described above in Section 12(b) of proposed Rule 2C, NSCC would have
discretion in the event it ceases to act for a Sponsoring Member to
close-out the positions of Sponsored Members for which the defaulting
Sponsoring Member was responsible or to allow them to settle. If NSCC
does close-out such positions, it would do so in accordance with
Section 14 of proposed Rule 56. If a Corporation Default has occurred
with respect to NSCC, each Sponsored Member's positions would be closed
out in accordance with Section 17 of proposed Rule 56.
Section 14(b) of proposed Rule 2C would set out the process by
which a Sponsoring Member or NSCC may cause the termination of a
Sponsored Member's positions. It would provide that on any Business
Day, the Sponsoring Member or NSCC may cause such termination by
delivering a notice to NSCC or the Sponsoring Member, respectively.
NSCC anticipates that each Sponsored Member and Sponsoring Member would
agree in the bilateral documentation between them as to what
circumstances or events give rise to the ability of the Sponsoring
Member to deliver a notice to NSCC terminating the Sponsored Member's
positions.\64\
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\64\ It bears noting in this regard that termination of the
Sponsored Member's positions would not be the exclusive mechanism by
which a Sponsoring Member may limit its credit risk. As described
above, under Section 2(m) of proposed Rule 2C, a Sponsoring Member
may voluntarily elect to terminate its status as a Sponsoring Member
in respect of one or more Sponsored Members. Such a termination
would not affect the settlement of the Sponsored Member's existing
positions but would restrict the ability of the Sponsored Member to
have its future trades accepted for novation by NSCC through such
Sponsoring Member. The proposed rule change in Section 14(b) of
proposed Rule 2C would not affect the functioning of the proposed
rule change in Section 2(m) of proposed Rule 2C or the general
ability of a Sponsoring Member and the Sponsored Member to agree on
the circumstances of when the Sponsoring Member may terminate its
status as Sponsoring Member for the Sponsored Member.
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The notice submitted by a Sponsoring Member to NSCC (or vice versa)
would cause the termination of all of the SFT Positions of the
Sponsored Member established in the Sponsored Member Sub-Account. The
notice would also cause the immediate termination of the corresponding
SFT Positions of the Sponsoring Member established in the Sponsoring
Member's proprietary SFT Account. The effect of such terminations would
be to leave NSCC flat.
Section 14(b) of proposed Rule 2C would also provide that the
termination of the Sponsored Member's positions (and the Sponsoring
Member's corresponding positions) would be effected by the Sponsoring
Member's establishment of a final net settlement position for each
eligible security with a distinct CUSIP number (``Final Net Settlement
Position'').
Section 14(c) of proposed Rule 2C would specify how the Final Net
Settlement Positions established pursuant to Section 14(b) of proposed
Rule 2C would be liquidated (i.e., how such positions would be
converted into an amount payable). It would also provide how the amount
payable arising from the liquidation of the Final Net Settlement
Positions would be discharged.
Specifically, Section 14(c) of proposed Rule 2C would first provide
that the Sponsoring Member would liquidate the Final Net Settlement
Positions established pursuant to Section 14(b) of proposed Rule 2C by
establishing (i) a single liquidation amount in respect of the
Sponsored Member's Final Net Settlement Positions (a ``Sponsored Member
Liquidation Amount'') and (ii) a single liquidation amount in respect
of the Sponsoring Member's Final Net Settlement Positions (a
``Sponsoring Member Liquidation Amount''). The Sponsored Member
Liquidation Amount would be owed either by NSCC to the Sponsored Member
or by the Sponsored Member to NSCC because it would relate to the
Sponsored Member's Final Net Settlement Positions with NSCC, while the
Sponsoring Member Liquidation Amount would be owed either by NSCC to
the Sponsoring Member or by the Sponsoring Member to NSCC because it
would relate to the Sponsoring Member's Final Net Settlement Positions
with NSCC.
Because the Final Net Settlement Positions of the Sponsoring Member
would be identical to, but in the opposite direction of, the Final Net
Settlement Positions of the Sponsored Member, the Sponsored Member
Liquidation Amount would equal the Sponsoring Member Liquidation
Amount. Therefore, if NSCC were to owe the Sponsored Member Liquidation
Amount to the Sponsored Member, the Sponsoring Member would owe the
Sponsoring Member Liquidation Amount to NSCC. By the same token, if the
Sponsored Member were to owe the Sponsored Member Liquidation Amount to
NSCC, NSCC would owe the Sponsoring Member the Sponsoring
[[Page 44548]]
Member Liquidation Amount. In all instances, NSCC would owe and be owed
the same amount of money.
Section 14(c) of proposed Rule 2C would also provide how the
Sponsoring Member may calculate the Sponsoring Member Liquidation
Amount. It would state that the Sponsoring Member may calculate the
Sponsoring Member Liquidation Amount based on prevailing market prices
of the relevant securities and/or the gains realized and losses
incurred by the Sponsoring Member in hedging its risk associated with
the liquidation of the Sponsoring Member's Final Net Settlement
Positions. Section 14(c) of proposed Rule 2C would further clarify that
such Sponsoring Member Liquidation Amount may also take into account
any losses and expenses incurred by the Sponsoring Member in connection
with the liquidation of the positions.
Section 14(c) of proposed Rule 2C would further provide that, if a
Sponsored Member Liquidation Amount is due to NSCC, the Sponsoring
Member would be obligated to pay such Sponsored Member Liquidation
Amount to NSCC under the Sponsoring Member Guaranty and that this
obligation would, automatically and without further action, be set off
against the obligation of NSCC to pay the corresponding Sponsoring
Member Liquidation Amount to the Sponsoring Member. By virtue of such
setoff, the Sponsored Member's obligation to NSCC would be discharged,
as would NSCC's obligation to the Sponsoring Member. The Sponsoring
Member would, however, have a reimbursement claim against the Sponsored
Member in an amount equal to the Sponsored Member Liquidation Amount.
This reimbursement claim would arise as a matter of law by virtue of
the Sponsoring Member's performance under Sponsoring Member Guaranty,
though Sponsoring Members and Sponsored Members may specify terms
related to the reimbursement claim in their bilateral submission. NSCC
would have no rights or obligations in respect of any such
reimbursement claim.
If a Sponsored Member Liquidation Amount were owed by NSCC to the
Sponsored Member, Section 14(c) of proposed Rule 2C would provide for
the Sponsoring Member to satisfy that obligation by transferring the
Sponsored Member Liquidation Amount to the Sponsoring Member's account
at its Settling Bank (``Sponsoring Member Settling Bank Omnibus
Account''). Section 14(c) of proposed Rule 2C would state that, to the
extent the Sponsoring Member makes such a transfer, it would discharge
NSCC's obligation to transfer the Sponsored Member Liquidation Amount
to the Sponsored Member and the Sponsoring Member's corresponding
obligation to transfer the Sponsoring Member Liquidation Amount to
NSCC.
Section 14(d) of proposed Rule 2C would provide for the Sponsoring
Member to indemnify NSCC and its employees, officers, directors,
shareholders, agents, and Members (collectively, the ``Sponsoring/
Sponsored Membership Program Indemnified Parties'' or ``SMP Indemnified
Parties'') for any and all losses, liability, or expenses arising from
any claim by an affected Sponsored Member disputing the Sponsoring
Member's calculation of any Sponsored Member Liquidation Amount or
Sponsoring Member Liquidation Amount.
Section 14(e) of proposed Rule 2C would provide that NSCC
acknowledges that a Sponsoring Member may take a security interest in
NSCC's obligations to a Sponsored Member in respect of its transactions
that have been novated to NSCC by such Sponsoring Member and
established in the Sponsoring Member's Sponsored Member Sub-Account for
the Sponsored Member. Such security interest would not impose new
obligations on NSCC but could allow the Sponsoring Member to direct
NSCC to submit payments due to the Sponsored Member to the Sponsoring
Member, so that the Sponsoring Member can apply such amounts to the
Sponsored Member's unsatisfied obligations to the Sponsoring Member.
(B) Proposed Rule 2D--Agent Clearing Members
NSCC is proposing to add Rule 2D, entitled ``Agent Clearing
Members.'' This new rule would govern the proposed agent clearing
membership and would be comprised of 12 sections, each of which is
described below.
Proposed Rule 2D, Section 1 (General)
Section 1 of proposed Rule 2D would be a general provision
regarding the Rules applicable to Agent Clearing Members.
Section 1 of proposed Rule 2D would provide that NSCC will permit a
Member that is approved to be an Agent Clearing Member to submit
transactions to NSCC for novation on behalf of one or more of the Agent
Clearing Member's Customers. Section 1 of proposed Rule 2D would
further provide that the rights, liabilities and obligations of Agent
Clearing Members shall be governed by proposed Rule 2D, and that
references to the term ``Member'' in other Rules would not apply to
Agent Clearing Members, in their respective capacities as such, unless
specifically noted as such in proposed Rule 2D or in such other Rules.
Section 1 of proposed Rule 2D would also provide that an Agent
Clearing Member shall continue to have all of the rights, liabilities
and obligations as set forth in the Rules and in any agreement between
it and NSCC pertaining to its status as a Member, and such rights,
liabilities and obligations shall be separate from its rights,
liabilities and obligations as an Agent Clearing Member except as
contemplated under Sections 6, 7 and 8 of proposed Rule 2D.
Proposed Rule 2D, Section 2 (Qualifications of Agent Clearing Members,
the Application Process and Continuance Standards)
Section 2 of proposed Rule 2D would establish the eligibility
requirements for Members that wish to become Agent Clearing Members,
the membership application process that would be required of each
Member to become an Agent Clearing Member, the on-going membership
requirements that would apply to Agent Clearing Members, as well as the
requirements regarding an Agent Clearing Member's election to
voluntarily terminate its membership.
Under Section 2(a) of proposed Rule 2D, any Member would be
eligible to apply to become an Agent Clearing Member; however, if a
Member is a Registered Broker-Dealer, such Member would only be
permitted to apply to become an Agent Clearing Member if it has (1) Net
Worth of at least $25 million and (2) excess net capital over the
minimum net capital requirement imposed by the Commission (or such
higher minimum capital requirement imposed by the Member's designated
examining authority) of at least $10 million.\65\ As proposed, NSCC may
[[Page 44549]]
require that a Person be a Member for a certain time period before that
Person may be considered to become an Agent Clearing Member.
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\65\ NSCC is proposing these financial minimums for Registered
Broker-Dealer Agent Clearing Member applicants to reflect the
additional responsibility that the applicant would undertake as an
Agent Clearing Member. These financial minimums are determined based
on NSCC's assessment of the minimum capital that would be necessary
for a broker-dealer to conduct meaningful level of NSCC-cleared
activity while serving as a credit counterparty in respect of
others' trades. In addition, NSCC is proposing these financial
minimums for Registered Broker-Dealer Agent Clearing Member
applicants to be consistent with proposed requirements applicable to
Registered Broker-Dealer Sponsoring Member applicants. NSCC believes
this approach to financial minimums is appropriate because both
Sponsoring Members and Agent Clearing Members would be viewed and
surveilled as the credit counterparties to NSCC in respect of the
transactions that they submit for clearing in respect of Sponsoring
Member Sub-Accounts and Agent Clearing Member Customer Omnibus
Accounts, respectively. Although the model of clearing would differ
as between Sponsoring Members and Agent Clearing Members, both would
be types of Members that would be standing behind the credit of
their clients. Accordingly, NSCC believes it is appropriate to use
consistent financial minimums.
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Section 2(b) of proposed Rule 2D would provide that each Member
applicant to become an Agent Clearing Member would be required to
provide an application and other information requested by NSCC. Agent
Clearing Member applications shall first be reviewed by NSCC and would
require the Board of Directors' approval, unless the Member applicant
is already a Sponsoring Member under proposed Rule 2C or a sponsoring
member of FICC. NSCC believes this approach to the Board of Directors'
approval for Agent Clearing Members is appropriate in light of the fact
that the critical components of the FICC sponsoring member applications
as well as the NSCC Agent Clearing Member and Sponsoring Member
applications and the criteria that the respective boards assess when
determining whether to admit a Member in such respective capacities are
substantially similar.
Under Section 2(c) of proposed Rule 2D, if the Agent Clearing
Member application is denied, such denial would be handled in
accordance with Section 1 of Rule 2A (Initial Membership Requirements).
As proposed in Section 2(d) of proposed Rule 2D, NSCC may impose
additional financial requirements on an Agent Clearing Member applicant
based upon the level of the anticipated positions and obligations of
such applicant, the anticipated risk associated with the volume and
types of transaction such applicant proposes to process through NSCC as
an Agent Clearing Member and the overall financial condition of such
applicant. Under the proposal, with respect to an application of a
Member to become an Agent Clearing Member that requires the Board of
Directors' approval, the Board of Directors shall also approve any
increased financial requirements imposed by NSCC in connection with the
approval of the application, and NSCC would thereafter regularly review
such Agent Clearing Member regarding its compliance with the increased
financial requirements.\66\
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\66\ If the increased financial requirements are imposed in
connection with an Agent Clearing Member application that does not
require the Board of Directors' approval, the increased financial
requirements would not be subject to the Board of Directors'
approval. Nonetheless, once an Agent Clearing Member application is
approved with increased financial requirements, NSCC would
thereafter regularly review such Agent Clearing Member regarding its
continued adherence to such increased financial requirements as well
as determine whether such increased financial requirements are still
appropriate. If the Agent Clearing Member is unable to adhere to the
increased financial requirements, the Board of Directors may,
pursuant to Section 9 of proposed Rule 2D, suspend, prohibit or
limit the Agent Clearing Member's access to NSCC's services.
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In addition, under Section 2(e) of proposed Rule 2D, NSCC may
require each Agent Clearing Member or any Agent Clearing Member
applicant to furnish adequate assurances of such Agent Clearing Member
or Agent Clearing Member applicant's financial responsibility and
operational capability within the meaning of Rule 15 (Assurances of
Financial Responsibility and Operational Capability), as NSCC may at
any time or from time to time deem necessary or advisable in order to
protect NSCC, its participants, creditors or investors, to safeguard
securities and funds in the custody or control of NSCC and for which
NSCC is responsible, or to promote the prompt and accurate clearance,
settlement and processing of securities transactions.\67\
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\67\ As an example, NSCC may require an Agent Clearing Member or
an Agent Clearing Member applicant to furnish adequate assurances of
such Agent Clearing Member or Agent Clearing Member applicant's
financial responsibility and operational capability if NSCC has
concerns about such Agent Clearing Member or Agent Clearing Member
applicant's overall financial health or credit rating.
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Section 2(f) of proposed Rule 2D would provide that each Member
whose Agent Clearing Member application is approved would sign and
deliver to NSCC an agreement between NSCC and the Member and specifies
the terms and conditions deemed by NSCC to be necessary in order to
protect itself and its participants (``Agent Clearing Member
Agreement'') and a related legal opinion in a form satisfactory to
NSCC.
Section 2(g) of proposed Rule 2D would provide that each Agent
Clearing Member shall submit to NSCC, within the timeframes and in the
formats required by NSCC, the reports and information that all Members
are required to submit regardless of type of Member and the reports and
information required to be submitted for its respective type of Member,
all pursuant to Section 2 of Rule 2B (Ongoing Membership Requirements
and Monitoring) and, if applicable, Addendum O (Admission of Non-US
Entities as Direct NSCC Members).
Section 2(h) of proposed Rule 2D would provide that an Agent
Clearing Member's books and records, insofar as they relate to the
Agent Clearing Member Transactions submitted to NSCC, shall be open to
the inspection of the duly authorized representatives of NSCC to the
same extent provided in Rule 2A (Initial Membership Requirements) for
other Members.
Section 2(i) of proposed Rule 2D would provide that an Agent
Clearing Member shall promptly inform NSCC, both orally and in writing,
if it is no longer in compliance with the relevant standards and
qualifications for applying to become an Agent Clearing Member set
forth in the proposed Rule 2D. Notification must take place immediately
and in no event later than 2 Business Days from the date on which the
Agent Clearing Member first learns of its non-compliance. As proposed,
NSCC would assess a fine in accordance with the Fine Schedule in
Addendum P against any Agent Clearing Member that fails to so notify
NSCC.\68\ If the Agent Clearing Member fails to remain in compliance
with the relevant standards and qualifications, NSCC would, if
necessary, undertake appropriate action to determine the status of the
Agent Clearing Member and its continued eligibility as such. In
addition, NSCC may review the financial responsibility and operational
capability of the Agent Clearing Member, and otherwise require from the
Agent Clearing Member additional reports of its financial or
operational condition at such intervals and in such detail as NSCC
shall determine. In addition, if NSCC has reason to believe that an
Agent Clearing Member may fail to comply with any of the Rules
applicable to Agent Clearing Members, it may require the Agent Clearing
Member to provide it, within such timeframe, and in such detail, and
pursuant to such manner as NSCC shall determine, with assurances in
writing of a credible nature that the Agent Clearing Member shall not,
in fact, violate any of the Rules.
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\68\ See Addendum P (Fine Schedule), supra note 4.
---------------------------------------------------------------------------
Section 2(j) of proposed Rule 2D would provide that in the event
that an Agent Clearing Member fails to remain in compliance with the
relevant requirements of the Rules or the Agent Clearing Member
Agreement, NSCC shall have the right to cease to act for the Agent
Clearing Member in its capacity as an Agent Clearing Member in
accordance with Section 9 of proposed Rule 2D or as a Member more
generally, unless the Agent Clearing Member requests that such action
not be taken and NSCC determines that, depending upon the specific
circumstances and the record of the Agent Clearing Member, it is
appropriate instead to establish for such Agent Clearing Member a time
period,
[[Page 44550]]
which shall be determined by NSCC and which shall be no longer than 30
calendar days unless otherwise determined by NSCC, during which the
Agent Clearing Member must resume compliance with such requirements. As
proposed, in the event that the Agent Clearing Member is unable to
satisfy such requirements within the time period specified by NSCC,
NSCC shall, pursuant to the Rules, cease to act for the Agent Clearing
Member in its capacity as an Agent Clearing Member pursuant to Section
9 of the proposed Rule 2D or as a Member more generally.
Section 2(k) of proposed Rule 2D would provide that if the sum of
the Volatility Charges applicable to an Agent Clearing Member's Agent
Clearing Member Customer Omnibus Account(s) and its other accounts at
NSCC exceeds its Net Member Capital, the Agent Clearing Member shall
not be permitted to submit activity into its Agent Clearing Member
Customer Omnibus Account(s), unless otherwise determined by NSCC in
order to promote orderly settlement.\69\ As proposed, an ``Agent
Clearing Member Customer Omnibus Account'' would mean a ledger
maintained on the books and records of NSCC that reflects the
outstanding Agent Clearing Member Transactions that an Agent Clearing
Member enters into on behalf of Customers and that have been novated to
NSCC, the SFT Positions or SFT Cash associated with those transactions,
and any debits or credits of cash associated with such transactions
effected pursuant to Rule 12 (Settlement).
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\69\ NSCC selected the Volatility Charges and Net Member Capital
as the criteria for purposes of establishing the activity limit for
Agent Clearing Members. This is because an Agent Clearing Member's
total Volatility Charges being in excess of its Net Member Capital
is an important indicator that the Agent Clearing Member's financial
resources, as measured by its Net Capital, net assets or equity
capital, may be insufficient to meet the largest component of its
Required Fund Deposit (i.e., Volatility Charges).
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Section 2(l) of proposed Rule 2D would provide that an Agent
Clearing Member may voluntarily elect to terminate its status as an
Agent Clearing Member by providing NSCC with a written notice from an
Agent Clearing Member to NSCC that the Agent Clearing Member is
voluntarily electing to terminate its status as an Agent Clearing
Member (``Agent Clearing Member Voluntary Termination Notice''). The
Agent Clearing Member shall specify in the Agent Clearing Member
Voluntary Termination Notice a desired date for such termination, which
date shall not be prior to the scheduled Final Settlement Date of any
remaining obligation owed by the Agent Clearing Member to NSCC as of
the time such Agent Clearing Member Voluntary Termination Notice is
submitted to NSCC, unless otherwise approved by NSCC.
Section 2(l) of proposed Rule 2D would also provide that such
termination would not be effective until accepted by NSCC, which shall
be no later than 10 Business Days after the receipt of the Agent
Clearing Member Voluntary Termination Notice from such Agent Clearing
Member. NSCC's acceptance shall be evidenced by a notice to NSCC's
participants announcing the termination of the Agent Clearing Member's
status as such and the date on which the termination of the Agent
Clearing Member's status as an Agent Clearing Member becomes effective
(``Agent Clearing Member Termination Date''). As proposed, after the
close of business on the Agent Clearing Member Termination Date, the
Agent Clearing Member shall no longer be eligible to submit Agent
Clearing Member Transactions. If any Agent Clearing Member Transaction
is submitted to NSCC by the Agent Clearing Member that is scheduled to
settle after the Agent Clearing Member Termination Date, such Agent
Clearing Member's Agent Clearing Member Voluntary Termination Notice
would be deemed void, and the Agent Clearing Member would remain
subject to the proposed Rule 2D as if it had not given such Agent
Clearing Member Voluntary Termination Notice.
Section 2(m) of proposed Rule 2D would provide that an Agent
Clearing Member's voluntary termination of its status as such shall not
affect its obligations to NSCC, or the rights of NSCC, with respect to
Agent Clearing Member Transactions submitted to NSCC before the
applicable Agent Clearing Member Termination Date. Any such Agent
Clearing Member Transactions that have been novated to NSCC shall
continue to be processed by NSCC. The return of the Agent Clearing
Member's Clearing Fund deposit shall be governed by Section 7 of Rule 4
(Clearing Fund). If an Event Period were to occur after an Agent
Clearing Member has submitted the Agent Clearing Member Voluntary
Termination Notice but on or prior to the Agent Clearing Member
Termination Date, in order for the Agent Clearing Member to benefit
from its Loss Allocation Cap pursuant to Section 4 of Rule 4, the Agent
Clearing Member would need to comply with the provisions of Section 6
of Rule 4 and submit a Loss Allocation Withdrawal Notice, which notice,
upon submission, shall supersede and void any pending Agent Clearing
Member Voluntary Termination Notice previously submitted by the Agent
Clearing Member.
Section 2(n) of proposed Rule 2D would provide that any non-public
information furnished to NSCC pursuant to proposed Rule 2D shall be
held in confidence as may be required under the laws, rules and
regulations applicable to NSCC that relate to the confidentiality of
records. Section 2(n) would also provide that each Agent Clearing
Member shall maintain DTCC Confidential Information in confidence to
the same extent and using the same means it uses to protect its own
confidential information, but no less than a reasonable standard of
care, and shall not use DTCC Confidential Information or disclose DTCC
Confidential Information to any third party except as necessary to
perform such Agent Clearing Member's obligations under the Rules or as
otherwise required by applicable law. Section 2(n) would further
provide that each Agent Clearing Member acknowledges that a breach of
its confidentiality obligations under the Rules may result in serious
and irreparable harm to NSCC and/or DTCC for which there is no adequate
remedy at law. In addition, Section 2(n) would provide that in the
event of such a breach by the Agent Clearing Member, NSCC and/or DTCC
shall be entitled to seek any temporary or permanent injunctive or
other equitable relief in addition to any monetary damages
thereunder.\70\
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\70\ Section 2(n) of proposed Rule 2D is designed to be
consistent with NSCC's proposed change to revise certain provisions
in the Rules relating to the confidentiality of information
furnished by participants. See Securities Exchange Act Release No.
92334 (July 7, 2021), 86 FR 36815 (July 13, 2021) (SR-NSCC-2021-
007).
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Proposed Rule 2D, Section 3 (Compliance With Laws)
Section 3 of proposed Rule 2D would provide that each Agent
Clearing Member shall comply in all material respects with all
applicable laws, including applicable laws relating to securities,
taxation and money laundering, as well as global sanctions laws, in
connection with the use of NSCC's services.
Proposed Rule 2D, Section 4 (Agent Clearing Member Transactions)
Section 4 of proposed Rule 2D would provide that an Agent Clearing
Member shall be permitted to submit to NSCC on behalf of one or more
Customers' Securities Financing Transactions (``Agent Clearing Member
[[Page 44551]]
Transactions'') in accordance with proposed Rule 56, as described
below.
Proposed Rule 2D, Section 5 (Agent Clearing Member Agent Obligations)
Section 5 of proposed Rule 2D would establish rules-based
obligations for Agent Clearing Members and the establishment of Agent
Clearing Member Customer Omnibus Accounts.
Section 5(a) of proposed Rule 2D would provide that an Agent
Clearing Member shall be permitted to submit to NSCC for novation Agent
Clearing Member Transactions entered into by the Agent Clearing Member
as agent on behalf of one or more Customers. Any such submission shall
be in accordance with proposed Rule 2D. As proposed, subject to the
provisions of the Rules, an Agent Clearing Member's clearing of Agent
Clearing Member Transactions for Customers (``Customer Clearing
Service'') may be provided by an Agent Clearing Member to its Customers
on any terms and conditions mutually agreed to by the Agent Clearing
Member and its Customers; provided, that each Agent Clearing Member
shall, before providing Customer Clearing Service to any Customer,
enter into an agreement with that Customer that binds the Customer to
the provisions of the Rules applicable to Agent Clearing Member
Transactions and Customers.
Section 5(b) of proposed Rule 2D would provide that, with respect
to an Agent Clearing Member that submits Agent Clearing Member
Transactions to NSCC for novation on behalf of its Customers, NSCC
shall maintain one or more Agent Clearing Member Customer Omnibus
Accounts in the name of the Agent Clearing Member for the benefit of
its Customers. Each Agent Clearing Member Customer Omnibus Account
would be permitted to contain only (i) SFTs entered into by the Agent
Clearing Member, on behalf of a Customer, as Transferor or (ii) SFTs
entered into by the Agent Clearing Member, on behalf of a Customer, as
a Transferee. An Agent Clearing Member would not be permitted to
combine SFTs entered into as Transferee and Transferor in the same
Agent Clearing Member Customer Omnibus Account. This is designed to
ensure that NSCC's volatility-based Clearing Fund deposit requirements
represent the sum of each individual Customer's activity (i.e., that
the positions are margined on a gross basis).\71\
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\71\ If an Agent Clearing Member were permitted to maintain SFTs
entered into as both Transferee and Transferor in the same Agent
Clearing Member Customer Omnibus Account, the Required Fund Deposit
obligations of the Agent Clearing Member could potentially be
reduced by offsetting SFT Positions of different Customers in the
same SFT Security.
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Section 5(c) of proposed Rule 2D would provide that an Agent
Clearing Member shall act solely as agent of its Customers in
connection with the clearing of Agent Clearing Member Transactions;
provided that the Agent Clearing Member shall remain fully liable for
the performance of all obligations to NSCC arising in connection with
Agent Clearing Member Transactions; and provided further, that the
liabilities and obligations of NSCC with respect to Agent Clearing
Member Transactions entered into by the Agent Clearing Member shall
extend only to the Agent Clearing Member. Section 5(c) of proposed Rule
2D would further provide that, without limiting the generality of the
foregoing, NSCC shall not have any liability or obligation arising out
of or with respect to any Agent Clearing Member Transaction to any
Customer on behalf of whom an Agent Clearing Member entered into the
Agent Clearing Member Transaction.
Section 5(d) of proposed Rule 2D would provide that nothing in the
Rules shall prohibit an Agent Clearing Member from seeking
reimbursement from a Customer for payments made by the Agent Clearing
Member (whether out of Clearing Fund deposits or otherwise) under the
Rules, or as otherwise may be agreed between the Agent Clearing Member
and the Customer.
Proposed Rule 2D, Section 6 (Clearing Fund Obligations)
Section 6 of proposed Rule 2D would set forth the Clearing Fund
obligations.
Section 6(a) of proposed Rule 2D would provide that NSCC shall
maintain one or more Agent Clearing Member Customer Omnibus Accounts
for an Agent Clearing Member. Each Agent Clearing Member shall make and
maintain so long as such Member is an Agent Clearing Member a deposit
to the Clearing Fund as a Required Fund Deposit to support the activity
in its Agent Clearing Member Customer Omnibus Account(s) (the ``Agent
Clearing Member Required Fund Deposit''). Deposits to the Clearing Fund
would be held by NSCC or its designated agents, to be applied as
provided in the Rules.
Section 6(b) of proposed Rule 2D would provide that, in the
ordinary course, for purposes of satisfying the Agent Clearing Member's
Clearing Fund requirements under the Rules for its Member activity, its
Agent Clearing Member activity, and, to the extent applicable, its
Sponsoring Member activity, the Agent Clearing Member's proprietary
accounts, its Agent Clearing Member Customer Omnibus Account(s), and
its Sponsored Member Sub-Accounts, if any, shall be treated separately,
as if they were accounts of separate entities. Notwithstanding the
previous sentence, however, NSCC may, in its sole discretion, at any
time and without prior notice to the Agent Clearing Member (but being
obligated to give notice to the Agent Clearing Member as soon as
possible thereafter) and whether or not the Agent Clearing Member is in
default of its obligations to NSCC, treat the Agent Clearing Member's
accounts as a single account for the purpose of applying Clearing Fund
deposits; apply Clearing Fund deposits made by the Agent Clearing
Member with respect to any account as necessary to ensure that the
Agent Clearing Member meets all of its obligations to NSCC under any
other account(s); and otherwise exercise all rights to offset and net
against the Clearing Fund deposits any net obligations among any or all
of the accounts, whether or not any other Person is deemed to have any
interest in such account.\72\
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\72\ NSCC believes this is appropriate because the Clearing Fund
deposits of an Agent Clearing Member are the proprietary assets of
the Agent Clearing Member and NSCC generally has the right to apply
the Clearing Fund deposits of a Member to any of the Member's
obligations to NSCC, regardless of whether those were the
obligations that generated the Clearing Fund deposit requirement.
NSCC therefore believes that, consistent with the FICC Sponsoring
Member/Sponsored Member Program for the reasons described above in
Item II(B)(iii) ``Sponsoring Members and Sponsored Members,'' an
Agent Clearing Member's Clearing Fund deposits should be available
to satisfy any of the Agent Clearing Member's obligations to NSCC.
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Section 6(c) of proposed Rule 2D would provide that the Agent
Clearing Member Required Fund Deposit for each Agent Clearing Member
Customer Omnibus Account shall be calculated separately based on the
Agent Clearing Member Transactions in such Agent Clearing Member
Customer Omnibus Account, and the Agent Clearing Member shall, as
principal, be required to satisfy the Agent Clearing Member Required
Fund Deposit for each of the Agent Clearing Member's Agent Clearing
Member Customer Omnibus Accounts.
Section 6(d) of proposed Rule 2D would provide that Sections 1, 2,
4, 5, 6, 7, 8, 9, 10, 11 and 12 of Rule 4 (Clearing Fund) shall apply
to the Agent Clearing Member Required Fund Deposit with respect to
obligations of an Agent Clearing Member under the Rules, including its
obligations arising under the Agent Clearing Member
[[Page 44552]]
Customer Omnibus Account(s), to the same extent as such sections apply
to any Required Fund Deposit and any other obligations of a Member. For
purposes of Section 1 of Rule 4, obligations and liabilities of a
Member to NSCC that shall be secured shall include, without limitation,
a Member's obligations as an Agent Clearing Member under the Rules,
including, without limitation, any obligation of any such Agent
Clearing Member to provide the Agent Clearing Member Required Fund
Deposit and such Agent Clearing Member's obligations arising under SFTs
established in the Agent Clearing Member Customer Omnibus Accounts of
such Agent Clearing Member.
Section 6(e) of proposed Rule 2D would provide that an Agent
Clearing Member shall be subject to such fines as may be imposed in
accordance with the Rules for any late satisfaction of a Clearing Fund
deficiency call.
Proposed Rule 2D, Section 7 (Right of Offset)
Section 7 of proposed Rule 2D would provide that in the ordinary
course, with respect to satisfaction of any Agent Clearing Member's
obligations under the Rules, the Agent Clearing Member's Agent Clearing
Member Customer Omnibus Accounts, the Agent Clearing Member's
proprietary accounts, and the Agent Clearing Member's Sponsored Member
Sub-Accounts, if any, at NSCC shall be treated separately, as if they
were accounts of separate entities. Notwithstanding the previous
sentence, however, NSCC may, in its sole discretion, at any time any
obligation of the Agent Clearing Member arises in respect of any Agent
Clearing Member Customer Omnibus Account, exercise a right of offset
and net any such obligation against any obligations of NSCC to the
Agent Clearing Member in respect of such Agent Clearing Member's
proprietary accounts at NSCC.
Proposed Rule 2D, Section 8 (Loss Allocation Obligations)
Section 8 of proposed Rule 2D would establish loss allocation
obligations for Agent Clearing Members.
Section 8(a) of proposed Rule 2D would provide that, to the extent
NSCC incurs a loss or liability from a Defaulting Member Event or a
Declared Non-Default Loss Event and a loss allocation obligation
arises, that would be the responsibility of the Agent Clearing Member
Customer Omnibus Account as if the Agent Clearing Member Customer
Omnibus Account were a Member, NSCC shall calculate such loss
allocation obligation and the Agent Clearing Member shall be, as
principal, responsible for satisfying such obligations.
Section 8(b) of proposed Rule 2D would provide that the entire
amount of the Required Fund Deposit associated with the Agent Clearing
Member's proprietary accounts at NSCC and the entire amount of the
Agent Clearing Member Required Fund Deposit may be used to satisfy any
amount allocated against an Agent Clearing Member, whether in its
capacity as a Member, an Agent Clearing Member, or otherwise. With
respect to an obligation to make payment due to any loss allocation
amounts assessed on an Agent Clearing Member pursuant to Section 8(a)
of proposed Rule 2D, the Agent Clearing Member may instead elect to
terminate its membership in NSCC pursuant to Section 6 of Rule 4 and
thereby benefit from its Loss Allocation Cap pursuant to Section 4 of
Rule 4; however, for the purpose of determining the Loss Allocation Cap
for such Agent Clearing Member, its Required Fund Deposit shall be the
sum of its Required Fund Deposits associated with its proprietary
accounts at NSCC (including its proprietary SFT Account pursuant to
proposed Rule 56), its Agent Clearing Member Required Fund Deposit for
each of its Agent Clearing Member Customer Omnibus Accounts, and its
Sponsoring Member Required Fund Deposit, if any.
Proposed Rule 2D, Section 9 (Restrictions on Access to Services by an
Agent Clearing Member)
Section 9 of proposed Rule 2D would establish the rights of NSCC to
restrict an Agent Clearing Member's access to NSCC's services.
Section 9(a) of proposed Rule 2D would provide that the Board of
Directors may at any time upon NSCC providing notice to an Agent
Clearing Member pursuant to Section 5 of Rule 45 (Notices), suspend an
Agent Clearing Member in its capacity as an Agent Clearing Member from
any service provided by NSCC either with respect to a particular
transaction or transactions or with respect to transactions generally,
or prohibit or limit such Agent Clearing Member's access to services
offered by NSCC in the event that one or more of the factors set forth
in Section 1 of Rule 46 (Restrictions on Access to Services) is present
with respect to the Agent Clearing Member.
Section 9(b) of proposed Rule 2D would provide that Rule 46 shall
apply with respect to an Agent Clearing Member in the same way as it
applies to Members, including the Board of Directors' right to
summarily suspend the Agent Clearing Member and to cease to act for
such Agent Clearing Member. As under Rule 46, the Board of Directors
would need to make the determination of whether to suspend, prohibit or
limit an Agent Clearing Member's access to services offered by NSCC on
the basis of the factors set forth in that rule.
Section 9(c) of proposed Rule 2D would provide that if NSCC ceases
to act for an Agent Clearing Member in its capacity as an Agent
Clearing Member, Section 14 of proposed Rule 56 shall apply and NSCC
shall decline to accept or process data from the Agent Clearing Member
on Agent Clearing Member Transactions and close-out any Agent Clearing
Member Transactions that have been novated to NSCC. Section 9(c) would
also provide that if NSCC suspends, prohibits or limits an Agent
Clearing Member in its capacity as an Agent Clearing Member with
respect to such Agent Clearing Member's access to services offered by
NSCC, NSCC shall decline to accept or process data from the Agent
Clearing Member on Agent Clearing Member Transactions for so long as
NSCC is suspending, prohibiting or limiting the Agent Clearing Member.
Furthermore, Section 9(c) would state that, in addition, NSCC would
close-out any Agent Clearing Member Transactions which have been
novated to NSCC.
This is different from how NSCC would treat Sponsored Member
Transactions of a Sponsoring Member under Section 10 of proposed Rule
2C if NSCC ceases to act for the Sponsoring Member. With respect to
such transactions, NSCC would have the option to either terminate or
settle a Sponsored Member's positions after ceasing to act for the
Sponsoring Member. The reason for this difference is that NSCC would
have the practical and legal capability to make such an election
because each Sponsored Member would be a limited-purpose member of
NSCC. Accordingly, NSCC would have the requisite information about each
of the Sponsored Member's novated positions (by virtue of each
Sponsored Member's novated portfolio represented as a different sub-
account of the Sponsoring Member (i.e., Sponsored Member Sub-Account)
on the books and records of NSCC) to make such an election. By
contrast, an Agent Clearing Member's Customers would not be limited-
purpose members of NSCC nor would NSCC know which transactions within
an Agent Clearing Member Customer Omnibus Account belong to which
Customers. As such, NSCC would not be able to separately terminate or
complete settlement with respect to Customer's novated positions.
[[Page 44553]]
Proposed Rule 2D, Section 10 (Insolvency of an Agent Clearing Member)
Section 10(a) of proposed Rule 2D would provide that an Agent
Clearing Member shall be obligated to immediately notify NSCC that (a)
it fails, or is unable, to perform its contracts or obligations or (b)
it is insolvent as required by Section 1 of Rule 20 (Insolvency) for
other Members. An Agent Clearing Member shall be treated by NSCC in all
respects as insolvent under the same circumstances set forth in Section
2 of Rule 20 for other Members. Section 3 of Rule 20 shall apply, in
the same manner in which such section applies to other Members, in the
case where NSCC treats an Agent Clearing Member as insolvent.
Section 10(b) of proposed Rule 2D would provide that in the event
that NSCC determines to treat an Agent Clearing Member as insolvent
pursuant to Rule 20 (Insolvency), NSCC shall have the right to cease to
act for the insolvent Agent Clearing Member pursuant to Section 9 of
proposed Rule 2D. If NSCC ceases to act for the insolvent Agent
Clearing Member, NSCC shall decline to accept or process data from the
Agent Clearing Member, including Agent Clearing Member Transactions. As
proposed, NSCC would close-out any Agent Clearing Member Transactions
which have been novated to NSCC.
This is different from how NSCC would treat Sponsored Member
Transactions. As described above, NSCC would have the option to either
terminate or settle a Sponsored Member's novated positions after
ceasing to act for the Sponsoring Member. However, with respect to
Agent Clearing Member Transactions, NSCC would close-out any such
transactions which have been novated to NSCC. This is because NSCC
would have the practical and legal capability to make such an election
with respect to Sponsored Member Transactions because each Sponsored
Member would be a limited-purpose member of NSCC. Accordingly, NSCC
would have the requisite information about each of the Sponsored
Member's novated positions (by virtue of each Sponsored Member's
novated portfolio represented as a different sub-account of the
Sponsoring Member (i.e., Sponsored Member Sub-Account) on the books and
records of NSCC) to make such an election. By contrast, an Agent
Clearing Member's Customers would not be limited-purpose members of
NSCC nor would NSCC know which transactions within an Agent Clearing
Member Customer Omnibus Account belong to which Customers. As such,
NSCC would not be able to separately terminate or complete settlement
with respect to Customers' novated positions.
Proposed Rule 2D, Section 11 (Transfer of Agent Clearing Member
Transactions in Agent Clearing Member Customer Omnibus Accounts)
Section 11 of proposed Rule 2D would (i) permit an Agent Clearing
Member, upon a default of a Customer and consent of NSCC, to transfer
Agent Clearing Member Transactions of the Customer established in one
or more of the Agent Clearing Member's Agent Clearing Member Customer
Omnibus Accounts from such Agent Clearing Member Customer Omnibus
Accounts to the Agent Clearing Member's proprietary account at NSCC as
a Member and (ii) govern how the transfer would be effectuated.
Section 11(a) of proposed Rule 2D would clarify the scope to which
Section 11 of proposed Rule 2D applies. It would state that Section 11
would not apply if either (i) the relevant Agent Clearing Member is a
Defaulting Member or (ii) a Corporation Default has occurred. This is
because, as described above with respect to Section 10(b) of proposed
Rule 2D, NSCC would close-out all Agent Clearing Member Transactions
for which the defaulting Agent Clearing Member was responsible. If a
Corporation Default has occurred with respect to NSCC, each Agent
Clearing Member's positions would be closed out in accordance with
Section 17 of proposed Rule 56.
Section 11(b) of proposed Rule 2D would set out the process by
which an Agent Clearing Member may transfer the Agent Clearing Member
Transactions of a defaulting Customer in one or more of Agent Clearing
Member's Agent Clearing Member Customer Omnibus Accounts. It would
provide that, to the extent permitted under applicable laws and
regulations, an Agent Clearing Member may, upon a default of a Customer
and the consent of NSCC, transfer the Agent Clearing Member
Transactions of the Customer established in one or more of the Agent
Clearing Member's Agent Clearing Member Customer Omnibus Accounts from
such Agent Clearing Member Customer Omnibus Accounts to the Agent
Clearing Member's proprietary account at NSCC as a Member. As proposed,
any such transfer shall occur by novation, such that the obligations
between NSCC and the relevant Customer in respect of the Agent Clearing
Member Transactions shall be terminated and replaced with identical
obligations between NSCC and the Agent Clearing Member, acting as
principal. Section 11(b) would also provide the Agent Clearing Member
shall indemnify NSCC, and its employees, officers, directors,
shareholders, agents, and Members, for any and all losses, liability,
or expenses incurred by them arising from, or in relation to, any such
transfer.
Proposed Rule 2D, Section 12 (Customer Acknowledgments)
Section 12 of proposed Rule 2D would provide that each Agent
Clearing Member on behalf of each of its Customers agrees that such
Customer, by participating in and entering into Agent Clearing Member
Transactions through the Agent Clearing Member, understands,
acknowledges, and agrees that: (a) The service provided by NSCC with
regard to the Customer Clearing Service would be subject to and
governed by the Rules; (b) the Rules shall govern the novation of Agent
Clearing Member Transactions and all transactions between the Customer
and its Agent Clearing Member resulting in the novation of such
transactions, and at the time of novation of an Agent Clearing Member
Transaction, the Customer on whose behalf it was submitted would be
bound by the Agent Clearing Member Transaction automatically and
without any further action by the Customer or by its Agent Clearing
Member, and the Customer agrees to be bound by the applicable
provisions of the Rules in all respects; (c) NSCC shall be under no
obligation to deal directly with the Customer, and NSCC may deal
exclusively with the Customer's Agent Clearing Member; (d) NSCC shall
have no obligations to the Customer with respect to any Agent Clearing
Member Transactions submitted by an Agent Clearing Member on behalf of
the Customer, including with respect to any payment or delivery
obligations; and (e) the Customer shall have no right to receive from
NSCC, or any right to assert a claim against NSCC with respect to, nor
shall NSCC be liable to the Customer for, any payment or delivery
obligation in connection with any Agent Clearing Member Transactions
submitted by an Agent Clearing Member on behalf of the Customer, and
NSCC shall make any such payments or redeliveries solely to the
relevant Agent Clearing Member.
(C) Proposed Rule 56--Securities Financing Transaction Clearing Service
NSCC is proposing to add Rule 56, entitled ``Securities Financing
Transaction Clearing Service.'' This new rule would govern the proposed
SFT
[[Page 44554]]
Clearing Service and would be comprised of 18 sections, each of which
is described below.
In connection with the proposed SFT Clearing Service, NSCC is
proposing to add the following terms and definitions, as described
below.
The term ``Aggregate Net SFT Close-out Value'' would mean, with
respect to an SFT Member, the sum of the SFT Close-out Value (as
defined below and in the proposed rule change) for each SFT Position to
which the SFT Member is a party.
The term ``Approved SFT Submitter'' would mean a provider of
transaction data on an SFT that the parties to the SFT have selected
and NSCC has approved, subject to such terms and conditions as to which
the Approved SFT Submitter and NSCC may agree.
The term ``Bilaterally Initiated SFT'' would mean an SFT, the
Initial Settlement of which occurred prior to the submission of such
SFT to NSCC.
The term ``Buy-In Amount'' would mean a net amount equal to (x) the
Buy-In Costs or Deemed Buy-In Costs (as defined below and in the
proposed rule change) of the SFT Securities in respect of which a
Transferor has effected a Buy-In, less (y) the amount of the SFT Cash
for the relevant SFT (unless the Transferor effected a Buy-In in
respect of some, but not all, of the SFT Securities that are the
subject of the SFT, in which case (y) shall be the amount of the
Corresponding SFT Cash (as defined below and in the proposed rule
change)).
The term ``Contract Price'' would mean, with respect to SFT
Securities subject to an SFT, the price of such securities at the time
the SFT is submitted to NSCC for novation, which price shall be
determined by the SFT Member parties to the relevant SFT and provided
by an Approved SFT Submitter to NSCC in accordance with the
communication links, formats, timeframes and deadlines established by
NSCC for such purpose; provided that if no such price is provided by
the time required by NSCC, the ``Contract Price'' shall be the Current
Market Price of the SFT Securities.
The term ``Corresponding SFT Cash'' would mean (a) in respect of a
Recalled SFT (as defined below and in the proposed rule change) for
which a Transferor has effected a Buy-In in respect of some, but not
all, of the SFT Securities that are the subject of the SFT, the portion
of the SFT Cash for such SFT equal to the product of (i) the percentage
of the SFT Securities in respect of which the Transferor effected a
Buy-In and (ii) the SFT Cash of the SFT; and (b) in respect of a
Settling SFT which has a greater quantity of SFT Securities as its
subject than the corresponding Linked SFT, the portion of the SFT Cash
of the Settling SFT equal to the product of (i) the percentage of the
SFT Securities of the Settling SFT that the Linked SFT has as its
subject and (ii) the SFT Cash of the Settling SFT.
The term ``Deemed Buy-In Costs'' would mean the product of the
number of SFT Securities subject to the relevant Buy-In and the per-
share price therefor on the date of the Buy-In obtained from a
generally recognized source or the last bid quotation from such a
source at the most recent close of trading for the SFT Security.
The term ``Defaulting SFT Member'' would mean an SFT Member for
which NSCC has declined or ceased to act in accordance with Section 14
of proposed Rule 56, as described below.
The term ``Distribution'' would mean, with respect to any SFT
Security at any time, any cash payment of a
[…truncated; see source link]Indexed from Federal Register on August 12, 2021.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.