Notice2022-12009
Self-Regulatory Organizations; National Securities Clearing Corporation; Order Approving Proposed Rule Change To Introduce Central Clearing for Securities Financing Transaction Clearing Service
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
June 6, 2022
Issuing agencies
Securities and Exchange Commission
Full Text
<html>
<head>
<title>Federal Register, Volume 87 Issue 108 (Monday, June 6, 2022)</title>
</head>
<body><pre>
[Federal Register Volume 87, Number 108 (Monday, June 6, 2022)]
[Notices]
[Pages 34339-34345]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-12009]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-95011; File No. SR-NSCC-2022-003]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Order Approving Proposed Rule Change To Introduce Central
Clearing for Securities Financing Transaction Clearing Service
May 31, 2022.
I. Introduction
On March 28, 2022, National Securities Clearing Corporation
(``NSCC'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\
proposed rule change SR-NSCC-2022-003. The proposed rule change was
published for comment in the Federal Register on April 19, 2022.\3\ For
the reasons discussed below, the Commission is approving the proposed
rule change.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 94694 (April 12, 2022),
87 FR 23372 (April 19, 2022) (SR-NSCC-2022-003) (``Notice of
Filing''). NSCC also filed the proposal contained in the Proposed
Rule Change as advance notice SR-NSCC-2022-801 (``Advance Notice'')
with the Commission pursuant to Section 806(e)(1) of the Dodd-Frank
Wall Street Reform and Consumer Protection Act entitled the Payment,
Clearing, and Settlement Supervision Act of 2010 (``Clearing
Supervision Act''). 12 U.S.C. 5465(e)(1); 17 CFR 240.19b-4(n)(1)(i).
Notice of filing of the Advance Notice was published for comment in
the Federal Register on April 19, 2022. Securities Exchange Act
Release No. 94695 (April 12, 2022), 87 FR 23328 (April 19, 2022)
(SR-NSCC-2022-801). On May 27, 2022, the Commission published a
notice of no objection to the Advance Notice. Securities Exchange
Act Release No. 94998 (May 27, 2022). The proposal contained in the
Proposed Rule Change and the Advance Notice shall not take effect
until all regulatory actions required with respect to the proposal
are completed.
---------------------------------------------------------------------------
II. Description of the Proposed Rule Change
A. Overview of Proposal
NSCC proposes to expand its central counterparty (``CCP'') services
to include securities financing transactions (``SFTs''), also referred
to generally as securities lending.\4\ SFTs are transactions in which a
securities lender loans securities to a securities borrower, for a fee.
The borrowers typically use the borrowed securities to cover short
sales or fails to deliver that may result from either short or long
sales.\5\ A lender typically lends securities to generate income
through the fees that it charges.
---------------------------------------------------------------------------
\4\ The Options Clearing Corporation (``OCC'') operates a stock
loan program as a CCP. NSCC's new service is similar to OCC's
service with one key difference: Unlike OCC's service, which only
covers transactions between OCC's direct members (i.e., broker to
broker), NSCC's new service would allow indirect participation by
buy-side clients. See Section II.B.(2).
\5\ A short sale is any sale of securities that a seller does
not own or has borrowed. See 17 CFR 242.200(a).
---------------------------------------------------------------------------
As a CCP, NSCC would interpose itself between the securities lender
and borrower and become the counterparty to each entity. NSCC would
then be obligated to complete the transaction, that is, to return
loaned securities to the lender and collateral to the borrower, even if
a lender or borrower in an SFT fails to satisfy its obligations,
thereby assuming the risk of each entity's failure to perform to each
other.
Specifically, NSCC would novate and guarantee SFTs that involve
eligible securities, meaning equity securities (including ETFs) cleared
at NSCC with a particular per share price, initially set at $5 or
greater. The service would be limited to overnight SFTs (i.e., with a
one business day term), with the ability for the parties to extend an
expiring SFT into a new transaction.
The SFT service would be available to existing NSCC members.\6\ In
addition, NSCC would create two new membership categories that would be
able to submit SFTs for central clearing: Sponsoring Members that would
sponsor institutional clients into NSCC and act as a principal to SFTs
with their clients, and Agent Clearing Members that submit SFTs on
behalf of institutional customers strictly as an agent. These two new
types of membership would allow the proposed service to meet the
existing market practices for SFTs, where different types of entities
employ different trading strategies and relationships to accommodate
their regulatory and other requirements.
---------------------------------------------------------------------------
\6\ Capitalized terms not defined herein are defined in the NSCC
Rules & Procedures (``Rules''), available at http://www.dtcc.com/~/
media/Files/Downloads/legal/rules/nscc_rules.pdf.
---------------------------------------------------------------------------
Consistent with its risk management for all other transactions in
equity securities, NSCC would collect margin from the lender and
borrower for
[[Page 34340]]
novated SFTs to address the credit risk arising from such transactions.
NSCC would also identify potential liquidity exposures if an SFT member
were to default and address that potential need in its risk management.
According to NSCC, the proposed SFT clearing service would provide
several benefits for market participants, including increased balance
sheet netting benefits, capital efficiency opportunities, and
mitigation of fire sale risk.\7\ With respect to balance sheet netting
benefits and capital efficiency opportunities, NSCC states that the SFT
clearing service may allow participants to net down payables and
receivables related to the SFTs on their balance sheets because such
payables and receivables have one counterparty, NSCC. In turn, NSCC
states that because of the capital requirements arising under Basel III
rules that favor a netted balance sheet,\8\ market participants may
reduce the amount of capital they are required to hold under the
applicable leverage requirements.\9\
---------------------------------------------------------------------------
\7\ See Notice of Filing, supra note 3, at 23372-73.
\8\ See 12 CFR 217.10(c)(4)(ii)(E)-(F).
\9\ The Basel III capital and leverage requirements, as
implemented by the U.S. banking regulators, mandate banks and
depository institutions to hold certain amounts of capital. See
generally, e.g., 12 CFR part 3; 12 CFR part 217; 12 CFR part 252,
subpart Q; 12 CFR part 324.
---------------------------------------------------------------------------
In addition, NSCC believes that the proposal would reduce the
potential for market disruption from fire sales for a number of
reasons.\10\ First, NSCC believes that it would be able to better
manage default scenarios by conducting a centralized and orderly
liquidation of the defaulter's SFT positions.\11\ NSCC represents that
a centralized and orderly liquidation would result in substantially
less price depreciation and market disruption compared to the multiple
independent non-defaulting parties racing against one another to
liquidate the positions. Second, NSCC would be able to liquidate the
defaulter's net positions instead of gross positions, meaning that a
position that needs to be liquidated would be smaller in size and a
market disruption can be minimized. Third, by guaranteeing SFTs through
central clearing, NSCC believes that it would be able to provide
confidence to market participants in a stressed market scenario,
thereby lessening any inclination to rush to unwind transactions.\12\
---------------------------------------------------------------------------
\10\ See Notice of Filing, supra note 3, at 23373.
\11\ Id.
\12\ Id.
---------------------------------------------------------------------------
B. Securities Financing Transaction Clearing Service
NSCC proposes to introduce central clearing for SFTs by
establishing rules governing (1) key aspects of the SFTs; (2) SFT
participant categories; and (3) SFT risk management, as elaborated
below.
(1) Key Aspects of the SFTs
Overnight SFTs. The proposed SFT clearing service would apply to
transactions with a one business day term (i.e., overnight SFTs) in
eligible equity securities. NSCC represents that the proposal applies
to overnight SFTs, as opposed to open SFTs, to offer balance sheet
netting and capital efficiency opportunities, which require a scheduled
settlement date.\13\ However, a lender and a borrower would have an
option to extend an expiring SFT by rolling it, or a portion thereof,
into a new, linked SFT. Accordingly, an expiring SFT would be eligible
for renewal every day.
---------------------------------------------------------------------------
\13\ See Notice of Filing, supra note 3, at 23374.
---------------------------------------------------------------------------
Operational Issues. SFTs would be required to be submitted to NSCC
on a locked-in basis and matched between the lender and the
borrower.\14\ NSCC would receive underlying SFT securities from a
lender, send them to a borrower, receive cash collateral equal to no
less than 100% of the market value of the securities from the borrower,
and send it to the lender.\15\
---------------------------------------------------------------------------
\14\ Specifically, the transaction data for an SFT must be
submitted by an entity that the parties have selected, which could
be either a member or a third-party vendor. The SFT members would
select which approved submitter to use, and NSCC would have to
approve any entity serving as an approved submitter.
\15\ To address regulatory and investment guideline requirements
applicable to certain institutional firms (e.g., Section 17(f) of
the Investment Company Act of 1940 and Rule 17f-2 thereunder), a
participant would be permitted to transfer an additional cash
haircut above 100% (e.g., 102%) to such institutional firms as part
of this initial settlement of the SFT.
---------------------------------------------------------------------------
When an SFT settles, in general, NSCC would essentially reverse the
transaction of the prior day by receiving the underlying SFT securities
from the borrower and returning them to the lender, and receiving the
cash collateral from the lender and returning it to the borrower. NSCC
would also pass through daily interest,\16\ as applicable. If the
parties decide to extend into a linked SFT, instead of transferring the
underlying securities and collateral, NSCC would transfer the daily
interest and calculate and pass through a mark-to-market payment on the
underlying securities, effectively putting the parties in a position of
closing the settling SFT and starting a new SFT.
---------------------------------------------------------------------------
\16\ NSCC refers to this daily interest as a ``Rate Payment.''
---------------------------------------------------------------------------
Eligible Equity Securities. As an initial matter, NSCC would
provide the proposed SFT service for securities that are eligible to be
processed through NSCC's Continuous Net Settlement (``CNS'')
System,\17\ and have a per share price of $5 or more.\18\ If the price
of the underlying securities of a novated SFT falls below the threshold
price established by NSCC, that SFT would continue to be novated to
NSCC, but the margin required for such SFT would be 100% of the market
value of such underlying securities until the per share price of the
underlying securities equals or exceeds the threshold price.
---------------------------------------------------------------------------
\17\ NSCC processes clearance and settlement of equity
securities using the CNS System. Securities are CNS-eligible if they
are eligible for book-entry transfer on the books of DTC, not
subject to certain transfer restrictions, and not subject to certain
corporate actions. NSCC, Disclosure Framework for Covered Clearing
Agencies and Financial Market Infrastructures (December 2021),
<a href="https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/NSCC_Disclosure_Framework.pdf">https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/NSCC_Disclosure_Framework.pdf</a>. (``NSCC Disclosure'').
NSCC would maintain a list of the securities that may underlie
an SFT that NSCC will accept. Such list would not be a rule but a
separate document maintained by NSCC and available to members,
consistent with NSCC's practice for equity securities. See Notice of
Filing, supra note 3, at 23375; Rule 3 (Lists to be Maintained) of
the Rules, supra note 6.
\18\ Notice of Filing, supra note 3, at 23375. NSCC selected $5
as the per share price minimum for underlying equity securities
because $5 is a common share price minimum adopted in brokerage
margin eligibility schedules. NSCC may modify the eligible equity
securities' minimum share price and would announce any such change
via notice to its members. See id.
---------------------------------------------------------------------------
Recall, Buy-In, and Accelerated Settlement. Consistent with the
existing bilateral market, NSCC proposes to introduce recall, buy-in,
and accelerated settlement features in its proposed SFT clearing
service. Under the proposal, a lender would have a right to recall an
existing SFT and stop the SFT from being extended.
Once a lender issues a recall notice, a borrower would be required
to satisfy its final settlement obligations by the recall date, which
would be the second business day following NSCC's receipt of such
notice. If the borrower fails to satisfy its final settlement
obligations by the recall date, the lender could go to the market to
conduct a buy-in in a commercially reasonable manner,\19\ that is, to
purchase some or all of securities equivalent to the underlying
securities that are the subject to the SFT and charge the borrower for
the cost of this purchase or to elect to be deemed to
[[Page 34341]]
have purchased such securities.\20\ Similar to a lender's recall right,
a borrower would have a right to accelerate the scheduled final
settlement of an SFT that has been novated to NSCC. NSCC states that
this right is required to ensure that certain borrowers would be able
to satisfy their regulatory requirements.\21\
---------------------------------------------------------------------------
\19\ After a buy-in, the lender would give written notice to
NSCC of its costs to purchase the relevant SFT securities or the
buy-in costs. NSCC would then transfer the costs from the borrower
to the lender, and the SFT would be closed.
\20\ NSCC states that the requirement that a party exercising
buy-in rights do so in a ``commercially reasonable manner'' is the
current industry standard, as reflected in the Master Securities
Loan Agreement published by Securities Industry and Financial
Markets Association. See Notice of Filing, supra note 3, at 23402;
Section 13.1 of the Master Securities Loan Agreement published by
Securities Industry and Financial Markets Association.
\21\ Specifically, NSCC states that borrowers may have the need
to accelerate settlement of securities lending transactions if they
lose a ``permitted purpose'' for such loans under Regulation T. See
12 CFR 220.1-220.12.
---------------------------------------------------------------------------
(2) SFT Participant Categories
The proposed SFT clearing service would be available for SFTs
entered into between two current NSCC members. In addition, NSCC
proposes new categories of membership that are designed to accommodate
current bilateral SFT arrangements.\22\
---------------------------------------------------------------------------
\22\ See Notice of Filing, supra note 3, at 23374.
---------------------------------------------------------------------------
First, the Sponsoring Member/Sponsored Member categories would
accommodate principal-style trades, in which a Sponsoring Member acting
as principal for its own account completes a Sponsored Member's trades
using its own inventory. Typically, in these types of arrangements, a
Sponsoring Member can earn a profit from the bid-ask spread differences
between its Sponsored Member trades and any offsetting trades.
Second, the Agent Clearing Member category would accommodate
transactions by firms who typically conduct trades on an agent basis
for their institutional clients. An Agent Clearing Member would arrange
a transaction on behalf of an institutional client and charge fees for
the services (rather than taking spreads).\23\ Such client firms may,
as part of their business models and agreed-upon investment guidelines,
only permit agented transactions, making the Agent Clearing Member a
better fit.
---------------------------------------------------------------------------
\23\ See Notice of Filing, supra note 3, at 23382.
---------------------------------------------------------------------------
According to NSCC, the costs of clearing that may be passed through
to the institutional clients, whether as Sponsored Members or as
clients to the Agent Clearing Members (``Customers''), by its
intermediary would be largely equivalent.\24\ However, one key
difference between Sponsored Members and Customers would be that
Sponsored Members would have a contractual relationship with NSCC while
the Agent Clearing Member's Customers would not. NSCC states that, from
the perspective of an institutional firm client, whether to become a
Sponsored Member or Customer to an Agent Clearing Member may be
determined based on who the client's current clearing intermediaries
are and the nature of the client's commercial arrangement with its
intermediaries.\25\ NSCC states that giving a choice to institutions to
become a Sponsored Member or Customer should facilitate additional
central clearing of SFTs.\26\
---------------------------------------------------------------------------
\24\ See id.
\25\ See Notice of Filing, supra note 3, at 23381-82.
\26\ See Notice of Filing, supra note 3, at 23374.
---------------------------------------------------------------------------
Sponsoring Members. All NSCC members would be eligible to apply to
become Sponsoring Members, so long as they meet the specified
requirements.\27\ For operational and administrative purposes, NSCC
would interact solely with the Sponsoring Member as the agent of its
Sponsored Members, and the Sponsoring Member would be responsible for
posting the required margin on Sponsored Member transactions and for
covering any default loss allocated to Sponsored Members.\28\
---------------------------------------------------------------------------
\27\ 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 certain financial requirements. 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, for example, for a new member that has yet to demonstrate a
track record of financial responsibility and operational capability.
Moreover, after becoming a Sponsoring Member, it would be obligated
to notify NSCC if it is no longer compliant with the relevant
standards and qualifications. NSCC would have a right to review the
financial responsibility and operational capability of Sponsoring
Members.
\28\ NSCC aggregates all members' margin together with certain
other deposits required under NSCC's Rules as its clearing fund.
NSCC would be able to access the clearing fund should a defaulted
member's own margin be insufficient to satisfy losses to NSCC caused
by the liquidation of that member's portfolio. See Rule 4 (Clearing
Fund) and Procedure XV (Clearing Fund Formula and Other Matters) of
the Rules, supra note 6.
---------------------------------------------------------------------------
Sponsoring Members would unconditionally guarantee to NSCC the
payment and performance of their Sponsored Members' 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 proposal, the Sponsoring Member would be required
to satisfy those settlement obligations on behalf of a Sponsored Member
if the Sponsored Member defaults and fails to perform its settlement
obligations. Moreover, Sponsoring Members would be subject to an
activity limit based on the perceived volatility of its portfolio as
compared to its capital.\29\
---------------------------------------------------------------------------
\29\ Specifically, if the sum of the margin charges applied by
NSCC to capture the risks related to market price movement
applicable to its Sponsored Member sub-accounts and its other
accounts at NSCC exceeds its required net assets or equity capital,
the Sponsoring Member would not be permitted to submit new Sponsored
Member transactions, unless otherwise determined by NSCC.
---------------------------------------------------------------------------
Sponsored Members. Sponsored Members would be required to be either
a qualified institutional buyer \30\ or a legal entity that satisfies
the financial requirements necessary to be a qualified institutional
buyer. Sponsored Members would enter into an agreement with NSCC
whereby Sponsored Members would agree to terms and conditions NSCC
identifies as necessary in order to protect NSCC and its members.
Sponsored Members would not be full-service NSCC members, but instead
would be limited members which rely on the Sponsoring Members to access
NSCC's services.
---------------------------------------------------------------------------
\30\ The term qualified institutional buyer is defined by Rule
144A under the Securities Act of 1933, as amended. See 17 CFR
230.144A.
---------------------------------------------------------------------------
A Sponsored Member would only be eligible to submit transactions in
which its respective Sponsoring Member is the counterparty (i.e.,
``done with'' transactions). However, a Sponsored Member can be
sponsored by more than one Sponsoring Member, should it wish to
continue to transact with different entities.
Agent Clearing Members. Agent Clearing Members would serve as agent
and credit intermediary for its institutional clients. Agent-style
trading is the manner in which such agent lenders are typically
approved to transact in securities lending transactions on behalf of
their Customers. All NSCC members would be eligible to apply to become
Agent Clearing Members in NSCC, so long as they meet the specified
requirements.
In addition, Agent Clearing Members would be subject to similar
responsibilities as Sponsoring Members. Specifically, an Agent Clearing
Member would be responsible for posting to NSCC the required margin for
its Customers' activity and covering any default loss allocable to its
Customers. Agent Clearing Member transactions would be subject to the
same activity limit applicable to Sponsored Member transactions.
An Agent Clearing Member would be fully liable for all obligations
of its Customers under the Agent Clearing Member transactions that it
submitted to
[[Page 34342]]
NSCC as the member.\31\ Unlike Sponsored Members, Customers would not
have any direct relationship with NSCC and would not need to apply to
become a member or enter into an agreement with NSCC. Moreover, the
Agent Clearing Members would be able to submit transactions with a
counterparty other than the Agent Clearing Member, resulting in
transactions ``done away'' from the Agent Clearing Member.
---------------------------------------------------------------------------
\31\ Like a Sponsoring Member, an Agent Clearing Member would be
obligated to notify NSCC if it is no longer in compliance with the
relevant standards and qualifications. NSCC would have a right to
review Agent Clearing Members' financial and operational capability.
---------------------------------------------------------------------------
(3) Risk Management
Under the proposal, NSCC would centrally manage risks associated
with SFTs in a manner consistent with other transactions in equity
securities that NSCC clears.
Calculation of Margin. NSCC would require all SFT members to
provide margin with respect to their SFT activity, subject to a
$250,000 minimum amount. NSCC is proposing to calculate an SFT member's
required margin by applying the methodology used to determine margin
for transactions in equity securities. Specifically, the determination
would include certain risk-based margin components \32\ that are
currently applicable to NSCC's equity securities transactions.
---------------------------------------------------------------------------
\32\ Specifically, it would include the volatility charge, mark-
to-market charge, special charge, margin required differential
component charge, coverage component charge, and margin liquidity
adjustment (``MLA'') charge set forth in NSCC's Rules, as well as
charges for non-returned SFTs, which is similar to the charges that
NSCC for CNS fails under its Rules. A further description of these
charges is available in Procedure XV of NSCC's Rules and in the NSCC
Disclosure. For the volatility charge, NSCC would consider the
potential future exposure of a given portfolio based on historical
price movements and the margin floor, and it would also determine
margin to address the risk due to a high concentration level in a
single stock (``gap risk''). For the MLA charge, NSCC would consider
the risk when a member's portfolio contains large net unsettled
positions in a particular group of securities with a similar risk
profile or in a particular asset type, which could pose particular
liquidation risk in the event of a default.
---------------------------------------------------------------------------
NSCC would determine an SFT member's required margin independently
of the member's other positions, including its equity securities
transaction positions outside of the SFTs. NSCC would not net a
member's SFT positions with its other positions to determine margin,
except for the margin liquidity adjustment charge component. Because
NSCC would aggregate all members' margins together as its clearing fund
\33\ regardless of whether they are for SFTs or CNS transactions, an
SFT or CNS member default may impact NSCC's clearing fund as a whole.
In other words, a default by an SFT member may impact non-SFT members
and vice versa.
---------------------------------------------------------------------------
\33\ See supra note 31.
---------------------------------------------------------------------------
NSCC would require that a certain portion of its margin be a
combination of cash and eligible securities, i.e., the specific
Treasury securities that NSCC accepts as collateral. NSCC would also
have the discretion to require an SFT member to post its margin in a
higher proportion of cash than would otherwise be required, based on
the current market conditions and the SFT member's financial and
operational capabilities.
For transactions submitted by Sponsoring Members or Agent Clearing
Members, NSCC would require that the Sponsoring Members and Agent
Clearing Members establish an account or accounts for the margin
collected on behalf of Sponsored Members and Customers, respectively.
This account would be separate from the Sponsoring Member or Agent
Clearing Member's proprietary account. NSCC would determine the
required margin for transactions for each Sponsored Member and Customer
on a gross basis, that is, separately without netting. The margin
obligated for a Sponsoring Member or Agent Clearing Member would be the
sum of the individual margin amounts determined for each Sponsored
Member and Customer to ensure that the total margin amount represents
the sum of each individual institutional client's activity.
Default Management. NSCC's proposed rules would specify the
procedures that it would use to centrally manage the default of that
member,\34\ including liquidating the underlying securities and meeting
the final settlement obligations. If there is an SFT member default,
NSCC would continue paying to and receiving from a non-defaulting SFT
member the difference in market value of the underlying securities with
respect to the novated SFTs until final settlement. By continuing to
process the difference in market value, NSCC would maintain the non-
defaulting SFT member in largely the same position as if the defaulting
SFT member has not defaulted.
---------------------------------------------------------------------------
\34\ NSCC would be able to take actions listed above when NSCC
``ceases to act'' for an SFT member. The factors NSCC would consider
in making the decision to cease to act include the member's
suspension from any regulatory organization, failure to make a
payment to NSCC, or other financial issues. See Rules 46
(Restrictions on Access to Service) and 18 (Procedures for When the
Corporation Ceases to Act) of the Rules, supra note 6.
---------------------------------------------------------------------------
In addition, in the event an SFT member defaults, NSCC would have
all the rights and obligations of the defaulting party, whether it was
the lender or borrower in relation to such default-related SFTs. For
example, if a borrower defaults, NSCC would assume all the rights of a
lender and the defaulting borrower, and be able to issue a recall
notice and conduct a buy-in in a commercially reasonable manner.\35\ On
the other hand, if a lender defaults, NSCC would be able to deliver a
recall notice to a borrower to stop the final settlement date of a
default-related SFT from being further delayed.
---------------------------------------------------------------------------
\35\ The proposal would specify that in the case of a default-
related SFT, the commercial reasonableness of a buy-in shall be
determined by NSCC based on whether such buy-in would create a
disorderly market in the relevant SFT security, consistent with the
applicable market standard. See supra note 20.
---------------------------------------------------------------------------
To the extent that an SFT default generates a loss larger than the
resources that the defaulter has provided to NSCC, i.e., its margin and
the proceeds from its liquidated portfolio, NSCC's loss allocation rule
would apply to all members including Sponsoring Members and Agent
Clearing Members.\36\
---------------------------------------------------------------------------
\36\ Specifically, under NSCC's loss allocation rule, NSCC would
use its own capital (referred to as the ``Corporate Contribution'')
and then allocate losses to members pro rata via rounds of cash
calls. See Rule 4 (Clearing Fund) of the Rules, supra note 6.
---------------------------------------------------------------------------
Liquidity Risk. The proposal also describes how NSCC manages
potential liquidity exposures arising from clearing SFT transactions.
Currently, NSCC is required to hold sufficient liquidity resources to
cover the largest settlement obligation stemming from the cleared CNS
positions, assuming a member default. Under the proposal, NSCC's
liquidity exposures would also include settlement obligation arising
from SFT positions. Specifically, the liquidity obligations relating to
SFT would include the daily market to market of the underlying
securities as well as any final cash settlement obligation owed by the
defaulting member.
To account for a potentially higher liquidity need as a result of
the SFT expansion, NSCC is planning to utilize its current suite of
qualifying liquidity resources, including the supplemental liquidity
deposit. NSCC may collect supplemental liquidity deposits from members
whose default would pose the largest liquidity exposure to NSCC.\37\
Accordingly, such deposits may be used to address any heightened
liquidity exposures stemming from clearing SFTs because the deposits,
by design, act to cover the difference between a
[[Page 34343]]
member's peak liquidity need and NSCC's liquidity resources.
---------------------------------------------------------------------------
\37\ See Rule 4A (Supplemental Liquidity Deposits) of the Rules,
supra note 6.
---------------------------------------------------------------------------
III. Discussion and Commission Findings
Section 19(b)(2)(C) of the Act \38\ directs the Commission to
approve a proposed rule change of a self-regulatory organization if it
finds that such proposed rule change is consistent with the
requirements of the Act and rules and regulations thereunder applicable
to such organization. After carefully considering the proposed rule
change, the Commission finds that the proposed rule change is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to NSCC. In particular, the
Commission finds that the proposed rule change is consistent with
Sections 17A(b)(3)(F) \39\ and (b)(3)(I) \40\ of the Act and Rules
17Ad-22(e)(6), (e)(7), (e)(18), (e)(19), and (e)(21) \41\ for the
reasons described below.
---------------------------------------------------------------------------
\38\ 15 U.S.C. 78s(b)(2)(C).
\39\ 15 U.S.C. 78q-1(b)(3)(F).
\40\ 15 U.S.C. 78q-1(b)(3)(I).
\41\ 17 CFR 240.17Ad-22(e)(6), (e)(7), (e)(18), (e)(19), and
(e)(21).
---------------------------------------------------------------------------
A. Consistency With Section 17A(b)(3)(F) of the Act
Section 17A(b)(3)(F) of the Act \42\ requires that the rules of a
clearing agency, such as NSCC, be designed to, among other things,
promote the prompt and accurate clearance and settlement of securities
transactions; assure the safeguarding of securities and funds which are
in the custody or control of the clearing agency or for which it is
responsible; and foster cooperation and coordination with persons
engaged in the clearance and settlement of securities transactions.
---------------------------------------------------------------------------
\42\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
The Commission believes that the proposal is consistent with
Section 17A(b)(3)(F) of the Act for the reasons stated below.
(1) Prompt and Accurate Clearance and Settlement
The Commission believes that NSCC's proposal to introduce the
central clearing of SFTs is designed to promote the prompt and accurate
clearance and settlement of securities transactions, and to protect
investors and the public interest.
As described above in Section II.A., the proposal would create a
new central clearing service for SFTs. Unlike bilateral transactions,
NSCC as the central counterparty would become a counterparty to all
novated trades, and in essence, replace multiple counterparties as one
counterparty to a market participant. In turn, NSCC would be able to
net a participant's transactions and offset delivery obligations and
reduce the number of securities that need to be delivered on a
settlement date. Central clearing would remove the bilateral exposures
that are scattered among different market participants and consolidate
them into a single net exposure with NSCC, which would increase
operational efficiency and decrease trade processing. The Commission
believes that, by novating and centrally clearing SFTs, the proposal is
designed to promote the prompt and accurate clearance and settlement of
securities.
(2) Fostering Cooperation
The Commission believes that NSCC's proposal to introduce the
central clearing of SFTs is designed to foster cooperation and
coordination with persons engaged in the clearance and settlement of
securities transactions. As described above in Section II.B., the
proposal is designed to allow the central clearing of SFTs to be
accessible by a wide range of market participants. For example, the
membership categories able to access the service would accommodate
market participants' differing business models and regulatory
requirements, and the accelerated settlement feature would allow
members who need to quickly unwind SFTs to satisfy their applicable
regulatory requirements when needed. NSCC represents that the proposal
reflects the feedback of market participants requesting these
features.\43\ By designing the new SFT clearing service to be
accessible, the proposal is designed to encourage more market
participants to bring SFTs into central clearing from the bilateral
market. And by allowing market participants to centrally clear and
settle SFTs, the Commission believes that the proposal is designed to
foster cooperation and coordination with persons engaged in the
clearance and settlement of securities transactions.
---------------------------------------------------------------------------
\43\ See Notice of Filing, supra note 3, at 23374.
---------------------------------------------------------------------------
(3) Safeguarding of Securities and Funds
The Commission believes that NSCC's proposal to introduce the
central clearing of SFTs is designed to assure the safeguarding of
securities and funds which are in the custody or control of the
clearing agency or for which it is responsible.
As described in Section II.B.(3), NSCC proposes to manage risks
associated with the new SFT central clearing service by collecting
margin for each transaction and ensuring that it has sufficient
resources to meet its liquidity needs. First, NSCC would manage its
credit risk with respect to SFTs by requiring minimum margin deposits
and applying specific aspects of its margin methodology to determine
the appropriate margin to cover the risks posed by the SFTs, as well as
by applying an additive margin component designed to address any high
concentration risk posed by SFTs. When calculating margin, NSCC would
not net SFT members' SFT positions with other CNS position, and NSCC
also would not net across Sponsored Member accounts or Customer
accounts, thereby collecting greater amounts of margin and improving
NSCC's overall resilience. NSCC also would specify that a certain
portion of margin be in cash and eligible Treasury clearing fund
securities to protect against market risk of the collateral. Further,
as described in Section II.B.(2), NSCC would apply activity limits to
ensure that SFT members' financial resources are sufficient to meet
their margin requirements.
Second, as described in Section II.B.(3), NSCC would include an SFT
member's potential liquidity exposures as part of NSCC's potential
liquidity need. This means that, if a member's SFT activity were to
drive NSCC's potential liquidity need, that member would have to
provide supplemental liquidity under NSCC's existing rules, to ensure
that NSCC would maintain adequate resources to satisfy liquidity needs
arising from its SFT settlement obligations.
Third, the proposal would provide a process to address SFT member
defaults to allow NSCC to take timely action to contain losses and
continue to meet its obligations. Specifically, NSCC would have a right
to close out a defaulting member's positions, assume the rights of the
non-defaulting party in relation to such default-related SFTs, and
apply its loss allocation procedure if the defaulting member's
resources are insufficient to cover a loss.\44\
---------------------------------------------------------------------------
\44\ See supra note 36.
---------------------------------------------------------------------------
Taken together, these risk management procedures should minimize
the likelihood that losses arising out of an SFT member default would
exceed NSCC's prefunded resources and threaten the safety and soundness
of NSCC's ongoing operations. Accordingly, the Commission believes that
the proposal is designed to assure the safeguarding of
[[Page 34344]]
securities and funds which are in NSCC's custody or control.\45\
---------------------------------------------------------------------------
\45\ A large number of commenters expressed concerns that the
proposal is designed to exclusively benefit large institutions by
obscuring and facilitating negligent risky behavior, and the
proposal would hamper a fair and transparent market. See, e.g.,
Letters from David Lincoln and from Joe Jacobs, dated April 19,
2022. The commenters' concerns generally rely on the premise that
SFTs are designed to promote short sales and potentially naked short
sales that such commenters believe should be illegal. See, e.g.,
Letters from Jack Sarken and Duncan Stanley, dated April 19, 2022.
Any SFTs that would be cleared as part of the proposed service are
transactions that occur bilaterally today, and the proposal does not
impact Commission rules applicable to short sales. Because this
proposal is not addressing short sales, and is designed to reduce
risks associated with bilateral SFTs, the Commission believes that
the commenters' concerns related to short sales are outside the
scope of the proposed rule change.
---------------------------------------------------------------------------
B. Consistency With Rule 17Ad-22(e)(6)(i)
Rule 17Ad-22(e)(6)(i) under the Exchange Act requires that NSCC
establish, implement, maintain and enforce written policies and
procedures reasonably designed to cover its credit exposures to its
participants by establishing a risk-based margin system that, at a
minimum, considers, and produces margin levels commensurate with, the
risks and particular attributes of each relevant product, portfolio,
and market.\46\
---------------------------------------------------------------------------
\46\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------
As described above in Section II.B.(3)(i), NSCC proposes to
establish margin requirements to cover its credit exposures to the SFT
members. First, NSCC proposes to collect margin from SFT members,
including the application of both a minimum margin amount and of NSCC's
existing margin system that contains multiple component charges
designed to cover various types of risk and meet applicable regulatory
requirements.\47\ Second, NSCC would apply more conservative approaches
to the calculation of SFT, as compared to NSCC's existing margin
system. For example, unlike the current calculation of the volatility
of a member's net unsettled positions, NSCC would apply a more
stringent method to address risks associated with issuer-specific
events affecting the price of the concentrated security within the SFT
portfolio, and risk associated with liquidating a defaulted SFT
member's portfolio with a large position by asset class, relative to
market-wide liquidity.\48\ Further, NSCC would not net SFTs against
other equity transactions at NSCC when determining margin requirements,
to ensure that margins associated with SFTs would not be reduced by
other equity transactions outside of the SFTs. Separately, it would
collect margin on a gross basis for different Sponsored Members or
different Customers, thereby accounting and collecting margin for each
individual Sponsored Member and Customer.
---------------------------------------------------------------------------
\47\ See supra note 32.
\48\ See id.
---------------------------------------------------------------------------
Because NSCC applies its risk-based margin methodology, tailored to
address SFTs, the Commission believes that the proposal is reasonably
designed to cover NSCC's credit exposures from SFT members and
consistent with Rules 17Ad-22(e)(6)(i).
C. Consistency With Rule 17Ad-22(e)(7)
Rule 17Ad-22(e)(7)(i) under the Exchange Act requires that NSCC
establish, implement, maintain and enforce written policies and
procedures reasonably designed to effectively measure, monitor, and
manage the liquidity risk that arises in or is borne by the covered
clearing agency, including measuring, monitoring, and managing its
settlement and funding flows on an ongoing and timely basis, and its
use of intraday liquidity by, at a minimum maintaining sufficient
liquid resources at the minimum in all relevant currencies to effect
same-day and, where appropriate, intraday and multiday settlement of
payment obligations with a high degree of confidence under a wide range
of foreseeable stress scenarios that includes, but is not limited to,
the default of the participant family that would generate the largest
aggregate payment obligation for the covered clearing agency in extreme
but plausible market conditions.\49\
---------------------------------------------------------------------------
\49\ 17 CFR 240.17Ad-22(e)(7)(i).
---------------------------------------------------------------------------
As described above in Section II.B.(3)(ii), when calculating its
liquidity need, in addition to liquidity exposures relating to other
equity positions, NSCC would include all the differences in market
value of the underlying securities owed by a defaulting SFT member in
the event an SFT member defaults, as well as all novated open SFT
transactions of a defaulting SFT. This determination of the liquidity
need is designed to ensure that NSCC would cover any liquidity need
associated with its final settlement obligations to non-defaulting SFT
members and members. NSCC currently relies on various liquidity
resources, all of which would be available in the event of a liquidity
shortfall relating to SFTs. The Commission believes that NSCC's
existing liquidity risk management framework, including NSCC's ability
to collect supplemental liquidity if a member's activity, including its
SFT activity, increases NSCC's liquidity need,\50\ would be sufficient
to ensure that NSCC would continue to meet its regulatory obligations.
---------------------------------------------------------------------------
\50\ NSCC is required to have policies and procedures reasonably
designed to monitor and manage its liquidity risk by maintaining
sufficient liquid resources at the minimum to effect settlement of
payment obligations with a high degree of confidence under a wide
range of foreseeable stress scenarios that includes, but is not
limited to, the default of the participant family that would
generate the largest aggregate payment obligation for the covered
clearing agency in extreme but plausible market conditions, and by
determining that amount and regularly testing the sufficiency of its
liquidity resources. 17 CFR 240.17Ad-22(e)(7)(i) and (vi). Pursuant
to this regulatory requirement, NSCC's Liquidity Risk Management
Framework outlines NSCC's liquidity resources and liquidity risk
management practices. See Securities Exchange Act Release No. 82377
(December 21, 2017), 82 FR 61617 (December 28, 2017).
One such liquidity resource is NSCC's supplemental liquidity
deposit, which is designed to withstand NSCC's fluctuating peak
liquidity needs and source adequate liquidity at all times. To do
so, NSCC allocates a funding obligation to those members driving
peak liquidity needs that surpass NSCC's available liquidity
resources through SLDs. See Securities Exchange Act Release No.
71000 (December 5, 2013), 78 FR 75400 (December 11, 2013).
---------------------------------------------------------------------------
The Commission believes that NSCC's proposal to manage its
potential liquidity exposures associated with SFTs by using its
established liquidity resources is reasonably designed to manage the
liquidity risk that may arise in the SFT central clearing service, and
consistent with Rule 17Ad-22(e)(7)(i).\51\
---------------------------------------------------------------------------
\51\ 17 CFR 240.17Ad-22(e)(7)(i).
---------------------------------------------------------------------------
D. Consistency With Rule 17Ad-22(e)(18)
Rule 17Ad-22(e)(18) under the Exchange Act requires that NSCC
establish, implement, maintain and enforce written policies and
procedures reasonably designed to establish objective, risk-based, and
publicly disclosed criteria for participation, which permit fair and
open access by direct and, where relevant, indirect participants and
other financial market utilities, require participants to have
sufficient financial resources and robust operational capacity to meet
obligations arising from participation in the clearing agency, and
monitor compliance with participation requirements on an ongoing
basis.\52\
---------------------------------------------------------------------------
\52\ 17 CFR 240.17Ad-22(e)(18).
---------------------------------------------------------------------------
First, the Commission believes that the proposal is reasonably
designed to establish objective, risk-based, and publicly-disclosed
criteria for SFT members. As described above, all members would be
eligible to apply to become Sponsoring Members or Agent Clearing
Members subject to such criteria, similar to how NSCC currently
provides membership criteria for its members. For example, if a
Sponsoring
[[Page 34345]]
or Agent Clearing Member applicant is a registered broker-dealer, it
would be subject to particular financial resource requirements, as
specified in the proposed rule. Only a qualified institutional buyer or
a legal entity that satisfies the financial requirements necessary to
be a qualified institutional buyer would be eligible to be a Sponsored
Member. In addition, an applicant must provide adequate assurances for
its financial responsibility and operational capability.
Second, the proposal is reasonably designed to allow direct and
indirect participants to access the new SFT central clearing service by
establishing new membership categories to allow for such access by
particular types of market participants. For example, a participant who
cannot or does not want to meet the requirements to become either a
member, a Sponsoring Member, or an Agent Clearing Member can
participate as a Sponsored Member or as a Customer, the latter of which
does not have a direct relationship with NSCC.
Third, the proposal is reasonably designed to allow NSCC to monitor
compliance with participation requirements on an ongoing basis. The
proposal would require an SFT member to notify NSCC if it is no longer
in compliance with applicable requirements to be an SFT member, and
allow NSCC to inspect SFT members' financial resources and operational
capability on an ongoing basis.
For the foregoing reasons, the Commission believes that the
proposal is consistent with Rule 17Ad-22(e)(18).\53\
---------------------------------------------------------------------------
\53\ Id.
---------------------------------------------------------------------------
E. Consistency With Rule 17Ad-22(e)(19)
Rule 17Ad-22(e)(19) under the Exchange Act requires a covered
clearing agency to establish, implement, maintain, and enforce written
policies and procedures reasonably designed to identify, monitor, and
manage the material risks to the covered clearing agency arising from
arrangements in which firms that are indirect participants in the
covered clearing agency rely on the services provided by direct
participants to access the covered clearing agency's payment, clearing,
or settlement facilities.\54\
---------------------------------------------------------------------------
\54\ 17 CFR 240.17Ad-22(e)(19).
---------------------------------------------------------------------------
The proposal allows Sponsoring Members to submit Sponsored Members'
transactions to NSCC, and Agent Clearing Members to submit its
Customers' transactions to NSCC. In both cases, Sponsoring Members and
Agent Clearing Members would be ultimately responsible to NSCC for
Sponsored Members' and Customers' transactions and liable to satisfy
all settlement obligations. Both Sponsoring Members and Agent Clearing
Members serve as the processing agent for all the Sponsored Member and
Customer transactions responsible for posting margin and satisfying any
losses arising from the client transactions. Sponsoring Members and
Customers do not have any direct mechanism to submit their own margin
or settle transactions directly with NSCC. Moreover, even though
Sponsored Members would be principally liable for their own settlement
obligations, Sponsoring Members' guaranty requires Sponsoring Members
to satisfy settlement obligations on behalf of its Sponsored Members.
By calculating and collecting margins for Sponsored Members' and
Customers' transactions and providing certainty that Sponsoring Members
and Agent Clearing Members would be responsible for their Sponsored
Members' and Customers' transactions, the Commission believes that the
proposal is consistent with Rule 17Ad-22(e)(19).\55\
---------------------------------------------------------------------------
\55\ Id.
---------------------------------------------------------------------------
F. Consistency With Rule 17Ad-22(e)(21)
Rule 17Ad-22(e)(21) under the Exchange Act requires a covered
clearing agency to establish, implement, maintain, and enforce written
policies and procedures reasonably designed to be efficient and
effective in meeting the requirements of its participants and the
markets it serves, including the clearing agency's clearing and
settlement arrangements and the scope of products cleared or
settled.\56\
---------------------------------------------------------------------------
\56\ 17 CFR 240.17Ad-22(e)(21).
---------------------------------------------------------------------------
As described above in Section II.B.(1) and (2), the proposal is
designed to reflect the current structure of the bilateral securities
lending market, ensuring that relevant features and market participants
subject to differing regulatory requirements and existing contractual
relationships can be accommodated as part of the service provided by
NSCC. For example, the proposal would allow for central clearing of
SFTs with a one business day term, in order to provide a scheduled
settlement date so that the transaction may be eligible for balance
sheet netting benefit as explained in Section II.(B)(1). Second, the
proposal would allow accelerated settlement so that certain market
participants are able to quickly unwind their SFTs to satisfy
applicable regulatory requirements. Third, the proposed membership
categories would accommodate principal and agency trading to allow
different types of market participants to enter into the new SFT
central clearing service, consistent with their business models and
applicable regulatory requirements.
Accordingly, the Commission believes that the proposal is
reasonably designed to be efficient and effective in meeting the
requirements of its participants and the market it serves, and
consistent with Rule 17Ad-22(e)(21).\57\
---------------------------------------------------------------------------
\57\ Id.
---------------------------------------------------------------------------
VI. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in particular with the requirements of Section 17A of the Act \58\ and
the rules and regulations promulgated thereunder.
---------------------------------------------------------------------------
\58\ 15 U.S.C. 78q-1.
---------------------------------------------------------------------------
It is therefore ordered, pursuant to Section 19(b)(2) of the Act
\59\ that proposed rule change SR-NSCC-2022-003, be, and hereby is,
APPROVED.\60\
---------------------------------------------------------------------------
\59\ 15 U.S.C. 78s(b)(2).
\60\ In approving the proposed rule change, the Commission
considered the proposals' impact on efficiency, competition, and
capital formation. 15 U.S.C. 78c(f). See also Section II.B.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\61\
---------------------------------------------------------------------------
\61\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2022-12009 Filed 6-3-22; 8:45 am]
BILLING CODE 8011-01-P
</pre></body>
</html>Indexed from Federal Register on June 6, 2022.
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.