Notice2023-17127
Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of No Objection to Advance Notice Related to Certain Enhancements to the Gap Risk Measure and the VaR Charge
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
August 10, 2023
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 88 Issue 153 (Thursday, August 10, 2023)</title>
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[Federal Register Volume 88, Number 153 (Thursday, August 10, 2023)]
[Notices]
[Pages 54365-54370]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-17127]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-98064; File No. SR-NSCC-2022-802)]
Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of No Objection to Advance Notice Related to
Certain Enhancements to the Gap Risk Measure and the VaR Charge
August 4, 2023.
I. Introduction
On December 2, 2022, the National Securities Clearing Corporation
(``NSCC'') filed with the Securities and Exchange Commission
(``Commission'') advance notice SR-NSCC-2022-802 (``Advance Notice'')
pursuant to section 806(e)(1) of Title VIII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act, entitled Payment, Clearing
and Settlement Supervision Act of 2010 (``Clearing Supervision Act'')
\1\ and Rule 19b-4(n)(1)(i) \2\ under the Securities Exchange Act of
1934 (``Exchange Act'') \3\ regarding certain enhancements to its gap
risk charge and the volatility component of a member's required
margin.\4\ The Advance Notice was published for comment in the Federal
Register on December 21, 2022.\5\ On January 10, 2023, the Commission
issued an extension of the review period for the Advance Notice.\6\ On
March 27, 2023, the Commission requested additional information from
NSCC pursuant to section 806(e)(1)(D) of the Clearing Supervision Act,
which tolled the Commission's period of review of the Advance Notice
until 120 days \7\ from the date the requested information was received
by the Commission.\8\ The Commission received NSCC's response to the
Commission's request for additional information on April 28, 2023. The
Commission has received comments regarding the changes proposed in the
Advance Notice.\9\ The Commission is hereby providing notice of no
objection to the Advance Notice.
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\1\ 12 U.S.C. 5465(e)(1).
\2\ 17 CFR 240.19b-4(n)(1)(i).
\3\ 15 U.S.C. 78a et seq.
\4\ See Notice of Filing, infra note 5, at 87 FR 78175.
\5\ Exchange Act Release No. 96513 (Dec. 15, 2022), 87 FR 78175
(Dec. 21, 2022) (File No. SR-NSCC-2022-802) (``Notice of Filing'').
\6\ Exchange Act Release No. 96624 (Jan. 10, 2023), 88 FR 2707
(Jan. 17, 2023).
\7\ The Commission may extend the review period for an
additional 60 days (to 120 days total) for proposed changes that
raise novel or complex issues. See 12 U.S.C. 5465(e)(1)(H).
\8\ See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); Memorandum from
Office of Clearance and Settlement, Division of Trading and Markets,
titled ``Commission's Request for Additional Information'' (dated
Mar. 27, 2023), available at <a href="https://www.sec.gov/comments/sr-nscc-2022-802/srnscc2022802-20161718-330589.pdf">https://www.sec.gov/comments/sr-nscc-2022-802/srnscc2022802-20161718-330589.pdf</a>.
\9\ The Commission received one comment that was not relevant to
the proposal in the Advance Notice. See <a href="https://www.sec.gov/comments/sr-nscc-2022-802/srnscc2022802-320764.htm">https://www.sec.gov/comments/sr-nscc-2022-802/srnscc2022802-320764.htm</a> (commenting on
certain aspects of NSCC's operations that are not addressed or
changed in this proposal). In addition, the Commission received one
comment on the related proposed rule change filed as NSCC-2022-015.
See Exchange Act Release No. 96511 (Dec. 15, 2022), 87 FR 78157
(Dec. 21, 2022) (``Proposed Rule Change''), with comments at <a href="https://www.sec.gov/comments/sr-nscc-2022-015/srnscc2022015.htm">https://www.sec.gov/comments/sr-nscc-2022-015/srnscc2022015.htm</a>. Because
the proposals contained in the Advance Notice and the Proposed Rule
Change are the same, all public comments received on the proposals
were considered regardless of whether the comments were submitted
with respect to the Advance Notice or the Proposed Rule Change.
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II. Background \10\
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\10\ Capitalized terms not defined herein are defined in NSCC's
Rules & Procedures (``Rules''), available at https://www.dtcc.com/~/
media/Files/Downloads/legal/rules/nscc_rules.pdf.
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NSCC provides clearing, settlement, risk management, central
counterparty services, and a guarantee of completion for virtually all
broker-to-broker trades involving equity securities, corporate and
municipal debt securities, and unit investment trust transactions in
the U.S. markets. A key tool that NSCC uses to manage its credit
exposure to its members is collecting an appropriate amount of margin
(i.e., collateral) from each member.\11\
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\11\ Pursuant to its Rules, NSCC uses the term ``Required Fund
Deposit'' to denote margin or collateral collected from its members.
See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund Formula
and Other Matters) of the Rules, supra note 10.
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A. Overview Regarding NSCC's Margin Methodology
A member's margin is designed to mitigate potential losses to NSCC
associated with the liquidation of the member's portfolio in the event
that
[[Page 54366]]
member defaults.\12\ The aggregate of all members' margin deposits
(together with certain other deposits required under the Rules)
constitutes NSCC's clearing fund. NSCC would access its clearing fund
should a defaulting member's own margin and resources at NSCC be
insufficient to satisfy losses to NSCC caused by the liquidation of
that member's portfolio.\13\
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\12\ Under NSCC's Rules, a default would generally be referred
to as a ``cease to act'' and could encompass a number of
circumstances, such as a member's failure to make a margin payment
on time. See Rule 46 (Restrictions on Access to Services) of the
Rules, supra note 10.
\13\ See Rule 4, supra note 10.
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NSCC employs daily backtesting to determine the sufficiency of each
member's margin, by simulating the liquidation gains or losses using
the actual unsettled positions in the member's portfolio, and the
actual historical returns for each security held in the portfolio. A
backtesting deficiency would result if the liquidation losses were
greater than the member's margin. NSCC investigates the causes of any
backtesting deficiencies, paying particular attention to members with
backtesting deficiencies that bring the results for that member below
the 99 percent confidence target (i.e., greater than two backtesting
deficiency days in a rolling twelve-month period) to determine if there
is an identifiable cause of repeat backtesting deficiencies.\14\ NSCC
also evaluates whether multiple members may experience backtesting
deficiencies for the same underlying reason.\15\
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\14\ See National Securities Clearing Corporation, Disclosure
Framework for Covered Clearing Agencies and Financial Market
Infrastructures, at 61 (Dec. 2022), available at <a href="https://www.dtcc.com/legal/policy-and-compliance">https://www.dtcc.com/legal/policy-and-compliance</a>.
\15\ See id.
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Each member's margin consists of a number of applicable components,
each of which is calculated to address specific risks faced by
NSCC.\16\ Each member's start of day required fund deposit is
calculated overnight, based on the member's prior end-of-day net
unsettled positions.\17\ NSCC notifies members early the following
morning, and members are required to make deposits by approximately
10:00 a.m. EST.\18\
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\16\ See Procedure XV of the Rules, supra note 10.
\17\ See Procedure XV, Sections II(B) of the Rules, supra note
10.
\18\ See id. The Rules provide that required deposits to the
clearing fund are due within one hour of demand, unless otherwise
determined by NSCC. Id.
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Generally, the largest portion of a member's margin is the
volatility component. The volatility component is designed to reflect
the amount of money that could be lost on a portfolio over a given
period within a 99th percentile level of confidence. This component
represents the amount assumed necessary to absorb losses while
liquidating the member's portfolio.
NSCC's methodology for calculating the volatility component of a
member's required fund deposit depends on the type of security and
whether the security has sufficient pricing or trading history for NSCC
to robustly estimate the volatility component using statistical
techniques. Generally, for most securities (e.g., equity securities),
NSCC calculates the volatility component using, among other things, a
parametric Value at Risk (``VaR'') model, which results in a ``VaR
Charge.'' \19\ The VaR Charge usually comprises the largest portion of
a member's required fund deposit.
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\19\ See Sections I(A)(1)(a)(i) and I(A)(2)(a)(i) of Procedure
XV of the Rules, supra note 10.
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B. Current Treatment of Gap Risk in NSCC's Margin Methodology
Under NSCC's current Rules, one of the potential methods of
calculating the VaR Charge relies on a measure of gap risk. It does not
accrue for all portfolios, but instead only serves as the VaR Charge if
it is the largest of three potential calculations.\20\
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\20\ Specifically, the VaR Charge is the greatest of (1) the
larger of two separate calculations based on different underlying
estimates that utilize a parametric VaR model, which addresses the
market risk of a member's portfolio (referred to as the core
parametric estimation), (2) the gap risk calculation, and (3) a
portfolio margin floor calculation based on the market values of the
long and short positions in the portfolio, which addresses risks
that might not be adequately addressed with the other volatility
component calculations.
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Gap risk events have been generally understood as idiosyncratic
issuer events (for example, earning reports, management changes, merger
announcements, insolvency, or other unexpected, issuer-specific events)
that cause a rapid shift in price volatility levels. The gap risk
charge was designed to address the risk presented by a portfolio that
is more susceptible to the effects of gap risk events, i.e., those
portfolios holding positions that represent more than a certain percent
of the entire portfolio's value, such that the event could impact the
entire portfolio's value.\21\
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\21\ See Section I(A)(1)(a)(i)II and I(A)(2)(a)(i)II of
Procedure XV of the Rules, supra note 10. See also Exchange Act
Release Nos. 82780 (Feb. 26, 2018), 83 FR 9035 (Mar. 2, 2018) (SR-
NSCC-2017-808); 82781 (Feb. 26, 2018), 83 FR 9042 (Mar. 2, 2018)
(SR-NSCC-2017-020) (``Initial Filing'').
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The current gap risk charge applies only if a member's overall net
unsettled non-index position with the largest absolute market value in
the portfolio represents more than a certain percent of the entire
portfolio's value, that is, if the net unsettled position exceeds a
specified ``concentration threshold.'' The concentration threshold can
be set no higher than 30 percent and is evaluated periodically based on
members' backtesting results over a twelve month look-back period, and
it is currently set at 5%.\22\ NSCC's Rules currently calculate a gap
risk charge only for ``non-index'' positions, meaning positions in the
portfolio other than positions in ETFs that track diversified indices.
This is because index-based ETFs that track closely to diversified
indices are generally considered less prone to the effects of gap risk
events.
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\22\ See Section I(A)(1)(a)(i)II and I(A)(2)(a)(i)II of
Procedure XV of the Rules, supra note 10; see Important Notice a9055
(Sept. 27, 2021), at <a href="https://www.dtcc.com/-/media/Files/pdf/2021/9/27/a9055.pdf">https://www.dtcc.com/-/media/Files/pdf/2021/9/27/a9055.pdf</a> (notifying members that the concentration threshold had
been changed from 10% to 5%).
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The risk of large, unexpected price movements, particularly those
caused by a gap risk event, are more likely to have a greater impact on
portfolios with large net unsettled positions in securities that are
susceptible to those events. Generally, index-based ETFs that track
closely to diversified indices are less prone to the effects of gap
risk events. Therefore, if the concentration threshold is met, NSCC
currently calculates the gap risk charge for positions in the portfolio
other than positions in ETFs that track diversified indices, referred
to as ``non-index positions.''
To calculate the gap risk charge, NSCC multiplies the gross market
value of the largest non-index net unsettled position in the portfolio
by a gap risk haircut, which can be no less than 10 percent (``gap risk
haircut'').\23\ Currently, NSCC determines the gap risk haircut
empirically as no less than the larger of the 1st and 99th percentiles
of three-day returns of a set of CUSIPs that are subject to the VaR
Charge pursuant to the Rules, giving equal rank to each to determine
which has the highest movement over that three-day period. NSCC uses a
look-back period of not less than ten years plus a one-year stress
period, and if the one-year stress period overlaps with the look-back
period, only the non-overlapping period would be combined with the
look-back period. The resulting haircut is then rounded up to the
nearest whole percentage and applied to the largest non-index net
unsettled position to determine the gap risk charge.
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\23\ See Section I(A)(1)(a)(i)II and I(A)(2)(a)(i)II of
Procedure XV of the Rules, supra note 10.
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[[Page 54367]]
III. The Advance Notice
NSCC is proposing to make the following changes to the gap risk
charge: (1) make the gap risk charge an additive component of the
member's total VaR Charge when it is applicable, rather than being
applied as the applicable VaR Charge only when it is the largest of
three separate calculations, (2) adjusting the gap risk charge to be
based on the two largest positions in a portfolio, rather than based on
the single largest position, (3) changing the floor of the gap risk
haircut from 10 percent to 5 percent for the largest position, adding a
floor of the gap risk haircut of 2.5 percent for the second largest
position, and providing that gap risk haircuts would be determined
based on backtesting and impact analysis, and (4) amending which ETF
positions are excluded from the gap risk charge to more precisely
include ETFs that are more prone to gap risk, i.e., are non-
diversified.
First, NSCC is proposing to make the result of the gap risk charge
calculation an additive component of a member's total VaR Charge,
rather than applicable as the VaR Charge only when it is the highest
result of three calculations. Under the proposal, the VaR Charge would
be equal to the sum of (1) the greater of either the core parametric
estimation or the portfolio margin floor calculation, neither of which
is changing in this proposal,\24\ and (2) the gap risk charge
calculation. Rather than being applied only when the gap risk charge
exceeds the other two calculations, the gap risk charge calculation
would apply every time the top two positions exceed the concentration
threshold and would always be a portion of the overall VaR Charge in
such circumstances. NSCC states that making this charge additive could
improve its ability to mitigate idiosyncratic risks that it could face
through the collection of the VaR Charge.\25\ Based on impact studies,
NSCC believes this broader application together with the other proposed
changes outlined below would better protect against more idiosyncratic
risk scenarios than the current methodology.\26\
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\24\ See note 20 supra.
\25\ See Notice of Filing, supra note 5, 87 FR at 78178.
\26\ Id.
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Second, NSCC is proposing to make the gap risk charge rely upon the
absolute values of the two largest non-diversified net unsettled
positions, as opposed to using the absolute value of only the single
largest non-diversified net unsettled position. Therefore, the gap risk
charge would be calculated by first multiplying each of the two largest
non-diversified net unsettled positions with a gap risk haircut, and
then adding the sum of the resulting products. The gap risk charge
would be applicable if that sum of the resulting products exceeded the
concentration threshold.\27\ NSCC states that applying the gap risk
charge to the two largest non-diversified positions in the portfolio
would cover concurrent gap moves involving more than one concentrated
position, adding more flexibility and coverage.\28\
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\27\ As noted in Section II.B above, the concentration threshold
is currently set at 5%, and the Rules define the concentration
threshold as no more than 30 percent of the value of the entire
portfolio. See Section I(A)(1)(a)(i)II and I(A)(2)(a)(i)II of
Procedure XV of the Rules, supra note 20. The proposed changes would
clarify that the concentration threshold is not fixed at 30 percent
by defining concentration threshold as a percentage designated by
NSCC of the value of the entire portfolio and determined by NSCC
from time to time, and that shall be no more than 30 percent. NSCC
believes this proposed change will help clarify that the
concentration threshold could change from time to time but could not
be set to be more than 30 percent. See Notice of Filing, supra note
5, 87 FR at 78179.
\28\ See Notice of Filing, supra note 5, 87 FR at 78178.
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Third, NSCC proposes to revise the calculation of the gap risk
haircut in response to making the proposal an additive component of a
member's VaR Charge. Currently, the gap risk haircut is determined by
selecting the largest of the 1st and 99th percentiles of three-day
returns of a composite set of equities, using a look-back period of not
less than 10 years plus a one year stress period.\29\ NSCC believes
that this methodology results in implicit overlapping of the risk
covered by the core parametric VaR and the gap risk charge.\30\ Because
the proposal would make the gap risk charge an additive component to
the VaR Charge rather than a substitutive component, NSCC does not
believe that the current methodology for the gap risk haircut would
result in an appropriate level of margin.\31\ Under the proposal, NSCC
would determine and calibrate the concentration threshold and the gap
risk haircut periodically based on backtesting and impact analysis.
NSCC states that the concentration threshold and the gap risk haircuts
would be selected from various combinations of concentration thresholds
and gap risk haircuts based on backtesting and impact analysis across
all member portfolios, initially using a five year look-back
period.\32\ NSCC believes that this would provide more flexibility to
set the parameters from time to time to provide improved backtesting
performance, broader coverage for idiosyncratic risk scenarios and
flexibility for model tuning to balance performance and cost
considerations.\33\
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\29\ Id.
\30\ See id.
\31\ Id.
\32\ Id.
\33\ Id.
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In addition, NSCC proposes to revise the determination of the gap
risk haircut in response to the proposal's inclusion of the two largest
non-diversified net unsettled positions, as opposed to only the one,
and to its additive nature. Currently, the percent that is applied to
the largest non-index net unsettled position in the portfolio is no
less than 10 percent.\34\ Because of the proposal's shift to including
the two largest positions, NSCC believes it is appropriate to set a
lower floor for the gap risk haircut that applies to the largest of
those two positions.\35\ Moreover, because the gap risk charge would
now be additive and would apply more frequently, NSCC believes that the
flexibility to set a lower floor for the largest position would be
appropriate.\36\
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\34\ Id.
\35\ Id. at 78178-79.
\36\ Id. at 78179.
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Specifically, NSCC is proposing to lower the gap risk haircut that
would be applied to the largest non-diversified net unsettled position
to be a percent that is no less than 5 percent. The gap risk haircut
that would be applied to the second largest non-diversified net
unsettled position in the portfolio would be no larger than the gap
risk haircut that would be applied to the largest non-diversified net
unsettled position and would be subject to a floor of 2.5 percent. NSCC
states that, upon implementation of the proposed rule change, NSCC
would set the concentration threshold at 10%, apply a gap risk haircut
on the largest non-diversified net unsettled position of 10% and a gap
risk haircut on the second largest non-diversified net unsettled
position of 5%.\37\ NSCC would set the concentration threshold and the
gap risk haircuts based on backtesting and impact analysis in
accordance with NSCC's model risk management practices and governance
set forth in the Model Risk Management Framework.\38\ NSCC would
provide
[[Page 54368]]
notice to members by important notice of the concentration threshold
and gap risk haircuts that it would be applying.
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\37\ Id.
\38\ See Exchange Act Release Nos. 81485 (Aug. 25, 2017), 82 FR
41433 (Aug. 31, 2017) (File No. SR-NSCC-2017-008); 84458 (Oct. 19,
2018), 83 FR 53925 (Oct. 25, 2018) (File No. SR-NSCC-2018-009);
88911 (May 20, 2020), 85 FR 31828 (May 27, 2020) (File No. SR-NSCC-
2020-008); 92381 (July 13, 2021), 86 FR 38163 (July 19, 2021) (File
No. SR-NSCC-2021-008); and 94272 (Feb. 17, 2022), 87 FR 10419 (Feb.
24, 2022) (File No. SR-NSCC-2022-001). NSCC's model risk management
governance procedures include daily backtesting of model
performance, periodic sensitivity analyses of models and annual
validation of models. They would also provide for review of the
concentration threshold and the gap risk haircuts at least annually.
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Fourth, NSCC is proposing to amend what positions are excluded from
the gap risk charge calculation. Currently, only ``non-index''
positions and index-based exchange-traded products that track a narrow
market index are included in the gap risk charge.\39\ Under the
proposal, this would be revised to refer to ``non-diversified''
positions instead of non-index positions. The rule text would specify
that NSCC would exclude ETF positions from the calculation (that is, it
would consider them diversified) if the positions have characteristics
that indicate that they are less prone to the effects of gap risk
events, including whether the ETF positions track to an index that is
linked to a broad based market index, contain a diversified underlying
basket, are unleveraged or track to an asset class that is less prone
to gap risk. NSCC states that the proposed change would result in
certain non-index based ETFs being excluded from the gap risk charge
whereas they are currently included, such as unleveraged U.S. dollar
based ETFs.\40\ NSCC also states that this proposed change would
provide greater transparency to members regarding which positions are
excluded from this calculation.\41\
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\39\ See Section I(A)(1)(a)(i)II and I(A)(2)(a)(i)II of
Procedure XV of the Rules, supra note 10. See also Initial Filing,
supra note 21.
\40\ See Notice of Filing, supra note 5, 87 FR at 78178.
\41\ Id. NSCC states that it uses a third-party provider to
identify ETFs that meet its criteria of being diversified. See id.
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NSCC states that certain ETFs, both index based and non-index
based, are less prone to the effects of gap risk events as a result of
having certain characteristics and, therefore, are less likely to pose
idiosyncratic risks that the gap risk charge is designed to
mitigate.\42\ By contrast, based on the proposed methodology, NSCC
would include certain commodity ETFs in the gap risk charge that track
to an index that is not a broad-based diversified commodity index; such
ETFs are not currently subject to the gap risk charge, but would be
subject going forward.
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\42\ Id.
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III. Commission Findings and Notice of No Objection
Although the Clearing Supervision Act does not specify a standard
of review for an advance notice, the stated purpose of the Clearing
Supervision Act is instructive: to mitigate systemic risk in the
financial system and promote financial stability by, among other
things, promoting uniform risk management standards for systemically
important financial market utilities (``SIFMUs'') and strengthening the
liquidity of SIFMUs.\43\
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\43\ See 12 U.S.C. 5461(b).
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Section 805(a)(2) of the Clearing Supervision Act authorizes the
Commission to prescribe regulations containing risk management
standards for the payment, clearing, and settlement activities of
designated clearing entities engaged in designated activities for which
the Commission is the supervisory agency.\44\ section 805(b) of the
Clearing Supervision Act provides the following objectives and
principles for the Commission's risk management standards prescribed
under section 805(a) :\45\
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\44\ 12 U.S.C. 5464(a)(2).
\45\ 12 U.S.C. 5464(b).
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<bullet> to promote robust risk management;
<bullet> to promote safety and soundness;
<bullet> to reduce systemic risks; and
<bullet> to support the stability of the broader financial system.
Section 805(c) provides, in addition, that the Commission's risk
management standards may address such areas as risk management and
default policies and procedures, among other areas.\46\
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\46\ 12 U.S.C. 5464(c).
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The Commission has adopted risk management standards under section
805(a)(2) of the Clearing Supervision Act and section 17A of the
Exchange Act (the ``Clearing Agency Rules'').\47\ The Clearing Agency
Rules require, among other things, each covered clearing agency to
establish, implement, maintain, and enforce written policies and
procedures that are reasonably designed to meet certain minimum
requirements for its operations and risk management practices on an
ongoing basis.\48\ As such, it is appropriate for the Commission to
review advance notices against the Clearing Agency Rules and the
objectives and principles of these risk management standards as
described in section 805(b) of the Clearing Supervision Act. As
discussed below, the Commission believes the changes proposed in the
Advance Notice are consistent with the objectives and principles
described in section 805(b) of the Clearing Supervision Act,\49\ and in
the Clearing Agency Rules, in particular Rule 17Ad-22(e)(4)(i) and
(e)(6)(i).\50\
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\47\ 17 CFR 240.17Ad-22. See Exchange Act Release No. 68080
(Oct. 22, 2012), 77 FR 66220 (Nov. 2, 2012) (S7-08-11). See also
Covered Clearing Agency Standards Adopting Release, Exchange Act
Release No. 78961 (Sept. 28, 2016), 81 FR 70786 (Oct. 13, 2016).
NSCC is a ``covered clearing agency'' as defined in Rule 17Ad-
22(a)(5).
\48\ 17 CFR 240.17Ad-22.
\49\ 12 U.S.C. 5464(b).
\50\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i).
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A. Consistency With Section 805(b) of the Clearing Supervision Act
The Commission believes that the proposal contained in NSCC's
Advance Notice is consistent with the stated objectives and principles
of section 805(b) of the Clearing Supervision Act. Specifically, as
discussed below, the Commission believes that the changes proposed in
the Advance Notice are consistent with promoting robust risk
management, promoting safety and soundness, reducing systemic risks,
and supporting the stability of the broader financial system.\51\
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\51\ 12 U.S.C. 5464(b).
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The Commission believes that the Advance Notice is consistent with
promoting robust risk management as well as safety and soundness
because, based on the confidential information provided by NSCC and
reviewed by the Commission, including the impact study demonstrating
the collective impact of the proposed changes on the margin collected
both at the overall clearing agency level and on a member-by-member
basis and on NSCC's backtesting performance, the proposed changes with
respect to the calculation of the gap risk charge provide better margin
coverage than the current methodology. The Commission believes that the
changes described in the Advance Notice should enable NSCC to better
manage its exposure to portfolios with identified concentration risk,
which should, in turn, limit its exposure to members in the event of a
member default, which is consistent with promoting robust risk
management.
The Commission believes that making the gap risk charge an additive
component, as opposed to a potential substitutive option applicable
only if it exceeds other methodologies for determining the VaR Charge,
should help NSCC better protect against more idiosyncratic risk
scenarios in concentrated portfolios than the current methodology. In
addition, adjusting the gap risk calculation to take into account the
two largest positions, as well as to apply two separate haircuts based
on backtesting and impact analysis with floors set forth in the Rules,
should allow NSCC to cover concurrent gap moves involving more than one
concentrated position. Moreover, modifying the criteria for ETF
positions subject to the gap risk charge based on
[[Page 54369]]
whether they are non-diversified rather than whether they are non-index
would allow NSCC to more accurately determine which ETFs should be
included and excluded from the gap risk charge based on characteristics
that indicate that such ETFs are more or less prone to the effects of
gap risk events, thereby providing more accurate coverage of the
potential exposure arising from such positions.
Further, the Commission believes that, to the extent the proposed
changes are consistent with promoting NSCC's safety and soundness, they
are also consistent with reducing systemic risk and supporting the
stability of the broader financial system. NSCC has been designated as
a SIFMU, in part, because its failure or disruption could increase the
risk of significant liquidity or credit problems spreading among
financial institutions or markets.\52\ The Commission believes that the
proposed changes would support NSCC's ability to continue providing
services to the markets it serves by addressing losses and shortfalls
arising out of a member default. NSCC's continued operations would, in
turn, help reduce systemic risk and support the stability of the
financial system by reducing the risk of significant liquidity or
credit problems spreading among market participants that rely on NSCC's
central role in the market.
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\52\ Financial Stability Oversight Council, 2012 Annual Report,
Appendix A, <a href="https://home.treasury.gov/system/files/261/2012-Annual-Report.pdf">https://home.treasury.gov/system/files/261/2012-Annual-Report.pdf</a>.
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Accordingly, and for the reasons stated above, the Commission
believes the changes proposed in the Advance Notice are consistent with
section 805(b) of the Clearing Supervision Act.\53\
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\53\ 12 U.S.C. 5464(b).
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B. Consistency With Rule 17Ad-22(e)(4)(i) Under the Exchange Act
Rule 17Ad-22(e)(4)(i) under the Exchange Act requires that a
covered clearing agency establish, implement, maintain and enforce
written policies and procedures reasonably designed to effectively
identify, measure, monitor, and manage its credit exposures to
participants and those arising from its payment, clearing, and
settlement processes, including by maintaining sufficient financial
resources to cover its credit exposure to each participant fully with a
high degree of confidence.\54\
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\54\ 17 CFR 240.17Ad-22(e)(4)(i).
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Based on its review of the record, the Commission believes NSCC's
proposal to broaden the scope of the gap risk charge and the related
adjustments to its calculation could help improve NSCC's backtesting
performance, provide broader coverage for idiosyncratic risk scenarios,
and could help address the potential increased risks NSCC may face
related to its ability to liquidate a portfolio that is susceptible to
such risks in the event of a member default. Specifically, the
Commission has reviewed and analyzed NSCC's analysis of the
improvements in its backtesting coverage,\55\ and agrees that the
analysis demonstrates that the proposal would result in better
backtesting coverage and, therefore, less credit exposure to its
members.
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\55\ NSCC submitted more detailed results of the impact study as
confidential Exhibit 3 to the Advance Notice. NSCC requested
confidential treatment of Exhibit 3 pursuant to 5 U.S.C. 552(b)(4)
and 552(b)(8) and 17 CFR. 200.80(b)(4) and 200.80(b)(8). A commenter
raised a concern regarding redacted portions of the filing, which
consisted of certain supporting exhibits filed confidentially as
Exhibit 3 to the filing. See <a href="https://www.sec.gov/comments/sr-nscc-2022-015/srnscc2022015-320658.htm">https://www.sec.gov/comments/sr-nscc-2022-015/srnscc2022015-320658.htm</a>. NSCC asserted that this exhibit
to the filing was entitled to confidential treatment because it
contains: (i) trade secrets and commercial information that is
privileged or confidential and which, if disclosed, would be
accessible to the DTCC Companies' competitors and could result in
substantial competitive injury to the DTCC Companies; and (ii) non-
public, confidential information prepared for use by Commission
staff. Under section 23(a)(3) of the Exchange Act, the Commission is
not required to make public statements filed with the Commission in
connection with a proposed rule change of a self-regulatory
organization if the Commission could withhold the statements from
the public in accordance with the Freedom of Information Act
(``FOIA''), 5 U.S.C. 552. 15 U.S.C. 78w(a)(3). The Commission has
reviewed the documents for which NSCC requests confidential
treatment and concludes that they could be withheld from the public
under the FOIA. FOIA Exemption 4 protects confidential commercial or
financial information. 5 U.S.C. 552(b)(4). Under Exemption 4,
information is confidential if it ``is both customarily and actually
treated as private by its owner and provided to government under an
assurance of privacy.'' Food Marketing Institute v. Argus Leader
Media, 139 S. Ct. 2356, 2366 (2019). Based on its review of the
materials submitted, the Commission believes that the information is
the type that would not customarily be disclosed to the public.
Specifically, this information consists of an impact study analyzing
the effect that the changes to NSCC's margin methodology would have
on each member's individual margin requirement to NSCC; information
regarding NSCC's analysis and development of the particular changes
to the margin methodology, including its consideration of potential
alternative haircuts and thresholds; and excerpts from NSCC's non-
public detailed margin methodology. In addition, by requesting
confidential treatment, NSCC had an assurance of privacy because the
Commission generally protects information that can be withheld under
Exemption 4. Thus, the Commission has determined to accord
confidential treatment to the confidential exhibits.
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Accordingly, the Commission believes that the proposal would enable
NSCC to better manage its credit risks by allowing it to respond
regularly and more effectively to any material deterioration of
backtesting performances, market events, market structure changes, or
model validation findings, thereby helping to ensure that NSCC can take
steps to collect sufficient margin to maintain sufficient financial
resources to cover its exposure to its members. Therefore, the
Commission believes the changes proposed in the Advance Notice are
consistent with Rule 17Ad-22(e)(4)(i) under the Exchange Act.
C. Consistency With Rule 17Ad-22(e)(6)(i) Under the Exchange Act
Rule 17Ad-22(e)(6)(i) under the Exchange Act requires that each
covered clearing agency that provides central counterparty services
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.\56\
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\56\ 17 CFR 240.17Ad-22(e)(6)(i).
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The Commission understands that, as described above, the proposal
as a whole is designed to enable NSCC to more effectively address the
risks presented by members' concentrated positions in securities more
prone to gap risk events and to produce margin levels that are more
commensurate with the particular risk attributes of these concentrated
holdings, including the market price risk of liquidating large
positions in securities that are more prone to gap risk events. The
Commission believes that the proposal would improve NSCC's ability to
consider, and produce margin levels commensurate with, the risks and
particular attributes presented by a portfolio that meets the
concentration threshold and, therefore, is more susceptible to the
impacts of idiosyncratic risks.
First, the Commission believes that broadening the gap risk charge
to an additive feature of the VaR Charge and using the two largest non-
diversified positions would help NSCC to more effectively manage the
idiosyncratic risks of portfolios with concentrated holdings.
Specifically, the proposed changes should result in an overall increase
of margin for members that have positions subject to the gap risk
charge.\57\
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\57\ The impact study indicated that the proposed changes would
have resulted in a 10.88% increase for the daily total VaR Charge on
average and would have resulted in a 4.89% increase in the daily
total clearing fund on average during that period. See Notice of
Filing, supra note 5, 87 FR at 78176. In addition, the Commission
reviewed confidential materials submitted to the Commission, which
included more granular information, at a member level, of the
impacts of this proposal as compared to the current methodology. See
note 55 supra.
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[[Page 54370]]
Second, given the proposed additive nature of the gap risk charge,
the Commission believes the adjustments to the gap risk charge
calculation (i.e., establishing floors for the gap risk haircuts
applicable to the two largest positions) are reasonably designed to
cover NSCC's exposure to members arising from gap risks. The Commission
believes the adjustments to the gap risk charge calculation are
reasonable because the record shows the proposal should improve NSCC's
ability to mitigate against idiosyncratic risks that NSCC may face when
liquidating a portfolio that contains a concentration of positions,
while balancing NSCC's consideration of the potential costs to members
that may be subject to the gap risk charge.\58\ The Commission believes
that the established floors for the two haircuts should also help
ensure that the gap risk charge collects margin sufficient to cover the
potential exposure in a gap risk event.
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\58\ As part of the confidential materials submitted to the
Commission, NSCC provided analysis of alternative potential haircuts
and thresholds that it considered when developing the proposal. See
note 55 supra. The Commission's review of those materials further
supports its belief as to the reasonableness of this aspect of the
proposal.
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Third, by providing additional specific objective criteria to
determine which positions would be subject to the gap risk charge, the
Commission believes that NSCC should be able to better identify those
securities that may be more prone to idiosyncratic risks. Specifically,
the proposal should ensure that ETFs identified as non-diversified
(whether index-based or not) and therefore more prone to idiosyncratic
risks will be subject to the gap risk charge.
Taken together, the Commission believes that the proposal should
permit NSCC to calculate a gap risk charge that is more appropriately
designed to address the gap risks presented by concentrated positions
in portfolios. Accordingly, the Commission believes the proposal is
consistent with Rule 17Ad-22(e)(6)(i) under the Exchange Act because it
is designed to assist NSCC in maintaining a risk-based margin system
that considers, and produces margin levels commensurate with, the risks
and particular attributes of portfolios with identified concentration
risks.\59\
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\59\ 17 CFR 240.17Ad-22(e)(6)(i).
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IV. Conclusion
It is therefore noticed, pursuant to section 806(e)(1)(I) of the
Clearing Supervision Act, that the Commission DOES NOT OBJECT to
Advance Notice (SR-NSCC-2022-802) and that NSCC is AUTHORIZED to
implement the proposal as of the date of this notice, or the date of an
order by the Commission approving proposed rule change SR-NSCC-2022-
015, whichever is later.
By the Commission.
J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2023-17127 Filed 8-9-23; 8:45 am]
BILLING CODE 8011-01-P
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</html>Indexed from Federal Register on August 10, 2023.
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