Notice2024-10957
Self-Regulatory Organizations; Fixed Income Clearing Corporation; Notice of Filing of Partial Amendment No. 1 and Order Instituting Proceedings To Determine Whether To Approve or Disapprove a Proposed Rule Change, as Modified by Partial Amendment No. 1, Concerning the Adoption of a Minimum Margin Amount at GSD
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
May 20, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 89 Issue 98 (Monday, May 20, 2024)</title>
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[Federal Register Volume 89, Number 98 (Monday, May 20, 2024)]
[Notices]
[Pages 43915-43926]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-10957]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-100141; File No. SR-FICC-2024-003]
Self-Regulatory Organizations; Fixed Income Clearing Corporation;
Notice of Filing of Partial Amendment No. 1 and Order Instituting
Proceedings To Determine Whether To Approve or Disapprove a Proposed
Rule Change, as Modified by Partial Amendment No. 1, Concerning the
Adoption of a Minimum Margin Amount at GSD
May 14, 2024.
I. Introduction
On February 27, 2024, Fixed Income Clearing Corporation (``FICC'')
filed with the Securities and Exchange Commission (``Commission'')
proposed rule change SR-FICC-2024-003 pursuant to section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder.\2\ The notice of filing of the proposed rule change was
published for comment in the Federal Register on March 15, 2024.\3\ On
March 25, 2024, the Commission extended the review period of the
proposed rule change, pursuant to section 19(b)(2) of the Act,\4\ until
June 13, 2024, as the date by which the Commission shall either
approve, disapprove, or institute proceedings to determine whether to
disapprove the proposed rule change.\5\ The Commission has received
comments regarding the proposed rule change.\6\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 99711 (March 11, 2024),
89 FR 18991 (March 15, 2024) (SR-FICC-2024-003).
\4\ 15 U.S.C. 78s(b)(2)(ii).
\5\ Securities Exchange Act Release No. 99769 (March 19, 2024),
89 FR 20716 (March 25, 2024) (SR-FICC-2024-003).
\6\ Comments on the proposed rule change are available at
<a href="https://www.sec.gov/comments/sr-ficc-2024-003/srficc2024003.htm">https://www.sec.gov/comments/sr-ficc-2024-003/srficc2024003.htm</a>.
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On April 5, 2024, FICC filed Partial Amendment No. 1 to the
proposed rule change to correct errors FICC discovered regarding the
impact analysis filed as Exhibit 3 and discussed in the filing
narrative, as well as correct a typo in the methodology formula in
Exhibit 5b.\7\
[[Page 43916]]
The corrections in Partial Amendment No. 1 do not change the substance
of the proposed rule change.
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\7\ To promote the public availability and transparency of its
post-notice partial amendment, FICC submitted a copy of Partial
Amendment No. 1 through the Commission's electronic public comment
letter mechanism. Accordingly, Partial Amendment No. 1 has been
posted to the Commission's website at <a href="https://www.sec.gov/comments/sr-ficc-2024-003/srficc2024003-455611-1167714.pdf">https://www.sec.gov/comments/sr-ficc-2024-003/srficc2024003-455611-1167714.pdf</a> and thus been
publicly available since April 5, 2024. FICC has requested
confidential treatment pursuant to 17 CFR 240.24b-2 with respect to
Exhibit 3 and Exhibit 5b.
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Partial Amendment No. 1 includes corrections to percentages and
other figures throughout the filing narrative. Accordingly, the
Commission is publishing notice of the proposed rule change, as
modified by Partial Amendment No. 1 (hereinafter, the ``Proposed Rule
Change''), in its entirety and reopening the public comment period.\8\
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\8\ On February 27, 2024, FICC filed the proposed rule change as
an advance notice with the Commission pursuant to section 806(e)(1)
of Title VIII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act entitled the Payment, Clearing, and Settlement
Supervision Act of 2010 (``Clearing Supervision Act'') and Rule 19b-
4(n)(1)(i) under the Act. 12 U.S.C. 5465(e)(1); 17 CFR 240.19b-
4(n)(1)(i). Notice of the advance notice was published in the
Federal Register on March 15, 2024. Securities Exchange Act Release
No. 99712 (March 11, 2024), 89 FR 18981 (March 15, 2024) (SR-FICC-
2024-801). Pursuant to section 806(e)(1)(H) of the Clearing
Supervision Act, the Commission extended the review period of the
advance notice for an additional 60 days after finding that the
Advance Notice raised novel and complex issues. On March 22, 2024,
the Commission requested additional information from FICC pursuant
to section 806(e)(1)(D) of the Clearing Supervision Act, which
tolled the Commission's review period of review of the Advance
Notice. 12 U.S.C. 5465(e)(1)(D). On April 26, 2024, the Commission
received FICC's response to the Commission's request for additional
information. On April 5, 2024, FICC filed Partial Amendment No. 1 to
the advance notice, which makes the same corrections as Partial
Amendment No. 1 to the proposed rule change. In a separate
publication, the Commission is publishing notice of the advance
notice, as modified by Partial Amendment No. 1, in its entirety and
reopening the public comment period.
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The Proposed Rule Change, as modified by Partial Amendment No. 1,
is described in Items II and III below, which Items have been prepared
primarily by FICC. The Commission is publishing this notice to solicit
comments on the Proposed Rule Change, as modified by Partial Amendment
No. 1, from interested persons and is instituting proceedings, pursuant
to section 19(b)(2)(B) of the Exchange Act,\9\ to determine whether to
approve or disapprove the Proposed Rule Change, as modified by the
Partial Amendment No. 1.
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\9\ 15 U.S.C. 78s(b)(2)(B).
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II. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change, as Modified by Partial Amendment No. 1
The proposed rule change consists of modifications to FICC's
Government Securities Division (``GSD'') Rulebook (``GSD Rules'') \10\
to (1) enhance the VaR Floor by incorporating a ``Minimum Margin
Amount'' and (2) expand the application of the enhanced VaR Floor to
include Margin Proxy, as described in greater detail below. The
proposed rule change would necessitate changes to the Methodology
Document--GSD Initial Market Risk Margin Model (the ``QRM
Methodology''), which is filed as Exhibit 5b.\11\ FICC is requesting
confidential treatment of the QRM Methodology and has filed it
separately with the Commission.\12\
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\10\ Terms not defined herein are defined in the GSD Rules,
available at <a href="http://www.dtcc.com/legal/rules-and-procedures">www.dtcc.com/legal/rules-and-procedures</a>.
\11\ The QRM Methodology was filed as a confidential exhibit as
part of proposed rule change SR-FICC-2018-001 (the ``VaR Filing'').
See Securities Exchange Act Release No. 83362 (June 1, 2018), 83 FR
26514 (June 7, 2018) (SR-FICC-2018-001) (``VaR Filing Approval
Order''). FICC also filed the VaR Filing proposal as an advance
notice pursuant to section 806(e)(1) of the Payment, Clearing, and
Settlement Supervision Act of 2010 (12 U.S.C. 5465(e)(1) and Rule
19b-4(n)(1)(i) under the Act (17 CFR 240.19b-4(n)(1)(i)), with
respect to which the Commission issued a Notice of No Objection. See
Securities Exchange Act Release No. 83223 (May 11, 2018), 83 FR
23020 (May 17, 2018) (SR-FICC-2018-801). The QRM Methodology has
been subsequently amended following the VaR Filing Approval Order.
See Securities Exchange Act Release Nos. 85944 (May 24, 2019), 84 FR
25315 (May 31, 2019) (SR-FICC-2019-001), 90182 (Oct. 14, 2020), 85
FR 66630 (Oct. 20, 2020) (SR-FICC-2020-009), 93234 (Oct. 1, 2021),
86 FR 55891 (Oct. 7, 2021) (SR-FICC-2021-007), 95605 (Aug. 25,
2022), 87 FR 53522 (Aug. 31, 2022) (SR-FICC-2022-005), 97342 (Apr.
21, 2023), 88 FR 25721 (Apr. 27, 2023) (SR-FICC-2023-003), and 99447
(Jan. 30, 2024), 89 FR 8260 (Feb. 6, 2024) (SR-FICC-2024-001).
\12\ 17 CFR 240.24b-2.
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III. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change, as Modified by Partial Amendment No. 1
In its filing with the Commission, the clearing agency included
statements concerning the purpose of and basis for the proposed rule
change and discussed any comments it received on the proposed rule
change. The text of these statements may be examined at the places
specified in Item V below. The clearing agency has prepared summaries,
set forth in sections A, B, and C below, of the most significant
aspects of such statements.
(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change, as modified by Partial Amendment No. 1
1. Purpose
FICC is proposing to enhance the VaR Floor by incorporating a
Minimum Margin Amount in order to supplement the VaR model and improve
its responsiveness and resilience to extreme market volatility.
Specifically, FICC is proposing to modify the VaR Floor and the
corresponding description in the GSD Rules to incorporate a Minimum
Margin Amount. In addition, FICC is proposing to expand the application
of the enhanced VaR Floor to include Margin Proxy. The proposed change
would necessitate changes to the QRM Methodology.
FICC has observed extreme market volatility in the fixed income
market due to monetary policy changes, inflation, and recession fears.
The extreme market volatility has led to greater risk exposures for
FICC. Specifically, the extreme market volatilities during the two
arguably most stressful market periods, i.e., the COVID period during
March of 2020 and the successive interest rate hikes that began in
March 2022, have led to market price changes that exceeded the VaR
model's projections, which yielded insufficient VaR Charges. As a
result, FICC's VaR backtesting metrics fell below the performance
target due to unprecedented levels of extreme market volatility. This
highlighted the need for FICC to enhance its VaR model so that it can
better respond to extreme market volatility.
In order to better manage its risk exposures during extreme market
volatility events, FICC is proposing to adopt a Minimum Margin Amount
that would be applied as a minimum volatility calculation to ensure
that FICC calculates sufficient margin to cover its risk exposures,
particularly during extreme market volatility. The proposed Minimum
Margin Amount would be incorporated into the VaR Floor to supplement
the VaR model and enhance its responsiveness to extreme market
volatility. As proposed, the Minimum Margin Amount is designed to
improve the margin backtesting performance during periods of heightened
market volatility by maintaining a VaR Charge that is appropriately
calibrated to reflect the current market volatility. The proposed
Minimum Margin Amount aims to enhance backtesting coverage when there
are potential VaR model performance challenges, particularly when
securities price changes significantly exceed those implied by the VaR
model risk factors, as observed during the recent periods of extreme
market volatility. FICC believes the proposed Minimum Margin Amount
would provide a more reliable estimate for the portfolio risk level
when current market conditions significantly deviate from historical
observations.
The proposed Minimum Margin Amount would be determined using
historical price returns to represent risk along with amounts
calculated (i) using a filtered historical simulation approach, (ii)
using a haircut method, and (iii) to incorporate other risk factors. By
using a filtered historical simulation
[[Page 43917]]
approach in which historical returns are scaled to current market
volatility, the proposed Minimum Margin Amount would operate as a floor
to the VaR Charge to improve the responsiveness of the VaR model to
extreme volatility. Because the use of historical price return-based
risk representation is not dependent on any sensitivity data vendor, it
would allow the proposed Minimum Margin Amount to also operate as a
floor to the Margin Proxy and improve the responsiveness of Margin
Proxy to extreme volatility.
As a result of this proposal, Members may experience increases in
their Required Fund Deposits to the Clearing Fund. Based on an impact
study conducted by FICC, on average, at the Member level, the proposed
Minimum Margin Amount would have increased the SOD VaR Charge by
approximately $22.43 million, or 17.56%, and the noon VaR Charge by
approximately $23.25 million, or 17.43%, over a 2-year impact study
period.
Background
FICC, through GSD, serves as a central counterparty and provider of
clearance and settlement services for transactions in the U.S.
government securities, as well as repurchase and reverse repurchase
transactions involving U.S. government securities.\13\ As part of its
market risk management strategy, FICC manages its credit exposure to
Members by determining the appropriate Required Fund Deposit to the
Clearing Fund and monitoring its sufficiency, as provided for in the
GSD Rules.\14\ The Required Fund Deposit serves as each Member's
margin.
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\13\ GSD also clears and settles certain transactions on
securities issued or guaranteed by U.S. government agencies and
government sponsored enterprises.
\14\ See GSD Rule 4 (Clearing Fund and Loss Allocation), supra
note 10. FICC's market risk management strategy is designed to
comply with Rule 17Ad-22(e)(4) under the Act, where these risks are
referred to as ``credit risks.'' 17 CFR 240.17Ad-22(e)(4).
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The objective of a Member's Required Fund Deposit is to mitigate
potential losses to FICC associated with liquidating a Member's
portfolio in the event FICC ceases to act for that Member (hereinafter
referred to as a ``default'').\15\ The aggregate amount of all Members'
Required Fund Deposit constitutes the Clearing Fund. FICC would access
the Clearing Fund should a defaulting Member's own Required Fund
Deposit be insufficient to satisfy losses to FICC caused by the
liquidation of that Member's portfolio.
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\15\ The GSD Rules identify when FICC may cease to act for a
Member and the types of actions FICC may take. For example, FICC may
suspend a firm's membership with FICC or prohibit or limit a
Member's access to FICC's services in the event that Member defaults
on a financial or other obligation to FICC. See GSD Rule 21
(Restrictions on Access to Services) of the GSD Rules, supra note
10.
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FICC regularly assesses market and liquidity risks as such risks
relate to its margin methodologies to evaluate whether margin levels
are commensurate with the particular risk attributes of each relevant
product, portfolio, and market. For example, FICC employs daily
backtesting to determine the adequacy of each Member's Required Fund
Deposit.\16\ FICC compares the Required Fund Deposit \17\ for each
Member with the simulated liquidation gains/losses, using the actual
positions in the Member's portfolio(s) and the actual historical
security returns. A backtesting deficiency occurs when a Member's
Required Fund Deposit would not have been adequate to cover the
projected liquidation losses and highlights exposure that could subject
FICC to potential losses in the event that a Member defaults.
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\16\ The Model Risk Management Framework (``Model Risk
Management Framework'') sets forth the model risk management
practices of FICC and states that Value at Risk (``VaR'') and
Clearing Fund requirement coverage backtesting would be performed on
a daily basis or more frequently. See Securities Exchange Act
Release Nos. 81485 (Aug. 25, 2017), 82 FR 41433 (Aug. 31, 2017) (SR-
FICC-2017-014), 84458 (Oct. 19, 2018), 83 FR 53925 (Oct. 25, 2018)
(SR-FICC-2018-010), 88911 (May 20, 2020), 85 FR 31828 (May 27, 2020)
(SR-FICC-2020-004), 92380 (July 13, 2021), 86 FR 38140 (July 19,
2021) (SR-FICC-2021-006), 94271 (Feb. 17, 2022), 87 FR 10411 (Feb.
24, 2022) (SR-FICC-2022-001), and 97890 (July 13, 2023), 88 FR 46287
(July 19, 2023) (SR-FICC-2023-008).
\17\ Members may be required to post additional collateral to
the Clearing Fund in addition to their Required Fund Deposit amount.
See e.g., section 7 of GSD Rule 3 (Ongoing Membership Requirements),
supra note 10 (providing that adequate assurances of financial
responsibility of a member may be required, such as increased
Clearing Fund deposits). For backtesting comparisons, FICC uses the
Required Fund Deposit amount, without regard to the actual, total
collateral posted by the member to the GSD Clearing Fund.
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FICC investigates the cause(s) of any backtesting deficiencies and
determines if there is an identifiable cause of repeat backtesting
deficiencies. FICC also evaluates whether multiple Members may
experience backtesting deficiencies for the same underlying reason.
Pursuant to the GSD Rules, each Member's Required Fund Deposit
amount consists of a number of applicable components, each of which is
calculated to address specific risks faced by FICC, as identified
within the GSD Rules.\18\ These components include the VaR Charge,
Blackout Period Exposure Adjustment, Backtesting Charge, Holiday
Charge, Margin Liquidity Adjustment Charge, special charge, and
Portfolio Differential Charge.\19\ The VaR Charge generally comprises
the largest portion of a Member's Required Fund Deposit amount.
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\18\ Supra note 10.
\19\ See GSD Rule 4 (Clearing Fund and Loss Allocation), Section
1b. Supra note 10.
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VaR Charge
The VaR Charge is based on the potential price volatility of
unsettled positions using a sensitivity-based Value-at-Risk (VaR)
methodology. The VaR methodology provides an estimate of the possible
losses for a given portfolio based on: (1) confidence level, (2) a time
horizon and (3) historical market volatility. The VaR methodology is
intended to capture the risks related to market price that are
associated with the Net Unsettled Positions in a Member's Margin
Portfolios. This risk-based margin methodology is designed to project
the potential losses that could occur in connection with the
liquidation of a defaulting Member's Margin Portfolio, assuming a
Margin Portfolio would take three days to liquidate in normal market
conditions. The projected liquidation gains or losses are used to
determine the amount of the VaR Charge to each Margin Portfolio, which
is calculated to capture the market price risk \20\ associated with
each Member's Margin Portfolio(s) at a 99% confidence level.
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\20\ Market price risk refers to the risk that volatility in the
market causes the price of a security to change between the
execution of a trade and settlement of that trade. This risk is
sometimes also referred to as volatility risk.
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FICC's VaR model is designed to provide a margin calculation that
covers the market risk in a Member's Margin Portfolio. The VaR model
calculates the risk profile of each Member's Margin Portfolio by
applying certain representative risk factors to measure the degree of
responsiveness of the Margin Portfolio's value to the changes of these
risk factors over a historical lookback period of at least 10 years
that may be supplemented with an additional stressed period.
The VaR model has been shown to perform well in low to moderate
volatility markets. From January 2013 to March 2020, the VaR model has
generally performed above the 99% performance target, with
deterioration in backtesting coverage only during the two arguably most
stressful market periods, i.e., the COVID period during March of 2020
and the successive interest rate hikes that began in March 2022. The
market events during these two stressful periods, including monetary
policy changes, inflation and recession fears, have resulted in
[[Page 43918]]
significant market volatility in the fixed income market that exceeded
the 99-percentile of the observed historical data set. Specifically,
the extreme market volatilities during these two periods have led to
market price changes that exceeded the VaR model's projections, which
yielded insufficient VaR Charges. As a result, FICC's VaR backtesting
metrics fell below the performance target due to unprecedented levels
of extreme market volatility. This highlighted the need for FICC to
enhance its VaR model so that it can better respond to extreme market
volatility. Accordingly, FICC is proposing changes to the VaR Floor
that FICC believes would mitigate the risk of potential
underperformance of its VaR model under extreme market volatility.
Current VaR Floor
On June 1, 2018, the Commission approved FICC's VaR Filing to make
changes to GSD's method of calculating a Member's Required Fund Deposit
amount, including the VaR Charge.\21\ The VaR Filing amended the
definition of VaR Charge to, among other things, incorporate the VaR
Floor.\22\ FICC established the VaR Floor to address the risk that in a
long/short portfolio the VaR model could calculate a VaR Charge that is
erroneously low where the gross market value of unsettled positions in
a Member's portfolio is high and the cost of liquidation in the event
of the Member default is also high. This is likely to occur when the
VaR model applies substantial risk offsets among long and short
unsettled positions in different classes of securities that have a high
degree of historical price correlation.\23\ When this high degree of
historical price correlations does not apply as a result of changing
market conditions, the VaR Charge derived from the VaR model can be
inadequate, and the VaR Floor would then be applied by FICC to mitigate
such risk.
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\21\ See VaR Filing Approval Order, supra note 11.
\22\ The term ``VaR Floor'' is currently defined within the
definition of VaR Charge. See GSD Rule 1 (Definitions), supra note
10.
\23\ As an example, certain securities may have highly
correlated historical price returns, but if market conditions were
to substantially change, these historical correlations could break
down, leading to model-generated offsets that could not adequately
capture a portfolio's risk.
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Currently, the VaR Floor is based upon the market value of the
gross unsettled positions in the Member's portfolio. The VaR Floor is
determined by multiplying the absolute value of the sum of Net Long
Positions and Net Short Positions of Eligible Securities, grouped by
product and remaining maturity, by a percentage designated by FICC from
time to time for such group. For U.S. Treasury and agency securities,
such percentage shall be a fraction, no less than 10%, of the
historical minimum volatility of a benchmark fixed income index for
such group by product and remaining maturity. For mortgage-backed
securities, such percentage shall be a fixed percentage that is no less
than 0.05%.\24\
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\24\ See ``VaR Charge'' definition in GSD Rule 1 (Definitions).
Supra note 10.
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The current VaR Floor is not designed to address the risk of
potential underperformance of the VaR model under extreme market
volatility.
Incorporate a Minimum Margin Amount Into the VaR Floor
In order to mitigate the risk of potential underperformance of its
VaR model under extreme market volatility, FICC proposes to incorporate
a Minimum Margin Amount into the VaR Floor to supplement the VaR model
and enhance its responsiveness to extreme market volatility. FICC
believes this proposal would complement and improve the VaR model
performance during stressed market conditions. Specifically, FICC
believes this proposal would improve the margin backtesting performance
during periods of heightened market volatility by maintaining a VaR
Charge that is appropriately calibrated to reflect the current market
volatility.
FICC is proposing to introduce a new calculation called the
``Minimum Margin Amount'' to complement the existing VaR Floor in the
GSD Rules. The Minimum Margin Amount would enhance backtesting coverage
when there are potential VaR model performance challenges, particularly
when securities price changes significantly exceed those implied by the
VaR model risk factors, as observed during the recent periods of
extreme market volatility. FICC believes the proposed Minimum Margin
Amount would provide a more reliable estimate for the portfolio risk
level when current market conditions significantly deviate from
historical observations.
The Minimum Margin Amount would be defined in the GSD Rules as,
with respect to each Margin Portfolio, a minimum volatility calculation
for specified Net Unsettled Positions of a Netting Member as of the
time of such calculation. The proposed definition would provide that
the Minimum Margin Amount shall use historical price returns to
represent risk \25\ and be calculated as the sum of the following: (a)
amounts calculated using a filtered historical simulation (``FHS'')
approach \26\ to assess volatility by scaling historical market price
returns to current market volatility, with market volatility being
measured by applying exponentially weighted moving average to the
historical market price returns with a decay factor between 0.93 and
0.99, as determined by FICC from time to time based on sensitivity
analysis, macroeconomic conditions, and/or backtesting performance, (b)
amounts calculated using a haircut method to measure the risk exposure
of those securities that lack sufficient historical price return data,
(c) amounts calculated to incorporate risks related to (i) repo
interest volatility (``repo interest volatility charge'') \27\ and (ii)
transaction costs related to bid-ask spread in the market that could be
incurred when liquidating a portfolio (``bid-ask spread risk
charge'').\28\ In addition, the proposed definition would require FICC
to provide Members with at a minimum one Business Day advance notice of
any change to the decay factor via an Important Notice.\29\
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\25\ This proposed approach is referred to as the ``price
return-based risk representation'' in the QRM Methodology. Given the
availability and accessibility of historical price returns data,
FICC believes the proposed approach would help minimize and
diversify FICC's risk exposure from external data vendors.
\26\ The FHS method differs from the historical simulation
method by incorporating the volatilities of historical price returns
as a crucial element. In particular, the FHS method constructs the
filtered historical price returns in two steps: first,
``devolatilizing'' the historical price returns by dividing them by
a volatility estimate for the day of the price return, and second,
``revolatilizing'' the devolatilized price returns by multiplying
them by a volatility estimate based on the current market. For
additional background on the FHS method, see Filtered historical
simulation Value-at-Risk models and their competitors, Pedro
Gurrola-Perez and David Murphy, Bank of England, March 2015, at
<a href="http://www.bankofengland.co.uk/working-paper/2015/filtered-historical-simulation-value-at-risk-models-and-their-competitors">www.bankofengland.co.uk/working-paper/2015/filtered-historical-simulation-value-at-risk-models-and-their-competitors</a>.
\27\ The ``repo interest volatility charge'' is a component of
the VaR Charge that is designed to address repo interest volatility.
The repo interest volatility charge is calculated based on
internally constructed repo interest rate indices. This rule change
is proposing to also include the repo interest volatility charge as
a component of the Minimum Margin Amount; however, it is not
proposing to change the repo interest volatility charge or the
manner in which this component is calculated.
\28\ The ``bid-ask spread risk charge'' is a component of the
VaR Charge that is designed to address transaction costs related to
bid-ask spread in the market that could be incurred when liquidating
a portfolio. This rule change is proposing to also include the bid-
ask spread risk charge as a component of the Minimum Margin Amount;
however, it is not proposing to change the bid-ask spread risk
charge or the manner in which this component is calculated.
\29\ Although the QRM Methodology is being submitted as a
confidential Exhibit 5b to this proposal due to its proprietary
content, FICC makes available to Members a Value-at-Risk (VaR)
calculator that can be used to estimate their Clearing Fund
requirements based on their portfolios.
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[[Page 43919]]
FICC is proposing to revise the definition of the VaR Floor to
incorporate the Minimum Margin Amount, such that the VaR Floor would be
the greater of (i) the VaR Floor Percentage Amount and (ii) the Minimum
Margin Amount.
The ``VaR Floor Percentage Amount'' would be the new defined term
used to describe the current VaR Floor percentage calculation in the
GSD Rules. This rule change is not proposing to change the VaR Floor
percentage or the manner in which this component is calculated.
As proposed, the Minimum Margin Amount would be utilized as the VaR
Charge for a Member's Margin Portfolio when it is greater than the
current VaR Charge of the Margin Portfolio and the VaR Floor Percentage
Amount.
Under the proposed changes to the QRM Methodology, the Minimum
Margin Amount would use a price return-based risk representation (i.e.,
use historical price returns to represent risk) \30\ and be calculated
as the sum of (i) amounts calculated using a FHS method that scales
historical market price returns to current market volatility, (ii)
amounts calculated using a haircut method for securities that lack
sufficient historical price return data, and (iii) amounts calculated
to incorporate additional risk factors.
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\30\ Supra note 25.
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FHS Method
Following the FHS method, FICC would first construct historical
price returns using certain mapped fixed income securities benchmarks.
As proposed, the mapped fixed income securities benchmarks to be used
with the FHS method when calculating the Minimum Margin Amount in the
QRM Methodology would be Bloomberg Treasury indexes for U.S. Treasury
and agency securities, Bloomberg TIPS indexes for Treasury Inflation-
Protected Securities (``TIPS''), and to-be-announced (``TBA'')
securities for mortgage-backed securities (``MBS'') pools. These
benchmarks were selected because their price movements generally
closely track those of the securities mapped to them and that their
price history is generally readily available and accessible.
After constructing historical price returns, FICC would estimate a
market volatility associated with each historical price return by
applying exponentially weighted moving average (``EWMA'') to the
historical price returns. The historical price returns are then
``devolatilized'' by dividing them by the corresponding EWMA
volatilities to obtain the residual returns. The residual returns are
then ``revolatilized'' by multiplying them by the current EWMA
volatility to obtain the filtered returns.
The filtered return time series are then used to simulate the
profits and losses of a Member's Margin Portfolio and derive the
volatility of the Margin Portfolio using the standard historical
simulation approach. In particular, each security that is in a Member's
Margin Portfolio would be mapped to a respective fixed income
securities benchmark, as applicable, based on the security's asset
class and remaining maturity. The filtered returns of the benchmark are
used as the simulated returns of the mapped security to calculate the
simulated profits and losses of a Member's Margin Portfolio. The
Minimum Margin Amount is then calculated as the 99-percentile of the
simulated portfolio loss.
Haircut Method
Occasionally, a Member's Margin Portfolio(s) contain classes of
securities that reflect market price changes that are not consistently
related to historical price moves. The value of these securities is
often uncertain because the securities' market volume varies widely,
thus the price histories are limited. Because the volume and price
information for such securities are not robust, the FHS method would
not generate Minimum Margin Amounts that adequately reflect the risk
profile of such securities. Accordingly, the proposed changes to the
QRM Methodology would provide that the Minimum Margin Amount would use
a haircut method to assess the market risk of those securities that are
more difficult to simulate, for example, because of thin trading
history.
Specifically, the proposed haircut method would be used for MBS
pools that are not TBA securities eligible, floating rate notes and
U.S. Treasury/agency securities with remaining time to maturities of
less than or equal to one year.
A haircut method would also be used to size up the basis risk
between an agency security and the mapped U.S. Treasury index to
supplement the historical market price moves generated by the FHS
method for agency securities to reflect any residual risks between
agency securities and the mapped fixed income securities benchmarks,
i.e., Bloomberg Treasury indexes. Similarly, a haircut method would be
used to size up the MBS pool/TBA basis risk to address the residual
risk for using TBA price returns as proxies for MBS pool returns used
in the FHS method.
Minimum Margin Amount Calculation
FICC is proposing to modify the QRM Methodology to specify that the
Minimum Margin Amount would use a price return-based risk
representation and be calculated per Member Margin Portfolio as the sum
of (i), (ii), and (iii):
(i) FHS Method
(a) the amount calculated using historical market price returns of
mapped fixed income securities benchmarks derived based on the FHS
method.
(ii) Haircut Method
(a) the haircut charge for MBS pools that are not TBA securities
eligible,
(b) the supplemental haircut charge for agency securities,
(c) the haircut charge for floating rate notes and U.S. Treasury/
agency securities with remaining time to maturities of less than or
equal to one year, and
(d) the supplemental basis haircut charge for mortgage pool
securities.
(iii) Additional Risk Factors
(a) the repo interest volatility charge,\31\ and
---------------------------------------------------------------------------
\31\ Supra note 27.
---------------------------------------------------------------------------
(b) the bid-ask spread risk charge.\32\
---------------------------------------------------------------------------
\32\ Supra note 28.
---------------------------------------------------------------------------
The mapped fixed income securities benchmarks, historical market
price returns, parameters and volatility assessments to be used to
calculate the Minimum Margin Amount would be determined by FICC from
time to time in accordance with FICC's model risk management practices
and governance set forth in the Clearing Agency Model Risk Management
Framework.\33\
---------------------------------------------------------------------------
\33\ See Model Risk Management Framework, supra note 16.
---------------------------------------------------------------------------
Minimum Margin Amount Parameters
The proposed Minimum Margin Amount uses a lookback period for the
filtered historical simulation and a decay factor for calculating the
EWMA volatility of the historical prices returns.
In particular, the lookback period of the proposed Minimum Margin
Amount is the same as the lookback period used for the VaR model, which
is 10 years, plus, to the extent applicable, a stressed period.
Consistent with the VaR methodology outlined in the QRM Methodology and
pursuant to the model performance monitoring required under the Model
Risk Management Framework,\34\ the lookback period
[[Page 43920]]
would be analyzed to evaluate its sensitivity and impact to the model
performance.
---------------------------------------------------------------------------
\34\ The Model Risk Management Framework provides that all
models undergo ongoing model performance monitoring and backtesting
which is the process of (i) evaluating an active model's ongoing
performance based on theoretical tests, (ii) monitoring the model's
parameters through the use of threshold indicators, and/or (iii)
backtesting using actual historical data/realizations to test a VaR
model's predictive power. Supra note 16.
---------------------------------------------------------------------------
The decay factor in general affects (i) whether and how the Minimum
Margin Amount would be invoked, (ii) the peak level of margin increase
or the degree of procyclicality, and (iii) how quickly the margin would
fall back to pre-stress levels. Similar to the lookback period, the
decay factor of the proposed Minimum Margin Amount would also be
analyzed to evaluate its sensitivity and impact to the model
performance pursuant to the model performance monitoring required under
the Model Risk Management Framework.\35\ The decay factor would be, as
proposed, between 0.93 and 0.99, and any update thereto is expected to
be an infrequent event and would typically happen only when there is an
unprecedented market volatility event which resulted in risk exposures
to FICC that cannot be adequately mitigated by the then calibrated
decay factor. The decision to update the decay factor would be based on
the above-mentioned sensitivity analysis with considerations to
factors, such as the impact to the VaR Charges, macroeconomic
conditions, and/or backtesting performance. The initial decay factor
for the Minimum Margin Amount calculation would be 0.97 but may be
adjusted as set forth above in accordance with FICC's model risk
management practices and governance set forth in the Model Risk
Management Framework.\36\
---------------------------------------------------------------------------
\35\ Supra note 34.
\36\ See Model Risk Management Framework, supra note 16.
---------------------------------------------------------------------------
The Model Risk Management Framework would also require FICC to
conduct ongoing model performance monitoring of the Minimum Margin
Amount methodology.\37\ FICC's current model performance monitoring
practices would provide for sensitivity analysis of relevant model
parameters and assumptions to be conducted monthly, or more frequently
when markets display high volatility. In addition, FICC would monitor
each Member's Required Fund Deposit and the aggregate Clearing Fund
requirements versus the requirements calculated by the Minimum Margin
Amount. Specifically, FICC would review and assess the robustness of
the Required Fund Deposit inclusive of the Minimum Margin Amount by
comparing the results versus the three-day profit and loss of each
Member's Margin Portfolio based on actual market price moves. Based on
the results of the sensitivity analysis and/or backtesting, FICC could
consider adjustments to the Minimum Margin Amount, including changing
the decay factor as appropriate. Any adjustment to the Minimum Margin
Amount calculation would be subject to the model risk management
practices and governance process set forth in the Model Risk Management
Framework.\38\
---------------------------------------------------------------------------
\37\ See note 34.
\38\ See Model Risk Management Framework, supra note 16.
---------------------------------------------------------------------------
Expand Application of VaR Floor To Include Margin Proxy
The GSD Margin Proxy methodology is currently deployed as an
alternative volatility calculation in the event that the requisite
vendor data used for the VaR model is unavailable for an extended
period of time.\39\ In circumstances where the Margin Proxy is applied
by FICC, FICC is proposing to have the VaR Floor operate as a floor for
the Margin Proxy. Specifically, FICC is proposing to expand the
application of the VaR Floor to include Margin Proxy so that if the
Margin Proxy, when deployed, is lower than the VaR Floor, then the VaR
Floor would be utilized as the VaR Charge with respect to a Member's
Margin Portfolio. FICC believes this proposed change would enable
Margin Proxy to be a more effective risk mitigant under extreme market
volatility and heightened market stress, thereby enhancing the overall
resilience of the FICC risk management.
---------------------------------------------------------------------------
\39\ FICC may deem such data to be unavailable and deploy Margin
Proxy when there are concerns with the quality of data provided by
the vendor.
---------------------------------------------------------------------------
Proposed GSD Rule Changes
In connection with incorporating the Minimum Margin Amount into the
VaR Floor, FICC would modify the GSD Rules to:
I. Add a definition of ``Minimum Margin Amount'' and define it as,
with respect to each Margin Portfolio, a minimum volatility calculation
for specified Net Unsettled Positions of a Member as of the time of
such calculation. The definition would provide that the Minimum Margin
Amount shall use historical price returns to represent risk and be
calculated as the sum of the following: (a) amounts calculated using a
filtered historical simulation approach to assess volatility by scaling
historical market price returns to current market volatility, with
market volatility being measured by applying exponentially weighted
moving average to the historical market price returns with a decay
factor between 0.93 and 0.99, as determined by FICC from time to time
based on sensitivity analysis, macroeconomic conditions, and/or
backtesting performance, (b) amounts calculated using a haircut method
to measure the risk exposure of those securities that lack sufficient
historical price return data, and (c) amounts calculated to incorporate
risks related to (i) repo interest volatility (``repo interest
volatility charge'') and (ii) transaction costs related to bid-ask
spread in the market that could be incurred when liquidating a
portfolio (``bid-ask spread risk charge''). In addition, the proposed
definition would require FICC to provide Members with at a minimum one
Business Day advance notice of any change to the decay factor via an
Important Notice;
II. Add a definition of ``VaR Floor Percentage Amount'' which would
be defined the same as the current calculation for the VaR Floor
percentage with non-substantive modifications to reflect that the
calculated amount is a separate defined term; and
III. Move the defined term VaR Floor out of the definition of VaR
Charge and define it as the greater of (i) the VaR Floor Percentage
Amount and (ii) the Minimum Margin Amount.
In connection with applying the VaR Floor to include Margin Proxy,
FICC would modify the GSD Rules to revise the definition of ``VaR
Charge'' by adding a reference to the Margin Proxy with respect to the
VaR Floor application and clarifying that VaR Charge is calculated at
the Margin Portfolio-level.
Proposed QRM Methodology Changes
In connection with incorporating the Minimum Margin Amount into the
VaR Floor, FICC would modify the QRM Methodology to:
I. Describe how the Minimum Margin Amount, as defined in the GSD
Rules, would be calculated, including:
(i) Establishing mapped fixed income securities benchmarks for
purposes of the calculation using historical market price returns of
such securities with the FHS method;
(ii) Using a haircut method to assess the market risk of certain
securities that are more difficult to simulate due to thin trading
history; and
(iii) Detailing other risk factors that would be incorporated in
the calculation.
II. Describe the developmental evidence and impacts to backtesting
performance and margin charges relating to Minimum Margin Amount.
In connection with applying the VaR Floor to include Margin Proxy,
FICC
[[Page 43921]]
would modify the QRM Methodology to reflect that the Minimum Margin
Amount would serve as a floor for the Margin Proxy.
In addition, FICC would modify the QRM Methodology to:
I. Make certain clarifying changes to the QRM Methodology to delete
an out-of-date description of the Margin Proxy being used as an
adjustment factor to the VaR,\40\ enhance the description of the VaR
Floor Percentage Amount, and update the list of key model parameters to
reflect the Margin Proxy lookback period; and
---------------------------------------------------------------------------
\40\ FICC currently does not use Margin Proxy as an adjustment
factor to the VaR and does not intend to use it as such in the
future.
---------------------------------------------------------------------------
II. Make certain technical changes to the QRM Methodology to
renumber sections and tables, correct grammatical and typographical
errors, delete out-of-date index names, and update certain formula
notations and section titles as necessary.
Impact Study
FICC performed an impact study on Members' Margin Portfolios for
the period beginning July 1, 2021 through June 30, 2023 (``Impact Study
Period').<SUP>41 42</SUP> If the proposed rule changes \43\ had been in
place during the Impact Study Period compared to the existing GSD
Rules, the aggregate average daily start-of-day (``SOD'') VaR Charges
would have increased by approximately $2.90 billion or 13.89%, the
aggregate average daily noon VaR Charges would have increased by
approximately $3.03 billion or 14.06%, and the aggregate average daily
Backtesting Charges would have decreased by approximately $622 million
or 64.46%.
---------------------------------------------------------------------------
\41\ GSD increased the minimum Required Fund Deposit for Members
to $1 million on Dec. 5, 2022 (see Securities Exchange Act Release
No. 96136 (Oct. 24, 2022), 87 FR 65268 (Oct. 28, 2022) (SR-FICC-
2022-006)); however, for the purpose of this Impact Study, the $1
million minimum Requirement Fund Deposit is assumed to be in effect
for the entirety of the Impact Study period.
\42\ GSD adopted a Portfolio Differential Charge (``PD Charge'')
as an additional component to the GSD Required Fund Deposit on Oct.
30, 2023 (see Securities Exchange Act Release No. 98494 (Sep. 25,
2023), 88 FR 67394 (Sep. 29, 2023) (SR-FICC-2023-011)); however, for
the purpose of this Impact Study, the PD Charge is assumed to be in
effect for the entirety of the Impact Study period.
\43\ Margin Proxy was not deployed during the Impact Study
Period; however, if the proposed rule changes had been in place and
the Margin Proxy were deployed during the Impact Study Period, the
aggregate average daily SOD VaR Charges would have increased by
approximately $4.16 billion or 20.97%. The impact study also
indicated that if the proposed rule changes had been in place and
the Margin Proxy were deployed, the VaR model backtesting coverage
would have increased from approximately 98.17% to 99.38% during the
Impact Study Period. Specifically, if the proposed rule changes had
been in place and the Margin Proxy were deployed during the Impact
Study Period, the number of the VaR model backtesting deficiencies
would have been reduced by 899 (from 1358 to 459, or approximately
66.2%).
---------------------------------------------------------------------------
The impact study indicated that if the proposed rule changes had
been in place, the VaR model backtesting coverage would have increased
from approximately 98.86% to 99.46% during the Impact Study Period.
Specifically, if the proposed rule changes had been in place during the
Impact Study Period, the number of VaR model backtesting deficiencies
would have been reduced by 441 (from 843 to 402, or approximately 52%).
The impact study also indicated that if the proposed rule changes
had been in place, overall margin backtesting coverage would have
increased from approximately 98.87% to 99.33% during the Impact Study
Period. Specifically, if the proposed rule changes had been in place
during the Impact Study Period, the number of overall margin
backtesting deficiencies would have been reduced by 280 (from 685 to
405, or approximately 41%) and the overall margin backtesting coverage
for 94 Members (approximately 72% of the GSD membership) would have
improved with 36 Members who were below 99% coverage would be brought
back to above 99%.
Impacts to Members Over the Impact Study Period
On average, at the Member level, the proposed Minimum Margin Amount
would have increased the SOD VaR Charge by approximately $22.43
million, or 17.56%, and the noon VaR Charge by approximately $23.25
million, or 17.43%, over the Impact Study Period. The largest average
percentage increase in SOD VaR Charge for any Member would have been
approximately 66.88%, or $97,051 (0.21% of the Member's average Net
Capital),\44\ and the largest average percentage increase in noon VaR
Charge for any Member would have been approximately 64.79%, or $61,613
(0.13% of the Member's average Net Capital). The largest average dollar
increase in SOD VaR Charge for any Member would have been approximately
$268.51 million (0.34% of the Member's average Net Capital), or 19.06%,
and the largest dollar increase in noon VaR Charge for any Member would
have been approximately $289.00 million (1.07% of the Member's average
Net Capital), or 13.67%. The top 10 Members based on the size of their
average SOD VaR Charges and average noon VaR Charges would have
contributed approximately 51.87% and 53.64% of the aggregated SOD VaR
Charges and aggregated noon VaR Charges, respectively, during the
Impact Study Period had the proposed Minimum Margin Amount been in
place. The same Members would have contributed to 50.08% and 51.52% of
the increase in aggregated SOD VaR Charges and aggregated noon VaR
Charges, respectively, had the proposed Minimum Margin Amount been in
place during the Impact Study Period.
---------------------------------------------------------------------------
\44\ The term ``Net Capital'' means, as of a particular date,
the amount equal to the net capital of a broker or dealer as defined
in SEC Rule 15c3-1(c)(2), or any successor rule or regulation
thereto. See GSD Rule 1 (Definitions), supra note 10.
---------------------------------------------------------------------------
Implementation Timeframe
FICC would implement the proposed rule changes by no later than 60
Business Days after the later of the approval of the proposed rule
change and no objection to the related advance notice \45\ by the
Commission. FICC would announce the effective date of the proposed
changes by an Important Notice posted to its website.
---------------------------------------------------------------------------
\45\ Supra note 8.
---------------------------------------------------------------------------
2. Statutory Basis
FICC believes that this proposal is consistent with the
requirements of the Act and the rules and regulations thereunder
applicable to a registered clearing agency. Specifically, FICC believes
that this proposal is consistent with section 17A(b)(3)(F) of the Act
\46\ and Rules 17Ad-22(e)(4)(i) and (e)(6)(i), each promulgated under
the Act,\47\ for the reasons described below.
---------------------------------------------------------------------------
\46\ 15 U.S.C. 78q-1(b)(3)(F).
\47\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i).
---------------------------------------------------------------------------
Section 17A(b)(3)(F) of the Act requires, in part, that the GSD
Rules be 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.\48\ FICC believes the proposed changes are designed
to assure the safeguarding of securities and funds which are in its
custody or control or for which it is responsible because they are
designed to enable FICC to better limit its exposure to Members in the
event of a Member default, as described below.
---------------------------------------------------------------------------
\48\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
The Required Fund Deposits are made up of risk-based components (as
margin) that are calculated and assessed daily to limit FICC's credit
exposures to Members. FICC is proposing changes to the GSD Rules and
QRM Methodology that are designed to more effectively measure and
address risk characteristics in situations where the risk factors used
in the VaR method do not adequately predict market price movements. The
proposed changes above would adjust
[[Page 43922]]
the VaR Floor to help ensure that FICC collects adequate margin from
its Members, particularly in periods of extreme market volatility.
During periods of extreme market volatility, the existing VaR model has
been shown to underperform based on backtesting performances.
Backtesting percentages covering such periods indicate the risk that
VaR Charges would be insufficient to manage risk in the event of a
Member default. FICC pays particular attention to Members with
backtesting deficiencies that bring the backtesting results for that
Member below the 99% confidence target to determine if there is an
identifiable cause of repeat backtesting deficiencies. During the
recent period of extreme market volatility, there was an increase in
observed backtesting deficiencies. The Minimum Margin Amount, to be
defined in the GSD Rules and further incorporated in the QRM
Methodology as described herein, is a proposed targeted response to
enhance the GSD VaR model performance and improve the backtesting
coverage during periods of extreme market volatility.
As a result of the recent extreme market volatility, FICC's VaR
model did not achieve a 99% confidence level for all Members during the
COVID period during March of 2020 and the successive interest rate
hikes that began in June 2022. The Minimum Margin Amount is intended to
allow the VaR Charge to be more responsive during market conditions
when the VaR model projections do not closely correspond with observed
market price changes. Backtesting studies indicate that the aggregate
average daily SOD VaR Charges would have increased by approximately
$2.90 billion or 13.89%, the aggregate average daily noon VaR Charges
would have increased by approximately $3.03 billion or 14.06%, the
aggregate average daily Backtesting Charges would have decreased by
approximately $622 million or 64.46% during the Impact Study Period,
and the overall margin backtesting coverage (based on 12-month trailing
backtesting) would have improved from approximately 98.87% to 99.33%
during the Impact Study Period if the Minimum Margin Amount calculation
had been in place. Improving the overall backtesting coverage level
would help FICC ensure that it maintains an appropriate level of margin
to address its risk management needs.
The use of the Minimum Margin Amount would reduce risk by allowing
FICC to calculate the exposure in each portfolio using historical price
returns to represent risk along with amounts calculated (i) using a FHS
method that scales historical market price returns to current market
volatility, (ii) using a haircut method for securities that lack
sufficient historical price return data, and (iii) to incorporate other
risk factors. As reflected by backtesting studies during the Impact
Study Period, the proposed changes would appropriately limit FICC's
credit exposure to Members when current market conditions deviate from
historical observations, resulting in the risk factors used in the VaR
method do not adequately predict market price movements and associated
credit risk exposure. Adding the Minimum Margin Amount to the VaR Floor
would help to ensure that the risk exposure during periods of extreme
market volatility is adequately captured in the VaR Charges. Similarly,
the proposed change to expand the application of VaR Floor to include
Margin Proxy would enable Margin Proxy to be a more effective risk
mitigant under extreme market volatility and heightened market stress.
By improving the effectiveness of Margin Proxy as a risk mitigant under
extreme market volatility and heightened market stress would help
ensure that the margin that FICC collects from Members is sufficient to
mitigate the credit exposure presented by the Members. Overall, FICC
believes these proposed changes would help to ensure that FICC
continues to accurately calculate and assess margin and in turn,
collect sufficient margin from its Members and better enable FICC to
limit its exposures that could be incurred when liquidating a
portfolio.
FICC believes the proposed clarifying and technical changes to the
GSD Rules and QRM Methodology described above would enhance the clarity
of the GSD Rules and the QRM Methodology for FICC and its membership.
Having clear and accurate rules would help Members better understand
their rights and obligations under the GSD Rules, and Members would be
more likely to act in accordance with the GSD Rules. Similarly, having
a clear and accurate methodology document that describes how the VaR
Charges are calculated would help to ensure that FICC continues to
accurately calculate and assess margin and in turn, collect sufficient
margin from its Members and better enable FICC to limit its exposures
that could be incurred when liquidating a portfolio.
By better enabling FICC to limit its exposure to Members, the
proposed changes to the GSD Rules and QRM Methodology are designed to
better ensure that, in the event of a Member default, FICC would have
adequate margin from the defaulting Member and non-defaulting Members
would not be exposed to losses they cannot anticipate or control.
Therefore, the proposed changes would be designed to assure the
safeguarding of securities and funds which are in the custody or
control of FICC or for which it is responsible, consistent with section
17A(b)(3)(F) of the Act.\49\
---------------------------------------------------------------------------
\49\ Id.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(4)(i) under the Act \50\ requires a covered
clearing agency to 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 exposures arising from its payment, clearing, and settlement
processes by maintaining sufficient financial resources to cover its
credit exposure to each participant fully with a high degree of
confidence. As described above, FICC believes that the proposed changes
would enable it to better identify, measure, monitor, and, through the
collection of Members' Required Fund Deposits, manage its credit
exposures to Members by maintaining sufficient resources to cover those
credit exposures fully with a high degree of confidence. More
specifically, as indicated by backtesting studies, implementation of a
Minimum Margin Amount by changing the GSD Rules and QRM Methodology as
described herein would allow FICC to limit its credit exposures to
Members in the event that the current VaR model yields too low a VaR
Charge for such portfolios and improve backtesting performance. As
indicated by the backtesting studies, the aggregate average daily SOD
VaR Charges would have increased by approximately $2.90 billion or
13.89%, the aggregate average daily noon VaR Charges would have
increased by approximately $3.03 billion or 14.06%, the aggregate
average daily Backtesting Charges would have decreased by approximately
$622 million or 64.46% during the Impact Study Period, and the overall
margin backtesting coverage (based on 12-month trailing backtesting)
would have improved from approximately 98.87% to 99.33% during the
Impact Study Period if the Minimum Margin Amount calculation had been
in place. By identifying and providing for appropriate VaR Charges,
adding the Minimum Margin Amount to the VaR Floor would help to ensure
that the risk exposure during periods of extreme market volatility is
adequately identified, measured and monitored. Similarly, the proposed
change to expand the application of VaR Floor to
[[Page 43923]]
include Margin Proxy would enable Margin Proxy to be a more effective
risk mitigant under extreme market volatility and heightened market
stress. By improving the effectiveness of Margin Proxy as a risk
mitigant under extreme market volatility and heightened market stress
would help ensure that the margin that FICC collects from Members is
sufficient to mitigate the credit exposure presented by the Members. As
a result, FICC believes that the proposal would enhance FICC's ability
to effectively identify, measure and monitor its credit exposures and
would enhance its ability to maintain sufficient financial resources to
cover its credit exposure to each participant fully with a high degree
of confidence, consistent with the requirements of Rule 17Ad-
22(e)(4)(i) under the Act.\51\
---------------------------------------------------------------------------
\50\ 17 CFR 240.17Ad-22(e)(4)(i).
\51\ Id.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(6)(i) under the Act \52\ requires a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to cover its credit
exposures to its participants by establishing a risk-based margin
system that, at a minimum, considers, and produces margin levels
commensurate with, the risks and particular attributes of each relevant
product, portfolio, and market. FICC believes that the proposed changes
to adjust the VaR Floor to include the Minimum Margin Amount by
changing the GSD Rules and QRM Methodology as described herein are
consistent with the requirements of Rule 17Ad-22(e)(6)(i) cited above.
The Required Fund Deposits are made up of risk-based components (as
margin) that are calculated and assessed daily to limit FICC's credit
exposures to Members. FICC is proposing changes that are designed to
more effectively measure and address risk characteristics in situations
where the risk factors used in the VaR method do not adequately predict
market price movements. As reflected in backtesting studies, FICC
believes the proposed changes would appropriately limit FICC's credit
exposure to Members in the event that the VaR model yields too low a
VaR Charge in such situations. Such backtesting studies indicate that
the aggregate average daily SOD VaR Charges would have increased by
approximately $2.90 billion or 13.89%, the aggregate average daily noon
VaR Charges would have increased by approximately $3.03 billion or
14.06%, the aggregate average daily Backtesting Charges would have
decreased by approximately $622 million or 64.46% during the Impact
Study Period, and the overall margin backtesting coverage (based on 12-
month trailing backtesting) would have improved from approximately
98.87% to 99.33% during the Impact Study Period if the Minimum Margin
Amount calculation had been in place. By identifying and providing for
appropriate VaR Charges, adding the Minimum Margin Amount to the VaR
Floor would help to ensure that margin levels are commensurate with the
risk exposure of each portfolio during periods of extreme market
volatility. Similarly, the proposed change to expand the application of
VaR Floor to include Margin Proxy would enable Margin Proxy to be a
more effective risk mitigant under extreme market volatility and
heightened market stress. By improving the effectiveness of Margin
Proxy as a risk mitigant under extreme market volatility and heightened
market stress would help ensure that the margin that FICC collects from
Members is sufficient to mitigate the credit exposure presented by the
Members. Overall, the proposed changes would allow FICC to more
effectively address the risks presented by Members. In this way, the
proposed changes enhance the ability of FICC to produce margin levels
commensurate with the risks and particular attributes of each relevant
product, portfolio, and market. As such, FICC believes that the
proposed changes are consistent with the requirements of Rule 17Ad-
22(e)(6)(i) under the Act.\53\
---------------------------------------------------------------------------
\52\ 17 CFR 240.17Ad-22(e)(6)(i).
\53\ Id.
---------------------------------------------------------------------------
(B) Clearing Agency's Statement on Burden on Competition
FICC believes the proposed rule changes to (i) modify the VaR Floor
to incorporate a Minimum Margin Amount and (ii) expand the application
of the VaR Floor to include Margin Proxy, each as described above,
could impose a burden on competition. As a result of the proposed rule
changes, Members may experience increases in their Required Fund
Deposits. An impact study during the Impact Study Period indicates that
on average each Member would have had an increase in the SOD VaR Charge
and the noon VaR Charge of approximately $22.43 million, or 17.56%, and
$23.25 million, or 17.43%, respectively. Such increases could burden
Members that have lower operating margins or higher costs of capital
than other Members. It is not clear whether the burden on competition
would necessarily be significant because it would depend on whether the
affected Members were similarly situated in terms of business type and
size. Regardless of whether the burden on competition is significant,
FICC believes that any burden on competition would be necessary and
appropriate in furtherance of the purposes of the Act, as permitted by
section 17A(b)(3)(I) of the Act.\54\
---------------------------------------------------------------------------
\54\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------
Specifically, FICC believes that the proposed rule changes would be
necessary in furtherance of the Act, as described in this filing and
further below. FICC believes that the above-described burden on
competition that may be created by the proposed changes is necessary,
because the GSD Rules must be designed to assure the safeguarding of
securities and funds that are in FICC's custody or control or which it
is responsible, consistent with section 17A(b)(3)(F) of the Act.\55\ As
described above, FICC believes that the use of the Minimum Margin
Amount would reduce risk by allowing FICC to calculate the exposure in
each portfolio using historical price returns to represent risk along
with amounts calculated (i) using a FHS method that scales historical
market price returns to current market volatility, (ii) a haircut
method for securities that lack sufficient historical price return
data, and (iii) to incorporate other risk factors, based on open
positions within each portfolio. FICC believes the proposed change
would provide a more reliable estimate than the FICC VaR historical
data set for the portfolio risk level when current market conditions
deviate from historical observations. Accurately calculating and
assessing margin and in turn, collecting sufficient margin from its
Members would better enable FICC to limit its exposures that could be
incurred when liquidating a portfolio. Similarly, the proposed change
to expand the application of VaR Floor to include Margin Proxy would
enable Margin Proxy to be a more effective risk mitigant under extreme
market volatility and heightened market stress. By improving the
effectiveness of Margin Proxy as a risk mitigant under extreme market
volatility and heightened market stress would help ensure that the
margin that FICC collects from Members is sufficient to mitigate the
credit exposure presented by the Members. By better enabling FICC to
limit its exposure to Members, the proposed changes to the GSD Rules
and QRM Methodology are designed to better ensure that, in the event of
a Member default, FICC would have adequate margin from the defaulting
Member and non-defaulting Members would not be exposed to losses they
cannot anticipate or control. Therefore, the proposed
[[Page 43924]]
changes would be designed to assure the safeguarding of securities and
funds which are in the custody or control of FICC or for which it is
responsible, consistent with section 17A(b)(3)(F) of the Act.\56\
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\55\ 15 U.S.C. 78q-1(b)(3)(F).
\56\ Id.
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FICC also believes these proposed changes are necessary to support
FICC's compliance with Rule 17Ad-22(e)(4)(i) and Rule 17Ad-22(e)(6)(i)
under the Act,\57\ which require FICC to establish, implement, maintain
and enforce written policies and procedures reasonably designed to (x)
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 and (y) 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.
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\57\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i).
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As described above, FICC believes that implementing the Minimum
Margin Amount into the VaR Floor would allow FICC to more effectively
measure and address risk characteristics in situations where the risk
factors used in the VaR method do not adequately predict market price
movements, particularly in periods of extreme volatility and economic
uncertainty. FICC's existing VaR model underperformed in response to
the significant levels of extreme market volatility, and the VaR Charge
amounts that were calculated using the profit and loss scenarios
generated by FICC's VaR model did not achieve the 99% backtesting
coverage target during the COVID period during March of 2020 and the
successive interest rate hikes that began in March 2022. In addition,
the current VaR Floor is not designed to address the risk of potential
underperformance of the VaR model under extreme market volatility. As
reflected in backtesting studies during the Impact Study Period, FICC
believes the proposed changes would appropriately cover FICC's credit
exposure to Members with a high degree of confidence in the event that
the VaR model yields too low a VaR Charge in such situations. The
proposed rule changes would limit FICC's exposure to Members by
ensuring that each Member has an appropriate minimum VaR Charge applied
to its portfolios in the event that the VaR model yields too low a VaR
Charge for such portfolios. By identifying and providing for
appropriate VaR Charges, adding the Minimum Margin Amount to the VaR
Floor would help to ensure that margin levels are commensurate with the
risk exposure of each portfolio during periods of extreme market
volatility. Similarly, the proposed change to expand the application of
VaR Floor to include Margin Proxy would enable Margin Proxy to be a
more effective risk mitigant under extreme market volatility and
heightened market stress. By improving the effectiveness of Margin
Proxy as a risk mitigant under extreme market volatility and heightened
market stress would help ensure that the margin that FICC collects from
Members is sufficient to mitigate the credit exposure presented by the
Members. Therefore, FICC believes that these proposed changes would
allow FICC to effectively identify, measure, monitor, and manage its
credit exposures to Members and better limit FICC's credit exposures to
Members by maintaining sufficient financial resources to cover its
credit exposure to each Member fully with a high degree of confidence
and producing margin levels commensurate with the risks and particular
attributes of each relevant product and portfolio consistent with the
requirements of Rule 17Ad-22(e)(4)(i) and Rule 17Ad-22(e)(6)(i) under
the Act.\58\
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\58\ Id.
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FICC also believes that the above-described burden on competition
that could be created by the proposed changes would be appropriate in
furtherance of the Act because such changes have been appropriately
designed to assure the safeguarding of securities and funds which are
in the custody or control of FICC or for which it is responsible, as
described in detail above. The proposed changes to incorporate the
Minimum Margin Amount and apply the VaR Floor to include Margin Proxy
would enable FICC to produce margin levels more commensurate with the
risks and particular attributes of each Member's portfolio. Any
increase in Required Fund Deposit as a result of such proposed changes
for a particular Member would be in direct relation to the specific
risks presented by such Members' portfolio, and each Member's Required
Fund Deposit would continue to be calculated with the same parameters
and at the same confidence level. Therefore, Members with portfolios
that present similar risks, regardless of the type of Member, would
have similar impacts on their Required Fund Deposit amounts. In
addition, the proposed changes would improve the risk-based margining
methodology that FICC employs to set margin requirements and better
limit FICC's credit exposures to its Members. Impact studies indicate
that the proposed methodology would result in backtesting coverage that
more appropriately addresses the risks presented by each portfolio.
Therefore, because the proposed changes are designed to provide FICC
with a more appropriate and complete measure of the risks presented by
Members' portfolios, FICC believes the proposals are appropriately
designed to meet its risk management goals and its regulatory
obligations.
Therefore, FICC does not believe that the proposed changes would
impose any burden on competition that is not necessary or appropriate
in furtherance of the Act.\59\
---------------------------------------------------------------------------
\59\ 15.U.S.C. 78q-1(b)(3)(I).
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FICC does not believe the proposed clarifying and technical changes
to the GSD Rules and the QRM Methodology would impact competition.
These changes would help to ensure that the GSD Rules and the QRM
Methodology remain clear. Specifically, the changes to the GSD Rules
would facilitate members' understanding of the GSD Rules and their
obligations thereunder, and the changes to the QRM Methodology would
help ensure that FICC continues to accurately calculate and assess
margin from its Members. These changes would not affect FICC's
operations or the rights and obligations of the membership. As such,
FICC believes the proposed clarifying and technical changes would not
have any impact on competition.
(C) Clearing Agency's Statement on Comments on the Proposed Rule Change
Received From Members, Participants, or Others
FICC has not received or solicited any written comments relating to
this proposal. If any additional written comments are received, they
will be publicly filed as an Exhibit 2 to this filing, as required by
Form 19b-4 and the General Instructions thereto.
Persons submitting comments are cautioned that, according to
Section IV (Solicitation of Comments) of the Exhibit 1A in the General
Instructions to Form 19b-4, the Commission does not edit personal
identifying information from comment submissions. Commenters should
submit only information that they wish to make available publicly,
including their name, email address, and any other identifying
information.
[[Page 43925]]
All prospective commenters should follow the Commission's
instructions on how to submit comments, available at <a href="http://www.sec.gov/regulatory-actions/how-to-submit-comments">www.sec.gov/regulatory-actions/how-to-submit-comments</a>. General questions regarding
the rule filing process or logistical questions regarding this filing
should be directed to the Main Office of the SEC's Division of Trading
and Markets at <a href="/cdn-cgi/l/email-protection#2a5e584b4e43444d4b444e474b58414f5e596a594f49044d455c"><span class="__cf_email__" data-cfemail="b1c5c3d0d5d8dfd6d0dfd5dcd0c3dad4c5c2f1c2d4d29fd6dec7">[email protected]</span></a> or 202-551-5777.
FICC reserves the right not to respond to any comments received.
IV. Proceedings To Determine Whether To Approve or Disapprove the
Proposed Rule Change, as Modified by Partial Amendment No. 1, and
Grounds for Disapproval Under Consideration
The Commission is instituting proceedings pursuant to section
19(b)(2)(B) of the Exchange Act to determine whether the Proposed Rule
Change, as modified by Partial Amendment No. 1, should be approved or
disapproved.\60\ Institution of proceedings is appropriate at this time
in view of the legal and policy issues raised by the Proposed Rule
Change, as modified by Partial Amendment No. 1. Institution of
proceedings does not indicate that the Commission has reached any
conclusions with respect to any of the issues involved. Rather, the
Commission seeks and encourages interested persons to comment on the
Proposed Rule Change, as modified by Partial Amendment No. 1, which
would provide the Commission with arguments to support the Commission's
analysis as to whether to approve or disapprove the Proposed Rule
Change, as modified by Partial Amendment No. 1.
---------------------------------------------------------------------------
\60\ 15 U.S.C. 78s(b)(2)(B).
---------------------------------------------------------------------------
Pursuant to section 19(b)(2)(B) of the Exchange Act,\61\ the
Commission is providing notice of the grounds for disapproval under
consideration. The Commission is instituting proceedings to allow for
additional analysis of, and input from commenters with respect to, the
consistency of the Proposed Rule Change, as modified by Partial
Amendment No. 1, with section 17A of the Exchange Act \62\ and the
rules thereunder, including the following provisions:
---------------------------------------------------------------------------
\61\ Id.
\62\ 15 U.S.C. 78q-1.
---------------------------------------------------------------------------
<bullet> Section 17A(b)(3)(F) of the Exchange Act,\63\ which
requires, among other things, that the rules of a clearing agency are
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;
---------------------------------------------------------------------------
\63\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
<bullet> Rule 17Ad-22(e)(4)(i) under the Exchange Act,\64\ which
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 exposures arising from its payment, clearing,
and settlement processes by maintaining sufficient financial resources
to cover its credit exposure to each participant fully with a high
degree of confidence; and
---------------------------------------------------------------------------
\64\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------
<bullet> Rule 17Ad-22(e)(6)(i) under the Exchange Act,\65\ which
requires that a covered clearing agency 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.
---------------------------------------------------------------------------
\65\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------
V. Procedure: Request for Written Comments
The Commission requests that interested persons provide written
submissions of their views, data, and arguments with respect to the
issues identified above, as well as any other concerns they may have
with the Proposed Rule Change, as modified by Partial Amendment No. 1.
In particular, the Commission invites the written views of interested
persons concerning whether the Proposed Rule Change, as modified by
Partial Amendment No. 1, is consistent with section 17A(b)(3)(F) \66\
and Rules 17Ad-22(e)(4)(i), and (e)(6)(i) \67\ of the Exchange Act, or
any other provision of the Exchange Act, or the rules and regulations
thereunder. Although there do not appear to be any issues relevant to
approval or disapproval that would be facilitated by an oral
presentation of views, data, and arguments, the Commission will
consider, pursuant to Rule 19b-4(g) under the Exchange Act,\68\ any
request for an opportunity to make an oral presentation.\69\
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\66\ 15 U.S.C. 78q-1(b)(3)(F).
\67\ 17 CFR 240.17Ad-22(e)(4)(i) and 17 CFR 240.17Ad-
22(e)(6)(i).
\68\ 17 CFR 240.19b-4(g).
\69\ Section 19(b)(2) of the Exchange Act grants to the
Commission flexibility to determine what type of proceeding--either
oral or notice and opportunity for written comments--is appropriate
for consideration of a particular proposal by a self-regulatory
organization. See Securities Act Amendments of 1975, Senate Comm. on
Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st
Sess. 30 (1975).
---------------------------------------------------------------------------
The Commission asks that commenters address the sufficiency of
FICC's statements in support of the Proposed Rule Change, as modified
by Partial Amendment No. 1, which are set forth herein, in addition to
any other comments they may wish to submit about the Proposed Rule
Change, as modified by Partial Amendment No. 1.
Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="http://www.sec.gov/rules/sro.shtml">www.sec.gov/rules/sro.shtml</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#e694938a83cb85898b8b83889295a6958385c8818990"><span class="__cf_email__" data-cfemail="b5c7c0d9d098d6dad8d8d0dbc1c6f5c6d0d69bd2dac3">[email protected]</span></a>. Please include
File Number SR-FICC-2024-003 on the subject line.
Paper Comments
<bullet> Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549.
All submissions should refer to File Number SR-FICC-2024-003. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (<a href="http://www.sec.gov/rules/sro.shtml">www.sec.gov/rules/sro.shtml</a>). Copies
of the submission, all subsequent amendments, all written statements
with respect to the proposed rule change that are filed with the
Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of FICC and on DTCC's website
(<a href="http://dtcc.com/legal/sec-rule-filings">dtcc.com/legal/sec-rule-filings</a>). Do not include personal identifiable
information in submissions; you should submit only information that you
wish to make available publicly. We may redact in part or withhold
entirely from publication submitted material that is obscene or subject
to copyright protection.
All submissions should refer to File Number SR-FICC-2024-003 and
should
[[Page 43926]]
be submitted on or before June 10, 2024. Rebuttal comments should be
submitted by June 24, 2024.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\70\
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\70\ 17 CFR 200.30-3(a)(31).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-10957 Filed 5-17-24; 8:45 am]
BILLING CODE 8011-01-P
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