Notice2024-26531
Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Approving a Proposed Rule Change, as Modified by Partial Amendment No. 1, To Adopt 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
November 14, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 89 Issue 220 (Thursday, November 14, 2024)</title>
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[Federal Register Volume 89, Number 220 (Thursday, November 14, 2024)]
[Notices]
[Pages 90109-90122]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-26531]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-101569; File No. SR-FICC-2024-003]
Self-Regulatory Organizations; Fixed Income Clearing Corporation;
Order Approving a Proposed Rule Change, as Modified by Partial
Amendment No. 1, To Adopt a Minimum Margin Amount at GSD
November 8, 2024.
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 proposed rule change was published for comment in
the Federal Register on March 15, 2024.\3\ On March
[[Page 90110]]
25, 2024, pursuant to Section 19(b)(2) of the Act,\4\ the Commission
designated a longer period within which to approve, disapprove, or
institute proceedings to determine whether to approve or disapprove the
Proposed Rule Change.\5\ 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.\6\ The corrections in Partial Amendment No. 1 did not
change the substance of the proposed rule change.\7\ The proposed rule
change, as modified by Partial Amendment No. 1, is hereinafter referred
to as the ``Proposed Rule Change.'' On May 20, 2024, the Commission
published in the Federal Register notice of filing of Partial Amendment
No. 1 and an order instituting proceedings to determine whether to
approve or disapprove the Proposed Rule Change.\8\ On September 12,
2024, pursuant to Section 19(b)(2) of the Act,\9\ the Commission
extended the period for the conclusion of proceedings to determine
whether to approve or disapprove the Proposed Rule Change.\10\
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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). FICC also filed the
proposals contained in the proposed rule change as advance notice
SR-FICC-2024-801 with the Commission pursuant to Section 806(e)(1)
of the Dodd-Frank Wall Street Reform and Consumer Protection Act
entitled the Payment, Clearing, and Settlement Supervision Act of
2010 (``Clearing Supervision Act''). 12 U.S.C. 5465(e)(1); 17 CFR
240.19b-4(n)(1)(i). Notice of 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.
\4\ 15 U.S.C. 78s(b)(2).
\5\ Securities Exchange Act Release No. 99769 (March 19, 2024),
89 FR 20716 (March 25, 2024) (SR-FICC-2024-003).
\6\ FICC has requested confidential treatment pursuant to 17 CFR
240.24b-2 with respect to Exhibit 3 and Exhibit 5b.
\7\ 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. The Commission
published notice of the advance notice, as modified by Partial
Amendment No. 1, for comment in the Federal Register on May 20,
2024. Securities Exchange Act Release No. 100140 (May 14, 2024), 89
FR 43941 (May 20, 2024) (SR-FICC-2024-801). The advance notice, as
modified by Partial Amendment No. 1, is hereinafter referred to as
the ``Advance Notice.'' On August 13, 2024, the Commission made a
second request for 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 September 26, 2024, the Commission received
FICC's response to the Commission's second request for additional
information.
\8\ Securities Exchange Act Release No. 100141 (May 14, 2024),
89 FR 43915 (May 20, 2024) (SR-FICC-2024-003) (``Notice'').
\9\ 15 U.S.C. 78s(b)(2)(B)(ii)(II).
\10\ Securities Exchange Act Release No. 100958 (Sept. 6, 2024),
89 FR 74309 (Sept. 12, 2024) (SR-FICC-2024-003).
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The Commission received comment letters on the Proposed Rule
Change.\11\ In addition, the Commission received a letter from FICC
responding to the public comments.\12\ For the reasons discussed below,
the Commission is approving the Proposed Rule Change.
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\11\ 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>.
Comments on the Advance Notice are available at <a href="https://www.sec.gov/comments/sr-ficc-2024-801/srficc2024801.htm">https://www.sec.gov/comments/sr-ficc-2024-801/srficc2024801.htm</a>. Because the proposals
contained in the Advance Notice and the Proposed Rule Change are the
same, all 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.
\12\ See Letter from Timothy B. Hulse, Managing Director
Financial Risk, Governance & Credit Risk of Depository Trust &
Clearing Corporation, (June 24, 2024) (``FICC Letter'').
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I. Description of the Proposed Rule Change
A. Executive Summary
FICC proposes to add a new Minimum Margin Amount (``MMA'')
calculation to the GSD margin methodology to ensure that FICC collects
sufficient margin amounts from its members during sudden periods of
extreme market volatility. Recently, FICC faced increased risk exposure
to its members during two periods of extreme market volatility, i.e.,
the COVID-related volatility in March 2020 and the volatility resulting
from the successive interest rate hikes that began in March 2022. Those
periods of volatility involved market price changes that exceeded the
GSD margin model's projections, causing FICC to collect margin amounts
that were insufficient to cover FICC's risk exposure to its members.
This highlighted the need for FICC to enhance the GSD margin
methodology to provide better coverage during periods of extreme market
volatility.
FICC proposes to add the MMA calculation to the Value-at-Risk
charge (``VaR Charge'') component of the GSD margin methodology.
Whereas the current VaR Charge is determined as the greater of two
separate calculations, FICC proposes to add the MMA as a third
calculation so that the VaR Charge would be the greater of three
separate calculations. FICC specifically designed the MMA calculation
to be more responsive to volatile market conditions than the two
existing VaR Charge calculations. As described more fully below, the
MMA calculation uses a filtered historical simulation (``FHS'')
approach, which takes historical price data, removes the historical
volatility estimates, and replaces them with volatility estimates that
reflect current market conditions. The FHS approach also incorporates
parameters that would give more weight to recent market events, such
that when market volatility spikes, the MMA calculation would generate
higher amounts and be more likely to exceed the other two VaR Charge
calculations. Conversely, when market volatility subsides, the MMA
calculation would generate lower amounts and be less likely to exceed
the other two VaR Charge calculations.
FICC conducted a 2-year impact study to analyze, among other
things, the actual daily member-level margin amounts and backtesting
results in comparison to the margin amounts and backtesting results had
the MMA calculation been in place. The impact study indicates that if
FICC used the MMA calculation during the 2-year period of analysis,
FICC's margin collections and backtesting coverage would have
significantly improved and enabled FICC to meet its 99 percent
backtesting performance targets.
B. Background
FICC, through its Government Securities Division (``GSD''),\13\
serves as a central counterparty (``CCP'') and provider of clearance
and settlement services for transactions in U.S. government securities,
as well as repurchase and reverse repurchase transactions involving
U.S. government securities.\14\ A key tool that FICC uses to manage its
credit exposures to its members is the daily collection of the Required
Fund Deposit (i.e., margin) from each member.\15\ The aggregated amount
of all members' Required Fund Deposits constitutes the Clearing Fund,
which FICC would access should a defaulted member's own Required Fund
Deposit be insufficient to satisfy losses to FICC caused by the
liquidation of that member's portfolio.\16\
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\13\ The GSD Rules are available at https://www.dtcc.com/~/
media/Files/Downloads/legal/rules/ficc_gov_rules.pdf. Terms not
otherwise defined herein are defined in the GSD Rules.
\14\ GSD also clears and settles certain transactions on
securities issued or guaranteed by U.S. government agencies and
government sponsored enterprises.
\15\ See GSD Rule 4 (Clearing Fund and Loss Allocation), supra
note 13.
\16\ See id.
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A member's Required Fund Deposit consists of a number of
components,
[[Page 90111]]
each of which is calculated to address specific risks faced by
FICC.\17\ The VaR Charge generally comprises the largest portion of a
member's Required Fund Deposit amount. The VaR Charge is a calculation
of the volatility of the unsettled securities positions in a member's
portfolio.\18\ For each member portfolio, FICC currently uses two
separate methods to calculate amounts, the greater of which constitutes
the member's VaR Charge.\19\
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\17\ Supra note 15.
\18\ See GSD Rule 1 (Definitions--VaR Charge), supra note 13.
\19\ See id.
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FICC's first calculation uses a sensitivity-based VaR methodology
to estimate the possible losses for a given portfolio based on: (1)
confidence level, (2) a time horizon, and (3) historical market
volatility. The sensitivity VaR methodology is intended to capture the
market price risks that are associated with the securities positions in
a member's margin portfolio,\20\ at a 99 percent confidence level. This
methodology projects the potential losses that could occur in
connection with the liquidation of a defaulting member's portfolio,
assuming a portfolio would take three days to liquidate in normal
market conditions. The sensitivity VaR methodology relies on
sensitivity data and historical risk factor time series data generated
by an external vendor to calculate the risk profile of each member's
portfolio. In the event of a vendor data disruption, the GSD Rules
provide for an alternative volatility calculation that relies on
historical market index proxies (the ``Margin Proxy'' calculation).\21\
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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.
\21\ See GSD Rule 1 (Definitions--Margin Proxy), supra note 13;
Securities Exchange Act Release Nos. 80341 (March 30, 2017), 82 FR
16644 (April 5, 2017) (SR-FICC-2017-801); Securities Exchange Act
Release No. 83223 (May 11, 2018), 83 FR 23020 (May 17, 2018) (SR-
FICC-2018-801).
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FICC recognizes that the sensitivity VaR methodology might not
generate margin amounts sufficient to cover its exposure to its members
consistent with its regulatory obligations when applied to certain
types of member portfolios.\22\ Therefore, FICC's second calculation
uses a haircut-based methodology (currently referred to in the GSD
Rules as the ``VaR Floor''),\23\ in which FICC applies a haircut to the
market value of the gross unsettled positions in the member's
portfolio.\24\ The current VaR Floor is not designed to address the
risk of potential underperformance of the sensitivity VaR methodology
under extreme market volatility.\25\ Each member's VaR Charge is either
the sensitivity VaR calculation or the VaR Floor calculation, whichever
is greater.\26\
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\22\ See Notice, supra note 8 at 43918. Specifically, for member
portfolios that contain both long and short positions in different
classes of securities that have a high degree of historical price
correlation, the sensitivity VaR methodology can generate inadequate
VaR Charges. See id.
\23\ Supra note 18.
\24\ See Securities Exchange Act Release No. 83362 (June 1,
2018), 83 FR 26514 (June 7, 2018) (SR-FICC-2018-001). Specifically,
FICC calculates the VaR Floor by multiplying the absolute value of
the sum of the portfolio's net long positions and net short
positions, grouped by product and remaining maturity, by a
percentage designated by FICC for such group. For U.S. Treasury and
agency securities, such percentage shall be a fraction, no less than
10 percent, 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 percent. Supra note 18.
\25\ See Notice, supra note 8 at 43918.
\26\ Supra note 18.
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FICC regularly assesses whether its margin methodologies generate
margin levels commensurate with the particular risk attributes of each
relevant product, portfolio, and market. For example, FICC employs
daily backtesting \27\ to determine the adequacy of margin collections
from its members.\28\ FICC compares each Member's Required Fund Deposit
\29\ with the simulated liquidation gains/losses, using the actual
positions in each member portfolio 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. Backtesting deficiencies highlight exposures that could subject
FICC to potential losses in the event of a member default.
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\27\ Backtesting is an ex-post comparison of actual outcomes
(i.e., the actual margin collected) with expected outcomes derived
from the use of margin models. See 17 CFR 240.17ad-22(a)(1).
\28\ FICC's Model Risk Management Framework (``Model Risk
Management Framework'') sets forth the model risk management
practices of FICC and states that 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); 97890 (July 13, 2023), 88 FR 46287 (July 19, 2023) (SR-FICC-
2023-008).
\29\ 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 13 (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 believes that its current VaR model has performed well in low
to moderate volatility markets,\30\ though it has not met FICC's
performance targets during periods of extreme market volatility.\31\ As
described more fully below, FICC performed an impact study on its
members' margin portfolios covering the period beginning July 1, 2021
through June 30, 2023 (``Impact Study'').\32\ During the period of the
Impact Study, FICC's VaR model backtesting coverage was 98.86 percent,
with 843 VaR model backtesting deficiencies.\33\ Also, during the
period of the Impact Study, FICC's overall margin backtesting coverage
was 98.87 percent, with 685 overall margin backtesting
deficiencies.\34\ Thus, the Impact Study demonstrates that FICC's
backtesting metrics fell below performance targets during the period of
the Impact Study.\35\ FICC states that the foregoing backtesting
deficiencies are attributable to recent periods of extreme volatility
in the fixed income market caused by monetary policy changes,
inflation, and recession fears, which have led to greater risk
exposures for FICC.\36\ Specifically, FICC states that the periods of
extreme market volatility in March 2020 related to the COVID pandemic
and the successive interest rate hikes that began in March 2022, have
led to market price changes that exceeded the projections of FICC's
current VaR model, resulting in insufficient VaR Charges.\37\
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\30\ During the periods of relatively low to moderate market
volatility from January 2013 to March 2020, the VaR model generally
performed above the 99 percent performance targets. See Notice,
supra note 8 at 43917.
\31\ During the pandemic-related volatility in March 2020 and
the successive interest rate hikes that began in March 2022, the VaR
model fell below the 99 percent performance targets. See Notice,
supra note 8 at 43916-18.
\32\ As part of the Proposed Rule Change, FICC filed Exhibit 3--
FICC Impact Study. Pursuant to 17 CFR 240.24b-2, FICC requested
confidential treatment of Exhibit 3.
\33\ See Notice, supra note 8 at 43921.
\34\ See id.
\35\ See Notice, supra note 8 at 43916-18.
\36\ See id.
\37\ See id.
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Accordingly, in the Proposed Rule Change, FICC proposes changes to
the VaR model that FICC believes would mitigate the risk of potential
underperformance of the VaR model during periods of extreme market
volatility.\38\
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\38\ The proposed changes would revise the GSD Rules and FICC's
Methodology Document--GSD Initial Market Risk Margin Model (the
``QRM Methodology'') relevant to the VaR model. As part of the
Proposed Rule Change, FICC filed Exhibit 5b--Proposed Changes to the
QRM Methodology. Pursuant to 17 CFR 240.24b-2, FICC requested
confidential treatment of Exhibit 5b. FICC originally filed the QRM
Methodology as a confidential exhibit to proposed rule change SR-
FICC-2018-001. See supra note 24; see also Securities Exchange Act
Release No. 83223 (May 11, 2018), 83 FR 23020 (May 17, 2018) (SR-
FICC-2018-801). FICC has subsequently amended the QRM Methodology.
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); 99447
(Jan. 30, 2024), 89 FR 8260 (Feb. 6, 2024) (SR-FICC-2024-001).
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[[Page 90112]]
C. Proposed Changes
In the Proposed Rule Change, FICC proposes to introduce a new
minimum margin amount (i.e., the MMA) into the GSD margin methodology.
FICC proposes to calculate the MMA for each member portfolio as a
supplement to the existing sensitivity VaR calculation and the haircut-
based VaR Floor calculation described above in Section I.B. FICC
proposes to rename the current haircut-based VaR Floor calculation as
the ``VaR Floor Percentage Amount.'' FICC proposes to revise the
existing VaR Floor definition to mean the greater of (1) the VaR Floor
Percentage Amount, and (2) the MMA. Thus, the greater of the three
calculations (i.e., sensitivity VaR, VaR Floor Percentage Amount, and
MMA) would constitute the member's VaR Charge. Additionally, FICC
proposes to clarify that the VaR Floor would also apply in the event
that the Margin Proxy is invoked. The proposed changes are described in
greater detail below.
1. Minimum Margin Amount Calculation
FICC would calculate the MMA for each portfolio using historical
price returns to represent risk.\39\ FICC would calculate the MMA as
the sum of the following: (1) amounts calculated using an FHS approach
\40\ to assess volatility by scaling historical market price returns to
current market volatility, with market volatility being measured by
applying an exponentially weighted moving average (``EWMA'') to the
historical market price returns with a decay factor between 0.93 and
0.99,\41\ as determined by FICC based on sensitivity analysis,
macroeconomic conditions, and/or backtesting performance; (2) amounts
calculated using a haircut method to measure the risk exposure of those
securities that lack sufficient historical price return data; and (3)
amounts calculated to incorporate risks related to (i) repo interest
volatility (``repo interest volatility charge'') \42\ 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'').\43\
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\39\ FICC refers to the proposed approach as the ``price return-
based risk representation'' in the QRM Methodology. See Notice,
supra note 8 at 43918. 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. See id.
\40\ The FHS method differs from the historical simulation
method, which uses historical price return data as is, by
incorporating the volatilities of historical price returns. In
particular, the FHS method constructs the filtered historical price
returns in two steps: ``devolatilizing'' the historical price
returns by dividing them by a volatility estimate for the day of the
price return; and ``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>.
\41\ FICC would provide members with at least one Business Day
advance notice of any change to the decay factor via an Important
Notice.
\42\ The ``repo interest volatility charge'' is a component of
the VaR Charge designed to address repo interest volatility. The
repo interest volatility charge is calculated based on internally
constructed repo interest rate indices. As proposed, FICC would
include the repo interest volatility charge as a component of the
MMA; however, FICC is not proposing to otherwise change the repo
interest volatility charge or the manner in which it is calculated.
See Notice, supra note 8 at 43918.
\43\ The ``bid-ask spread risk charge'' is a component of the
VaR Charge designed to address transaction costs related to bid-ask
spread in the market that FICC could incur when liquidating a
portfolio. As proposed, FICC would include the bid-ask spread risk
charge as a component of the MMA; however, FICC is not proposing to
otherwise change the bid-ask spread risk charge or the manner in
which it is calculated. See Notice, supra note 8 at 43918.
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FHS Method: For the FHS method, FICC would first construct
historical price returns using certain mapped fixed income securities
benchmarks. Specifically, FICC proposes to use the following mapped
fixed income securities benchmarks with the FHS method when calculating
the MMA: (1) Bloomberg Treasury indexes for U.S. Treasury and agency
securities; (2) Bloomberg TIPS indexes for Treasury Inflation-Protected
Securities (``TIPS''); and (3) to-be-announced (``TBA'') securities for
mortgage-backed securities (``MBS'') pools. FICC states that it chose
these benchmarks 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.\44\
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\44\ See Notice, supra note 8 at 43919.
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After constructing historical price returns, FICC would estimate a
market volatility associated with each historical price return by
applying an EWMA to the historical price returns. FICC would
``devolatilize'' the historical price returns (i.e., remove an amount
attributable to the historical market volatility from the price
returns) by dividing them by the corresponding EWMA volatilities to
obtain the residual returns. FICC would ``revolatilize'' the residual
returns (i.e., add an amount attributable to the current market
volatility to the residual returns) by multiplying them by the current
EWMA volatility to obtain the filtered returns.
FICC proposes to use the FHS method to improve the responsiveness
of the VaR model to periods of extreme market volatility because
historical returns are scaled to current market volatility.\45\ FICC
would use filtered return time series to simulate the profits and
losses of a member's portfolio and derive the volatility of the
portfolio using the standard historical simulation approach.
Specifically, FICC would map each security that is in a member's
portfolio to a respective fixed income securities benchmark, as
applicable, based on the security's asset class and remaining maturity.
FICC would use the filtered returns of the benchmark as the simulated
returns of the mapped security to calculate the simulated profits and
losses of a member's portfolio. Finally, FICC would calculate the MMA
as the 99-percentile of the simulated portfolio loss. In accordance
with FICC's model risk management practices and governance set forth in
the Clearing Agency Model Risk Management Framework,\46\ FICC would
determine the mapped fixed income securities benchmarks, historical
market price returns, parameters, and volatility assessments used to
calculate the MMA.
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\45\ See Notice, supra note 8 at 43916-17.
\46\ See Model Risk Management Framework, supra note 28.
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FHS Parameters: The proposed MMA would use a lookback period for
the FHS and a decay factor for calculating the EWMA volatility of the
historical price returns. Specifically, the MMA lookback period would
be the same as the lookback period currently used for the sensitivity
VaR calculation, which is 10 years, plus, to the extent applicable, a
stressed period. FICC would analyze the MMA's lookback period and
evaluate its sensitivity and impact on margin model performance,
consistent with the VaR methodology outlined in the QRM Methodology and
pursuant to the model performance monitoring
[[Page 90113]]
required under the Model Risk Management Framework.\47\
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\47\ The Model Risk Management Framework provides that all
models undergo ongoing model performance monitoring and backtesting,
which is the process of evaluating an active model's ongoing
performance based on theoretical tests, monitoring the model's
parameters through the use of threshold indicators, and/or
backtesting using actual historical data/realizations to test a VaR
model's predictive power. Supra note 28.
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The decay factor generally affects (1) whether and how the MMA
would be invoked (i.e., applied as a member's VaR Charge), (2) the peak
level of margin increase or the degree of procyclicality, and (3) how
quickly the margin would fall back to pre-stress levels. As proposed,
FICC would have the discretion to set the decay factor between 0.93 and
0.99, with the initial decay factor value set at 0.97. FICC expects
that any adjustment to the decay factor would be an infrequent event
that would typically happen only when there is an unprecedented market
volatility event resulting in risk exposures to FICC that cannot be
adequately mitigated by the then-calibrated decay factor.\48\ FICC's
decision to adjust the decay factor would be based on an analysis of
the decay factor's sensitivity and impact to the model performance,
considering factors including the impact to the VaR Charges,
macroeconomic conditions, and/or backtesting performance.\49\ Any
decision by FICC to adjust the decay factor would be in accordance with
FICC's model risk management practices and governance set forth in the
Model Risk Management Framework.\50\
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\48\ See Notice, supra note 8 at 43920.
\49\ See id.
\50\ See Model Risk Management Framework, supra note 28. Similar
to the lookback period described above, FICC would also analyze the
decay factor to evaluate its sensitivity and impact to the model
performance pursuant to the model performance monitoring required
under the Model Risk Management Framework.
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Haircut Method: Occasionally, a member's portfolio might contain
classes of securities that reflect market price changes that are not
consistently related to historical price moves. The value of such
securities is often uncertain because the securities' market volume
varies widely. Because the volume and historical price information for
such securities are not sufficient to perform accurate statistical
analyses, the FHS method would not generate an MMA amount that
adequately reflects the risk profile of such securities. Accordingly,
FICC would use a haircut method to assess the market risk of securities
that are more difficult to simulate (e.g., due to thin trading
history).
Specifically, FICC would use a haircut method 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. FICC would also use a haircut method to
account for 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).\51\
Similarly, FICC would use a haircut method to account for 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.
---------------------------------------------------------------------------
\51\ Accounting for the basis risk would enable FICC to
explicitly model and manage the basis risk between an agency
security and the mapped U.S. Treasury index, given that agency
securities are not as actively traded as U.S. Treasury securities.
---------------------------------------------------------------------------
Ongoing Performance Monitoring: The Model Risk Management Framework
would require FICC to conduct ongoing model performance monitoring of
the MMA methodology.\52\ 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.\53\ Additionally, FICC would
monitor each member's Required Fund Deposit and the aggregate Clearing
Fund requirements versus the requirements calculated by the MMA, by
comparing the results versus the three-day profit and loss of each
member's portfolio based on actual market price moves.\54\ Based on the
results of the sensitivity analysis and/or backtesting, FICC could
consider adjustments to the MMA, including changing the decay factor as
appropriate.\55\ Any adjustment to the MMA calculation would be subject
to the model risk management practices and governance process set forth
in the Model Risk Management Framework.\56\
---------------------------------------------------------------------------
\52\ See note 28.
\53\ See Notice, supra note 8 at 43920.
\54\ See id.
\55\ See id.
\56\ See Model Risk Management Framework, supra note 28.
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Impact Study: As mentioned above in Section I.B., FICC performed an
Impact Study on its members' margin portfolios covering the period
beginning July 1, 2021 through June 30, 2023.\57\ The Impact Study
lists the actual daily and average VaR Charges at both the member-level
and CCP-level during the period of the Impact Study, compared with how
those amounts would have changed if the proposed MMA had been in place.
The Impact Study also lists the actual daily backtesting results at the
member-level during the period of the Impact Study, compared with how
those amounts would have changed if the proposed MMA had been in place.
The Impact Study shows that if the proposed MMA had been in place
during the period of the Impact Study, when compared to the current VaR
methodology: (1) the aggregate average daily start-of-day (``SOD'') VaR
Charges would have increased by approximately $2.90 billion or 13.89
percent; (2) the aggregate average daily noon VaR Charges would have
increased by approximately $3.03 billion or 14.06 percent; and (3) the
aggregate average daily Backtesting Charges \58\ would have decreased
by approximately $622 million or 64.46 percent.\59\
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\57\ FICC states that it 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. See Notice, supra note 8 at 43921.
\58\ The Backtesting Charge is an additional charge that may be
added to a member's VaR Charge to mitigate exposures to FICC caused
when the member exhibits a pattern of breaching the target coverage
ratio of 99 percent. See GSD Rule 1 (Definitions--Backtesting
Charge), supra note 13.
\59\ Margin Proxy was not invoked during the period of the
Impact Study. However, if the proposed MMA had been in place and the
Margin Proxy was invoked during the period of the Impact Study: the
aggregate average daily SOD VaR Charges would have increased by
approximately $4.16 billion or 20.97 percent; the VaR model
backtesting coverage would have increased from approximately 98.17
percent to 99.38 percent; and the number of the VaR model
backtesting deficiencies would have been reduced by 899 (from 1358
to 459, or approximately 66.2 percent). See Notice, supra note 8 at
43921
---------------------------------------------------------------------------
The Impact Study indicates that if the proposed MMA had been in
place, the VaR model backtesting coverage would have increased from
approximately 98.86 percent to 99.46 percent during the period of the
Impact Study and the number of VaR model backtesting deficiencies would
have been reduced by 441 (from 843 to 402, or approximately 52
percent). The Impact Study also indicates that if the proposed MMA had
been in place: (1) overall margin backtesting coverage would have
increased from approximately 98.87 percent to 99.33 percent, (2) the
number of overall margin backtesting deficiencies would have been
reduced by 280 (from 685 to 405, or approximately 41 percent), and (3)
the overall margin backtesting coverage for 94 members (approximately
72 percent of the GSD membership) would have improved, with 36 members
who were below 99 percent coverage brought back to above 99 percent.
[[Page 90114]]
On average, at the member-level, the proposed MMA would have
increased the SOD VaR Charge by approximately $22.43 million, or 17.56
percent, and the noon VaR Charge by approximately $23.25 million, or
17.43 percent, over the period of the Impact Study. The largest average
percentage increase in SOD VaR Charge for any member would have been
approximately 66.88 percent, or $97,051 (0.21percent of the member's
average Net Capital),\60\ and the largest average percentage increase
in noon VaR Charge for any member would have been approximately 64.79
percent, or $61,613 (0.13 percent 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 percent of the
member's average Net Capital), or 19.06 percent, and the largest dollar
increase in noon VaR Charge for any member would have been
approximately $289.00 million (1.07 percent of the member's average Net
Capital), or 13.67 percent. 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 percent and 53.64 percent of the
aggregated SOD VaR Charges and aggregated noon VaR Charges,
respectively, during the period of the Impact Study had the proposed
MMA been in place. The same members would have contributed to 50.08
percent and 51.52 percent of the increase in aggregated SOD VaR Charges
and aggregated noon VaR Charges, respectively, had the proposed MMA
been in place during the period of the Impact Study.
---------------------------------------------------------------------------
\60\ 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 13.
---------------------------------------------------------------------------
2. Clarification of VaR Floor To Include Margin Proxy
As mentioned above in Section I.B., the Margin Proxy methodology is
currently invoked as an alternative volatility calculation if the
requisite vendor data used for the sensitivity VaR calculation is
unavailable for an extended period of time.\61\ FICC proposes to
clarify that the VaR Floor, which does not depend upon any vendor data,
operates as a floor for the Margin Proxy, such that if the Margin
Proxy, when invoked, is lower than the VaR Floor, then the VaR Floor
would be utilized as the VaR Charge with respect to a member's
portfolio. FICC believes this clarification would enable Margin Proxy
to be an effective risk mitigant under extreme market volatility and
heightened market stress because as discussed above in Section I.C.1.,
the proposed VaR Floor would include the MMA calculation.\62\
---------------------------------------------------------------------------
\61\ 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. See Notice, supra note 8 at 43920.
\62\ See id.
---------------------------------------------------------------------------
II. Discussion and Commission Findings
Section 19(b)(2)(C) of the Act \63\ directs the Commission to
approve a proposed rule change of a self-regulatory organization if it
finds that such proposed rule change is consistent with the
requirements of the Act and rules and regulations thereunder applicable
to such organization. After carefully considering the Proposed Rule
Change, the Commission finds that the Proposed Rule Change is
consistent with the requirements of the Act and the rules and
regulations thereunder applicable to FICC. In particular, the
Commission finds that the Proposed Rule Change is consistent with
Sections 17A(b)(3)(F) and (b)(3)(I) of the Act \64\ and Rules 17Ad-
22(e)(4)(i), (e)(6)(i), and (e)(23)(ii) thereunder.\65\
---------------------------------------------------------------------------
\63\ 15 U.S.C. 78s(b)(2)(C).
\64\ 15 U.S.C. 78q-1(b)(3)(F) and (b)(3)(I).
---------------------------------------------------------------------------
A. Consistency With Section 17A(b)(3)(F) of the Act
Section 17A(b)(3)(F) of the Act \66\ requires that the rules of a
clearing agency, such as FICC, be designed to, among other things, (i)
promote the prompt and accurate clearance and settlement of securities
transactions, (ii) assure the safeguarding of securities and funds
which are in the custody or control of the clearing agency or for which
it is responsible, and (iii) protect investors and the public interest.
---------------------------------------------------------------------------
\66\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
As described above in Section I.C., FICC proposes to introduce the
MMA into its margin methodology to help ensure that FICC collects
sufficient margin to manage its potential loss exposure during periods
of extreme market volatility. Specifically, the extreme market
volatilities during recent stressful market periods led to market price
changes that exceeded the current VaR model's projections, generating
margin amounts that were not sufficient to mitigate FICC's credit
exposure to its members' portfolios at a 99 percent confidence level.
FICC's proposed incorporation of the MMA calculation into the GSD
margin methodology would result in margin levels that better reflect
the risks and particular attributes of member portfolios during periods
of extreme market volatility.
Implementing the MMA would enable FICC to collect additional margin
when the market price volatility implied by the current sensitivity VaR
calculation and VaR Floor calculation is lower than the market price
volatility implied by the proposed MMA calculation. In its
consideration of the proposed MMA, the Commission reviewed and analyzed
the: (1) Proposed Rule Change, including the supporting exhibits that
provided confidential information on the proposed MMA calculation,
Impact Study (including detailed information regarding the impact of
the proposed changes on the portfolios of each FICC member over various
time periods),\67\ and backtesting coverage results, (2) FICC's
response to the Commission's requests for additional information; \68\
(3) public comments and FICC's response; and (4) the Commission's own
understanding of the performance of the current GSD margin methodology,
with which the Commission has experience from its general supervision
of FICC, compared to the proposed margin methodology.
---------------------------------------------------------------------------
\67\ The Impact Study, filed confidentially as Exhibit 3,
includes, among other things, the following confidentially filed
information covering the period from July 1, 2021 through June 30
2023: actual daily VaR amounts for each member; daily VaR amounts
for each member had MMA been implemented; daily VaR increase
(reflected in dollars, percent, and percent of Net Capital), if any,
attributable to MMA; average member-level VaR amounts (reflected in
dollars and average of Net Capital); average member-level VaR
amounts had MMA been implemented; average member-level VaR increase
(reflected in percent and percent of Net Capital), if any,
attributable to MMA; further analysis of the foregoing data to
determine minimum, maximum, and average increases to member-level
VaR amounts, Net Capital amounts, and CCP-level VaR amounts; member-
level VaR amounts had Margin Proxy been invoked (daily and
summarized); and member-level backtesting results (daily and
summarized).
\68\ See supra notes 3, 7. Because the proposals contained in
the Proposed Rule Change and the Advance Notice are the same, all
information submitted by FICC was considered regardless of whether
the information was submitted with respect to the Proposed Rule
Change or the Advance Notice. FICC's responses to the Commission's
requests for additional information with respect to the Advance
Notice include, among other things, the following confidentially
filed information: FICC's proprietary information regarding the GSD
margin methodology; backtesting data and analyses of daily member-
level sensitivity VaR, Margin Proxy, and MMA amounts with
alternative stress periods; daily member-level backtesting,
sensitivity VaR, and MMA amounts during the Impact Study period
specific to bond and MBS positions; and daily member-level
sensitivity VaR and MMA amounts for the period of February 1, 2024
through July 31, 2024, with analysis relating to the FICC-CME cross-
margining arrangement.
---------------------------------------------------------------------------
Based on the Commission's review of the Impact Study, had the
proposed
[[Page 90115]]
MMA been in place, both the VaR model backtesting coverage and the
overall margin backtesting coverage would have risen above the 99
percent confidence level to 99.46 percent and 99.33 percent,
respectively, over the time period covered by the Impact Study.\69\
Additionally, the number of VaR model backtesting deficiencies and
overall margin backtesting deficiencies would have been reduced by 441
and 280, respectively.\70\
---------------------------------------------------------------------------
\69\ See Notice, supra note 8 at 43921.
\70\ See id.
---------------------------------------------------------------------------
The proposed MMA methodology would be more likely to apply as the
VaR Charge during periods of extreme market volatility because the MMA
methodology is more responsive to spikes in market volatility than the
sensitivity VaR calculation. As described above in Section I.C.1., the
MMA calculation relies, in part, on the FHS method, which takes
historical price data, removes the historical volatility estimates, and
replaces them with volatility estimates that reflect current market
conditions. Additionally, as described above in Section I.C.1., the
decay factor used in the FHS method affects: (1) whether and how the
MMA would apply to determine a member's VaR Charge; (2) the peak level
of margin increase or the degree of procyclicality; and (3) how quickly
the margin would fall back to pre-stress levels. A faster decay (i.e.,
smaller decay factor value), like the one FICC intends to use
initially, would give more weight to more recent market events, while a
slower decay would give more weight to older market events. Thus, when
market volatility spikes, the MMA calculation would generate higher
amounts and thereby be more likely to apply as the VaR Charge (after
exceeding the sensitivity VaR calculation). Conversely, when market
volatility subsides, the MMA calculation would generate lower amounts
and be less likely to apply.
The Impact Study supports this analysis. If the proposed MMA
calculation had been in place during the period of the Impact Study,
the MMA would have applied primarily during the recent extreme market
volatility events (i.e., those in March 2020 and commencing in March
2022). In contrast, during periods of low to moderate market
volatility, the MMA calculation would generally not be the greatest
amount of the three calculations and thus, would not be invoked.
Instead, in periods of low to moderate market volatility, the
sensitivity VaR calculation is likely to be the VaR Charge for members
whose portfolios do not contain long and short positions in different
classes of securities that share a high degree of price correlation.
For such long/short portfolios, in low to moderate volatility markets,
the VaR Floor Percentage Amount calculation is more likely to be the
VaR Charge. The sensitivity VaR calculation and VaR Floor Percentage
Amount calculations are likely to generate sufficient margin levels
above FICC's 99 percent performance targets during periods of low to
moderate market volatility. Indeed, during the periods of low to
moderate market volatility from January 2013 to March 2020, the GSD VaR
model has generally performed above FICC's 99 percent backtesting
performance targets.\71\ Implementing the proposed MMA should enable
FICC to better manage its exposure to its members during periods of
extreme market volatility by generating margin levels that meet FICC's
99 percent backtesting performance targets.
---------------------------------------------------------------------------
\71\ See Notice, supra note 8 at 43917.
---------------------------------------------------------------------------
Additionally, FICC proposes to clarify that if the Margin Proxy,
when invoked, is lower than the VaR Floor, then the VaR Floor would be
utilized as the VaR Charge with respect to a member's portfolio.
Although Margin Proxy was not invoked during the period of the Impact
Study, had the proposed changes been in place during that period, the
VaR model backtesting coverage would have increased from approximately
98.17 percent to 99.38 percent and the VaR model backtesting
deficiencies would have been reduced by 899 (from 1,358 to 459). The
Commission agrees that ensuring the VaR Floor operates as a floor for
the Margin Proxy would be more effective at mitigating risks under
extreme market volatility because as proposed, the VaR Floor would
include the MMA calculation.
By helping to ensure that FICC collects margin amounts sufficient
to manage the risk associated with its members' portfolios during
periods of extreme market volatility, the proposed MMA changes and
Margin Proxy clarifications would help limit FICC's exposure in a
member default scenario. These proposed changes would generally provide
FICC with additional resources to manage potential losses arising out
of a member default. Such an increase in FICC's available financial
resources would decrease the likelihood that losses arising out of a
member default would exceed FICC's prefunded resources resulting in a
disruption of FICC's operation of its critical clearance and settlement
services. Accordingly, the MMA should help FICC to continue providing
prompt and accurate clearance and settlement of securities transactions
in the event of a member default, consistent with Section 17A(b)(3)(F)
of the Act.\72\
---------------------------------------------------------------------------
\72\ See 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
In addition, as described above in Section I.B., FICC would access
the mutualized Clearing Fund should a defaulted member's own margin be
insufficient to satisfy losses to FICC caused by the liquidation of
that member's portfolio. The MMA should help ensure that FICC has
collected sufficient margin from members, thereby limiting non-
defaulting members' exposure to mutualized losses. By helping to limit
the exposure of FICC's non-defaulting members to mutualized losses, the
MMA should help FICC assure the safeguarding of securities and funds
which are in its custody or control, consistent with Section
17A(b)(3)(F) of the Act.\73\
---------------------------------------------------------------------------
\73\ See id.
---------------------------------------------------------------------------
The Proposed Rule Change should also help protect investors and the
public interest by mitigating some of the risks presented by FICC as a
CCP. Because a defaulting member could place stresses on FICC with
respect to FICC's ability to meet its clearance and settlement
obligations upon which the broader financial system relies, it is
important for FICC to maintain a robust margin methodology to limit
FICC's credit risk exposure in the event of a member default. As
described above in Section I.C.1., the proposed MMA likely would
function as the VaR Charge during periods of extreme market volatility.
When applicable, the MMA would increase FICC's margin collection during
such periods of extreme market volatility. Therefore, implementing the
MMA should help improve FICC's ability to collect sufficient margin
amounts that are commensurate with the risks associated with its
members' portfolios during periods of extreme market volatility. By
better enabling FICC to collect margin that more accurately reflects
the risk characteristics of its members' portfolios during volatile
markets, FICC would be in a better position to absorb and contain the
spread of any losses that might arise from a member default. Therefore,
the MMA should reduce the possibility that FICC would need to utilize
resources from non-defaulting members due to a member default, which
could cause liquidity stress to non-defaulting members and inhibit
their ability to facilitate securities transactions. Accordingly,
because the MMA should help mitigate some of the risks presented by
FICC as a CCP, the Proposed Rule Change is designed to protect
investors and the public interest,
[[Page 90116]]
consistent with Section 17A(b)(3)(F) of the Act.\74\
---------------------------------------------------------------------------
\74\ See id.
---------------------------------------------------------------------------
One commenter states that implementation of the MMA would increase
costs for market participants, leading to negative effects on the
broader U.S. Treasury markets.\75\ Specifically, the commenter states
that markets with high margin costs generally have fewer market
participants, decreased market liquidity, wider bid/offer spreads, and
encourage market participants to either exit the market or pass
additional expenses to their customers.\76\ In response, FICC states
that the proposed MMA is not designed to advantage or disadvantage
capital formation.\77\ Instead, FICC states that the purpose of the
proposed MMA is to manage the risk associated with member portfolios
during periods of extreme market volatility.\78\ FICC states that
although the Proposed Rule Change's increased margin requirements could
lessen liquidity for members, it is necessary and appropriate to
mitigate the relevant risks.\79\
---------------------------------------------------------------------------
\75\ See Letter from Independent Dealer and Trade Association
(May 7, 2024) (``IDTA Letter'') at 5-6.
\76\ See id.
\77\ See FICC Letter at 5.
\78\ See id.
\79\ See id.
---------------------------------------------------------------------------
As stated above in Section I.B., during the period of the Impact
Study, the actual GSD VaR model backtesting coverage and overall margin
backtesting coverage both fell below the 99 percent confidence level.
These shortfalls are specifically attributable to the periods of
extreme market volatility of March 2020 and commencing in March 2022.
The Impact Study demonstrates that had the proposed MMA calculation
been in place during that period, margin amounts would have exceeded
the 99 percent backtesting coverage levels. Thus, implementing the MMA
calculation would have better enabled FICC to calculate and collect
margin amounts sufficient to mitigate the risks presented by its
members' portfolios during periods of extreme market volatility.
The Commission acknowledges that implementing the proposed MMA
would increase margin requirements during periods of extreme market
volatility. However, as detailed above in Section I.C.1., the Impact
Study demonstrates that the increased margin requirements attributable
to the MMA at the member-level would represent relatively small
percentages (i.e., typically a fraction of one percent) of members'
average Net Capital, which tends to indicate that members would likely
have access to sufficient financial resources to meet the increased MMA
obligation if invoked during periods of extreme market volatility.
Therefore, the comment that the increased margin costs attributable to
the MMA would decrease market liquidity, widen bid/offer spreads, and
encourage market participants to either exit the market or pass
additional expenses to their customers, do not appear likely based on
the limited size of increased VaR Charges from the Impact Study.
Additionally, by helping to ensure FICC collects sufficient margin to
cover its exposure to members, implementing the MMA would decrease the
likelihood of loss mutualization in the event of a member default,
which could encourage greater market participation. Moreover, FICC has
a regulatory obligation to have policies and procedures to calculate
and collect margin amounts sufficient to mitigate the relevant risks
presented to it by its members' portfolios.\80\ Indeed, FICC's role as
a CCP that reduces systemic risk and promotes market stability is
dependent on effectively managing the relevant risks, which includes
FICC's collection of sufficient margin from its members.
---------------------------------------------------------------------------
\80\ See 17 CFR 240.17ad-22(e)(4)(i).
---------------------------------------------------------------------------
The Commission also acknowledges the possibility that, as a result
of the Proposed Rule Change, some members might pass along some of the
costs related to margin requirements such that these costs ultimately
are borne, to some degree, by their customers. However, a non-
defaulting member's exposure to mutualized losses resulting from a
member default, and any consequent disruptions to clearance and
settlement absent the Proposed Rule Change, might also increase costs
to a member's customers and potentially adversely impact market
participation, liquidity, and access to capital. The Proposed Rule
Change, by helping to reduce counterparty default risk, would allow the
corresponding portion of transaction costs to be allocated to more
productive uses by members and their customers who otherwise would bear
those costs.\81\ Moreover, as discussed above, by helping to limit the
exposure of non-defaulting members to mutualized losses, the Proposed
Rule Change should help FICC assure the safeguarding of securities and
funds of its members that are in FICC's custody or control, consistent
with Section 17A(b)(3)(F).\82\
---------------------------------------------------------------------------
\81\ See Securities Exchange Act Release No. 78961 (September
28, 2016), 81 FR 70786, 70866-67 (October 13, 2016) (S7-03-14)
(``CCA Standards Adopting Release'').
\82\ See 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
One commenter states that the proposed MMA would negatively affect
markets by having a detrimental effect on certain trading strategies
that rely on margin offsets across maturity buckets.\83\ The commenter
states that the MMA would eliminate such offsets, resulting in gross
margining across maturity buckets and decreased liquidity.\84\ In
response, FICC states that the proposed MMA would not eliminate such
margin offsets across maturity buckets.\85\ Specifically, FICC states
that the MMA would not differ from the current VaR model insofar as the
FHS approach would likewise offset the market risk of long positions in
one maturity bucket with the market risk of short positions in another
maturity bucket.\86\ Based on the Commission's review and understanding
of FICC's proposed changes to the QRM Methodology,\87\ the Commission
agrees with FICC's response that the FHS approach allows for similar
offsetting as the current GSD VaR model regarding the market risk of
long positions in one maturity bucket offsetting the market risk of
short positions in another maturity bucket.\88\
---------------------------------------------------------------------------
\83\ See IDTA Letter at 5 (discussing trading strategies that
involve Treasury securities in separate maturity buckets, such as
buyers at Treasury auctions ``rolling backwards'' ahead of the
auction by short-selling one issue and buy a different outstanding
Treasury, Butterfly Spread, and ``roll down the curve'').
\84\ See id.
\85\ See FICC Letter at 5.
\86\ See id.
\87\ Supra note 38.
\88\ See FICC Letter at 5.
---------------------------------------------------------------------------
Another commenter states that FICC's Proposed Rule Change did not
adequately address the procyclicality risk \89\ associated with the MMA
calculation.\90\ The commenter suggests that FICC should consider
revising the MMA calculation to include anti-procyclical measures that
would avoid extreme reactions to changes in market volatility.\91\ In
response, FICC states that it considered and evaluated a number of
anti-procyclical measures when developing the MMA.\92\ However, FICC
states that, based on the ``outlook'' for interest rate volatility,
FICC determined to rely on the decay factor to control the
[[Page 90117]]
MMA's responsiveness to market volatility.\93\
---------------------------------------------------------------------------
\89\ Procyclicality risk with respect to margin requirements is
the cycle created when a decrease in the mark-to-market value of the
securities in a portfolio triggers an increase in margin
requirements, which in turn, causes a further decrease in portfolio
value.
\90\ See Letter from Robert Toomey, Head of Capital Markets,
Managing Director/Associate General Counsel, Securities Industry and
Financial Markets Association (May 22, 2024) (``SIFMA Letter'') at
6-7.
\91\ See SIFMA Letter at 7.
\92\ See FICC Letter at 5-6.
\93\ See id. When referring to the ``outlook for interest rate
volatility,'' the Commission understands that FICC is not referring
to a particular analysis of interest rate volatility, but rather is
referring to the potential for future interest rate volatility.
---------------------------------------------------------------------------
The Commission disagrees with the comment that FICC's proposed MMA
calculation does not adequately address procyclicality risk. The decay
factor affects, among other things, the speed of the MMA calculation's
responsiveness to spikes in extreme market volatility, as well as the
speed with which the MMA calculation would generate lower numbers after
such volatility subsides. FICC chose to initially set the decay factor
at 0.97--a relatively fast decay factor--to respond to market
volatility relatively quickly.\94\ FICC's data demonstrate that had the
MMA been in place during the period of the Impact Study, the MMA would
have been invoked in a targeted manner (i.e., specifically during
periods of extreme market volatility, but not during periods of low to
moderate market volatility). Further, the Commission understands that
FICC would be able to use the decay factor to address future interest
rate volatility that may occur. Thus, the Impact Study supports FICC's
assertion that including the decay factor in the MMA calculation would
have mitigated any procyclical results.
---------------------------------------------------------------------------
\94\ FICC could adjust the decay factor in accordance with the
Model Risk Management Framework. FICC would analyze the decay factor
to evaluate its sensitivity and impact to the model performance
pursuant to the model performance monitoring required under the
Model Risk Management Framework. Supra note 28.
---------------------------------------------------------------------------
Accordingly, the potential impacts of the Proposed Rule Change are
justified by the potential benefits to members and the resulting
overall improved risk management at FICC described above (i.e., the
prompt and accurate clearance and settlement of securities transactions
and the safeguarding of securities and funds based on the collection of
margin commensurate with the risks presented by members' portfolios),
to render the Proposed Rule Change consistent with the investor
protection and public interest provisions of Section 17A(b)(3)(F) of
the Act.\95\
---------------------------------------------------------------------------
\95\ See 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
For the reasons discussed above, the Proposed Rule Change is
consistent with the requirements of Section 17A(b)(3)(F) of the
Act.\96\
---------------------------------------------------------------------------
\96\ See id.
---------------------------------------------------------------------------
B. Consistency With Section 17A(b)(3)(I) of the Act
Section 17A(b)(3)(I) of the Act requires that the rules of a
clearing agency, such as FICC, do not impose any burden on competition
not necessary or appropriate in furtherance of the Act.\97\ Section
17A(b)(3)(I) does not require the Commission to make a finding that
FICC chose the option that imposes the least possible burden on
competition. Rather, the Act requires that the Commission find that the
Proposed Rule Change does not impose any burden on competition not
necessary or appropriate in furtherance of the purposes of the Act,
which involves balancing the competitive effects of the proposed rule
change against all other relevant considerations under the Act.\98\
---------------------------------------------------------------------------
\97\ 15 U.S.C. 78q-1(b)(3)(I).
\98\ See Bradford National Clearing Corp., 590 F.2d 1085, 1105
(D.C. Cir. 1978).
---------------------------------------------------------------------------
One commenter states that the MMA's increased margin requirements
would be disproportionately burdensome when compared to the MMA's
benefits.\99\ Specifically, the commenter cites FICC's statement that
during the period of the Impact Study, the overall margin backtesting
coverage was approximately 98.87 percent, which is only 0.13 percent
under the targeted 99 percent confidence level.\100\ In response, FICC
states that while the overall margin backtesting coverage during the
Impact Study period was 98.87 percent, the GSD's rolling 12-month
backtesting coverage actually fell below the 99 percent target in June
2022 and remained below 99 percent until June 2023, with the lowest
being 98.33 percent in November 2022.\101\ Thus, FICC states that the
MMA is not designed merely to increase overall margin backtesting
coverage by 0.13 percent.\102\ As discussed above, had the MMA had been
in place during the period of the Impact Study, GSD's overall margin
backtesting coverage would have increased from approximately 98.87
percent to 99.33 percent. FICC states that the proposed MMA is part of
FICC's overall risk management enhancement program in response to the
challenges presented by the market volatility in 2020 and 2022, with
MMA specifically designed to enhance the GSD VaR model performance and
improve backtesting coverage during periods of extreme market
volatility.\103\
---------------------------------------------------------------------------
\99\ See IDTA Letter at 2, 6.
\100\ See id.
\101\ See FICC Letter at 6.
\102\ See id.
\103\ See FICC Letter at 6-7.
---------------------------------------------------------------------------
The Commission acknowledges that the Proposed Rule Change would
entail increased margin charges in certain circumstances. However,
increased margin requirements do not present an undue burden on
competition if they are necessary or appropriate in furtherance of the
Act. As stated above, the Commission has reviewed FICC's backtesting
data, and the Commission agrees that it indicates that had the MMA been
in place during the Impact Study period, it would have generated margin
levels that better reflect the risks and particular attributes of the
member portfolios and help FICC achieve backtesting coverage above
FICC's targeted confidence level. In turn, the Proposed Rule Change
would improve FICC's ability to maintain sufficient financial resources
to cover its credit exposures to each member in full with a high degree
of confidence. Specifically, as described above, the MMA would better
enable FICC to calculate the VaR Charge based on the risks presented by
the securities positions in each member's portfolio during periods of
extreme market volatility. To the extent a member's VaR Charge would
increase under the Proposed Rule Change, that increase would be based
on the securities held by the member and FICC's requirement to collect
margin to appropriately address the associated risk. By helping FICC to
better manage its credit exposure, the MMA's increased margin
requirements would improve FICC's ability to mitigate the potential
losses to FICC and its members associated with liquidating a member's
portfolio in the event of a member default.
One commenter states that the MMA's increased margin requirements
would unfairly burden smaller FICC members. The commenter further
suggests that the MMA should be applied to either the largest FICC
members only, or to FICC members in proportion to the risk posed by
different segments of the market.\104\
---------------------------------------------------------------------------
\104\ See IDTA Letter at 6.
---------------------------------------------------------------------------
In response, FICC refers to its analysis in the Notice regarding
whether the Proposed Rule Change would impose a burden on
competition.\105\ Specifically, FICC acknowledges that during the
Impact Study period, the MMA would have increased members' SOD and noon
VaR Charges by an average of approximately $22.43 million, or 17.56
percent, and $23.25 million, or 17.43 percent, respectively, and that
the Proposed Rule Change could impose a burden on competition.\106\
Additionally, FICC states that members may be affected
disproportionately by the MMA because members with lower operating
margins or higher costs of capital than other members are more likely
to be
[[Page 90118]]
impacted.\107\ However, FICC states that any burden on competition from
the Proposed Rule Change is necessary and appropriate in furtherance of
FICC's obligations under the Act, because the Proposed Rule Change
would change the GSD Rules to better: (1) assure the safeguarding of
securities and funds that are in FICC's custody, control, or
responsibility, consistent with section 17A(b)(3)(F) of the Act; and
(2) enable FICC to collect sufficient margin amounts that are
commensurate with the risks presented by its member portfolios,
consistent with Rules 17Ad-22(e)(4)(i) and 17Ad-22(e)(6)(i).\108\
---------------------------------------------------------------------------
\105\ See FICC Letter at 3; Notice, supra note 8 at 43923-24.
\106\ See id.
\107\ See id.
\108\ See Notice, supra note 8 at 43923-24; FICC Letter at 3-4;
15 U.S.C. 78q-1(b)(3)(F); 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i).
---------------------------------------------------------------------------
Furthermore, FICC states that the methodology for computing the MMA
does not take into consideration the member's size or overall mix of
business relative to other members.\109\ Any effect the Proposed Rule
Change would have on a particular member's margin requirement is solely
a function of the default risk posed to FICC by the member's activity
at FICC--firm size or business model is not pertinent to the assessment
of that risk.\110\ Accordingly, FICC states that the Proposed Rule
Change does not discriminate against members or affect them differently
on either of those bases.\111\
---------------------------------------------------------------------------
\109\ See FICC Letter at 4.
\110\ See id.
\111\ See id.
---------------------------------------------------------------------------
As stated above, the Commission acknowledges that the Proposed Rule
Change would entail increased margin charges in certain circumstances.
In considering the costs and benefits of the requirements of Rule 17Ad-
22(e)(6), the Commission expressly acknowledged that ``since risk-based
initial margin requirements may cause market participants to
internalize some of the costs borne by the CCP as a result of large or
risky positions, ensuring that margin models are well-specified and
correctly calibrated with respect to economic conditions will help
ensure that they continue to align the incentives of clearing members
with the goal of financial stability.'' \112\ Nevertheless, in response
to the comment that the Proposed Rule Change would disproportionately
affect smaller FICC members, the Commission understands that the impact
of the MMA would be entirely determined by a member's portfolio
composition and trading activity rather than the member's size or type.
Specifically, as described above, the MMA would better enable FICC to
calculate the VaR Charge based on the risks presented by the securities
positions in each member's portfolio during periods of extreme market
volatility. To the extent a member's VaR Charge would increase under
the Proposed Rule Change, that increase would be based on the
securities held by the member and FICC's requirement to collect margin
to appropriately address the associated risk.
---------------------------------------------------------------------------
\112\ See CCA Standards Adopting Release at 70870, supra note
81. In addition, when considering the benefits, costs, and effects
on competition, efficiency, and capital formation, the Commission
recognized that a covered clearing agency, such as FICC, might pass
incremental costs associated with compliance on to its members, and
that such members may seek to terminate their membership with that
CCA. See id. at 70865.
---------------------------------------------------------------------------
In addition, as discussed above, the Commission acknowledges that
the impact of a higher margin requirement may present higher costs on
some members relative to others due to a number of factors, such as
access to liquidity resources, cost of capital, business model, and
applicable regulatory requirements. These higher relative burdens may
weaken certain members' competitive positions relative to other
members.\113\ However, in this instance, any competitive burden
stemming from a higher impact on some members than on others is
necessary or appropriate in furtherance of the Act. FICC is required to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to cover its credit exposures to its
participants by establishing a risk-based margin system that, at a
minimum, considers and produces margin levels commensurate with the
risks and particular attributes of each relevant product, portfolio,
and market.\114\ FICC's members include a large and diverse population
of entities with a range of ownership structures.\115\ By participating
in FICC, each member is subject to the same margin requirements, which
are designed to satisfy FICC's regulatory obligation to manage the
risks presented by its members. As discussed in more detail in Section
II.D. below, the Proposed Rule Change is designed to ensure that FICC
collects margin that is commensurate with the risks presented by each
member's portfolio during periods of extreme market volatility.
---------------------------------------------------------------------------
\113\ These potential burdens are not fixed, and affected
members may choose to restructure their liquidity sources, costs of
capital, or business model, thereby moderating the potential impact
of the Proposed Rule Change.
\114\ See 17 CFR 240.17Ad-22(e)(6)(i).
\115\ See FICC GSD Membership Directory, available at <a href="https://www.dtcc.com/client-center/ficc-gov-directories">https://www.dtcc.com/client-center/ficc-gov-directories</a>.
---------------------------------------------------------------------------
Additionally, as discussed above, the Commission has reviewed
FICC's backtesting data and agrees that it indicates that had the MMA
been in place during the Impact Study period, it would have generated
margin levels that better reflect the risks and particular attributes
of the member portfolios and help FICC achieve backtesting coverage
closer to FICC's targeted confidence level. In turn, the Proposed Rule
Change would improve FICC's ability to maintain sufficient financial
resources to cover its credit exposures to each member in full with a
high degree of confidence. By helping FICC to better manage its credit
exposure, the Proposed Rule Change would improve FICC's ability to (1)
mitigate the potential losses to FICC and its members associated with
liquidating a member's portfolio in the event of a member default, in
furtherance of FICC's obligations under Section 17A(b)(3)(F) of the
Act,\116\ and (2) collect sufficient margin amounts that are
commensurate with the risks presented by its members' portfolios,
consistent with Rules 17Ad-22(e)(4)(i) and 17Ad-22(e)(6)(i).\117\
---------------------------------------------------------------------------
\116\ See 15 U.S.C. 78q-1(b)(3)(F).
\117\ See 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i).
---------------------------------------------------------------------------
Commenters also expressed concerns about the cumulative burdens of
the Proposed Rule Change in conjunction with recent changes to the GSD
Rules regarding margin requirements, including an announced special
charge that FICC collects in connection with certain volatile market
events (``VME Special Charge'').\118\
---------------------------------------------------------------------------
\118\ See IDTA Letter at 4-5; SIFMA Letter at 5-6 (referring to
other recent margin changes at FICC, including, e.g., the imposition
of a special charge at volatile market events) (citing Memo from
FICC to Government Securities Division Members (Apr. 12, 2024)). See
also GSD Rule 4, Section 1b(a)(vii) (defining ``special charge''),
supra note 13.
---------------------------------------------------------------------------
In response, FICC states that each of the GSD margin components is
specifically designed to mitigate a different risk and limit FICC's
exposures.\119\ FICC states that it announced the VME Special Charge on
April 12, 2024 to supplement a member's margin requirement for the days
immediately surrounding five scheduled economic indicator release dates
if a forward looking indicator were to signal potential heightened
market volatility.\120\ FICC further states that the
[[Page 90119]]
VME Special Charge is designed to complement the Proposed Rule Change.
Specifically, FICC states that the VME Special Charge is designed to
cover the periods leading up to the market events that can impact the
market, while the Proposed Rule Change, in contrast, is specifically
designed to respond to observed market volatility and supplement the
VaR model following the observation of extreme market volatility.\121\
FICC states that by applying the VME Special Charge as disclosed in the
Important Notice, it expects that its VaR model, in conjunction with
the proposed MMA, would be able to respond to observed market
volatility, removing the need for additional special charges.\122\
---------------------------------------------------------------------------
\119\ See FICC Letter at 8-9.
\120\ See id. On April 12, 2024, FICC published on its website
an Important Notice indicating that as of April 15, 2024, FICC would
collect a special charge equal to 10 percent of a Netting Member's
VaR Charge on the two days prior to, and on the day of, certain
volatile market events specified in the Important Notice, if certain
conditions are met. The Important Notice is available at https://
www.dtcc.com/-/media/Files/pdf/2024/4/12/GOV1681-24_-Special-
Charge-at-Volatile-Market-Events.pdf.
\121\ See FICC Letter at 8.
\122\ See id.
---------------------------------------------------------------------------
FICC also describes a number of other recent changes to the GSD
margin model, although commenters did not specify any other recent
changes to the GSD Rules beyond the VME Special Charge. Specifically,
FICC states that in July 2023, FICC revised the stressed period used to
calculate the VaR Charge in order to provide better risk coverage on
the short-end of the curve.\123\ FICC also states that in October 2023,
FICC adopted a Portfolio Differential Charge in order to mitigate the
risk presented to FICC by period-over-period fluctuations in a member's
portfolio.\124\
---------------------------------------------------------------------------
\123\ See Securities Exchange Act Release No. 97342 (April 21,
2023), 88 FR 25721 (April 27, 2023) (SR-FICC-2023-003) (Order
Granting Proposed Rule Change to Revise the Description of the
Stressed Period Used to Calculate the VaR Charge and Make Other
Changes) (``Stressed Period Order''); see FICC Letter at 8.
\124\ See Securities Exchange Act Release No. 98494 (Sept. 25,
2023), 88 FR 67394 (Sept. 29, 2023) (SR-FICC-2023-011) (Order
Approving Proposed Rule Change, as Modified by Amendment No. 1, to
Adopt a Portfolio Differential Charge as an Additional Component to
the GSD Required Fund Deposit) (``Portfolio Differential Order'').
FICC also states that the Impact Study was generated based on the
assumption that the Portfolio Differential Charge was in effect
during the entirety of the Impact Study Period. See FICC Letter at
8.
---------------------------------------------------------------------------
As stated above in Section I.A., each member's Required Fund
Deposit consists of a number of components, which are calculated to
address specific risks faced by FICC.\125\ Each Required Fund Deposit
component, when applicable, may increase a member's margin
requirements. However, the various margin components are designed to
generate margin amounts commensurate with the relevant risks associated
with the content of member portfolios. For example, the special charge
is an additional margin component specifically provided for in the GSD
Rules and designed to address risks associated with market conditions
or other financial and operational factors.\126\ In particular, the VME
Special Charge is necessary to mitigate risks--not mitigated by other
margin components--regarding potentially heightened market volatility
for the days immediately surrounding five scheduled economic indicator
release dates, including the two days prior to the event when the
volatility would not yet be captured by the current VaR model.\127\
Although cumulative, these margin components are consistent with FICC's
obligation to maintain a risk-based margin system that considers, and
produces margin levels commensurate with, the risks and particular
attributes of each relevant product, portfolio, and market.\128\
---------------------------------------------------------------------------
\125\ Supra note 15.
\126\ See GSD Rule 4 (Clearing Fund and Loss Allocation), supra
note 13.
\127\ Supra note 120.
\128\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------
The Portfolio Differential Charge is designed to mitigate the risks
attributable to intraday margin fluctuations in certain member
portfolios as those members execute trades throughout the day.\129\
Specifically, since FICC generally novates and guarantees trades upon
trade comparison, a member's trading activity may result in coverage
gaps due to large unmargined intraday portfolio fluctuations that
remain unmitigated from the time of novation until the next scheduled
margin collection.\130\ The impact of the Portfolio Differential Charge
depends on the period-over-period change in the size and composition of
a member's portfolio.\131\ In approving FICC's Portfolio Differential
proposed rule change, the Commission determined, among other things,
that implementing the Portfolio Differential Charge would better enable
FICC to collect margin amounts commensurate with FICC's intraday credit
exposures to its members.\132\ The Commission also considered the
proposed Portfolio Differential Charge's impact on competition and
found the proposal to be consistent with the Act.\133\ Although the
Portfolio Differential Charge, when applicable, and the VaR Charge are
cumulative to one another, both margin components are designed to
mitigate different risks.
---------------------------------------------------------------------------
\129\ See Portfolio Differential Order, supra note 124 at 67396.
\130\ See id.
\131\ See Securities Exchange Act Release No. 98160 (Aug. 17,
2023), 88 FR 57485, 57488 (Aug. 23, 2023) (SR-FICC-2023-011) (Notice
of Filing of Proposed Rule Change, as Modified by Amendment No. 1,
to Adopt a Portfolio Differential Charge as an Additional Component
to the GSD Required Fund Deposit).
\132\ See Portfolio Differential Order, supra note 124 at 67397.
\133\ See id.
---------------------------------------------------------------------------
Additionally, not all margin components are cumulative to one
another. For example, in addition to the Portfolio Differential Charge
discussed above, one of the margin components recently changed relates
to FICC's Stressed Period Order,\134\ which involves a VaR Charge
calculation that would be an alternative to the MMA rather than in
addition to the MMA. As described above in Section I.C.1., the
sensitivity VaR methodology incorporates a lookback period of 10 years
to capture periods of historical volatility. As described in the
Stressed Period Order, the GSD VaR methodology allows FICC to include
an additional period of historically observed stressed market events if
the 10-year lookback period does not contain a sufficient number of
stressed events.\135\ Although FICC's decision to adjust the stressed
period could increase a member's VaR Charge, that increase would be in
direct relation to the specific risks presented by the member's
portfolio.\136\ The ability to quickly adjust the stressed period
provides FICC with the flexibility to timely respond to rapidly
changing market conditions and better ensure that the sensitivity VaR
calculation results in margin amounts that sufficiently risk manage
FICC's credit exposures to its members' portfolios during such market
conditions.\137\ However, as described above in Section I.C., a
member's VaR Charge would be the greater of three calculations (i.e.,
sensitivity VaR, VaR Floor Percentage Amount, and MMA). The sensitivity
VaR calculation, even if increased pursuant to the Stressed Period
Order, and MMA are not cumulative.
---------------------------------------------------------------------------
\134\ See Stressed Period Order, supra note 123.
\135\ See id. at 25722.
\136\ See id. at 25722-24.
\137\ See Stressed Period Order, supra note 123 at 25724.
---------------------------------------------------------------------------
One commenter states that the Commission's approval of the Proposed
Rule Change should be delayed until after conducting further analysis,
including analyses that incorporate expected increases in cleared
volumes and the totality of changes to margin requirements associated
with FICC's upcoming implementation of its requirement to facilitate
access to clearance and settlement services of all eligible secondary
market transactions in U.S. Treasury securities.\138\ The
[[Page 90120]]
Commission disagrees that the commenter's requested additional analyses
are necessary for the Commission to evaluate the Proposed Rule Change
for consistency with the Act and the rules thereunder. As stated above
in the preamble to Section II., the standard of review under Section
19(b)(2)(C) of the Act \139\ is for the Commission to approve a
proposed rule change of a self-regulatory organization upon finding
that such proposed rule change is consistent with the requirements of
the Act and rules and regulations thereunder applicable to such
organization. In this Section II., the Commission describes its review
of the Proposed Rule Change for consistency with the Act and
regulations thereunder, along with the Commission's rationale for
approving the Proposed Rule Change. The Commission will separately
evaluate any proposed rule change that FICC files in connection with
implementing FICC's obligations under the Treasury Clearing Rules.
---------------------------------------------------------------------------
\138\ See SIFMA Letter at 8; Securities Exchange Act Release No.
99149 (Dec. 13, 2023), 89 FR 2714 (Jan. 16, 2024) (the rules adopted
therein are referred to as the ``Treasury Clearing Rules'').
\139\ 15 U.S.C. 78s(b)(2)(C).
---------------------------------------------------------------------------
Therefore, for the reasons stated above, the Proposed Rule Change
is consistent with the requirements of Section 17A(b)(3)(I) of the
Act.\140\
---------------------------------------------------------------------------
\140\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------
C. Consistency With Rule 17Ad-22(e)(4)(i)
Rule 17Ad-22(e)(4)(i) under the Act requires that FICC 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.\141\
---------------------------------------------------------------------------
\141\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------
The Proposed Rule Change is consistent with Rule 17ad-22(e)(4)(i)
under the Exchange Act.\142\ As described above in Section I.C.1., the
current GSD VaR model generated margin amounts that were not sufficient
to mitigate FICC's credit exposure to its members' portfolios at the 99
percent backtesting confidence level during periods of extreme market
volatility, particularly during March 2020 and beginning in March 2022.
The Impact Study demonstrates that had the proposed MMA calculation
been in place during that period, margin amounts would have exceeded
the 99 percent backtesting coverage levels. Therefore, adding the MMA
calculation to the GSD margin methodology should better enable FICC to
calculate and collect margin amounts that are sufficient to mitigate
FICC's credit exposure to its members' portfolios during periods of
extreme market volatility.
---------------------------------------------------------------------------
\142\ See id.
---------------------------------------------------------------------------
Additionally, FICC proposes to clarify that if the Margin Proxy,
when invoked, is lower than the VaR Floor, then the VaR Floor would be
utilized as the VaR Charge with respect to a member's portfolio.
Although Margin Proxy was not invoked during the period of the Impact
Study, had the proposed changes been in place during that period, the
VaR model backtesting coverage would have been increased to exceed the
99 percent backtesting coverage level. Therefore, the proposed
clarifications regarding the applicability of the VaR Floor when Margin
Proxy is invoked would help ensure FICC's ability to manage its credit
exposures to members by maintaining sufficient financial resources to
cover such exposures fully with a high degree of confidence.
Accordingly, for the reasons discussed above, the proposed MMA
changes and Margin Proxy clarifications are reasonably designed to
enable FICC to effectively identify, measure, monitor, and manage its
credit exposure to participants, consistent with Rule 17ad-
22(e)(4)(i).\143\
---------------------------------------------------------------------------
\143\ See 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------
D. Consistency With Rules 17Ad-22(e)(6)(i)
Rules 17Ad-22(e)(6)(i) requires that FICC 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, and
calculates margin sufficient to cover its potential future exposure to
participants.\144\
---------------------------------------------------------------------------
\144\ 17 CFR 240.17ad-22(e)(6)(i).
---------------------------------------------------------------------------
The Proposed Rule Change is consistent with Rule 17ad-22(e)(6)(i).
As described above in Section I.C., the Impact Study demonstrates that
the current VaR model generated margin deficiencies during periods of
extreme market volatility, whereas implementing the proposed MMA
changes and Margin Proxy clarifications would result in VaR Charges
that reflect the risks of member portfolios during such periods better
than the current GSD VaR model. Moreover, FICC's inclusion of the decay
factor in the MMA calculation appropriately limits invoking the MMA as
the VaR Charge to periods of extreme market volatility. The decay
factor affects, among other things, the peak level of margin increase
or the degree of procyclicality and how quickly the margin would fall
back to pre-stress levels. FICC chose to initially set the decay factor
at 0.97--a relatively fast decay factor--to be quickly responsive to
market volatility.\145\ FICC's data demonstrate that had the MMA been
in place during the period of the Impact Study, the MMA would have been
invoked in a targeted manner (i.e., specifically during periods of
extreme market volatility, but not during periods of low to moderate
market volatility). Thus, the MMA is specifically designed to enable
FICC to collect margin amounts commensurate with the relevant risks
associated with member portfolios during periods of extreme market
volatility. The Proposed Rule Change would provide FICC with a margin
methodology better designed to enable FICC to cover its credit
exposures to its members by enhancing FICC's risk-based margin system
to produce margin levels commensurate with the relevant risks during
periods of extreme market volatility.
---------------------------------------------------------------------------
\145\ FICC could adjust the decay factor in accordance with the
Model Risk Management Framework. FICC would analyze the decay factor
to evaluate its sensitivity and impact to the model performance
pursuant to the model performance monitoring required under the
Model Risk Management Framework. Supra note 28.
---------------------------------------------------------------------------
Several commenters addressed FICC's Impact Study. Specifically, one
commenter states that the Impact Study is too limited, providing
backtesting data with extremely uneven daily impacts, thereby rendering
it impossible to properly assess the MMA's impacts.\146\ Another
commenter states that FICC underestimates the MMA's impacts by using
the full two-year period of the Impact Study to calculate average
impacts when the actual period of increased volatility only covers a
nine-month period.\147\ This commenter states that while FICC expressed
the increase in margin requirements in terms of long-term averages,
broker-dealers actually plan for capitalization based on meeting their
largest margin requirement rather than their average capital
usage.\148\ The commenters state that while FICC's impact analysis
cited examples of members with the largest average percentage and
dollar increases resulting from the MMA, those market
[[Page 90121]]
participants are either too small or too large to be representative of
the Proposed Rule Change's impact on other members.\149\ The commenters
state that the actual effects of the MMA on middle-market dealers will
be higher than FICC's cited examples.\150\ The commenters suggest that
alternative impact measurements would provide a more accurate analysis
of the proposed MMA's impacts.\151\
---------------------------------------------------------------------------
\146\ SIFMA Letter at 6.
\147\ See IDTA Letter at 3 (arguing that calculating averages
using a two-year period instead of a nine-month period decreases the
average 2.66 times).
\148\ See IDTA Letter at 3.
\149\ See IDTA Letter at 3; SIFMA Letter at 6.
\150\ See e.g., IDTA Letter at 3-4 (contrasting FICC's Impact
Study analysis that expresses the largest member increase that would
have resulted from the MMA as 0.21 percent of net capital, against
the average margin increase that the MMA would have added for IDTA
members of 5.1 percent of net capital, or 16.0 percent of net
capital for the top 100 days in terms of margin increases); see
SIFMA Letter at 6.
\151\ See IDTA Letter at 3-4, 7; SIFMA Letter at 6. For example,
one commenter suggests that FICC should express the impact as the
average percent increase for the top 100 most stressful days. See
IDTA Letter at 3-4 (stating that the average percentage increase for
the top 100 most stressful days in terms of margin increases for
IDTA members, the more relevant metric in terms of capital planning
in actual practice was 37.23 percent or $27.52 million). The other
commenter suggests that a better measure of liquidity impact than
average daily data would be the peak aggregate additional margin
that would be required for both a 1-day and 5-day period. See SIFMA
Letter at 6.
---------------------------------------------------------------------------
In response to these comments, FICC states that due to
confidentiality restrictions on releasing member-level data, the
public-facing Proposed Rule Change filing narrative analyzed the Impact
Study using anonymized data and averages of maximum dollar and
percentage changes.\152\ However, FICC provided the Commission with
expanded and detailed daily member-level Impact Study data
confidentially, as part of the Proposed Rule Change filing in Exhibit
3.\153\ FICC further states that both prior and subsequent to filing
the Proposed Rule Change, FICC actively engaged with members on
multiple occasions, conducting outreach to each member in order to
provide notice of the Proposed Rule Change along with individualized
anticipated impacts for each member.\154\
---------------------------------------------------------------------------
\152\ See FICC Letter at 7.
\153\ See id.
\154\ See FICC Letter at 6.
---------------------------------------------------------------------------
In considering the comments critical of the Impact Study and FICC's
analyses thereof, the Commission considered the Proposed Rule Change
(including the Impact Study \155\ and other confidentially filed data
\156\), comment letters, FICC's response letter, and the Commission's
own understanding of the GSD margin methodology based on its general
supervision of FICC. Based on the Commission's review and analysis of
these materials, the Commission disagrees with the comments suggesting
that FICC's Impact Study and analyses are inaccurate and/or misleading.
In the Proposed Rule Change narrative, FICC described the Impact Study
in anonymized terms, highlighting averages and maximum dollar and
percentage changes, due to the confidential nature of the member-level
transactions that comprise the underlying data. However, FICC filed the
confidential member-level data with the Commission in Exhibit 3 to the
Proposed Rule Change filing. FICC also provided relevant confidential
data in its response to the Commission's requests for additional
information with respect to the Advance Notice.\157\ Additionally, in
the Commission's supervisory role, the Commission routinely collects
confidential margin-related data from FICC. These data sources enable
the Commission to evaluate the effects of the MMA on a member-by-member
basis.
---------------------------------------------------------------------------
\155\ See supra note 67.
\156\ Supra notes 3, 7, 68.
\157\ Supra notes 3, 7.
---------------------------------------------------------------------------
The purpose of the Impact Study and FICC's analyses thereof in the
publicly available Proposed Rule Change filing materials is to
highlight comparisons of the GSD VaR model's performance with and
without incorporating the MMA and to highlight the Proposed Rule
Change's general impacts on members using anonymized data and averages
of maximum dollar and percentage changes. FICC did not state that its
public discussion of the Impact Study was the sole source of data for
the Commission and the public to utilize in evaluating the Proposed
Rule Change. Rather, FICC provided additional detailed member-level
data confidentially, both to members and the Commission, to more fully
evaluate the impacts of the Proposed Rule Change.
Regarding the comments that FICC's analysis of the Impact Study
data presented an inaccurate picture of the MMA's impacts,\158\ the
Commission recognizes that FICC provided individual impact studies for
each member that included the average impact for the entire period of
the Impact Study as well as the average impact on those days that the
proposed MMA would have been applied for each member.\159\ Therefore,
the commenters' concerns regarding the Impact Study do not take into
account that both the Commission and FICC's members also reviewed more
detailed confidential data to better understand the specific member-
level impacts of the Proposed Rule Change. The comment that FICC's
public discussion of the Impact Study presented limited data, rendering
it impossible to properly evaluate the MMA's impacts, does not take
into account that FICC provided more comprehensive confidential data to
the Commission and members that was sufficient to properly assess the
MMA's impacts. Specifically, such data includes, among other things,
actual daily VaR Charge for each member, hypothetical daily VaR Charge
for each member had the MMA been in place, hypothetical daily VaR
Charge for each member had Margin Proxy been invoked, analyses of
increases attributable to the MMA, and numerous backtesting analyses.
The comment that FICC's public discussion of the Impact Study
underestimated the MMA's impacts by calculating the average impacts
based on the full two-year period rather than the nine-month period of
volatility does not take into account that FICC confidentially provided
individual impact studies for each member that included average impacts
on each day that the MMA would have applied to the member.\160\
Similarly, the comment that FICC's public discussion of the Impact
Study expressed the increase in margin requirements in terms of long-
term averages as opposed to largest margin requirements does not take
into account that FICC confidentially provided individual impact
studies for each member indicating maximum margin increases on each day
that the MMA would have applied to the member.\161\ The comment that
FICC's public discussion of the Impact Study cited impacted members
that are not representative and underestimate the MMA's impacts on
middle-market participants does not take into account that FICC
provided member-level impact data to each member.\162\
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\158\ These comments include regarding: FICC's use of the two-
year period of the Impact Study instead of the 9-month period of
extreme market volatility when presenting average impacts (see IDTA
Letter at 3); FICC's use of long-term average margin increases
instead of maximum margin increases resulting from implementing the
MMA (see id.); FICC's examples of members with the largest average
percentage and dollar increases resulting from the MMA (see IDTA
Letter at 3; see SIFMA Letter at 6); and preferred alternative
impact measurements (see IDTA Letter at 3-4; see SIFMA Letter at 6).
\159\ See FICC Letter at 7.
\160\ See id.
\161\ See id.
\162\ See id.
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One commenter also states that FICC should expand the Impact Study
to cover the March 2020 period of stress in light of FICC's statements
that the Proposed Rule Change was driven, in part, by the VaR model's
underperformance during that
[[Page 90122]]
period.\163\ In response, FICC states that inclusion of that data is
not necessary because the Impact Study's two-year period achieves the
purpose of demonstrating the effectiveness of the proposed MMA during
periods of both low and high market volatility.\164\ The Commission
agrees that the Impact Study's two-year period sufficiently
demonstrates the performance of the proposed MMA during periods of both
low and high market volatility, as the two-year study period also
included periods of both low and high market volatility. Inclusion of
March 2020 in the Impact Study is not required for the Commission to
evaluate the responsiveness of the MMA.
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\163\ See SIFMA Letter at 6.
\164\ See FICC Letter at 6.
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Accordingly, the Proposed Rule Change is consistent with Rule 17ad-
22(e)(6)(i) because the new MMA margin calculation and Margin Proxy
clarifications should better enable FICC to establish a risk-based
margin system that considers and produces relevant margin levels
commensurate with the risks associated with liquidating participant
portfolios in a default scenario during periods of extreme market
volatility.\165\
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\165\ 17 CFR 240.17Ad-22(e)(6)(i).
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E. Consistency With Rule 17Ad-22(e)(23)(ii)
Rule 17Ad-22(e)(23)(ii) requires that FICC establish, implement,
maintain and enforce written policies and procedures reasonably
designed to provide sufficient information to enable participants to
identify and evaluate the risks, fees, and other material costs they
incur by participating in FICC.\166\
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\166\ 17 CFR 240.17ad-22(e)(23)(ii).
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One commenter states that the Proposed Rule Change lacks
transparency, quick implementation, and tools and resources to support
market preparedness to identify risks and costs associated with how
FICC calculates margin amounts.\167\ Specifically, the commenter urges
FICC to provide members with (1) daily VaR calculations, (2) an MMA
calculator, and (3) a phased implementation of the MMA, including a
parallel run period where the MMA is calculated but not invoked.\168\
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\167\ See SIFMA Letter at 7-8.
\168\ See id.
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In response, FICC states that it provides tools and resources to
enable members to determine their margin requirements and the impact of
FICC's proposals.\169\ Specifically, FICC maintains the Real Time
Matching Report Center, Clearing Fund Management System, FICC Customer
Reporting Service, and FICC Risk Client Portal which are client
accessible websites for accessing risk reports and other risk
disclosures.\170\ These resources enable members to view Clearing Fund
requirement information and margin component details, including
portfolio breakdowns by CUSIP and amounts attributable to the
sensitivity-based VaR model.\171\ Members are also able to view data on
market amounts for current clearing positions and associated VaR
Charges.\172\ Additionally, the FICC Client Calculator enables members
to, among other things, enter ``what-if'' position data to determine
hypothetical VaR Charges before trade execution. FICC states that as of
June 24, 2024, FICC is in the process of enhancing the FICC Client
Calculator to incorporate the MMA and FICC expects the enhancement to
be available to members prior to implementation of the MMA, subject to
the Commission's approval.\173\ FICC also states that it is currently
developing a tool that would enable non-members to assess potential VaR
Charges (including MMA) as well.\174\
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\169\ See FICC Letter at 7.
\170\ See id.
\171\ See id.
\172\ See id.
\173\ See id.
\174\ See id.
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The extensive tools and resources that FICC makes available to
members should enable members to obtain individualized information to
determine their Clearing Fund requirements, margin component details,
and assess the impact of FICC's proposals. Additionally, FICC's
multiple member outreach efforts (before and after development of the
Proposed Rule Change) provided members with relevant individualized
impact analyses with which to evaluate the Proposed Rule Change.
Accordingly, FICC has provided tools and resources sufficient for its
members to evaluate their daily VaR and other margin-related
calculations, rendering a phased implementation of the proposed MMA
unwarranted.
Based on the foregoing, FICC has provided sufficient information,
tools, and resources to enable members to identify and evaluate the
relevant risks and costs associated with the Proposed Rule Change,
consistent with Rule 17ad-22(e)(23)(ii).\175\
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\175\ 17 CFR 240.17Ad-22(e)(23)(ii).
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III. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in particular with the requirements of Section 17A of the Act \176\ and
the rules and regulations promulgated thereunder.
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\176\ 15 U.S.C. 78q-1.
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It is therefore ordered, pursuant to Section 19(b)(2) of the Act
\177\ that proposed rule change SR-FICC-2024-003, be, and hereby is,
approved.\178\
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\177\ 15 U.S.C. 78s(b)(2).
\178\ In approving the proposed rule change, the Commission
considered the proposals' impact on efficiency, competition, and
capital formation. 15 U.S.C. 78c(f). See also Sections II.A. and
II.B.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\179\
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\179\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-26531 Filed 11-13-24; 8:45 am]
BILLING CODE 8011-01-P
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