Notice2024-27763
Self-Regulatory Organizations; Fixed Income Clearing Corporation; Order Approving Proposed Rule Change, as Modified by Partial Amendment No. 1, To Modify the GSD Rules (i) Regarding the Separate Calculation, Collection and Holding of Margin for Proprietary Transactions and That for Indirect Participant Transactions, and (ii) To Address the Conditions of Note H to Rule 15c3-3a
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 27, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 89 Issue 229 (Wednesday, November 27, 2024)</title>
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[Federal Register Volume 89, Number 229 (Wednesday, November 27, 2024)]
[Notices]
[Pages 93763-93780]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-27763]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-101695; File No. SR-FICC-2024-007]
Self-Regulatory Organizations; Fixed Income Clearing Corporation;
Order Approving Proposed Rule Change, as Modified by Partial Amendment
No. 1, To Modify the GSD Rules (i) Regarding the Separate Calculation,
Collection and Holding of Margin for Proprietary Transactions and That
for Indirect Participant Transactions, and (ii) To Address the
Conditions of Note H to Rule 15c3-3a
November 21, 2024.
On March 14, 2024, Fixed Income Clearing Corporation (``FICC'')
filed with the Securities and Exchange Commission (``Commission'') the
proposed rule change SR-FICC-2024-007 pursuant to Section 19(b) of the
Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4
\2\ thereunder to modify FICC's Government Securities Division
(``GSD'') Rulebook (``GSD Rules'') to calculate, collect, and hold
margin for transactions that a direct GSD participant enters into for
its own benefit (``proprietary transactions'') separately from margin a
direct participant submits to FICC on behalf of indirect participants
and to address conditions of Note H to Rule 15c3-3a under the Exchange
Act (the ``Proposed Rule Change'').\3\ The Proposed Rule Change was
published for public comment in the Federal Register on March 28,
2024.\4\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 99149 (Dec. 13,
2023), 89 FR 2714 (Jan. 16, 2024) (S7-23-22) (``Adopting Release,''
and the rules adopted therein as ``Treasury Clearing Rules''). See
also 17 CFR 240.15c3-3a.
\4\ Securities Exchange Act Release No. 99844 (March 22, 2024),
89 FR 21603 (Mar. 28, 2024) (File No. SR-FICC-2024-007) (``Notice of
Filing''). FICC also filed a related Advance Notice with the
Commission pursuant to Section 806(e)(1) of Title VIII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act, entitled the
Payment, Clearing, and Settlement Supervision Act of 2010 and Rule
19b-4(n)(1)(i) under the Exchange Act. 12 U.S.C. 5465(e)(1). 15
U.S.C. 78s(b)(1) and 17 CFR 240.19b-4, respectively. The Advance
Notice was published in the Federal Register on March 28, 2024.
Securities Exchange Act Release No. 99845 (Mar. 22, 2024), 89 FR
21586 (Mar. 28, 2024) (File No. SR-FICC-2024-802). Upon publication
of notice of filing of the Advance Notice, the Commission extended
the review period of the advance notice for an additional 60 days
because the Commission determined that the advance notice raised
novel and complex issues. On April 24, 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 period of review of the Advance Notice until 120 days
from the date the information requested by the Commission was
received by the Commission. See 12 U.S.C. 5465(e)(1)(D). A memo
regarding the Request for Additional Information and the tolled
period of review is available at <a href="https://www.sec.gov/comments/sr-ficc-2024-802/srficc2024802-462751-1210414.pdf">https://www.sec.gov/comments/sr-ficc-2024-802/srficc2024802-462751-1210414.pdf</a>. On September 24,
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 period of review of the Advance Notice
until 120 days from the date the information requested by the
Commission was received by the Commission. On October 21, 2024, the
Commission received FICC's response to the Commission's September
24, 2024 request for additional information. See 12 U.S.C.
5465(e)(1)(E)(ii) and (G)(ii). A memo regarding receipt of FICC's
response to the Request for Additional Information is available at
<a href="https://www.sec.gov/comments/sr-ficc-2024-802/srficc2024802-539295-1544222.pdf">https://www.sec.gov/comments/sr-ficc-2024-802/srficc2024802-539295-1544222.pdf</a>.
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[[Page 93764]]
On April 24, 2024, pursuant to Section 19(b)(2) of the Exchange
Act,\5\ 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.\6\ On June 21, 2024,
pursuant to Section 19(b)(2)(B) of the Exchange Act,\7\ the Commission
instituted proceedings to determine whether to approve or disapprove
the Proposed Rule Change.\8\ On September 18, 2024, the Commission
extended the time period for Commission action on the proceedings to
determine whether to disapprove the Proposed Rule Change.\9\ On October
25, 2024, FICC filed Partial Amendment No. 1 to the Proposed Rule
Change.\10\ The Proposed Rule Change, as modified by Partial Amendment
No. 1, is referred to herein as the ``Proposed Rule Change.''
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\5\ 15 U.S.C. 78s(b)(2).
\6\ Securities Exchange Act Release No. 100022 (Apr. 24, 2024),
89 FR 34289 (Apr. 30, 2024) (File No. SR-FICC-2024-007).
\7\ 15 U.S.C. 78s(b)(2)(B).
\8\ Securities Exchange Act Release No. 100401 (Jun. 21, 2024),
89 FR 53690 (Jun. 27, 2024) (File No. SR-FICC-2024-007).
\9\ Securities Exchange Act Release No. 101082 (Sep. 18, 2024),
89 FR 77949 (Sep. 24, 2024) (File No. SR-FICC-2024-007).
\10\ Securities Exchange Act Release No. 101454 (Oct. 28, 2024),
89 FR 87441 (Nov. 1, 2024) (File No. SR-FICC-2024-007) (``Notice of
Partial Amendment'').
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The Commission has received comments regarding the substance of the
Proposed Rule Change.\11\ The Commission also received a letter from
FICC responding to the comments.\12\
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\11\ Comments on the Proposed Rule Change are available at
<a href="https://www.sec.gov/comments/sr-ficc-2024-007/srficc2024007.htm">https://www.sec.gov/comments/sr-ficc-2024-007/srficc2024007.htm</a>.
Comments on the Advance Notice are available at <a href="https://www.sec.gov/comments/sr-ficc-2024-802/srficc2024802.htm">https://www.sec.gov/comments/sr-ficc-2024-802/srficc2024802.htm</a>. Because the proposals
contained in the Proposed Rule Change and the Advance Notice are the
same, the Commission considers all comments received on the
proposal, regardless of whether the comments are submitted with
respect to the Advance Notice or the Proposed Rule Change. The
comment letters to the Proposed Rule Change and Advance Notice also
contained comments on the substance of another FICC proposed rule
change, FICC-2024-005. The Commission will only be addressing
comments relevant to this proposal and will address the comments on
the other proposed rule change in a separate order.
\12\ See Letter from Laura Klimpel, Managing Director, Head of
Fixed Income and Financing Solutions, Depository Trust & Clearing
Corporation, (Aug. 1, 2024) (``FICC Letter'').
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For the reasons discussed below, the Commission is approving the
Proposed Rule Change.
I. Description of the Proposed Rule Change
A. Background and Terminology
FICC, through its GSD, is a central counterparty and provider of
clearance and settlement services for the U.S. government securities
markets. As a central counterparty in the U.S. government securities
markets, FICC novates transactions between two counterparties,
effectively becoming the buyer to every seller and the seller to every
buyer, and guarantees the settlement of the novated transactions. This
means that FICC is exposed to a number of risks arising from such
transactions, including counterparty credit risk. FICC seeks to
maintain sufficient resources (i.e., margin) to cover its credit
exposures to its participants fully with a high degree of confidence
and mitigate potential losses from a default of a direct GSD
participant, which is generally referred to as a Netting Member under
the GSD Rules \13\ (and in this Order).
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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.
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On December 13, 2023, the Commission adopted amendments to the
standards applicable to covered clearing agencies that clear
transactions in U.S. Treasury securities (``Treasury CCAs''), such as
FICC.\14\ These amendments require Treasury CCAs to establish,
implement, maintain, and enforce written policies and procedures
reasonably designed to, among other things, calculate, collect, and
hold margin for direct participants' proprietary positions separately
and independently from margin calculated, collected, and held for
indirect participants that rely on the services provided by the direct
participant to access the Treasury CCA's payment, clearing, or
settlement facilities.\15\ The Commission also amended its broker-
dealer customer protection rule (``Rule 15c3-3'') \16\ and the customer
and proprietary accounts of broker-dealer (``PAB'' reserve formulas
thereunder (``Rule 15c3-3a'') \17\ to permit margin required and on
deposit with Treasury CCAs to be included under certain conditions as a
debit in the reserve formulas.\18\
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\14\ See supra note 3.
\15\ 17 CFR 240.17ad-22(e)(6)(i).
\16\ 17 CFR 240.15c3-3.
\17\ 17 CFR 240.15c3-3a.
\18\ See supra note 3.
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The GSD Rules describe how FICC provides clearance and settlement
services to both direct participants and indirect participants, the
latter of which rely on the services provided by direct participants to
access FICC's clearance and settlement facilities. Currently, the GSD
Rules allow indirect participants to access GSD's clearing services
through a Netting Member (that is, a direct participant) via two
models: the correspondent clearing/prime broker services \19\ and the
Sponsored Service.\20\ The primary difference between the two models is
that an indirect participant who becomes a Sponsored Member via the
Sponsored Service model must establish an indirect, limited purpose
FICC membership, whereas the correspondent clearing/prime broker
services do not require an indirect member to establish any
relationship with FICC.\21\
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\19\ See GSD Rule 8, supra note 13.
\20\ See generally GSD Rule 3A, supra note 13.
\21\ See Securities Exchange Act Release No. 99817 (Mar. 21,
2024), 89 FR 21362, at 21364 (Mar. 27, 2024) (File No. SR-FICC-2024-
005).
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The correspondent clearing/prime broker services allow a Netting
Member to submit eligible transactions to FICC on behalf of an indirect
participant (referred to as the ``Executing Firm''), record these
transactions in the same account as the proprietary transactions that
the Netting Member (referred to as a ``Submitting Member'') enters into
for its own benefit, and net the indirect participants' transactions
against the Netting Member's proprietary transactions for purposes of
calculating the Netting Member's margin requirements. Unlike the
Sponsored Service, FICC has no relationship with the Executing Firm,
and all obligations (i.e., margin and settlement) under the GSD Rules
remain with the Submitting Member.\22\
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\22\ Id. at 21365; see also GSD Rule 8, supra note 13.
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[[Page 93765]]
Under a proposed rule change being approved concurrently, FICC is
renaming the prime broker/correspondent clearing model to be known as
the Agent Clearing Service and providing further specificity around the
operation of that service.\23\ In that service, the Netting Member
which serves as the direct participant to FICC would be referred to as
the Agent Clearing Member, and the indirect participant would be
referred to as an Executing Firm Customer. An Executing Firm Customer
would have no direct relationship to FICC. This separate change would
require that a Netting Member using the Agent Clearing Service submit
transactions for Executing Firm Customers through an Agent Clearing
Member Omnibus Account, to be recorded separately from its other
clearing activity, including its proprietary activity. It would also
add a definition for transactions eligible to be submitted by an Agent
Clearing Member on behalf of its Executing Firm Customers (``Agent
Clearing Transactions'').
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\23\ See Order, FICC-2024-005, available at <a href="https://www.sec.gov/rules-regulations/self-regulatory-organization-rulemaking/ficc">https://www.sec.gov/rules-regulations/self-regulatory-organization-rulemaking/ficc</a>.
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In addition, in the Sponsored Service, both currently and in a
concurrently approved proposed rule change,\24\ Netting Members that
are approved to be Sponsoring Members are able to sponsor certain
indirect participants, referred to as Sponsored Members, into GSD
membership and submit transactions on behalf of those Sponsored
Members. A Sponsored Member is the legal counterparty to FICC for any
submitted transactions.\25\ However, the Sponsoring Member
unconditionally guarantees to FICC the Sponsored Member's performance
under a Sponsoring Member Guaranty, which guarantees to FICC the
payment and performance of a Sponsored Member's obligations to
FICC.\26\ Therefore, reliance upon the Sponsoring Member Guaranty
necessarily involves FICC's reliance upon the financial resources of
the Sponsoring Member.
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\24\ See id.
\25\ See GSD Rule 3A, section 7 (describing novation of
Sponsored Member Trades) and 2 (identifying membership types), supra
note 13.
\26\ See GSD Rules 3A (describing the operation of the
Sponsoring Member Guaranty) and 1 (defining the Sponsoring Member
Guaranty), supra note 13.
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Unlike the correspondent clearing/prime broker services,
transactions by the Sponsoring Member's Sponsored Members (``Sponsored
Member Trades'') are not netted, for margining purposes, against
transactions of the Sponsoring Member or another Sponsored Member.
Instead, FICC records Sponsored Member Trades in a Sponsored Member
Omnibus Account, and calculates margin requirements for each Sponsored
Member individually on a gross basis (i.e., without netting their
transactions against transactions of the Sponsoring Member or another
Sponsored Member).\27\
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\27\ See GSD Rule 3A, Section 10(c), supra note 13.
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B. Proposed Changes
In the Proposed Rule Change, FICC seeks to address the Commission's
new margin and account separation requirements and the conditions for
including margin in the broker-dealer reserve formulas discussed in
part I.A above.\28\ As described in greater detail below, the Proposed
Rule Change would (1) provide for the separate and independent
calculation, collection, and holding of margin for proprietary
transactions of a Netting Member from margin submitted to FICC by a
Netting Member to support the transactions of an indirect participant
(i.e., either an Executing Firm Customer or a Sponsored Member); (2)
establish segregated accounts for direct and indirect participants,
including establishing a minimum $1 million cash margin requirement for
each Segregated Indirect Participant; (3) consolidate the methodology
for calculating the margin requirements, including definitions of
relevant terms and components for calculating margin requirements from
various sections of the current GSD Rules into a single margin
component schedule (``Margin Component Schedule''), specify how the
various components relate to different types of margin, and make
certain changes to the margin methodology, including revising the
Margin Liquidity Adjustment (``MLA Charge'') \29\ definition, providing
a method for allocating net unsettled positions to individual indirect
participants for calculating margin requirements, and revising and
clarifying the calculation of the Excess Capital Premium (``ECP'')
component \30\ of the Clearing Fund; and (4) modify the terms relating
to transactions submitted by Inter-Dealer Broker Netting Members \31\
to FICC for clearance and settlement (``Brokered Transactions'').
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\28\ See supra note 3.
\29\ The MLA Charge is a margin component designed to address
the market impact costs of liquidating a defaulted Netting Member's
portfolio that may increase when that portfolio includes large net
unsettled positions in a particular group of securities with a
similar risk profile or in a particular asset type, thereby causing
those costs to be higher than the amount collected for the Netting
Member's volatility charge, which is designed to capture the market
price risk associated with liquidating each Netting Member's
portfolio at a 99th percentile level of confidence. See GSD Rule 1
(defining Margin Liquidity Adjustment Charge), supra note 13; see
also Securities Exchange Act Release No. 89560 (Aug. 14, 2020), 85
FR 51503 (Aug. 20, 2020) (File No. SR-FICC-2020-09) (approving the
MLA charge as a new component of the margin methodology); Securities
Exchange Act Release No. 98558 (Sep. 27, 2023), 88 FR 68179 (Oct. 3,
2023) (File No. SR-FICC-2023-012) (approving revisions to ECP
charge).
\30\ The ECP is a margin component that allows FICC to collect
additional margin if a member's exposure to FICC, based on its
clearing activity, is out of proportion to its capital levels. It is
designed to mitigate the heightened default risk a member could pose
to FICC if it operates with lower capital levels relative to its
margin requirements. See Margin Component Schedule (defining Excess
Capital Premium), supra note 13; see also Securities Exchange Act
Release No. 54457 (Sep. 15, 2006), 71 FR 55239 (Sep. 21, 2006) (File
Nos. SR-FICC-2006-03 and SR-NSCC-2006-03) (approving the ECP charge
as a new component of the margin methodology); Securities Exchange
Act Release No. 96786 (Feb. 7, 2023), 88 FR 8013 (Feb. 7, 2023)
(File No. SR-NSCC-2022-005) (approving revisions to ECP charge).
\31\ An Inter-Dealer Broker is defined as a Person which is in
the business of buying and selling securities as agent on behalf of
dealers and is registered under Section 15 or Section 15C of the
Exchange Act. GSD Rule 1 (defining Inter-Dealer Broker), supra note
13. An Inter-Dealer Broker Netting Member must meet that definition
and certain applicable membership requirements. See id. and Rule 2A
(setting forth membership requirements).
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1. Separate Calculation, Collection, and Holding of Margin
The Proposed Rule Change would provide for the separate and
independent calculation, collection, and holding of (i) margin
deposited by a Netting Member to support its proprietary transactions,
and (ii) margin deposited by a Netting Member to support the
transactions of an indirect participant, that is, either an Executing
Firm Customer or a Sponsored Member. To facilitate the separate and
independent calculation, collection, and holding proprietary and
indirect participant margin, FICC would establish proprietary accounts
to record the proprietary transactions that the Netting Member enters
into for its own benefit and separate indirect participant accounts to
record transactions that the Netting Member submits on behalf of an
indirect participant, which could be either a Sponsored Member or an
Executing Firm Customer.
For proprietary transactions, the accounts would include Dealer
Accounts, which would be available for all Netting Members, and Cash
Broker Accounts and Repo Broker Accounts, which would only be available
for Inter-Dealer Broker Netting Members.\32\ Cash
[[Page 93766]]
Broker Accounts would be available for recording an Inter-Dealer Broker
Netting Member's Brokered Transactions (other than Brokered Repo
Transactions), and Repo Broker Accounts would be for purposes of
recording an Inter-Dealer Broker Netting Member's Brokered Repo
Transactions.
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\32\ Under the proposed changes, ``Cash Broker Account'' would
be a proprietary account maintained by FICC for an Inter-Dealer
Broker Netting Member to record Brokered Transactions, other than
Brokered Repo Transactions, submitted to the Corporation by the
Inter-Dealer Broker Netting Member. ``Repo Broker Account'' would be
a proprietary account maintained by the FICC for an Inter-Dealer
Broker Netting Member in its capacity as a Repo Broker to record
Brokered Repo Transactions submitted to the Corporation by the
Inter-Dealer Broker Netting Member.
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For indirect participant transactions, FICC would establish
Indirect Participants Accounts to record transactions that a Netting
Member submits to FICC on behalf of Sponsored Members and Executing
Firm Customers. These Indirect Participants Accounts would include
Sponsoring Member Omnibus Accounts for recording Sponsored Member
Trades and Agent Clearing Member Omnibus Accounts for recording Agent
Clearing Transactions submitted on behalf of Executing Firm Customers.
In addition, the proposal would permit a Sponsoring Member or Agent
Clearing Member to designate any of its Indirect Participants Accounts
as a segregated customer account (a ``Segregated Indirect Participants
Account''). Such designation, as further described in part I.B.2 below,
would give Netting Members a mechanism to direct FICC to calculate and
segregate margin deposited in connection with the relevant Segregated
Indirect Participants Account in accordance with the conditions
described in Note H to Rule 15c3-3a.\33\
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\33\ 17 CFR 240.15c3-3a.
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The proposal would require each Netting Member to deposit two forms
of margin: the Required Fund Deposit and the Segregated Customer Margin
Requirement. The Required Fund Deposit, which would be deposited to the
Clearing Fund, would be the sum of each Netting Member's proprietary
accounts (e.g., Dealer Accounts and Broker Accounts) and indirect
participant accounts (e.g., Agent Clearing Omnibus Accounts and
Sponsoring Member Omnibus Accounts) not designated as Segregated
Indirect Participants Accounts. The Segregated Customer Margin
Requirement, which would be excluded from the Clearing Fund, would be
the sum of the Netting Member's Sponsoring Member Omnibus Accounts
designated as Segregated Indirect Participants Accounts and Agent
Clearing Member Omnibus Accounts designated as Segregated Indirect
Participants Accounts.
FICC's proposal would also provide that a Netting Member's Margin
Portfolio, which is utilized to determine a Netting Member's margin
requirement, cannot include both proprietary and indirect participant
accounts. As a result, the transactions a Netting Member submits to
FICC on behalf of an indirect participant either as a Sponsoring Member
or an Agent Clearing Member would no longer be netted against a Netting
Member's proprietary transactions for calculating a Netting Member's
margin requirements.\34\ Since proprietary transactions and
transactions submitted for indirect participants would not be recorded
in the same type of account, these changes would result in margin for a
Netting Member's proprietary transactions being calculated separately
and independently from margin calculated for the transactions that the
Netting Member submits on behalf of indirect participants.
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\34\ The Proposed Rule Change would also specify the types of
accounts in which Netting Members may record transactions to
identify the purpose and use of these accounts. FICC's ``Accounts''
are not custodial accounts in which FICC holds assets, but rather a
mechanism for FICC to record and group transactions. These records
are utilized by FICC in its calculation of a Netting Member's
margining, settlement, and other obligations. Proprietary Accounts
would include ``Dealer Accounts,'' which would be available for all
Netting Members, and ``Cash Broker Accounts'' and ``Repo Broker
Accounts,'' which would only be available for Inter-Dealer Broker
Netting Members. Non-Proprietary Accounts would include, in the case
of a Sponsoring Member, Sponsoring Member Omnibus Accounts for
purposes of recording Sponsored Member Trades, and, in the case of
an Agent Clearing Member, Agent Clearing Member Omnibus Accounts for
purposes of recording Agent Clearing Transactions of its Executing
Firm Customers.
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To help ensure that margin for proprietary transactions is
calculated, collected, and held separately and independently of margin
for indirect participant transactions, FICC would require each Netting
Member, at the time it submits a transaction to FICC for clearance and
settlement, to designate the account in which the particular
transaction should be recorded using a separate Deposit ID, which is an
existing operational mechanism used by Netting Members to identify the
type of account for which a margin deposit is being made. The use of
these separate Deposit IDs would result in margin for each type of
account being separately transferred to FICC and recorded on FICC's
books as separate margin amounts for each account type. The proposal
would also require FICC to report a Netting Member's Required Fund
Deposit and Segregated Customer Margin Requirement twice daily and
specify the amount of margin attributable to each Required Fund Deposit
Portion or Segregated Indirect Participants Account so that the Netting
Member can transfer the different margin amounts separately.
In addition, the proposal would eliminate the concept of a
Permitted Margin Affiliate, which allows a Netting Member to include
accounts of an affiliate that is also a Netting Member in the same
Margin Portfolio as its accounts and net their transactions for margin
calculation purposes. FICC states that no Netting Member currently has
a Permitted Margin Affiliate, so keeping this option in the rules in
conjunction with the proposed changes to establish separate and
independent calculation, collection, and holding of margin would
introduce unnecessary complexity in FICC's rules.\35\
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\35\ See Notice of Filing, supra note 4, at 21608.
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2. Segregation of Customer Margin
FICC is proposing several changes to allow for the segregation of
customer margin in a manner that satisfies the conditions for recording
a debit in the customer reserve formula under Note H to Exchange Act
Rule 15c3-3a.\36\ First, to satisfy Section (b)(2)(i) of Note H to Rule
15c3-3a,\37\ FICC would calculate the margin requirements applicable to
any segregated account on a gross basis (i.e., FICC would treat each
indirect participant as if it were a separate Netting Member for margin
calculations and would not net the transactions of one indirect
participant against the transactions of another indirect participant).
Second, to satisfy Section (b)(2)(iii) of Note H to Rule 15c3-3a,\38\
FICC would establish Segregated Customer Margin Custody Accounts for
eligible customers on its books and records. These accounts would
segregate the margin deposited for transactions in that account from
any margin for a Netting Member's proprietary positions, both on FICC's
own books and records and at FICC's custodians. FICC would only be able
to use such segregated margin to secure or satisfy the obligations of
the customer for whom such margin is held, and it would not be
considered part of the mutualized Clearing Fund. FICC would not be able
to apply such margin to the proprietary obligations of the Netting
Member that deposited it with FICC, to the obligations of any other
Netting Member or indirect participant, or to any lien or claim against
FICC.\39\ FICC would
[[Page 93767]]
provide written notice to any Netting Member that is a broker-dealer
that any Segregated Customer Margin Custody Account is being held for
the exclusive benefit of the customers and is being kept separate from
any other accounts maintained by the broker-dealer or any other Netting
Member at FICC, as required by Section (b)(2)(iii)(C) of Note H.\40\
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\36\ See id., at 21608 (citing 17 CFR 240.15c3-3a).
\37\ Id. at 21608-09.
\38\ Id. at 21609.
\39\ See FICC Letter at 35 (describing this as ``an express
prohibition on FICC using Segregated Customer Margin held in respect
of one Segregated Indirect Participant for the obligations of any
other person'' and stating that, as a result, the default of one
Segregated Indirect Participant should not generally cause another
segregated Indirect participant to lose its margin).
\40\ Id. at 21610.
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Further, as amended, the proposal would clarify that any interest
earned on Segregated Customer Margin consisting of cash must be paid to
the Netting Member on behalf of, and as agent for, its Segregated
Indirect Participant.\41\
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\41\ See Notice of Partial Amendment, supra note 10, at 87443.
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Moreover, to comply with the custody requirements of (b)(2)(iv) of
Note H,\42\ FICC would require segregated margin accounts to be held at
either a bank within the meaning of the Exchange Act that is insured by
the Federal Deposit Insurance Corporation and is a qualified custodian
under the 1940 Act, or the Federal Reserve Bank of New York.\43\ FICC
would require these accounts to be segregated from any other account of
FICC and used exclusively to hold Segregated Customer Margin, in
accordance with Section (b)(2)(iv)(A) of Note H. Moreover, each of
these accounts would be subject to (i) a written notice of the bank or
Federal Reserve Bank that the account is being held by the bank or
Federal Reserve Bank pursuant to Rule 15c3-3 and is being kept separate
from and not commingled with any other accounts maintained by FICC or
any other person at the bank or Federal Reserve Bank and (ii) a written
contract between FICC and the bank or Federal Reserve Bank which would
provide that the Segregated Customer Margin in the account is subject
to no right, charge, security interest, lien, or claim in favor of the
bank or Federal Reserve Bank or any person claiming through the bank or
Federal Reserve Bank, in accordance with Sections (b)(2)(iv)(B) and (C)
of Note H.\44\ FICC would also only allow Segregated Customer Margin
consisting of cash to be invested in U.S. Treasury securities with a
maturity of one year or less, in accordance with Section (b)(2)(ii) of
Note H.\45\
---------------------------------------------------------------------------
\42\ See Notice of Filing, supra note 4, at 21607.
\43\ See Notice of Partial Amendment, supra note 10, at 87443.
\44\ See Notice of Filing, supra note 4, at 21607.
\45\ Id.
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Finally, to satisfy Section (b)(2)(v) of Note H,\46\ FICC would
provide specific procedures to allow Netting Members to request the
return of excess segregated margin. FICC notes that these changes would
allow broker-dealer Netting Members to collect margin from customers
and deposit it with FICC and to provide all customers, including those
that access FICC through non-broker-dealers, the ability to segregate
margin they deposit.\47\ FICC would have the ability to retain some or
all of the excess segregated customer margin if the Netting Member had
an outstanding payment or margin obligation to FICC for transactions of
any Segregated Indirect Participant. FICC could not retain the excess
segregated customer margin for a Segregated Indirect Participant when
FICC has determined, in its sole discretion, that such outstanding
payment or margin obligation is unrelated to the transactions of that
Segregated Indirect Participant.\48\ FICC states that these aspects of
the Proposed Rule Change would allow for the segregation of certain
customer margin in a manner that satisfies the conditions for a broker-
dealer to record a debit in the customer reserve formula under Note H
to Rule 15c3-3a.\49\
---------------------------------------------------------------------------
\46\ Id.
\47\ Id. at 21606.
\48\ See Notice of Partial Amendment, supra note 10, at 87443.
\49\ See Notice of Filing, supra note 4, at 21606.
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a. $1 Million Minimum Cash Margin Requirement
FICC is also proposing a minimum $1 million cash margin requirement
for each Segregated Indirect Participant Account, similar to the $1
million minimum cash margin requirement currently applicable to each
Netting Member.\50\ FICC conducts daily backtesting to evaluate whether
each Netting Member's margin is sufficient to cover FICC's credit
exposures to that member based on a simulated liquidation of the
member's portfolio on that day. FICC's daily backtesting of the
sufficiency of Clearing Fund deposits has shown a heightened risk of
backtesting deficiencies (i.e., the projected liquidation losses to
FICC due to a Netting Member's default would be greater than the
member's margin) for members with lower deposits.\51\ Because FICC is
required to calculate the margin requirements for Segregated Indirect
Participants on a gross basis, as if each Segregated Indirect
Participant were a separate Margin Portfolio, and Segregated Customer
Margin would not be available to address losses from other direct or
indirect participants, FICC believes it is also appropriate to apply
the same minimum cash requirement to each Segregated Indirect
Participant that it applies to each Margin Portfolio.\52\ Moreover,
FICC believes that the $1 million cash requirement is the appropriate
minimum amount to optimize the balance between financial impact of the
requirement to participants and FICC's ability to continue to meet its
regulatory obligation to maintain a backtesting performance coverage
ratio above its 99 percent coverage target.\53\ FICC states that the $1
million minimum is supported by its prior analyses of the appropriate
minimum margin requirement for Netting Members.\54\ FICC further
describes this minimum requirement as critical to ensuring that the
account segregation does not expose FICC and its participants to undue
loss. FICC explains that the Segregated Customer Margin posted by an
individual Segregated Indirect Participant needs to be enough, on its
own, to address losses arising from the Segregated Indirect
Participant's positions, and that, otherwise, such losses may be
mutualized.\55\
---------------------------------------------------------------------------
\50\ Like the current requirement for Netting Member Required
Fund Deposits, the proposal would require that a minimum of 40
percent of the Segregated Customer Margin Requirement be satisfied
with cash and/or Eligible Clearing Fund Treasury Securities.
\51\ See Notice of Filing, supra note 4, at 21611.
\52\ Id.
\53\ Id.; FICC Letter at 28-29.
\54\ See FICC Letter at 28-29.
\55\ Id. at 29.
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However, FICC, in its sole discretion, would have the ability to
adjust the amount of the minimum $1 million margin requirement if FICC
determines that a different minimum charge would be appropriate and
consistent with achieving its backtesting coverage target.\56\ FICC
would notify Netting Members of any such adjustment to the minimum
margin requirement through an Important Notice.\57\ In discussing this
proposed ability, FICC states that it will review the $1 million floor
for Segregated Customer Margin as part of ongoing internal surveillance
and risk management monitoring procedures.\58\ FICC further states that
it would be prudent to have the ability to adjust the $1 million floor
proactively to the extent that FICC identifies as part of these reviews
that activity levels, margin performance observed through backtesting,
and other measures indicate that FICC would be able to continue to
[[Page 93768]]
manage the risks presented to it and meet its regulatory risk
management obligations (including, for example, its 99% backtesting
coverage target) with a lower minimum Segregated Customer Margin
Requirement (that is, an amount below $1 million).\59\
---------------------------------------------------------------------------
\56\ See Notice of Partial Amendment, supra note 10, at 87443.
\57\ Id.
\58\ See FICC Letter at 30.
\59\ Id. at 31.
---------------------------------------------------------------------------
3. Margin Component Schedule
To improve the clarity and transparency of its margin components
and Clearing Fund calculation methodology,\60\ FICC would move the
margin calculation methodology, including the relevant defined terms,
into a new Margin Component Schedule. Currently, the terms and
information concerning the margin calculation methodology, as well as
the relevant definitions, appear in several different locations.\61\
FICC states that its methodology and the included components would
continue to be substantively the same as the methodology under the
current Rules.\62\
---------------------------------------------------------------------------
\60\ See Notice of Filing, supra note 4, at 21612.
\61\ FICC would move the calculation methodology from Rule 4,
Sections 1b, and 2a, Rule 3, Section 14, and Rule 3A, Section 10 to
the new Margin Component Schedule. FICC would move the definitions
from Rule 1 to Section 5 of the Margin Component Schedule.
\62\ See Notice of Filing, supra note 4, at 21612.
---------------------------------------------------------------------------
The new Margin Component Schedule would set out the methodology for
calculating margin amounts. That Margin Component Schedule would
provide for FICC to perform substantially the same calculation it
currently performs when determining a Netting Member's Required Fund
Deposit, except that (i) the calculation would be performed on a
Segregated Indirect Participant-by-Segregated Indirect Participant
basis as though each Segregated Indirect Participant represented a
separate Margin Portfolio and (ii) FICC would not impose an ECP on
Segregated Indirect Participant Accounts. Specifically, for Required
Fund Deposit calculations, the margin amount shall equal the VaR
Charge, plus or minus the Blackout Period Exposure Adjustment (as
applicable), plus the Portfolio Differential Charge, with the following
potential additional charges, as applicable: the Backtesting Charge,
the Holiday Charge, the MLA Charge, the ECP, and the Intraday
Supplemental Fund Deposit.\63\ For Segregated Customer Margin
Requirement calculations, the margin amount shall equal the VaR Charge,
plus or minus the Blackout Period Exposure Adjustment (as applicable),
plus the Portfolio Differential Charge, with the following potential
additional charges, as applicable: the Backtesting Charge, the Holiday
Charge, the MLA Charge, and the Intraday Supplemental Fund Deposit.
---------------------------------------------------------------------------
\63\ This method does not represent a change from the current
method of calculating Required Fund Deposits, but merely moves the
description from current Rule 4 to the new Margin Component
Schedule.
---------------------------------------------------------------------------
For both types of calculations, the Margin Component Schedule
addresses the applicable minimum cash margin requirements ($1 million
for each Netting Member and Segregated Indirect Participant) \64\ and
FICC's authority to require increased deposits as appropriate,
including the use of a special charge. FICC would not add Segregated
Customer Margin to Section 4 of the Margin Component Schedule, which
describes FICC's ability to impose increased Required Fund Deposits
under certain circumstances.\65\ However, when determining whether to
increase the Required Fund Deposit of a Netting Member under the
circumstances described in Section 4, FICC would consider the risk
presented by a Netting Member from the activity it submits to FICC,
including activity of indirect participants.\66\
---------------------------------------------------------------------------
\64\ See supra Section I.B.2.a for a description of the proposed
$1 million minimum cash margin requirement for each Segregated
Indirect Participant Account.
\65\ See Notice of Filing, supra note 4, at 21609.
\66\ Id.
---------------------------------------------------------------------------
a. MLA Charge
FICC would amend the definition of the MLA Charge to account for
the use of Segregated Indirect Participant Accounts. Specifically, the
definition would provide that, if a Segregated Indirect Participant
clears through multiple Accounts \67\ (including Accounts of different
Netting Members), then the MLA Charge for transactions in a Segregated
Indirect Participants Account would be the greater of (i) an amount
calculated for only the transactions maintained in that Account (i.e.,
excluding the other Accounts where the Segregated Indirect
Participant's transactions are recorded) and (ii) an amount calculated
on a consolidated portfolio basis (i.e., taking into account the
transactions in each of the Accounts). This would be the same
methodology currently used for Sponsored Members clearing through
multiple Accounts.\68\
---------------------------------------------------------------------------
\67\ FICC proposed to amend the definition of Account to be an
account maintained by FICC for a Member to record transactions
submitted by the member. FICC states that this change would clarify
that Accounts are recordkeeping mechanisms for FICC to determine
which transactions should be netted against each other, but are not
custodial accounts through which FICC holds assets for a Netting
Member. See Notice of Filing, supra note 4, at 21608.
\68\ See GSD Rule 1 (defining MLA Charge, including for
Sponsored Members sponsored by multiple Sponsoring Members), supra
note 13; Securities Exchange Act Release No. 98558 (Sep. 27, 2024),
89 FR 68179 (Oct. 3, 2023) (File No. SR-FICC-2023-012).
---------------------------------------------------------------------------
b. Allocation of Net Unsettled Positions
The Proposed Rule Change would also provide a method for allocating
net unsettled positions to individual indirect participants for
calculating margin requirements. Specifically, as amended, FICC would
modify the definition of Current Net Settlement Positions in Rule 1 to
provide that, for calculating margin requirements and not for purposes
of calculating the Net Settlement Position under GSD Rule 11, positions
that are not clearly allocable to an individual Sponsored Member or
Segregated Indirect Participant (other than Sponsored GC Trades),
because one or more transactions recorded for indirect participants did
not settle on the original Scheduled Settlement Date, would be
allocated pro rata to Sponsored Members or Segregated Indirect
Participants that had positions in the same direction and CUSIP as the
un-allocable Current Net Unsettled Positions at the end of the
preceding business day. FICC states that this situation could arise if
a transaction recorded in a Sponsoring Member Omnibus Account or
Segregated Indirect Participants Account fails to settle and that such
failure to settle would not occur with Sponsored GC Trades.\69\ FICC
believes this methodology facilitates a reasonable and fair allocation
for purposes of calculating gross margin requirements.\70\
---------------------------------------------------------------------------
\69\ See Notice of Filing, supra note 4, at 21612-13; Notice of
Partial Amendment, supra note 10, at 87443.
\70\ See Notice of Filing, supra note 4, at 21613.
---------------------------------------------------------------------------
c. Calculation of Excess Capital Premium
In addition, the Proposed Rule Change would amend the terms related
to the ECP component of the Clearing Fund, which is used to collect
additional margin if a Netting Member's exposure to FICC through its
clearing activity is out of proportion to its capital. Currently, the
ECP applicable to a Netting Member equals the Netting Member's ``Excess
Capital Ratio'' (i.e., its VaR Charge divided by its Netting Member
Capital) multiplied by its ``Excess Capital Differential'' (i.e., the
amount by which a Netting Member's VaR Charge exceeds its Netting
Member Capital). However, FICC currently reserves the right to collect
less than
[[Page 93769]]
this amount or to return some or all of this amount.\71\
---------------------------------------------------------------------------
\71\ See GSD Rule 1 (defining Excess Capital Ratio and Excess
Capital Differential) and Rule 3, Section 14 (describing the Excess
Capital Premium), supra note 13.
---------------------------------------------------------------------------
The changes would seek to make the calculation of the ECP component
clearer and more predictable by (i) capping the amount of the ECP at
two times the amount by which a Netting Member's VaR Charge exceeds its
Netting Capital,\72\ (ii) specifying the Netting Member Capital amounts
used to calculate the ECP (that is, the Net Capital amount from each
Netting Member's most recent Form X-17-A-5 (Financial and Operational
Combined Uniform Single Report (``FOCUS Report'')) or the Equity
Capital amount on its most recent Consolidated Report of Condition and
Income (``Call Report'')), (iii) providing that FICC may calculate the
premium based on updated available information, and (iv) permitting
FICC, in its discretion, to waive the amount of the ECP and setting
forth a specific procedure for doing so. Regarding the waiver
procedure, only a Managing Director in FICC's Group Chief Risk Office
would be able to grant a waiver of an ECP in certain situations. These
situations would be limited to exigent circumstances or other
unexpected events. When deciding whether to grant a waiver, FICC would
consider the degree to which a Netting Member's capital position and
trading activity compare or correlate to the exigent circumstances and
whether FICC can effectively manage the risk exposure from the Netting
Member without collecting the ECP.\73\ Any waiver would be documented
in a written report made available to the Netting Member. FICC states
that these changes are substantially similar to changes recently
adopted by the National Securities Clearing Corporation (``NSCC'') and
they would enhance the ability of Netting Members to identify what
their ECP will be and to ensure such amount is accurately
calibrated.\74\
---------------------------------------------------------------------------
\72\ In addition, FICC would amend the definition of Netting
Member Capital to refer to a Netting Member's Net Capital, Net
Assets, or Equity Capital to link the calculation to the appropriate
regulatory framework for each Netting Member and add the term Equity
Capital to clarify that a Netting Member's most recent Call Report,
or financial statements or equivalent reporting if a Netting Member
is not required to file a Call Report, will be used for the
calculation of the Excess Capital Premium.
\73\ See Notice of Filing, supra note 4, at 21613.
\74\ See Securities Exchange Act Release No. 96786 (Feb. 1,
2023), 88 FR 8013 (Feb. 7, 2023) (SR-NSCC-2022-005).
---------------------------------------------------------------------------
In addition, the Proposed Rule Change would revise the definitions
of Excess Capital Ratio and Excess Capital Differential to exclude the
VaR Charge for Segregated Indirect Participants. FICC is proposing this
change because each indirect participant would be responsible for
satisfying its own respective VaR Charge, not the Netting Member, and
the Excess Margin Charge is designed to address the risk that a Netting
Member with low capital relative to value-at-risk is not able to
perform its obligations.\75\ FICC states that including the VaR Charge
that is calculated for an indirect participant and is satisfied by the
capital of that indirect participant in the calculation of the Netting
Member's ECP could result in assessing an ECP for that Netting Member
that is greater than the amount required to mitigate the risk this
margin component is designed to address.\76\ FICC also states that this
change is designed to ensure that the ECP does not result in
differential treatment of Netting Members that act as intermediaries
for Segregated Indirect Participants.
---------------------------------------------------------------------------
\75\ Id.
\76\ Id.
---------------------------------------------------------------------------
4. Modification of Terms for Brokered Transactions
The Proposed Rule Change would modify the terms relating to
Brokered Transactions. FICC's rules currently cap the amount of loss
allocation that may be applied to Inter-Dealer Broker Netting Members
and Non-IDB Repo Brokers submitting Brokered Transactions. FICC would
revise the definition of Brokered Transactions to include only the side
of the transactions submitted to FICC for novation by an Inter-Dealer
Broker Netting Member and entered into on the Inter-Dealer Broker
Netting Member's own trading platform.\77\ As a result, the favorable
loss allocation treatment for Brokered Transactions would apply only to
the transactions that present limited risk since an Inter-Dealer Broker
is standing between two counterparties in those transactions and is
therefore completely flat (that is, subject to offsetting
exposures).\78\ Since FICC believes the favorable loss allocation
treatment is appropriate only for Inter-Dealer Broker Netting Members
submitting Brokered Transactions, it would delete the term ``Non-IDB
Repo Broker'' from its rules.\79\ FICC states that these changes would
improve FICC's risk management and promote access by ensuring that its
differential treatment of different parties and transactions has a
sound risk management justification.\80\
---------------------------------------------------------------------------
\77\ See Notice of Partial Amendment, supra note 10, at 87444.
\78\ See Notice of Filing, supra note 4, at 21614.
\79\ Id.
\80\ See Notice of Filing, supra note 4, 21604.
---------------------------------------------------------------------------
In addition, the proposed changes would provide that transactions
entered into on inter-dealer brokers and similar platforms may be
cleared using the Sponsored Service or the Agent Clearing Service.\81\
---------------------------------------------------------------------------
\81\ Notice of Partial Amendment, supra note 10, at 87444; see
also FICC Letter at 22-23.
---------------------------------------------------------------------------
II. Discussion and Commission Findings
Section 19(b)(2)(C) of the Exchange Act \82\ 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 Exchange 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 Exchange 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 Exchange Act \83\ and Rules
17ad-22(e)(4)(i), (e)(6)(i), (e)(6)(iii), (e)(18)(ii), (e)(18)(iii),
(e)(18)(iv)(C), (e)(19), and (e)(23)(ii) thereunder.\84\
---------------------------------------------------------------------------
\82\ 15 U.S.C. 78s(b)(2)(C).
\83\ 15 U.S.C. 78q-1(b)(3)(F) and 15 U.S.C. 78q-1(b)(3)(I).
\84\ 17 CFR 240.17ad-22(e)(4)(i), (e)(6)(i), (e)(6)(iii),
(e)(18)(ii), (e)(18)(iii), (e)(18)(iv)(C), (e)(19), and (e)(23)(ii).
---------------------------------------------------------------------------
A. Consistency With Section 17A(b)(3)(F) of the Exchange Act
Section 17A(b)(3)(F) of the Exchange Act \85\ requires the rules of
a clearing agency to, among other things, promote the prompt and
accurate clearance and settlement of securities transactions and 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
protect investors and promote the public interest.
---------------------------------------------------------------------------
\85\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
1. Separate Calculation and Collection of Margin for Proprietary and
Customer Accounts
The proposed changes to require the separate and independent
calculation and collection of margin for Netting Members' proprietary
transactions and indirect participants' transactions, as described in
Section I.B.1., should allow FICC to better identify and measure the
unique risk profiles of each Netting
[[Page 93770]]
Member and indirect participant. This proposed change would ensure that
an indirect participant's positions are no longer netted against a
Netting Member's positions, that margin is collected with respect to
the indirect participant's positions specific to those transactions,
and that interest on an indirect participant's cash margin would be
paid to the Netting Member for the benefit of, and as agent for, the
indirect participant. As discussed in more detail in Section II.C.1
below, this should enhance FICC's ability to calculate and collect the
appropriate margin from each direct and indirect participant and,
therefore, meet its settlement obligations in the event of a Netting
Member or indirect participant default. By doing so, the Proposed Rule
Change should better ensure that, in the event of a default, FICC's
operation of its critical clearance and settlement services would not
be disrupted because of insufficient financial resources and,
therefore, it would be able to continue providing prompt and accurate
clearance and settlement of securities transactions, consistent with
Section 17A(b)(3)(F).\86\
---------------------------------------------------------------------------
\86\ Id.
---------------------------------------------------------------------------
The separate and independent calculation and collection of margin
for proprietary and indirect participants' transactions should allow
FICC to better identify and measure the unique risk profiles of each
Netting Member and indirect participant, enhancing FICC's ability to
calculate and collect sufficient margin from each Netting Member and
indirect participant to cover potential losses from a Netting Member or
indirect participant default, thereby reducing the likelihood that
FICC, Netting Members, or indirect participants would incur losses
resulting from a default. As a result, the proposed changes should
limit FICC's risk to a Netting Member or indirect participant default
and thereby enhance its ability to safeguard securities and funds in
its control and for which it is responsible.
2. $1 Million Minimum Cash Margin Requirement
For the reasons discussed below in more detail in Section II.C.2.,
the proposed $1 million minimum cash margin requirement for Segregated
Indirect Participants, which could be adjusted by FICC if it determines
that a different minimum amount would be appropriate and consistent
with achieving its backtesting coverage target, should help ensure that
each indirect participant provides sufficient margin to cover its
potential obligations to FICC, thereby helping to allow FICC to meet
its settlement obligations in the event of a default and to protect
FICC, non-defaulting Netting Members, indirect participants, and the
market from losses from an indirect participant default. Accordingly,
the proposed $1 million minimum cash margin requirement should assure
the safeguarding of securities and funds which are in the custody or
control of FICC.
In addition, as indicated by FICC's backtesting results, and
discussed further in Section II.C.2 below, the $1 million minimum
margin requirement should enhance FICC's ability to collect the
appropriate margin from each indirect participant and, therefore, meet
its settlement obligations in the event of a default. FICC's
flexibility to adjust the minimum margin amount if it determines that a
different amount would be appropriate and consistent with achieving its
backtesting coverage target is also consistent with ensuring that each
indirect participant provides sufficient margin to cover its
obligations to FICC. Achieving backtesting coverage targets is
essential to ensuring that the margin collected would be sufficient for
FICC to cover its credit exposures to its Netting Members and indirect
participants fully with a high degree of confidence, as required for a
covered clearing agency such as FICC.\87\ As defined in the Covered
Clearing Agency Standards, backtesting is an ex-post comparison of
actual outcomes with expected outcomes derived from the use of margin
models,\88\ and it is a key analytical mechanism for a CCP to consider
the effectiveness of its margin model. FICC's ability to adjust the
minimum margin amount would apply only where it would be appropriate
and consistent with achieving its backtesting coverage target. This
ability would, therefore, be limited to circumstances where its
backtesting coverage target requirements are not being met or the
amount of margin being collected exceeds the amount needed to cover the
indirect participant's exposure to FICC.
---------------------------------------------------------------------------
\87\ 17 CFR 240.17ad-22(e)(6).
\88\ 17 CFR 240.17ad-22(a).
---------------------------------------------------------------------------
Based on FICC's representations, the Commission understands that
FICC generally intends to use this ability to adjust the minimum margin
requirement below $1 million if a lower minimum would suffice to reduce
backtesting deficiencies comparably to the $1 million.\89\ As part of
its ongoing supervision of FICC, the Commission will continue to
monitor the performance of the $1 million minimum margin requirement,
including as its performance compares to backtesting, and will engage
with FICC regarding any changes to that requirement and the supporting
analysis for such changes, to help ensure that FICC is appropriately
exercising that discretion consistent with the requirements imposed
upon it by the rule (i.e., that it determines that any such adjustments
would be appropriate and consistent with achieving its backtesting
coverage target).\90\ For example, not meeting backtesting coverage
requirements would be an indication that the minimum margin amount is
insufficient to cover FICC's credit exposure to its Netting Members and
indirect participants, whereas, on the contrary, higher backtesting
performance could indicate that the margin collected exceeds the
exposure to FICC.
---------------------------------------------------------------------------
\89\ See FICC Letter at 3, 30-31.
\90\ In addition, the requirements applicable to FICC as a self-
regulatory organization under Section 19(b) of the Exchange Act and
as a designated financial market utility under Title VIII of the
Payment, Clearing, and Supervision Act (12 U.S.C. 5465(e)) would
continue to apply. Thus, for example, if FICC were to amend the $1
million minimum margin requirement to an amount that would
materially alter the level or nature of risk presented, FICC would
be obligated to submit an advance notice of such change with the
Commission.
---------------------------------------------------------------------------
Therefore, the $1 million minimum margin requirement should help
ensure that, in the event of a Segregated Indirect Participant default,
FICC's operation of its critical clearance and settlement services
would not be disrupted because of insufficient financial resources and
it can continue providing prompt and accurate clearance and settlement
of securities transactions.
3. Margin Component Schedule
The proposed changes in section I.B.3 regarding the calculation of
margin for segregated and non-segregated accounts should help ensure
that FICC collects margin sufficient to cover its exposures with
respect to both direct and indirect participants. Requiring that the
margin requirement for a Segregated Indirect Participant Account be
calculated in generally the same manner as a Netting Member's
requirement, which the Commission generally has reviewed and approved
as part of FICC's rules,\91\
[[Page 93771]]
should help ensure that FICC collects margin sufficient to cover its
exposures with respect to both direct and indirect participants, as
discussed further in Sections II.C.3 and II.D.3 below. In addition, by
doing so, these proposed changes should help ensure that, in the event
of such a default, FICC's operation of its critical clearance and
settlement services would not be disrupted because of insufficient
financial resources and, therefore, it could continue providing prompt
and accurate clearance and settlement of securities transactions,
consistent with Section 17A(b)(3)(F).\92\ For the same reasons, these
proposed changes should also help ensure that FICC is able to continue
to meet its obligation in the event of a default, without accessing
non-defaulting Netting Members' or indirect participants' margin
deposits, thereby helping FICC ensure that it can safeguard the funds
and securities within its custody or control, consistent with Section
17A(b)(3)(F).\93\
---------------------------------------------------------------------------
\91\ See, e.g., Self-Regulatory Organizations; Fixed Income
Clearing Corporation; Notice of Filing of Amendment No. 1 and Order
Granting Accelerated Approval of a Proposed Rule Change, as Modified
by Amendment No. 1, To Implement Changes to the Required Fund
Deposit Calculation in the Government Securities Division Rulebook,
Exchange Act Release No. 83362 (June 1, 2018), 83 FR 26514 (June 7,
2018) (approving changes to how FICC calculates the Value at Risk
component of its margin methodology, addition of the new ``Blackout
Period Exposure adjustment'' component to the margin methodology,
eliminating certain existing components, and revising additional
components).
\92\ 15 U.S.C. 78q-1(b)(3)(F).
\93\ Id.
---------------------------------------------------------------------------
In addition, the proposed changes described in Section I.B.4 to
consolidate the terms relating to margin calculation into a single
location and refine the description of FICC's margin methodology should
help FICC's Netting Members and indirect participants better understand
and anticipate their margin requirements. This improved understanding
of the potential margin requirements should, in turn, facilitate prompt
and accurate clearance and settlement by removing potential ambiguity
or confusion about market participants' obligations to FICC. Similarly,
the improved transparency provided by the proposed centralized margin
component schedule and enhanced descriptions of FICC's margin
components, such as the MLA Charge, should provide Netting Members,
indirect participants, and the public with more clarity about the
calculation and application of FICC's margin components and resolve
potential ambiguity about when certain components would or would not
apply, which is consistent with promoting the public interest.
4. Allocation of Net Unsettled Positions
The proposed changes described in Section I.B.3.b. to adopt a
method for allocating net unsettled positions to individual indirect
participants for calculating margin requirements should reduce the
potential exposure to FICC arising from indirect participant
transactions that fail to settle by ensuring that FICC has a mechanism
to collect margin for such transactions. Further, these proposed
changes should make clear that such obligations are allocated only to
participants that are outside the Sponsored GC service, since such
fails to deliver do not occur in that service. By accounting for risks
arising from net unsettled positions, the proposed changes should
enhance FICC's risk management and its ability to assure the safe
return of funds and securities, consistent with Section
17A(b)(3)(F).\94\
---------------------------------------------------------------------------
\94\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
5. Calculation of Excess Capital Premium
The proposed changes to the calculation of the ECP described in
Section I.B.3.c. above are consistent with promoting robust risk
management, because the changes should help ensure that FICC continues
to collect margin sufficient to address the heightened default risk
presented by a Netting Member operating with lower capital levels
relative to its margin requirements. Based on its review of the
Proposed Rule Change, including the detailed impact analysis submitted
as a confidential exhibit, FICC's margin coverage would not be impacted
by this change and FICC would continue to collect sufficient margin to
manage its potential exposure to its Netting Members.
In addition, the proposed changes to the calculation of the ECP
should result in a simplified and more straight-forward method for
calculating the ECP, based on understandable metrics with which FICC's
Netting Members are familiar. Using a clearly defined source for
determining Netting Member Capital in the calculation of the ECP would
result in a more consistent calculation across different types of
Netting Members. Moreover, capping the Excess Capital Ratio at 2.0
would provide transparency to Netting Members so they can understand
how the ECP will be calculated, and it also would align FICC's cap with
the recently approved changes to the ECP calculation at NSCC.\95\ By
improving the consistency and predictability of the ECP, the proposed
enhancements would also improve FICC's ability to collect margin
amounts that reflect the risks posed by its Netting Members such that,
in the event of Netting Member default, FICC's operations would not be
disrupted, and non-defaulting Netting Members and indirect participants
would not be exposed to losses they cannot anticipate or control. In
this way, the proposed rule change is designed to promote the prompt
and accurate clearance and settlement of securities transactions and to
assure the safeguarding of securities and funds which are in the
custody or control of NSCC or for which it is responsible, consistent
with Section 17A(b)(3)(F) of the Exchange Act.\96\
---------------------------------------------------------------------------
\95\ See Securities Exchange Act Release No. 96786 (Feb. 1,
2023), 88 FR 8013 (Feb. 7, 2023) (SR-NSCC-2022-005); see also id.
(discussing the view that capping the ratio at 2.0 strikes an
appropriate balance between addressing the heightened default risk
without imposing overly burdensome Excess Capital Premium charges).
\96\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
The proposed changes set forth in section I.B.3.c should improve
transparency and understanding of the FICC's governance and application
of the ECP. For example, FICC's proposal would describe the exigent
circumstances in which FICC may waive the ECP, describe what
information FICC would consider when determining whether to waive the
charge, and specify the approval necessary to waive the charge.
Moreover, using commonly understood inputs as the determinants of the
ECP (i.e., the FOCUS or Call Report) and capping the Excess Capital
Ratio at 2.0 should help Netting Members better anticipate and plan for
a potential ECP. These proposed changes should help FICC's members
better anticipate their required margin because of the use of
simplified inputs to the calculation of the ECP and the imposition of a
cap on the applicable Excess Capital Ratio. This improved understanding
of the potential margin requirements should, in turn, facilitate prompt
and accurate clearance and settlement by removing potential ambiguity
or confusion about a member's obligations to FICC.
Similarly, the improved transparency provided by this Proposed Rule
Change both with respect to a Netting Member's margin obligations and
the process by which FICC would consider waiver of an ECP should
provide Netting Members and the public with more clarity about the
nature and application of the ECP and resolve potential ambiguity about
when the ECP would or would not apply, which is consistent with
promoting the public interest.
6. Modification of Terms for Brokered Transactions
The proposed changes described in Section I.B.4. to revise the
definition of Brokered Transactions to include only the side of the
transactions submitted to FICC for novation by an Inter-Dealer Broker
Netting Member and entered into on the Inter-Dealer Broker Netting
Member's own trading platform should enhance FICC's risk management by
providing favorable loss allocation
[[Page 93772]]
treatment only to transactions that present limited risk to FICC. As a
result, these changes should help ensure that FICC has sufficient
prefunded financial resources to continue meeting its obligations in
the event of a default, which will facilitate the safeguarding of
securities and funds which are in the custody or control of FICC,
consistent with Section 17A(b)(3)(F).\97\
---------------------------------------------------------------------------
\97\ Id.
---------------------------------------------------------------------------
For these reasons, the proposed changes are consistent with Section
17A(b)(3)(F) of the Exchange Act.\98\
---------------------------------------------------------------------------
\98\ Id.
---------------------------------------------------------------------------
B. Consistency With Section 17A(b)(3)(I) of the Exchange Act
Section 17A(b)(3)(I) of the Exchange 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 Exchange
Act.\99\ 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 Exchange 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 Exchange Act, which involves balancing the
competitive effects of the proposed rule change against all other
relevant considerations under the Exchange Act.\100\
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\99\ 15 U.S.C. 78q-1(b)(3)(I).
\100\ See Bradford National Clearing Corp., 590 F.2d 1085, 1105
(D.C. Cir. 1978).
---------------------------------------------------------------------------
The Commission received comments regarding the impacts the Proposed
Rule Change may have on competition. Several commenters state that the
$1 million minimum Segregated Customer Margin Requirement for each
Segregated Indirect Participant could discourage small firms from using
the Segregated Indirect Participant Accounts.\101\ Several commenters
state that the requirement would increase costs for small firms and
limit execution counterparties,\102\ and several additional commenters
state that FICC's proposed $1 million margin requirement is arbitrarily
too high.\103\
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\101\ See Letter from Katherine Darras, General Counsel,
International Swaps and Derivatives Association (Apr. 17, 2024)
(``ISDA Letter I'') at 4; Letter from Jennifer W. Han, Executive
Vice President, Chief Counsel and Head of Global Regulatory Affairs,
Managed Funds Association (Apr. 17, 2024) (``MFA Letter I'') at 6-7;
Letter from Jennifer W. Han, Executive Vice President, Chief Counsel
and Head of Global Regulatory Affairs, Managed Funds Association
(Nov. 12, 2024) (``MFA Letter II'') at 7; Letter from Jiri Krol,
Deputy Chief Executive Officer, Global Head of Government Affairs,
Alternative Investment Management Association (Apr. 23, 2024)
(``AIMA Letter'') at 6-7; Letter at 10; Letter from William C. Thum,
Managing Director and Assistant General Counsel, Securities Industry
and Financial Markets Association, Asset Management Group (May 24,
2024) (``SIFMA AMG Letter'') at 8; Letter from Joanna Mallers,
Secretary, Futures Industry of America, Principal Traders Group
(Oct. 11, 2024) (``FIA PTG Letter II'') at 2-3.
\102\ See AIMA Letter at 6 (stating that the requirement will
have myriad negative effects on customers and market liquidity
generally, and that, for a customer with multiple clearing
relationships and multiple segregated accounts, the need to maintain
at $1 million cash in each account will increase costs for customers
and prevent them from utilizing that capital in more productive
ways); Letter from Joanna Mallers, Secretary, Futures Industry of
America, Principal Traders Group (Apr. 17, 2024) (``FIA PTG Letter
I'') at 7; FIA PTG Letter II at 2-3; SIFMA AMG Letter at 8-9. In
addition, one commenter stated that, with the proposed deletion of
the requirement to be a qualified institutional buyer (``QIB'') to
be a Sponsored Member, these market participants may not be able to
afford the $1 million cash requirement because QIBs, by definition,
manage more than $100 million in securities on a discretionary
basis, so it follows that the $1 million minimum could represent a
sizable portion of a non-QIB's assets, potentially disincentivizing
the non-QIB from pursuing indirect access to FICC. AIMA at 6-7.
\103\ See Letter from Sarah A. Bessin, Deputy General Counsel
and Nhan Nguyen, Associate General Counsel, Investment Company
Institute (Jun. 20, 2024) (``ICI Letter'') at 12; MFA Letter I at 6-
7; MFA Letter II at 6-7.
---------------------------------------------------------------------------
In response to concerns about increased costs to relatively small
indirect participants, FICC states that the margin segregation regime
under the proposal is entirely voluntary.\104\ To the extent the $1
million floor is too costly for certain indirect participants, FICC
states that they can choose to post margin to a Netting Member in a
non-segregated account that could require them to post lower margin or
no margin at all.\105\ Further, FICC amended the Margin Segregation
Proposal to provide that the minimum margin floor will be set at an
amount of $1 million but could be adjusted by FICC if it determines
that a different minimum amount would be appropriate and consistent
with achieving its backtesting coverage target, and it would require
that FICC's members would be notified of any such adjustment to the
applicable minimum charge by an Important Notice.\106\ Specifically,
FICC states that it would review the $1 million floor for Segregated
Customer Margin as part of ongoing internal surveillance and risk
management monitoring procedures.\107\ FICC also stated that it would
be prudent to have the ability to adjust the $1 million floor
proactively to the extent that FICC identifies, as part of these
reviews, that activity levels, margin performance observed through
backtesting, and other measures indicate that FICC would be able to
continue to manage the risks presented to it and meet its regulatory
risk management obligations (including, for example, its 99%
backtesting coverage target) with a lower minimum Segregated Customer
Margin Requirement.\108\
---------------------------------------------------------------------------
\104\ See FICC Letter at 30.
\105\ Id.
\106\ See Notice of Partial Amendment, supra note 10, at 87443.
\107\ See FICC Letter at 30.
\108\ Id. at 31.
---------------------------------------------------------------------------
The Commission acknowledges the commenters' concerns that the $1
minimum margin requirement could result in increased costs for small
firms that choose to utilize the proposed margin segregation regime,
which may weaken those firms' competitive positions relative to others.
In addition, the Commission acknowledges that FICC could, potentially,
adjust the minimum margin requirement to an amount above $1 million;
however, under the proposal, FICC would only be able to do so if it
determines that a different amount would be appropriate and consistent
with achieving its backtesting coverage target. As part of its ongoing
supervision of FICC, the Commission will continue to monitor the
performance of the $1 million minimum margin requirement, including as
its performance compares to backtesting, and will engage with FICC
regarding any changes to that requirement and the supporting analysis
for such changes, to help ensure that FICC is appropriately exercising
that discretion consistent with the requirements imposed upon it by the
rule (i.e., that it determines that any such adjustments would be
appropriate and consistent with achieving its backtesting coverage
target). In addition, the Commission acknowledges that firms are not
required to use a segregated account to participate at FICC and may
choose to access FICC through a different type of account. Although
some firms who choose to use segregated accounts could experience a
burden on competition because of these potentially higher costs, the
Commission concludes that any such burden to these firms is necessary
and appropriate in furtherance of the Exchange Act \109\ for the
following reasons.
---------------------------------------------------------------------------
\109\ 15 U.S.C. 78q 1(b)(3)(I). Specifically, as discussed in
greater detail in Section II.C and II.H below, the Proposed Rule
Change is necessary and appropriate to further the policy goals
under Rule 17Ad 22(e)(4)(i) and (e)(19). 17 CFR 240.17Ad 22(e)(4)(i)
and (e)(19).
---------------------------------------------------------------------------
As discussed in Section I.A above, FICC seeks to maintain
sufficient resources (i.e., margin) to cover its credit exposures to
its Netting Members and indirect participants fully with a high degree
of confidence and uses backtesting to determine when a Netting Member
or indirect participant's margin
[[Page 93773]]
would have been insufficient to cover FICC's credit exposure to that
Netting Member or indirect participant. As described in Section II.C.2
below, the impact studies conducted by FICC prior to and after
implementation of the $1 million Netting Member minimum margin
requirement demonstrate that a $1 million margin floor has a material
impact on reducing the number of backtesting deficiencies experienced
by FICC's Netting Members, thereby increasing the number of Netting
Members for which FICC maintained sufficient coverage at a confidence
level of at least 99 percent. Since FICC would only be able to use
Segregated Customer Margin posted by an individual Segregated Indirect
Participant to satisfy that customer's obligations, the Segregated
Customer Margin posted by each individual Segregated Indirect
Participant would need to be sufficient on its own to address losses
arising from the Segregated Indirect Participant's position. Therefore,
adding the proposed $1 million floor for Segregated Customer Margin
should enable FICC to better manage its credit exposure to a Segregated
Indirect Participant by ensuring FICC holds sufficient collateral to
cover that exposure, reducing the likelihood that FICC or non-
defaulting parties would incur losses resulting from a Segregated
Indirect Participant default. Moreover, if the $1 million floor is cost
prohibitive for certain indirect participants, they can continue to
access FICC's services by submitting activity through a Sponsoring
Member Omnibus Account or Agent Clearing Member Omnibus Account that is
not segregated, since the proposed margin segregation regime is
entirely voluntary.
Therefore, the Commission concludes that any competitive burden
imposed by the Proposed Rule Change is necessary and appropriate in
furtherance of the Exchange Act. Accordingly, the Commission finds that
the Proposed Rule Change is consistent with the requirements of Section
17A(b)(3)(I) of the Exchange Act.\110\
---------------------------------------------------------------------------
\110\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------
A. Consistency With Rule 17ad-22(e)(4)(i)
Rule 17ad-22(e)(4)(i) 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.\111\
---------------------------------------------------------------------------
\111\ 17 CFR 240.17ad-22(e)(4)(i).
---------------------------------------------------------------------------
1. Separate Calculation and Collection of Margin for Proprietary and
Customer Accounts
The proposed changes to require the separate and independent
calculation and collection of margin for Netting Members' proprietary
transactions and indirect participants' transactions, as described in
Section I.B.1., are consistent with Rule 17ad-22(e)(4)(i).\112\ The
separate calculation and collection of margin from Netting Members and
indirect participants should allow FICC to better identify and measure
the unique risk profile of each participant, enhancing FICC's ability
to calculate and collect the appropriate margin from each direct and
indirect participant. As a result, the proposed changes should help
ensure that FICC has sufficient margin to cover potential losses from a
Netting Member or indirect participant default, thereby reducing the
probability that FICC, non-defaulting Netting Members, or non-
defaulting indirect participants would incur losses resulting from a
default.
---------------------------------------------------------------------------
\112\ See id.
---------------------------------------------------------------------------
2. $1 Million Minimum Cash Margin Requirement
The proposed minimum $1 million cash margin requirement for each
Segregated Indirect Participant Account, as described in Section
I.B.2.a, is consistent with Rule 17ad-22(e)(4)(i). Several commenters
state that FICC lacks a sufficient basis or justification for the
required $1 million minimum margin amount.\113\ Specifically, one
commenter stated that using the amount applicable to Netting Members is
not an appropriate basis for establishing a minimum for indirect
participants, and also stated that the requirement lacks any support or
analysis as to the level of margin attributable to a typical fund's
positions in cleared Treasury repo, which is data FICC should have
readily available.\114\ An additional commenter stated the requirement
seems arbitrary, and not practical or necessary, especially in the
current done-with model, to force every segregated customer to be
subject to the same minimum requirement as a Netting Member.\115\
---------------------------------------------------------------------------
\113\ See ISDA Letter I at 4; ICI Letter at 12; AIMA Letter at
6-7; MFA Letter II at 6.
\114\ ICI Letter at 12.
\115\ AIMA Letter at 6. See also MFA Letter II at 7.
---------------------------------------------------------------------------
In addition, commenters state that FICC should adopt a lower
minimum requirement ($100,000 to $250,000), a dynamic minimum based on
average exposure subject to a $250,000 cap, or a minimum set by the
relevant Netting Member.\116\ Commenters also state that FICC should
determine a minimum deposit based on the individual client and the risk
that such client presents to FICC and other market participants.\117\
---------------------------------------------------------------------------
\116\ AIMA Letter at 7; MFA Letter I at 7; SIFMA AMG Letter at
9.
\117\ ISDA I at 4; see also MFA Letter II at 7 (stating that the
requirement should be determined based on a participant's particular
risk profile, including its planned and historical clearing
activity).
---------------------------------------------------------------------------
In response, FICC states that the $1 million floor for Segregated
Indirect Participants is the same floor FICC already has in place for
its Netting Members.\118\ FICC states that its impact study, conducted
in 2022 when adopting the rule applicable to Netting Members,
demonstrated that a $1 million floor would protect FICC and its
participants from incurring a loss in the event of a Netting Member
failure because the study indicated that a $1 million floor would
provide an adequate buffer for additional repo activity due to
increases in repo interest rates and would have mitigated 65 out of 396
backtesting deficiencies (16%) during the period from July 1, 2021 to
June 30, 2022.\119\ FICC further states that it analyzed alternative
minimum margin amounts, such as $500,000, and, based on the results of
its analysis, the $1 million floor provided the appropriate balance of
improving backtesting performance and margin coverage while minimizing
the impact on Netting Members.\120\
---------------------------------------------------------------------------
\118\ See FICC Letter at 28; Securities Exchange Act Release No.
96136 (Oct. 24, 2022), 87 FR 65268 (Oct. 28, 2022) (SR-FICC-2022-
006) (``FICC-2022-006 Order''). The impact study contains an
analysis of backtesting results on a member-by-member basis over a
twelve-month period ending June 30, 2022, and it includes, for both
the then-current rule and the proposed $1 million minimum rule, the
number of backtesting deficiencies and the level of coverage
obtained. It contains the same analysis for a $500,000 minimum as
well, including the same data points on a member-by-member basis.
\119\ See FICC Letter at 28.
\120\ Id.
---------------------------------------------------------------------------
FICC also states that the backtesting data from the period after
the $1 million minimum floor was implemented indicated a ``material
reduction of backtesting deficiencies at FICC.'' \121\ From December 5,
2022 to June 30, 2024, FICC states that the $1 million floor eliminated
24 backtesting deficiencies, a 12% reduction.\122\ Further, during a
period of 12-month period of moderate market volatility from July 1,
2023 to June 30, 2024, FICC states that the $1 million floor
[[Page 93774]]
eliminated 15 backtesting deficiencies, a 22% reduction.\123\
---------------------------------------------------------------------------
\121\ See FICC Letter at 29.
\122\ Id.
\123\ Id.
---------------------------------------------------------------------------
FICC further states that the $1 million floor is appropriate
because the Segregated Customer Margin posted by each individual
Segregated Indirect Participant needs to be sufficient on its own to
address losses arising from the Segregated Indirect Participant's
positions.\124\ This is because Segregated Customer Margin is not
subject to loss mutualization under the proposal, so FICC can only use
Segregated Customer Margin posted by an individual Segregated Indirect
Participant to satisfy that customer's obligations. As a result, each
Segregated Indirect Participant's portfolio would present a risk to
FICC that is equivalent to the risk of a proprietary portfolio of an
individual Netting Member.\125\ If the Segregated Customer Margin is
insufficient, losses would need to be mutualized, with harm to FICC,
its non-defaulting Netting Members, and, potentially, the market as a
whole.\126\
---------------------------------------------------------------------------
\124\ Id.
\125\ Id.
\126\ Id.
---------------------------------------------------------------------------
In addition, FICC stated that the risk cited by the Commission of
inconsistent activity giving rise to dramatic changes in risk exposure,
discussed by the Commission in the FICC-2022-006 Order,\127\ is
arguably more pronounced for indirect participants than for Netting
Members.\128\ First, indirect participants may clear through multiple
Netting Members and shift their activity through different Netting
Members, which can present risks to FICC since FICC cannot use the
Segregated Customer Margin posted by the Segregated Indirect
Participant through one Netting Member to address the Segregated
Indirect Participant's transactions cleared by another Netting
Member.\129\ As a result, FICC states that, even if the Segregated
Indirect Participant's overall activity remains steady, FICC could see
dramatic shifts in its risk simply because the Segregated Indirect
Participant shifts the Netting Members it uses as its intermediary at
FICC.\130\ Second, FICC states that it does not have the same general
understanding of indirect participants' business that it has for its
Netting Members, since it does not collect the same information on
individual customers' business or finances that it does for its Netting
Members.\131\ As a result, FICC states that it is less likely to know
when there may be significant swings in indirect participant risk
exposures as it would for its Netting Members and, since indirect
participants are likely to have a far more diverse array of business
models and interest rate considerations than FICC's Netting Members,
they could engage in inconsistent activity that could increase risk
exposure to FICC.\132\ According to FICC, the possibility of
inconsistent activity among indirect participants is potentially
greater.\133\
---------------------------------------------------------------------------
\127\ FICC-2022-006 Order, supra note 118, at 65270.
\128\ See FICC Letter at 30.
\129\ Id.
\130\ Id.
\131\ Id.
\132\ Id.
\133\ Id.
---------------------------------------------------------------------------
The Commission disagrees with commenters who stated that using the
same minimum as Netting Members is not appropriate for Segregated
Indirect Participants. As stated in Section I.A. above, FICC and non-
defaulting Netting Members and indirect participants may be subject to
losses should the Segregated Customer Margin of an indirect participant
be insufficient to satisfy losses caused by the liquidation of that
indirect participant's portfolio. This potential exposure both to FICC
and non-defaulting Netting Members and indirect participants makes it
essential that FICC determine margin amounts for Segregated Indirect
Participant Accounts that are reasonably designed to ensure that FICC
has sufficient margin to cover the losses of a defaulting Segregated
Indirect Participant.
The analyses conducted by FICC both in connection with the 2022
change to the required minimum margin amount for Netting Members and
after the implementation of that requirement, which the Commission has
reviewed and analyzed, support the use of the $1 million margin
requirement for Segregated Indirect Participant Accounts. The
Commission agrees that these studies demonstrate that a $1 million
margin floor has a material impact on reducing the number of
backtesting deficiencies experienced by FICC's Netting Members, which
would likely help FICC better manage its credit exposure to its Netting
Members and indirect participants and credit exposures arising from its
payment, clearing, and settlement processes.
Consideration of the appropriate Netting Member minimum is directly
relevant to what is appropriate for Segregated Indirect Participant
Accounts because FICC would treat such accounts the same as Netting
Member accounts in the event of a default of that individual
customer.\134\ Even though a Segregated Indirect Participant would be
the customer of a Sponsoring Member or an Agent Clearing Member, each
Segregated Indirect Participant Account would need to provide
sufficient margin to independently cover its losses in the event of a
default. FICC will determine the appropriate margin for each Segregated
Indirect Participant Account as if it were a separate Netting Member.
As discussed above, indirect participants may increase risk by clearing
through different Netting Members, which would provide FICC with less
insight into their overall portfolio. Accordingly, it is appropriate
for the minimum amount to be the same for both Netting Members and
indirect participants.
---------------------------------------------------------------------------
\134\ This also makes the 2022 impact study relevant to this
determination because FICC would calculate margin requirements for
each Segregated Indirect Participant in the same manner as margin
requirements for each Netting Member. The Commission reviewed and
analyzed that impact study when approving the current minimum
applicable to Netting Members, and the same analysis should apply
here as well.
---------------------------------------------------------------------------
In response to commenters who proposed an alternative amount or
approach, the Commission also has reviewed and analyzed the analysis of
alternative minimum amounts that FICC conducted, which show that there
would still be potential for higher amounts of backtesting deficiencies
using a $500,000 alternative minimum, making the alternatives proposed
by commenters ($100,000, $250,000 or a dynamic minimum with a $250,000
cap) not reasonably designed to allow FICC to collect sufficient margin
to cover its exposures. As discussed above, FICC's backtesting data
from December 5, 2022 to June 30, 2024 indicates that increasing the
minimum margin amount from $100,000 to $1 million eliminated 24 Netting
Member backtesting deficiencies, a 12% reduction.\135\ Further, during
a 12-month period of moderate market volatility from July 1, 2023 to
June 30, 2024, the $1 million floor eliminated 15 backtesting
deficiencies, a 22% reduction.\136\
---------------------------------------------------------------------------
\135\ See FICC Letter at 29.
\136\ Id.
---------------------------------------------------------------------------
Because FICC is not able to predict how many indirect participants
may elect to submit activity to FICC through a Segregated Indirect
Participants Account or the size or volume of that activity, margin
requirements for each Segregated Indirect Participant would be
calculated in the same manner as for Netting Members.\137\ FICC's
impact studies of Netting Members provide a reasonable approximation of
the risks FICC may face if the minimum margin amount is set below $1
million.
[[Page 93775]]
Therefore, the proposed $1 million floor is appropriate to increase the
probability that the margin amount collected by FICC is sufficient to
cover FICC's credit exposure to Segregated Indirect Participants and
protect non-defaulting parties from experiencing losses. However, as
described above in Section I.B.2.a., if FICC determines that a
different minimum charge would be appropriate and consistent with
achieving its backtesting coverage target, FICC would have the ability
to adjust the minimum charge of $1 million margin requirement. This
added flexibility should allow FICC to continue to collect the
appropriate amount of margin to cover its credit exposure to each
participant fully with a high degree of confidence, as demonstrated by
FICC's meeting its backtesting coverage targets, while minimizing the
burden on indirect participants.
---------------------------------------------------------------------------
\137\ See Notice of Filing, supra note 4, at 21595.
---------------------------------------------------------------------------
Moreover, the Commission disagrees that allowing the Netting Member
to determine a minimum would be appropriate. It is unclear what basis a
Netting Member would use to determine such a minimum in a way that
would ensure that the amount is sufficient to meet FICC's regulatory
obligations and minimize backtesting deficiencies because a Netting
Member would not be able to replicate FICC's backtesting or calculate
FICC's regulatory obligations.
The Commission disagrees that determining a minimum deposit on a
case-by-case basis would be feasible for every Segregated Indirect
Participant. FICC has stated that it does not know how many Segregated
Indirect Participants will participate in FICC. At this time, there are
over 2500 Sponsored Members at FICC,\138\ and it is likely that
additional indirect participants will want to access clearing going
forward in light of the Treasury Clearing rules. Determining a minimum
for even half the current Sponsored Members on a case-by-case basis
would be extremely burdensome for FICC and would require the submission
of detailed financial information by each Sponsored Member to inform
FICC of its planned business activities, and it is unclear how or on
what basis such a minimum would be adjusted over time. Establishment of
a minimum requirement is appropriate to ensure that FICC can meet its
obligations under Rule 17ad-22(e)(4)(i), and reliance upon the minimum
for Netting Members is appropriate because, as discussed above, FICC
has to treat each Segregated Indirect Participant as a stand-alone
account for risk management purposes to segregate its margin
appropriately.
---------------------------------------------------------------------------
\138\ See GSD Member Directories, available at <a href="https://www.dtcc.com/client-center/ficc-gov-directories">https://www.dtcc.com/client-center/ficc-gov-directories</a>.
---------------------------------------------------------------------------
For these reasons, the $1 million minimum margin requirement should
help ensure that FICC has sufficient margin to cover potential losses
from a Segregated Indirect Participant default, thereby reducing the
probability that FICC, non-defaulting Netting Members, and non-
defaulting indirect participants would incur losses resulting from a
default. Moreover, as described above in Section I.B.2.a., FICC would
have the ability to adjust the amount of the minimum $1 million margin
requirement if FICC determines that a different minimum charge would be
appropriate and consistent with achieving its backtesting coverage
target. The Commission agrees with FICC that it should continue to
assess the performance of this minimum requirement with respect to
FICC's backtesting coverage requirements, as it provided in the
Amendment to this filing, to ensure that FICC is not collecting more
margin than is necessary to meet its regulatory obligations to cover
its exposure to its participants.\139\ Although the Commission
recognizes that FICC could use this ability to increase the $1 million
minimum to some greater amount, it would only be able to do so if
determines that a different minimum charge would be appropriate and
consistent with achieving its backtesting coverage target.
---------------------------------------------------------------------------
\139\ One commenter states that FICC should not delay
recalibration of the minimum margin requirement to a later date. MFA
Letter II at 6-7. However, as the Commission discussed above, the
minimum margin requirement is appropriate, based on the data
available at this time. The Commission will continue to monitor
implementation of this requirement going forward once more data
regarding the use of segregated accounts is available.
---------------------------------------------------------------------------
3. Margin Component Schedule
The proposed changes in section I.B.3 regarding the calculation of
margin for segregated and non-segregated accounts should ensure that
FICC collects margin sufficient to cover its exposures with respect to
both direct and indirect participants. Requiring that the margin
requirement for a Segregated Indirect Participant Account be calculated
in generally the same manner as a Netting Member's requirement, which
the Commission has reviewed and approved as part of FICC's rules,
should help ensure that FICC collects margin sufficient to cover its
exposures with respect to both direct and indirect participants. By
doing so, this portion of the Advance Notice should better ensure that,
in the event of a Netting Member's or indirect participant's default,
FICC has sufficient margin to cover potential losses from the default,
thereby reducing the probability that FICC, non-defaulting Netting
Members, and non-defaulting indirect participants would incur losses
resulting from a default. Collecting the same margin components for a
Segregated Indirect Participant Account as those used for a Netting
Member Account is appropriate because FICC has to risk-manage each
Segregated Indirect Participant Account individually, and application
of the existing margin methodology would help ensure that FICC collects
sufficient margin to cover its exposures to participants for all
Accounts. FICC has, however, taken into account how the ECP should
apply differently when determining a Segregated Customer Margin
Requirement, which is appropriate for the reasons discussed in Section
II.C.3 below, and the changes related to the ECP Charge would ensure
that Segregated Indirect Participants are not required to post
additional margin to account for the capital position of its Netting
Member.
Accordingly, for the reasons discussed above, the Proposed Rule
Change is reasonably designed to enable FICC to effectively identify,
measure, monitor, and manage its credit exposure to Netting Members and
indirect participants, consistent with Rule 17ad-22(e)(4)(i).\140\
---------------------------------------------------------------------------
\140\ See id.
---------------------------------------------------------------------------
B. Consistency With Rule 17ad-22(e)(6)(i)
Rule 17ad-22(e)(6)(i) requires FICC 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, and, if the
covered clearing agency provides central counterparty services for U.S.
Treasury securities, calculates, collects, and holds margin amounts
from a direct participant for its proprietary positions in Treasury
securities separately and independently from margin calculated and
collected from that direct participant in connection with U.S. Treasury
securities transactions by an indirect participant that relies on the
services provided by the direct participant to access the covered
clearing agency's
[[Page 93776]]
payment, clearing, or settlement facilities.\141\
---------------------------------------------------------------------------
\141\ 17 CFR 240.17ad-22(e)(6)(i).
---------------------------------------------------------------------------
1. Separation of Proprietary and Customer Margin
The proposed changes to separate proprietary and customer margin
are consistent with Rule 17ad-22(e)(6)(i). First, to help ensure that
proprietary transactions and transactions submitted to FICC on behalf
of indirect participants are margined separately, FICC would require
that each margin portfolio contain only transactions from the same
account type and that Netting Members use separate Deposit IDs for
different transaction types. Second, FICC would calculate each
Segregated Indirect Participant's margin requirement separately on a
gross basis as though each Segregated Indirect Participant were a
separate Netting Member. Finally, FICC would create a separate
``Segregated Customer Margin Custody Account'' for each Netting Member
that contains deposits of Segregated Customer Margin for indirect
participants, with interest earned on cash margin paid to each
Segregated Indirect Participant's Netting Member for the benefit of,
and as an agent for, the Segregated Indirect Participant. Collectively,
these proposed changes should ensure that a Netting Member's
proprietary transactions are not netted with indirect participant
transactions for margin calculations and that margin for indirect
participant transactions is collected and held separately and
independently from margin for a Netting Member's proprietary
transactions. Moreover, by calculating each Segregated Indirect
Participant's margin requirement separately from Netting Members and
other Segregated Indirect Participants, the proposed changes should
allow FICC to better isolate the risk profiles of individual indirect
participants from Netting Members, which should help FICC better
understand and monitor each individual participant's risk
exposures.\142\
---------------------------------------------------------------------------
\142\ Commenters requested clarification that FICC's funds-only
settlement amounts are settlement payments rather than margin. See
ISDA Letter at 6; Letter from Katherine Darras, General Counsel,
International Swaps and Derivatives Association (July 18, 2024)
(``ISDA Letter II'') at 6; SIFMA Letter at 4; Letter from Walt L.
Lukken, President and Chief Executive Officer, Futures Industry of
America (Apr. 18, 2024) (``FIA Letter'') at 11. The Proposed Rule
Change does not make any amendments to the funds-only settlement
process at FICC. See GSD Rule 13. This aspect of FICC's rules is,
therefore, not relevant to this Proposed Rule Change. However, FICC
clarified that it views such payments as constituting settlements
that discharge outstanding payment obligations, rather than as
margin or collateral. FICC Letter at 43. The Commission agrees with
this clarification, based upon its knowledge of FICC's margin and
payment flows and the applicable GSD Rules.
---------------------------------------------------------------------------
One commenter expressed concern that the proposal would not fully
eliminate fellow customer risk because it would allow for the pro rata
allocation of Current Net Settlement positions among Segregated
Indirect Participant positions held in the same Segregated Indirect
Participants Account.\143\ In response, FICC explained that, due to the
requirement in the Treasury Clearing Rules that margin for customer
positions be calculated separately from margin for a Netting Member's
proprietary positions, FICC would not be able to allocate the margin
obligations from Current Net Settlement Positions to a Netting Member's
portfolio.\144\ As a result, such margin must be allocated to customer
positions and FICC states that, when it is not aware of the allocation
of Current Net Settlement Positions among customers, it is most
equitable to allocate such positions pro rata to customers who were
long or short the relevant securities.\145\ The Commission agrees that
allocating the positions to the Netting Member's account would be
inconsistent with Rule 17ad-22(e)(6)(i) because it would impermissibly
net proprietary transactions against indirect participant transactions.
The Commission further agrees that the positions must be allocated to
ensure that FICC is able to appropriately risk-manage those positions
(that is, to collect appropriate margin). The Commission further agrees
with FICC's approach of limiting such pro rata allocations only to
customers engaging in non-Sponsored GC Trades because settlement
failures do not occur with respect to Sponsored GC Trades. Therefore,
in the event that the positions are not allocated, a pro rata
allocation among customers is appropriate.
---------------------------------------------------------------------------
\143\ See SIFMA AMG Letter at 10.
\144\ See FICC Letter at 36.
\145\ Id.
---------------------------------------------------------------------------
Accordingly, the proposed changes in the Proposed Rule Change would
be consistent with Rule 17ad-22(e)(6)(i) because they should help
ensure that FICC calculates, collects, and holds margin for a Netting
Member's proprietary positions separately from the margin for positions
the member clears for customers.\146\
---------------------------------------------------------------------------
\146\ 17 CFR 240.17ad-22(e)(6)(i).
---------------------------------------------------------------------------
5. Margin Component Schedule
The proposed changes to establish a Margin Component Schedule,
which would consolidate the terms and information relating to margin
calculation throughout the Rules into a single schedule, are consistent
with Rule 17ad-22(e)(6)(i). Under the proposed Margin Component
Schedule, FICC would perform substantially the same calculation it
currently performs when determining a Netting Member's Required Fund
Deposit and include the methodology for calculating a Netting Member's
Segregated Customer Margin Requirement. By including a methodology to
calculate each Segregated Indirect Participant's margin requirement
separately from Netting Members and other Segregated Indirect
Participants, the proposed changes should help ensure that FICC
calculates, collects, and holds margin for a Netting Member's
proprietary positions separately from the margin for positions the
member clears for customers. Moreover, calculating margin requirements
for each Segregated Indirect Participant should allow FICC to better
isolate the risk profiles of individual indirect participants from
Netting Members, which should help FICC better understand and monitor
each individual participant's risk exposures and thereby collect margin
commensurate with the risks of each Netting Member and indirect
participant portfolio.
A commenter states that FICC should confirm that segregation of
margin for indirect participants does not magnify risk for Netting
Members. Specifically, the commenter states that it is not clear
whether the Required Fund Deposit to be posted by Netting Members
incorporates any exposure associated with Segregated Indirect
Participant Accounts and expresses concern as to whether FICC's rules
allow FICC to collect additional margin to cover any enhanced risk that
may arise relating to the Netting Member's obligations to FICC for its
clients who are indirect participants generally or who choose
segregation specifically.\147\ However, FICC's proposed rules establish
that the calculation of a Netting Member's Required Fund Deposit
excludes the exposure of its Segregated Indirect Participants.\148\
FICC's rules do permit FICC to collect increased Required Fund Deposits
from Netting Members if ``necessary to protect [FICC] and its Members
from Legal Risk,'' which, FICC states, would include the consideration
[[Page 93777]]
of the Netting Members' indirect participants.\149\
---------------------------------------------------------------------------
\147\ ISDA Letter I at 7; ISDA Letter II at 6.
\148\ Compare proposed Margin Component Schedule section 2
(regarding Required Fund Deposits) with section 3 (regarding
Segregated Customer Margin).
\149\ See proposed Margin Component Schedule section 4; see also
Notice of Filing, supra note 4, at 21593.
---------------------------------------------------------------------------
This commenter also states the fact that the ability to prefund
margin for a customer is only temporary puts pressure on the Netting
Member's own Required Fund Deposits, which ``it seems would still cover
the obligations of all its clients'' and also on the Netting Member and
the broader FICC membership, in the event of a failure by any
Segregated Indirect Participant.\150\ However, the Netting Member's
Required Fund Deposits would not be calculated based on the obligations
of its clients, and, in the event of the default of an indirect
participant, FICC would use the Segregated Customer Margin for only
that indirect participant. Therefore, the Commission disagrees that the
inability to permanently prefund the customer's margin requirement puts
additional pressure on the Netting Member's own Required Fund Deposits.
---------------------------------------------------------------------------
\150\ See ISDA Letter I at 7.
---------------------------------------------------------------------------
Another commenter states that FICC should explain why it is
appropriate to calculate a segregated customer's margin requirement as
if it were a Netting Member, even though the margin calculation for
FICC Netting Members covers both initial margin and guaranty fund
contributions (and customers are not expected to be contributing to the
guaranty fund).\151\ However, FICC does not maintain a separate
guaranty fund into which a Netting Member contributes for its
customers. The Segregated Customer Margin Requirement must be
sufficient to cover the exposures to FICC arising from that particular
customer's activity because, under the segregation system proposed by
the Proposed Rule Change which would allow broker-dealers participating
in FICC to comply with the conditions of Note H to Rule 15c3-3, FICC
would not be able to use the margin collected from a Segregated
Indirect Participant for any reason unrelated to the Segregated
Indirect Participant. Therefore, calculating each Segregated Customer
Margin Requirement in this manner is appropriate to ensure that FICC
has appropriate resources to cover each customer's exposures.
Therefore, this aspect of the Proposed Rule Change is consistent with
Rule 17ad-22(e)(6)(i) under the Exchange Act.
---------------------------------------------------------------------------
\151\ See Letter from Joanna Mallers, Secretary, Futures
Industry of America, Principal Traders Group (Apr. 17, 2024) (``FIA
PTG Letter I'') at 8.
---------------------------------------------------------------------------
6. Excess Capital Premium
The proposed changes to the calculation of the ECP charge are
consistent with Rule 17ad-22(e)(6)(i). FICC's margin deposits are made
up of risk-based components (as margin) that are calculated and
assessed daily to limit FICC's exposures to Netting Members. FICC's
proposed changes to use clearly defined sources in the calculation of
the ECP charge would collectively make the calculation clearer and more
predictable to Netting Members, while continuing to apply an
appropriate risk-based charge designed to mitigate the risks presented
to FICC. Similarly, the proposal to cap the Excess Capital Ratio at 2.0
would allow FICC to appropriately address the risks it faces without
imposing an overly burdensome ECP and would reduce the circumstances in
which FICC may waive the charge, resulting in a more transparent
margining methodology. Finally, the proposed rule change would clarify
the exigent circumstances under which FICC may determine that it is
appropriate to waive the ECP charge. Overall, these proposed changes
would improve the effectiveness of the calculation of the ECP and,
therefore, allow FICC to more effectively address the increased default
risks presented by Netting Members that operate with lower capital
levels relative to their margin requirements.
In addition, FICC proposes to exclude VaR Charges for Segregated
Indirect Participants Accounts when determining a Netting Member's
Excess Capital Differential, in order to take into account the fact
that each indirect participant would be responsible for satisfying its
own respective VaR Charge. Not including these Segregated Indirect
Participants Accounts when determining the Excess Capital Differential,
and, therefore, the ECP Charge, is consistent with the purpose of the
Excess Premium Charge. This charge is designed to address the risk that
a Netting Member with low capital relative to its value-at-risk to FICC
is not able to perform its obligations. Because the Netting Member's
capital is not used to meet the indirect participant's obligation to
FICC, excluding the indirect participant VaR Charges from the
determination of the ECP should result in FICC collecting margin
commensurate with the risks and particular attributes of each relevant
portfolio.
Taken together, the proposed changes enhance the ability of the ECP
to produce margin levels commensurate with the risks FICC faces related
to its Netting Members' operating capital levels. Therefore, this
aspect of the Proposed Rule Change is consistent with Rule 17ad-
22(e)(6)(i) under the Exchange Act.
C. Consistency With Rule 17ad-22(e)(6)(iii)
Rule 17ad-22(e)(6)(iii) 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, calculates
margin sufficient to cover its potential future exposure to members in
the interval between the last margin collection and the close out of
positions following a member default.\152\
---------------------------------------------------------------------------
\152\ 17 CFR 240.17ad-22(e)(6)(iii).
---------------------------------------------------------------------------
As summarized in Section I.B.3 above, FICC employs daily
backtesting to determine the adequacy of each Netting Member's Required
Fund Deposit, paying particular attention to members that have
backtesting deficiencies below the 99% confidence target. Such
backtesting deficiencies highlight exposure that could subject FICC to
potential losses if a Netting Member defaults. As discussed in Section
II.C.2, FICC's impact study during the period from July 1, 2021 to June
30, 2022 demonstrated that a $1 million floor would have protected FICC
and its participants by reducing the possibility of incurring a loss in
the event of a Netting Member failure by mitigating 16% of backtesting
deficiencies.\153\ Moreover, after the $1 million floor was implemented
for Netting Members, FICC states that it eliminated 22% of backtesting
deficiencies during a 12-month period of moderate market volatility
from July 1, 2023 to June 30, 2024.\154\
---------------------------------------------------------------------------
\153\ See FICC Letter at 28.
\154\ Id.
---------------------------------------------------------------------------
Therefore, adding the proposed $1 million minimum requirement for
Segregated Customer Margin, and the ability to adjust the minimum
million margin requirement to achieve FICC's backtesting coverage
target, should better ensure that FICC maintains sufficient margin to
cover its potential future exposure to its indirect participants in the
interval between the last margin collection and the close out of
positions following an indirect participant default. This should,
thereby, reduce the likelihood FICC or non-defaulting Netting Members
or indirect participants would incur losses as a result. Accordingly,
FICC's proposed $1 million minimum requirement for Segregated Customer
[[Page 93778]]
Margin would be consistent with Rule 17ad-22(e)(6)(iii).\155\
---------------------------------------------------------------------------
\155\ 17 CFR 240.17ad-22(e)(6)(iii).
---------------------------------------------------------------------------
D. Consistency With Rule 17ad-22(e)(18)(ii)
Rule 17ad-22(e)(18)(ii) requires that FICC establish, implement,
maintain and enforce written policies and procedures reasonably
designed to establish objective, risk-based, and publicly disclosed
criteria for participation, which require participants to have
sufficient financial resources and robust operational capacity to meet
obligations arising from participation in the clearing agency.\156\ The
proposed changes to consolidate FICC's margin methodology in a single
location, identify the particular Required Fund Deposit Portions and
Segregated Customer Margin Requirements, and clarify the calculation of
the Excess Capital Premium and circumstances in which FICC would waive
the application of such premium should enhance FICC's public disclosure
of the risk-based margin obligations that Netting Members and their
indirect participants would have as a result of their participation in
FICC's clearance and settlement services. This improved public
disclosure should allow Netting Members and their indirect participants
to better understand how their activity would impact margin
calculations, which are designed to ensure that participants have
sufficient financial resources and robust operational capacity to meet
obligations to FICC. Accordingly, the proposed changes would be
consistent with Rule 17ad-22(e)(18)(ii).\157\
---------------------------------------------------------------------------
\156\ 17 CFR 240.17ad-22(e)(4)(18)(ii).
\157\ Id.
---------------------------------------------------------------------------
E. Consistency With Rule 17ad-22(e)(18)(iii)
Rule 17ad-22(e)(18)(iii) requires that FICC establish, implement,
maintain and enforce written policies and procedures reasonably
designed to establish objective, risk-based, and publicly disclosed
criteria for participation, which monitor compliance with its
participant requirements on an ongoing basis.\158\ The proposed changes
would require Netting Members to designate the specific account type
when submitting transactions and to identify any Sponsored Member or
Executing Firm Customer for whom the transaction is submitted. These
changes should enhance FICC's ability to monitor which transactions are
being entered into by which entities and assess the specific risks
associated with those entities. This enhanced monitoring of participant
activity should allow FICC to better monitor participants' compliance
with FICC's Rules. Accordingly, the proposed changes would be
consistent with Rule 17ad-22(e)(18)(iii) because they should enhance
FICC's ability to monitor compliance with its participant requirements
on an ongoing basis.\159\
---------------------------------------------------------------------------
\158\ 17 CFR 240.17ad-22(e)(18)(iii).
\159\ 17 CFR 240.17ad-22(e)(18)(iii).
---------------------------------------------------------------------------
F. Consistency With Rule 17ad-22(e)(18)(iv)(C)
Rule 17ad-22(e)(18)(iv)(C) requires that FICC establish, implement,
maintain and enforce written policies and procedures reasonably
designed to ensure that it has appropriate means to facilitate access
to clearance and settlement services of all eligible secondary market
transactions in U.S. Treasury securities, including those of indirect
participants.\160\
---------------------------------------------------------------------------
\160\ 17 CFR 240.17ad-22(e)(18)(iv)(C).
---------------------------------------------------------------------------
As discussed above in Section II.B.3, by improving the transparency
of FICC's account offerings and margin calculation methodology, the
proposed changes should enhance market participants' understanding of
how margin is calculated and their options for posting margin, thereby
facilitating access to FICC's clearance and settlement services. In
addition, the proposed changes should offer greater optionality to
Netting Members and indirect participants, which should allow Netting
Members and indirect participants to adopt a margining arrangement that
aligns with their business objectives and regulatory, operational, and
practical constraints. By enhancing transparency of FICC's margin
framework and account options and offering greater optionality to
participants concerning the type of account they transact in and how
their margin is posted, the proposal should facilitate access to FICC's
clearance and settlement systems.
Several commenters proposed that FICC should require Netting
Members to offer account segregation to customers.\161\ One such
commenter specified that this should include bank Netting Members, who
would not face the same restrictions on the use of customer margin as
broker-dealer customers subject to Rule 15c3-3 and therefore may not be
as incentivized to provide segregated account services.\162\
---------------------------------------------------------------------------
\161\ Specifically, one commenter stated that for indirect
participants, having a ``right'' to direct their Netting Member to
segregate their margin is highly desirable because it would allow an
indirect participant to have certainty that margin that it posts
receives the protection afforded by segregation. SIFMA AMG Letter at
6. Another such commenter stated that, despite what a customer may
desire with respect to margin and segregation, there could be
incentives for direct participants to finance the margin for their
customers' transactions (and thereby earn extra fees for doing so)
instead of the customer financing or posting that margin, and for
the direct participant to accept the customer's margin without
offering the option of segregation (and thereby avoid the additional
operational and other costs associated with segregation), which
would still be permissible if FICC were not to require its Netting
Members to offer account segregation. MFA Letter I at 4.
\162\ SIFMA AMG Letter at 6.
---------------------------------------------------------------------------
FICC did not propose a requirement that its Netting Members offer
segregated accounts to their customers. Therefore, the Commission is
not addressing any changes related to such a requirement in this
Proposed Rule Change. Nothing in the Treasury Clearing Rules or Rule
15c3-3 requires a covered clearing agency, like FICC, to require its
Netting Members to provide certain services. Moreover, certain Netting
Members may have regulatory or other reasons not to offer segregation,
and, if required to offer such services, may choose to cease providing
customer clearing services, which could, in turn, increase
concentration in the market and reduce liquidity.\163\ Any such
requirement could constitute a burden on competition that would not be
permissible under Section 17A(b)(3)(I) of the Exchange Act.
---------------------------------------------------------------------------
\163\ FICC Letter at 33.
---------------------------------------------------------------------------
Additionally, a commenter urged FICC to allow indirect participants
to post margin directly to FICC without intermediation from a Netting
Member.\164\ The Treasury Clearing Rules do not require FICC to provide
this function, and FICC did not propose such a method for direct
posting of margin.\165\ Accordingly, the Commission is not addressing
any changes related to such a requirement in this Proposed Rule Change.
---------------------------------------------------------------------------
\164\ See ICI Letter at 13.
\165\ See supra note 3 at 2751.
---------------------------------------------------------------------------
One commenter sought clarification whether Netting Members other
than broker-dealers can elect segregation for their customers.\166\
Based on the Proposed Rule Change, the Commission understands, and FICC
confirmed,\167\ that any Sponsoring Member or Agent Clearing Member,
regardless of whether registered as broker-dealers, would be able to
designate an account as a Segregated Indirect Participants Account.
---------------------------------------------------------------------------
\166\ FIA-PTG Letter at 7-9.
\167\ FICC Letter at 39.
---------------------------------------------------------------------------
The same commenter also sought clarification whether a customer may
segregate margin obtained through a margin financing arrangement.\168\
Based
[[Page 93779]]
on the Proposed Rule Change, the Commission understands, and FICC
confirmed,\169\ that such segregation would be permissible under FICC's
rules.
---------------------------------------------------------------------------
\168\ FIA-PTG Letter at 7-9.
\169\ FICC Letter at 40.
---------------------------------------------------------------------------
This commenter also asked why excess margin would only be returned
on request and states that an indirect participant should not have to
request a return of its excess margin.\170\ The Treasury Clearing Rules
do not require FICC to provide this function, and FICC did not propose
such a function. Accordingly, the Commission is not addressing any
changes related to such a requirement in this Proposed Rule Change.
Moreover, when it adopted the amendments to Rule 15c3-3, the Commission
declined to adopt a requirement to ``push'' excess margin to direct
participants.\171\
---------------------------------------------------------------------------
\170\ See FIA PTG Letter I at 7-9.
\171\ See Treasury Clearing Adopting Release, supra note 3, at
2767 (removing, in response to commenters, the requirement that the
covered clearing agency have procedures to return customer position
margin to the broker-dealer that is no longer needed to meet a
current margin requirement resulting from positions in U.S. Treasury
securities of the broker-dealer's customers no later than the close
of the next business day after the day the customer position margin
is no longer needed for this purpose because such a requirement may
add significant operational burdens to covered clearing agencies for
U.S. Treasury securities and because the debit is limited to margin
required and on deposit at the covered clearing agency and therefore
does not include the excess margin).
---------------------------------------------------------------------------
Another commenter suggested that FICC allow customer margin to be
segregated, even when customers do not post the full amount of the
margin needed to cover their positions.\172\ FICC states that allowing
customer margin to be segregated when customers do not post the full
amount of margin would lead to disparities that would put broker-dealer
Netting Members at competitive disadvantage to other Netting
Members.\173\ The Treasury Clearing Rules do not require FICC to
provide this function, and FICC did not propose such a function. Any
changes to FICC's rules to impose such a requirement would have to be
filed with the Commission pursuant to Section 19(b) \174\ of the
Exchange Act, as well as, potentially, in an advance notice filed
pursuant to Section 806(e) of the Clearing Supervision Act.\175\
Therefore, the Commission is not addressing any changes related to such
a requirement in this Proposed Rule Change.
---------------------------------------------------------------------------
\172\ See MFA Letter I at 6.
\173\ See FICC Letter at 32. Specifically, FICC stated that the
Treasury Clearing Rules, in particular the amendments to Exchange
Act Rule 15c3-3a, provide that a broker-dealer may record a debit in
the customer and PAB reserve formulas for margin it collects from
customers and on-posts to FICC, but only if the broker-dealer
collects from the customer the full amount of margin required for
the customer's positions. Accordingly, a broker-dealer is
effectively precluded from collecting from customers only a portion
of the margin that their positions require and on-posting that
amount to FICC. Were FICC to allow segregation of customer margin
even if the customer did not fully fund its margin obligations, such
segregation would effectively allow non-broker-dealer Netting
Members to offer what broker-dealers cannot, i.e., permitting their
customers to post a portion of the margin required by FICC and on-
post that margin to FICC. This ability would place such Netting
Members at a competitive advantage relative to broker-dealer Netting
Members.
\174\ 15 U.S.C. 78s(b)(1).
\175\ See supra note 3 at 2751.
---------------------------------------------------------------------------
Finally, one commenter urged FICC to address the cross-border
implications of the proposal and provide a framework for compliance by
non-U.S. Netting Members and indirect participants.\176\ Specifically,
this commenter was concerned that the U.S. Treasury clearing mandate
will adversely impact foreign customers that are limited in their
ability, or prohibited entirely, to post margin in connection with
transactions involving U.S. Treasury securities.\177\ However, nothing
in the Proposed Rule Change would require a particular market
participant to post margin in connection with transactions involving
U.S. Treasury securities. Indirect participants remain able to access
FICC's central clearing services through access models that do not
require the direct posting of margin to FICC (e.g., via the non-
segregated versions of FICC's Sponsored and Agent Clearing Services),
which should allow flexibility for market participants to determine the
most effective way to access FICC indirectly regardless of potential
regulatory or other constraints on the ability to post margin directly.
---------------------------------------------------------------------------
\176\ See SIFMA AMG Letter at 12-13.
\177\ See id. (citing Article 15(2) of the European Union's
Money Market Fund Regulation, which it describes as prohibiting
European Money Market Mutual Funds from pledging any assets received
under reverse repos and certain restrictions on Undertakings for
Collective Investments in Transferable Securities and similar
investment vehicles related to their ability to post margin that
will be held on deposit at FICC).
---------------------------------------------------------------------------
Accordingly, the proposed changes would be consistent with Rule
17ad-22(e)(18)(iv)(C).\178\
---------------------------------------------------------------------------
\178\ 17 CFR 240.17ad-22(e)(18)(iv)(C).
---------------------------------------------------------------------------
G. Consistency With Rule 17ad-22(e)(19)
Rule 17ad-22(e)(19) requires that FICC establish, implement,
maintain and enforce written policies and procedures reasonably
designed to identify, monitor, and manage the material risks to the
covered clearing agency arising from arrangements in which firms that
are indirect participants in FICC rely on the services provided by
direct participants to access FICC's clearance and settlement
facilities.\179\ The proposed changes described in Section I.B.1 would
require that each margin portfolio contains only transactions from the
same account type, Netting Members use separate Deposit IDs for
different transaction types, each Segregated Indirect Participant's
margin requirement be calculated separately on a gross basis as though
each Segregated Indirect Participant were a separate Netting Member,
and Segregated Customer Margin for each indirect participant be
deposited into a separate interest-earning Segregated Customer Margin
Custody Account. These changes should enhance FICC's ability to isolate
the risk profiles of individual indirect participants from Netting
Members, which should help FICC better understand and monitor each
individual participant's risk exposures. In addition, the calculation
and collection of Segregated Customer Margin on a gross basis, as
described in Section I.B.1 and 1.B.2, and the establishment of a $1
million cash floor for Segregated Customer Margin, as described in
Section I.B.2.a, should help ensure that FICC will have sufficient
margin to manage the risk to FICC during an indirect participant
default.
---------------------------------------------------------------------------
\179\ 17 CFR 240.17ad-22(e)(19).
---------------------------------------------------------------------------
Accordingly, the proposed changes would be consistent with Rule
17ad-22(e)(19) because they should enhance FICC's ability to identify,
monitor, and manage the material risks to FICC associated with indirect
participants relying on Netting Members to access FICC's clearance and
settlement services.\180\
---------------------------------------------------------------------------
\180\ 17 CFR 240.17ad-22(e)(19).
---------------------------------------------------------------------------
H. 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 providing
sufficient information to enable participants to identify and evaluate
the risks, fees, and other material costs they incur by participating
in FICC.\181\ The proposed changes described in Section I.B.3 to
consolidate and clarify FICC's margin calculation methodology in the
proposed Margin Component Schedule, adopt a method for allocating net
unsettled positions to individual indirect participants for purposes of
calculating margin requirements and to clarify the calculation of the
ECP should make it easier for both Netting Members and indirect
participants to identify and price the potential margining costs
[[Page 93780]]
associated with how each chooses to submit transactions to FICC for
clearance and settlement.
---------------------------------------------------------------------------
\181\ 17 CFR 240.17ad-22(e)(23)(ii).
---------------------------------------------------------------------------
Accordingly, the proposed changes would be consistent with Rule
17ad-22(e)(23)(ii) because they should enhance the ability of Netting
Members and indirect participants to identify and evaluate the costs to
access FICC's clearance and settlement services.\182\
---------------------------------------------------------------------------
\182\ 17 CFR 240.17ad-22(e)(23)(ii).
---------------------------------------------------------------------------
I. Other Comments Received
Commenters submitted several comments that were not related to the
Proposed Rule Change. Commenters stated that FICC should publish a
roadmap and/or expedite their plans with the Chicago Mercantile
Exchange (``CME'') for expanding their cross-margining framework.\183\
The Proposed Rule Change does not address the cross-margining agreement
between FICC and CME. The current cross-margining agreement between
FICC and CME is part of FICC's rulebook, and therefore any changes to
the agreement would have to be filed with the Commission pursuant to
Section 19(b) \184\ of the Exchange Act.\185\ Therefore, the Commission
cannot approve or disapprove any changes related to the cross-margining
agreement at this time. Cross-margining is not required by the recently
adopted Treasury Clearing Rules.
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\183\ See AIMA Letter at 5; FIA PTG Letter I at 15; MFA Letter I
at 10; MFA Letter II at 5-6; SIFMA AMG Letter at 10.
\184\ 15 U.S.C. 78s(b)(1).
\185\ See supra note 3 at 2751.
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However, the Commission historically has supported and approved
cross-margining at clearing agencies and recognizes the potential
benefits of cross-margining systems, which include freeing capital
through reduced margin requirements, reducing clearing costs by
integrating clearing functions, reducing clearing agency risk by
centralizing asset management, and harmonizing liquidation
procedures.\186\ The Commission continues to believe that market
participants can benefit from cross-margining arrangements and
encourages U.S. Treasury CCAs to consider the potential of such
benefits. FICC states, in its response letter regarding the Proposed
Rule Change, that it is actively pursuing an end-user level cross-
margining arrangement with CME. The Commission would consider any
proposal arising from such pursuit in due course, if such a proposal
were to be filed with the Commission.
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\186\ Treasury Clearing Adopting Release, at 2751 at n. 362 and
accompanying text.
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Several commenters requested that FICC provide a legal analysis on
the enforceability of the proposed changes, including the protection of
segregated customer margin in the event of a Netting Member
default.\187\ In response, FICC states that it has prepared an analysis
on the treatment of Segregated Customer Margin in the event of a FICC
or Netting Member insolvency and that this analysis confirmed that, as
long as customers and their Netting Members make clear that their
relationship is a custodial one, Segregated Customer Margin would be
reserved for customers and would not form part of FICC's or the Netting
Member's general estate upon either institution's insolvency.\188\ FICC
states that it has made this analysis available to indirect
participants upon request on a non-reliance basis.\189\ This analysis
addresses the commenters' request, and the Commission does not believe
that any further action is necessary to respond to the commenters, who
can use this analysis to inform their consideration whether to utilize
a segregated account.
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\187\ See AIMA Letter at 7; MFA Letter I at 8-9; SIFMA AMG
Letter at 11.
\188\ FICC Letter at 41.
\189\ Id.
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
Proposed Rule Change is consistent with the requirements of the
Exchange Act and in particular with the requirements of Section 17A of
the Exchange Act \190\ and the rules and regulations promulgated
thereunder.
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\190\ 15 U.S.C. 78q-1.
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It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act \191\ that proposed rule change SR-FICC-2024-007, be, and
hereby is, APPROVED.\192\
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\191\ 15 U.S.C. 78s(b)(2).
\192\ In approving the Proposed Rule Change, the Commission
considered its impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\193\
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\193\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-27763 Filed 11-26-24; 8:45 am]
BILLING CODE 8011-01-P
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</html>Indexed from Federal Register on November 27, 2024.
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