[Federal Register Volume 76, Number 43 (Friday, March 4, 2011)]
[Notices]
[Pages 12144-12155]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-4836]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-63986; File No. SR-FICC-2010-09]
Self-Regulatory Organizations; Fixed Income Clearing Corporation;
Order Granting Approval of a Proposed Rule Change To Introduce Cross-
Margining of Certain Positions Cleared at the Fixed Income Clearing
Corporation and Certain Positions Cleared at New York Portfolio
Clearing, LLC
February 28, 2011.
I. Introduction
On November 12, 2010, Fixed Income Clearing Corporation (``FICC'')
filed with the Securities and Exchange Commission (``Commission'')
proposed rule change SR-FICC-2010-09 pursuant to Section 19(b)(1) of
the Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'').\1\
Notice of the proposed rule change was published in the Federal
Register on November 30, 2010.\2\ The Commission initially received
thirteen comments to the proposed rule change.\3\ FICC, as well as one
of the commenters, submitted letters responding to the comments.\4\ For
the reasons discussed below, the Commission is granting approval of the
proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 63361 (November 23,
2010), 75 FR 74110 (November 30, 2010) (FICC-2010-09). In its filing
with the Commission, FICC included statements concerning the purpose
of and basis for the proposed rule change. The text of these
statements are incorporated into the discussion of the proposed rule
change in Section II below.
\3\ Letter from Jack DiMaio, Managing Director, Morgan Stanley
(December 2, 2010); Letter from Douglas Engmann, President, Engmann
Options, Inc. (December 6, 2010); Letter from Ronald Filler,
Professor of Law and Director of the Center on Financial Services
Law, New York Law School (December 8, 2010); Letter from John C.
Hiatt, Chief Administrative Officer, Ronin Capital (December 10,
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of
ELX Futures, LP (December 15, 2010); Letter from John Willian,
Managing Director, Goldman Sachs (December 17, 2010); Letter from
James B. Fuqua and David Kelly, Managing Directors, Legal, UBS
Securities, LLC (December 20, 2010); Letter from Donald J. Wilson,
Jr., DRW Trading Group (December 21, 2010); Letter from John A.
McCarthy, General Counsel, GETCO (December 21, 2010); Letter from
Gary DeWaal, Senior Managing Director and Group General Counsel,
Newedge USA, LLC (December 21, 2010); Letter from Adam C. Cooper,
Senior Managing Director and Chief Legal Officer, Citadel, LLC
(December 21, 2010); Letter from William H. Navin, Executive Vice
President and General Counsel, The Options Clearing Corporation
(December 21, 2010); and Letter from Joan C. Conley, Senior Vice
President & Corporate Secretary, NASDAQ OMX (December 21, 2010).
\4\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011); Letter from
Michael Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 7, 2011); Letter from Michael
Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 27, 2011); and Letter from Alex
Kogan, Vice President and Deputy General Counsel, NASDAQ OMX
(January 10, 2011).
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II. Description
The proposed rule change allows FICC to offer cross-margining of
certain positions cleared at its Government Securities Division
(``GSD'') and certain positions cleared at New York Portfolio Clearing,
LLC (``NYPC'').\5\ GSD members will be able to combine their positions
at GSD with their positions at NYPC, or those positions of certain
permitted affiliates cleared at NYPC, within a single margin portfolio
(``Margin Portfolio''). The proposed rule change also makes certain
other related changes to GSD's rules.
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\5\ NYPC is jointly owned by NYSE Euronext and The Depository
Trust & Clearing Corporation (``DTCC''). DTCC is the parent company
of FICC. On January 31, 2011, the Commodity Futures Trading
Commission (``CFTC'') approved NYPC's registration as a derivatives
clearing organization (``DCO'') pursuant to Section 5b of the
Commodity Exchange Act and Part 39 of the Regulations of the CFTC.
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A. Cross-Margining With NYPC
Under the proposed rule, a member of FICC that is also an NYPC
clearing member (``Joint Clearing Member'') could in accordance with
the provisions of the GSD and NYPC Rules, elect to participate in the
cross-margining arrangement. FICC's rules permit a GSD netting member
that is a member (or that has an affiliate that is a member) of one or
more Futures Clearing Organizations (``FCO''),\6\ such as NYPC, to
become a cross-margining participant in a cross-margining arrangement
between FICC and one or more FCOs with the consent of FICC and each
such FCO. A netting member shall become a cross-margining participant
upon acceptance of FICC and each applicable FCO of an agreement
executed by such cross-margining participant in the form specified in
the applicable cross-margining agreement.\7\
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\6\ ``FCO'' is defined in GSD Rule 1 as a clearing organization
for a board of trade designated as a contract market under Section 5
of the Commodity Exchange Act that has entered into a Cross-
Margining Agreement with FICC.
\7\ See GSD Rule 43, Cross-Margining Arrangements, Section 2.
The cross-margining agreement between FICC and NYPC as well as the
cross-margining participant agreements for joint and permitted
affiliates are attached to FICC's filing of proposed rule change SR-
FICC-2010-09.
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Participating in the cross-margining arrangement would permit a
Joint Clearing Member to have its margin requirement calculated taking
into account both its positions at FICC and NYPC, which should provide
a clearer picture of its risk exposure and generally facilitate better
risk assessment by FICC. Specifically, each Joint Clearing Member would
have its margin requirement with respect to Eligible Positions (i.e.,
positions in certain securities netted by FICC or certain futures
contracts cleared by an FCO) \8\ in its proprietary account at
[[Page 12145]]
NYPC and its margin requirement with respect to Eligible Positions at
FICC calculated as a single portfolio, which would factor in the net
risk of such Eligible Positions at both clearing organizations. In
addition, an affiliate of a member of FICC that is also a clearing
member of NYPC (``Permitted Margin Affiliate'') \9\ could similarly
elect to participate in the cross-margining arrangement and have its
margin requirement with respect to Eligible Positions in its
proprietary account at NYPC calculated as a single portfolio with the
Eligible Positions of the FICC member.
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\8\ The term ``Eligible Position'' is currently defined in GSD's
rules as a position in certain Eligible Netting Securities netted by
FICC, or certain Government securities futures contracts or interest
rate futures contracts cleared by a FCO as identified in a Cross-
Margining Agreement as eligible for cross-margining treatment.
``Eligible Netting Security'' is defined in GSD Rule 1 as an
Eligible Security that FICC has designed as eligible for netting.
``Eligible Security'' is defined generally in GSD Rule 1 as a
security issued or guaranteed by the United States, a U.S.
government agency or instrumentality, a U.S. government-sponsored
corporation, or any other security approved by FICC's board of
directors from time to time, or one or more categories of such
securities as represented by a generic CUSIP number, that FICC has
listed on the Eligible Securities master file maintained by it
pursuant to GSD Rule 30.
\9\ The term ``Permitted Margin Affiliate'' is being added to
GSD Rule 1 and is defined as an affiliate of a Member that is (i)
also a member of GSD, and/or (ii) a member of an FCO with which FICC
has entered into a Cross-Margining Agreement that provides for
margining of positions between FICC and the FCO as if such positions
were in a single portfolio and that directly or indirectly controls
such particular member, or that is directly or indirectly controlled
by or under common control with such particular member. Ownership of
more than 50% of the common stock of the relevant entity (or
equivalent equity interests in the case of a form of entity that
does not issue common stock) will be conclusive evidence of prima
facie control of such entity for purposes of this definition.
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The proposed rule allows (i) Joint Clearing Members and (ii)
members of FICC and their Permitted Margin Affiliates to have their
margin requirements for positions at FICC and NYPC determined as a
single portfolio, with FICC and NYPC each having a security interest in
such members' and Permitted Margin Affiliates' margin deposits and
other collateral to secure their obligations to FICC and NYPC.
The following types of FICC members will not be eligible to
participate in the cross-margining arrangement (``NYPC Arrangement''),
in order to allow FICC to maintain segregation of certain business or
member types that are treated differently for purposes of loss
allocation: (i) GSD Sponsored Members,\10\ (ii) Inter-Dealer Broker
Netting Members,\11\ and (iii) Dealer Netting Members \12\ with respect
to their segregated brokered accounts. In addition, in order for a Bank
Netting Member \13\ to combine its accounts into a Margin Portfolio
with any other accounts, it will have to demonstrate to the
satisfaction of FICC and NYPC that doing so will comply with the
regulatory requirements applicable to the Bank Netting Member (e.g., by
providing an opinion of counsel or otherwise outlining compliance with
relevant statutory provisions).\14\
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\10\ A ``Sponsored Member'' of GSD is any person that has been
approved by FICC to be sponsored into membership by a ``Sponsoring
Member'' pursuant to GSD Rule 3A. A ``Sponsoring Member'' is a
member of GSD's comparison and netting system whose application to
become a sponsoring member has been approved by the FICC's board of
directors pursuant to GSD Rule 3A. See GSD Rule 1, Definitions.
\11\ The definition of ``Inter-Dealer Broker Netting Member,''
as revised by the proposed rule change, is an inter-dealer broker
admitted to membership in GSD's netting system. See GSD Rule 2A,
Initial Membership Requirements.
\12\ The definition of a ``Dealer Netting Member,'' as revised
by the proposed rule change, is a registered government securities
dealer admitted to membership in GSD's netting system. See GSD Rule
2A, Initial Membership Requirements.
\13\ Under GSD Rule 2A, a person shall be eligible to apply to
become a ``Bank Netting Member'' of GSD if it is a bank or trust
company chartered as such under the laws of the United States, or a
State thereof, or is a bank or trust company established or
chartered under the laws of a non-U.S. jurisdiction, and
participates in FICC through its U.S. branch or agency. A bank or
trust company that is admitted to membership in GSD's netting
system, the netting system, pursuant to these Rules, and whose
membership in the netting system has not been terminated, shall be a
Bank Netting Member. See GSD Rule 2A, Initial Membership
Requirements, Section 2.
\14\ See GSD Rule 4, Clearing Fund and Loss Allocation, Section
1a as proposed to be amended by the proposed rule change.
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In order to distinguish the NYPC Arrangement from an existing
cross-margining arrangement between the Chicago Mercantile Exchange
(``CME'') and FICC (``CME Arrangement''), the proposed rule amends the
definition of ``Cross-Margining Agreement'' in the GSD rules to mean an
agreement entered into between FICC and one or more FCOs pursuant to
which a Cross-Margining Participant,\15\ in accordance with the
provisions of the GSD Rules and otherwise at the discretion of FICC,
could elect to have its Required Fund Deposit \16\ with respect to
Eligible Positions at FICC, and its (or its Permitted Margin
Affiliates' Required Fund Deposit, if applicable) margin requirements
with respect to Eligible Positions at such FCO(s), calculated either
(i) by taking into consideration the net risk of such Eligible
Positions at each of the clearing organizations or (ii) as if such
positions were in a single portfolio. The CME Arrangement falls into
clause (i) of the definition, whereas the NYPC Arrangement will fall
into clause (ii). Conforming changes will be made to GSD Rule 1,
Definitions, relating to cross-margining. GSD Rule 43, Cross-Margining
Arrangements, also will be amended to add provisions regarding single-
portfolio margining (i.e., the proposed NYPC Arrangement). To implement
this proposal, FICC and NYPC will enter into a cross-margining
agreement (``NYPC Agreement''). The NYPC Agreement was filed with the
Commission as part of proposed rule change SR-FICC-2010-09 and will be
appended to the GSD Rules and made a part thereof.
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\15\ The term ``Cross-Margining Participant'' is defined in GSD
Rule 1 as a Netting Member that is authorized by FICC to participate
in the Cross-Margining Arrangement between FICC and one or more FCOs
pursuant to a Cross-Margining Agreement. GSD Rule 1 defines the term
``Cross-Margining Arrangement'' as the arrangement established
between FICC and one or more FCOs pursuant to Cross-Margining
Agreements and GSD Rule 43.
\16\ The definition of ``Required Fund Deposit,'' as revised by
the proposed rule change, is the amount that a Netting Member is
required by a GSD rule to contribute to GSD's clearing fund. See GSD
Rule 1, Definitions.
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Pursuant to the NYPC Agreement, and consistent with previous
approvals of cross-margining arrangements involving DCOs,\17\ cross-
margining with certain NYPC positions will be limited to positions
carried in proprietary accounts of clearing members of NYPC. Customers
of NYPC clearing members will not be permitted to participate in the
NYPC Arrangement, as their participation would require the resolution
of additional issues associated with fund segregation and operations.
Neither FICC nor NYPC rules require their members to participate in the
NYPC Arrangement, and any such participation by FICC and NYPC members
will be voluntary. Joint Clearing Members and members of FICC and their
Permitted Margin Affiliates will be required to execute the requisite
cross-margining participant agreements.\18\
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\17\ See, e.g., Securities Exchange Act Release No. 44301 (May
11, 2001), 66 FR 28207 (approving a proposed rule change
establishing cross-margining between FICC and CME) and Securities
Exchange Act Release No. 27296 (September 26, 1989), 54 FR 41195
(approving a proposed rule change establishing cross-margining
between The Options Clearing Corporation and the CME).
\18\ The NYPC Agreement and the cross-margining participant
agreements for Joint Members and Permitted Affiliates were filed
with the Commission as part of the proposed rule change.
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FICC will be responsible for performing the margin calculations in
its capacity as the Administrator under the terms of the NYPC
Agreement. Specifically, FICC will determine the combined FICC clearing
fund and NYPC original margin requirement for each participant.\19\
FICC will calculate those requirements using a Value-at-Risk (``VaR'')
methodology, with a 99-percent confidence level and a 3-day liquidation
period for cash positions and a 1-day liquidation period for futures
positions. In addition, each cross-margining participant's ``one-pot''
margin requirement will be subject to a daily
[[Page 12146]]
back test, and a supplemental risk-related charge referred to as a
coverage component that will be applied to the participant in the event
that the back test reflects insufficient coverage. The ``one-pot''
margin requirement for each participant would then be allocated between
FICC and NYPC in proportion to the clearing organizations' respective
``stand-alone'' margin requirements--in other words, an amount
reflecting the ratio of what each clearing organization would have
required from that participant if it was not participating in the
cross-margining program (``Constituent Margin Ratio''). The NYPC
Agreement provides that either FICC or NYPC can, at any time, require
additional margin to be deposited by a Cross-Margining Participant
above what is calculated under the NYPC Agreement based upon the
financial condition of the participant, unusual market conditions, or
other special circumstances (e.g., in the event of regulatory or
criminal proceedings). The standards that FICC proposes to use for
these purposes are the standards currently contained in the GSD rules,
so that notwithstanding the calculation of a Cross-Margin Participant's
clearing fund requirement pursuant to the NYPC Agreement, FICC will
retain its rights under the GSD rules to charge additional clearing
fund contributions under the circumstances specified in the GSD rules.
For example, the GSD rules provide that if a Dealer Netting Member
falls below its minimum financial requirement, it shall be required to
make additional clearing fund contributions equal to the greater of (i)
$1 million or (ii) 25 percent of its Required Fund Deposit.
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\19\ Original margin is the NYPC equivalent of the FICC clearing
fund.
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FICC will utilize the same VaR methodology for calculating margin
for futures and cash positions. Under this method, the prior 250 days
of historical information for futures positions and the prior 252 days
of historical information for cash positions, including prices, spreads
and market variables such as Treasury zero-coupon yields and London
Interbank Offered Rate curves, are used to simulate the market
environments in the forthcoming 1 day for futures positions and the
forthcoming 3 days for cash positions. Projected portfolio profits and
losses are calculated assuming these simulated environments will
actually be realized. These simulations will be used to calculate VaR.
Historical simulation is a continuation of the FICC margin methodology.
With respect to the confidence level, FICC currently utilizes
extreme value theory \20\ to determine the 99th percentile of loss
distribution. Upon implementation of the NYPC Arrangement, FICC will
utilize a front-weighting mechanism to determine the 99th percentile of
loss distribution. This front-weighting mechanism will place more
emphasis on more recent observations. Additionally, FICC's VaR
methodology will be enhanced to accommodate more securities; as a
result, certain CUSIPs, which are now considered to be ``non-
priceable'' (because, for example, of a lack of historical information
regarding the security) and subject to a ``haircut'' requirement (i.e.,
fixed percentage charge) where offsets are not permitted, will be
treated as ``priceable'' and therefore included in the core VaR
calculation.
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\20\ Extreme value theory is used to analyze outcomes beyond the
99 percent confidence interval used for VaR and provides an
assessment of the size of these events.
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Based on preliminary analyses, FICC expects that the FICC VaR
component of the clearing fund requirement may be reduced by as much as
approximately 20 percent for common FICC-NYPC members as a result of
the NYPC Arrangement. In order to help ensure that this reduction in
clearing fund is appropriately correlated to more precise assessment of
exposures associated with considering offsetting positions and will not
result in increased risks to the clearing agency, FICC has performed
back testing analysis to verify that there will be sufficient coverage
after the FICC-NYPC cross-margining reductions are applied.
In the event of the insolvency or default of a member that
participates in the NYPC Arrangement, the positions in such
participant's ``one-pot'' portfolio, including, where applicable, the
positions of its Permitted Margin Affiliate at NYPC, will be liquidated
by FICC and NYPC as a single portfolio and the liquidation proceeds
will be applied to the defaulting participant's obligations to FICC and
NYPC in accordance with the provisions of the NYPC Agreement.
The NYPC Agreement provides for the sharing of losses by FICC and
NYPC in the event that the ``one-pot'' portfolio margin deposits of a
defaulting participant are not sufficient to cover the losses resulting
from the liquidation of that participant's trades and positions. This
loss-sharing arrangement can be summarized as follows:
If either clearing organization had a net loss (``worse-
off party''), and the other had a net gain (``better-off party'') that
is equal to or exceeds the worse-off party's net loss, then the better-
off party pays the worse-off party the amount of the latter's net loss.
In this scenario, one clearing organization's gain will extinguish the
entire loss of the other clearing organization.
If either clearing organization had a net loss (``worse-
off party'') and the other clearing organization had a net gain
(``better-off party'') that is less than or equal to the worse-off
party's net loss, then the better-off party will pay the worse-off
party an amount equal to the net gain. Thereafter, if such payment did
not extinguish the net loss of the worse-off party, the better-off
party will pay the worse-off party an amount equal to the lesser of:
(i) The amount necessary to ensure that the net loss of each clearing
organization is in proportion to the Constituent Margin Ratio or (ii)
the better-off party's ``Maximum Transfer Payment'' less the better-off
party's net gain. The ``Maximum Transfer Payment'' will be defined with
respect to each clearing organization to mean an amount equal to the
product of (i) the sum of the aggregate margin reductions of the
clearing organizations and (ii) the other clearing organization's
Constituent Margin Ratio--in other words, the amount by which the other
clearing organization reduced its margin requirements in reliance on
the cross-margining arrangement. In this scenario, one clearing
organization's gain does not completely extinguish the entire loss of
the other clearing organization, and the better-off party will be
required to make an additional payment to the worse-off party. This
potential additional payment will be capped as described in this
paragraph.
If either clearing organization had a net loss, and the
other had the same net loss, a smaller net loss, or no net loss, then:
[cir] In the event that the net losses of the clearing
organizations were in proportion to the Constituent Margin Ratio, no
payment will be made.
[cir] In the event that the net losses of the clearing
organizations were not in proportion to the Constituent Margin Ratio,
then the clearing organization that had a net loss which was less than
its proportionate share of the total net losses incurred by the
clearing organizations (``better-off party'') will pay the other
clearing organization (``worse-off party'') an amount equal to the
lesser of: (i) The better-off party's Maximum Transfer Payment or (ii)
the amount necessary to ensure that the clearing organizations'
respective net losses were allocated between them in proportion to the
Constituent Margin Ratio.
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If FICC had a net gain after making a payment as described
above, FICC will pay to NYPC the amount of any deficiency in the
defaulting member's customer segregated funds accounts or, if
applicable, such defaulting member's Permitted Margin Affiliate held at
NYPC up to the amount of FICC's net gain.
If FICC received a payment under the Netting Contract and
Limited Cross-Guaranty (``Cross-Guaranty Agreement'') \21\ to which it
is a party (i.e., because FICC had a net loss), and NYPC had a net
loss, FICC will share the cross-guaranty payment with NYPC pro rata,
where such pro rata share is determined by comparing the ratio of
NYPC's net loss to the sum of FICC's and NYPC's net losses. This
allocation is appropriate because the ``one-pot'' combines FICC and
NYPC proprietary positions into a unified portfolio that will be
margined and liquidated as a single unit. FICC will no longer need to
share the cross-guaranty payments with NYPC once NYPC becomes a party
to the Cross-Guaranty Agreement.
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\21\ FICC's predecessors, the Government Securities Clearing
Corporation (``GSCC'') and the MBS Clearing Corporation (``MBSCC''),
filed rule filings in 2001 to enter into the Cross-Guaranty
Agreement with The Depository Trust Company, National Securities
Clearing Corporation, Emerging Markets Clearing Corporation, and The
Options Clearing Corporation. Securities Exchange Act Release No.
45868 (May 2, 2002), 67 FR 31394. Under the agreement, if the assets
of a defaulting member at one clearing agency exceed its liabilities
to that clearing agency, those excess assets may be made available
to satisfy the liabilities of that defaulting common member to
another clearing agency.
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The GSD rules will further provide that FICC will offset its
liquidation results in the event of a close out of the positions of a
Cross-Margining Participant in the NYPC Agreement first with NYPC
because the liquidation will essentially be of a single Margin
Portfolio and then will present its results for purposes of the
multilateral Cross-Guaranty Agreement.
B. Access to NYPC Arrangement
FICC has represented that the NYPC Arrangement has been structured
in a way that access to, and the benefits of, the ``one-pot'' are
provided to other futures exchanges and DCOs on fair and reasonable
terms as described below. The proposed ``one-pot'' cross-margining
method is expected to allow members to post margin that should more
accurately reflect the net risk of their aggregate positions across
asset classes, thereby releasing excess capital into the economy for
more efficient use. By linking positions in fixed income securities
held at FICC with interest rate products traded on NYSE Liffe U.S. and
other designated contract markets (``DCMs''), the NYPC Arrangement has
the potential to create a substantial pool of highly correlated assets
that are capable of being cross-margined. This pool will deepen as more
DCOs and DCMs join NYPC, creating the potential for even greater margin
and risk offsets.
The proposed ``one-pot'' is required to be accessed by other
futures exchanges and DCOs via NYPC.\22\ FICC stated that this is done
to ensure the uniformity and consistency of risk methodologies and risk
management, to simplify and standardize operational requirements for
new participants and to maximize the effectiveness of the one-pot
arrangement.
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\22\ Section 16 of the NYPC Agreement provides that FICC
covenants and agrees that, during the term of the NYPC Agreement:
(i) NYPC-cleared contracts shall have priority for margin offset
purposes over any other cross-margining agreement; (ii) FICC will
not enter into any other cross-margining agreement if such agreement
would adversely affect the priority of NYPC and FICC under the NYPC
Agreement with respect to available assets; and (iii) FICC will not,
without the prior written consent of NYPC, amend the CME Agreement,
if such further amendment would adversely affect NYPC's right to
cross-margin positions in eligible products prior to any cross-
margining of CME positions with FICC-cleared contracts or adversely
affect the priority of NYPC and FICC under the NYPC Agreement with
respect to available assets.
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FICC stated that NYPC will initially clear certain contracts
transacted on NYSE Liffe U.S. and that NYPC will clear for additional
DCMs that seek to clear through NYPC as soon as it is feasible for NYPC
do so. Such additional DCMs will be treated in the same way as NYSE
Liffe US, i.e., they must: (i) Be eligible under the rules of NYPC,
(ii) contribute to NYPC's guaranty fund, (iii) demonstrate that they
have the operational and technical ability to clear through NYPC, and
(iv) enter into a clearing services agreement with NYPC.
Moreover, NYPC has also committed to admit other DCOs as limited
purpose participants as soon as it is feasible, thereby allowing such
DCOs to participate in the one-pot margining arrangement with FICC
through their limited purpose membership in NYPC.\23\ Such DCOs will be
required to satisfy pre-defined, objective criteria set forth in NYPC's
rules.\24\ In particular, such DCOs must: (i) Submit trades subject to
the limited purpose participant agreement between NYPC and each DCO
that would otherwise be cleared by the DCO to NYPC, with NYPC acting as
central counterparty and DCO with respect to such trades,\25\ (ii) be
eligible under the rules of NYPC and agree to be bound by the NYPC
rules,\26\ (iii) contribute to NYPC's guaranty fund,\27\ (iv) provide
clearing services to unaffiliated markets on a ``horizontal'' basis
(i.e., not limit their provision of clearing services on a vertical
basis to a single market or limited number of markets),\28\ and (v)
agree to participate using the uniform risk methodology and risk
management policies, systems and procedures that have been adopted by
FICC and NYPC for implementation and administration of the NYPC
Arrangement.\29\ Reasonable clearing fees will be allocated between
NYPC and the limited purpose participant DCO as may be agreed by NYPC
and the DCO, taking into account factors such as the cost of services
(including capital expenditures incurred by NYPC), technology that may
be contributed by the limited purpose participant, the volume of
transactions, and such other factors as may be relevant.
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\23\ See NYPC Agreement, Section 14.
\24\ NYPC's rules can be viewed as part of NYPC's DCO
registration application on the CFTC's Web site (http:/
/.www.cftc.gov), as well as on NYPC's Web site (http://www.nypclear.com).
\25\ See NYPC Rule 801(b)(1).
\26\ See NYPC Rule 801(b)(2).
\27\ The NYPC Agreement provides that except as otherwise
provided in a limited purpose participant agreement, a limited
purpose participant shall make a contribution to the NYPC Guaranty
Fund in form and substance similar to and in an amount that is no
less than the amount of the NYSE Guaranty, which will initially
consist of a $50,000,000 guaranty secured by $25,000,000 in cash
during the first year of NYPC's operations. FICC and NYPC have
subsequently clarified and affirmatively represented that the
limited purpose participant agreements will be individually
negotiated and that ``the Guaranty Fund contribution that will be
required by NYPC from any Limited Purpose Participant will be
determined by risk-based factors without regard to whether such
contribution amount is more or less than the amount contributed to
the NYPC Guaranty Fund by NYSE Euronext.'' See Letter from Michael
Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 7, 2011). See also Letter from
Michael Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 27, 2011).
\28\ See NYPC Rule 801(c)(1)(i).
\29\ See NYPC Rule 801(c)(1)(ii).
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FICC and NYPC anticipate that the limited purpose participant
agreement will encompass the foregoing requirements for limited purpose
membership contained in NYPC's rules. Because each DCO could present
different operational issues, terms beyond the basic rules provisions
will be discussed on a case-by-case basis and reflected in the
respective limited purpose participant agreement accordingly. FICC and
NYPC envision that a possible structure for DCO limited purpose
participation could be an omnibus account, with the DCO limited purpose
participant essentially acting as
[[Page 12148]]
a processing agent for its clearing members vis-a-vis NYPC with respect
to the submission of eligible positions of the DCO's clearing members
to NYPC for purposes of inclusion in the one-pot arrangement with FICC.
In order for their eligible positions to be included in the ``one-
pot,'' clearing members of the DCO limited purpose participant would be
required to authorize the DCO to submit their positions to NYPC. Under
such a structure, the DCO would be responsible for fulfilling all
margin and guaranty fund requirements associated with the activity in
the omnibus account.
With respect to both the clearance of trades for unaffiliated DCMs
and the admission of DCOs as limited purpose participants, FICC has
indicated that NYPC has committed that it will complete the process to
allow one or more DCMs or DCOs to be admitted and integrated into the
``one-pot'' cross-margining arrangement as soon as feasible, but no
later than 24 months from the start of operations. FICC has represented
that this provision is necessary to the effective implementation of the
one-pot cross-margining methodology and that this window of time is
required to allow for refinement and enhancement of certain systems
after operations commence, to allow time for the possible simultaneous
integration with multiple major clearing members so that fair market
access is assured, and to allow time for the completion of the material
operational challenge of connecting and integrating NYPC with the
separate technologies of other DCMs and/or DCOs. However, during this
interim period, NYPC may engage, and FICC has represented in its filing
to the Commission that NYPC is engaging, in discussions with other DCMs
and DCOs. FICC has also represented in its filing that NYPC anticipates
that it will be able to complete the integration of additional DCMs
and/or DCOs in advance of this two-year period.
C. Other GSD Proposed Rule Changes
The proposed rule filing allows FICC to permit margining of
positions held in accounts of an affiliate of a member within GSD, akin
to the inter-affiliate margining in the CME Arrangement and the
proposed NYPC Arrangement. Thus, as in those arrangements, if a GSD
member defaults, its GSD clearing fund deposits, cash settlement
amounts and other available collateral will be available to FICC to
cover the member's default, as will the GSD clearing fund deposits and
available collateral of any Permitted Margin Affiliate with which it
cross-margins.
1. Loss Allocation
Under the current loss allocation methodology in GSD Rule 4,
Clearing Fund and Loss Allocation, GSD allocates losses first to the
most recent counterparties of a defaulting member. The proposed changes
to GSD Rule 4 will delete this step in the loss allocation methodology
in order to achieve a more even distribution of losses among GSD
members without a focus on recent counterparties.
Under the proposed rule change any loss allocation will be made
first against the retained earnings of FICC attributable to GSD in an
amount up to 25 percent of FICC's retained earnings or such higher
amount as may be approved by the Board of Directors of FICC.
If a loss still remains, GSD will divide the loss between the FICC
Tier 1 Netting Members and the FICC Tier 2 Netting Members. The terms
``Tier 1 Netting Member'' and ``Tier 2 Netting Member'' have been
introduced in the GSD Rules to reflect two different categories of
membership, which have been designated as such by FICC for loss
allocation purposes. Currently, only investment companies registered
under the Investment Company Act of 1940, as amended, (which companies
are subject to regulatory requirements restricting their ability to
mutualize losses) will qualify as Tier 2 Netting Members. Tier 2
Netting Members will only be subject to loss to the extent they traded
with the defaulting members and will not be responsible for mutualizing
losses with participants with which they do not trade, in order to
account for regulatory requirements applicable to such registered
investment companies.
Tier 1 Netting Members will be allocated the loss applicable to
them first by assessing the Clearing Fund deposit of each such member
in the amount of up to $50,000, equally. If a loss remains, Tier 1
Netting Members will be assessed ratably in accordance with the
respective amounts of their Required Fund Deposits based on the average
daily amount of the member's Required Fund Deposit over the prior
twelve months. Consistent with the current GSD rules, GSD members that
are acting as inter-dealer brokers will be limited to a loss allocation
of $5 million with respect to their inter-dealer broker activity.
2. Margin Calculation--Intraday Margin Calls
GSD proposes to calculate Clearing Fund requirements twice per day.
GSD will retain its regular calculation and call as set out in the GSD
rules. An additional daily intra-day calculation and call (``Intraday
Supplemental Clearing Fund Deposit'') are being added to GSD's
rules.\30\ The intra-day call will be subject to a threshold that will
be identified in FICC's risk management procedures.\31\ In addition,
GSD will process a mark-to-market pass-through twice per day, instead
of the current practice of once daily. The second collection and pass-
through of mark-to-market amounts will include a limited set of
components to be defined in FICC's risk management procedures. All
mark-to-market debits will be collected in full. FICC will pay out
mark-to-market credits only after any intra-day clearing fund deficit
is met.
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\30\ See GSD Rule 4, Clearing Fund and Loss Allocation, Section
2a as proposed to be amended by the proposed rule change.
\31\ Id. FICC shall establish procedures for collection of an
amount calculated in respect of a Member's Intraday Supplemental
Fund Deposit, including parameters regarding threshold amounts that
require payment, and the form and time by which payment is required
to be made to FICC.
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Since GSD will be recalculating and margining a GSD member's
exposure intra-day, the margin calculation methodology set forth in GSD
Rule 4, Clearing Fund and Loss Allocation, will be revised to eliminate
the ``Margin Requirement Differential'' component of the FICC clearing
fund calculation. In addition, GSD Rule 4 will be revised to provide
that in the case of a Margin Portfolio that contains accounts of a
Permitted Margin Affiliate, FICC will apply the highest VaR confidence
level applicable to the GSD member or the Permitted Margin Affiliate,
in the event that multiple confidence levels are used to determine
margin. Application of a higher VaR confidence level will result in a
higher margin rate. Consistent with current GSD rules, a minimum
Required Fund Deposit of $5 million will apply to a member that
maintains broker accounts.
3. Consolidated Funds-Only Settlement
The funds-only settlement process at GSD currently requires a
member to appoint a settling bank that will settle the member's net
debit or net credit amount due to or from GSD by way of the National
Settlement Service of the Board of Governors of the Federal Reserve
System (``NSS''). Any funds-only settling bank that will settle for a
member that is also an NYPC member or that will settle for a member and
a Permitted Margin Affiliate that is an NYPC member will have its net-
net credit or debit balances at each clearing corporation, other than
balances with respect to futures positions of a ``customer'' as such
term is defined in
[[Page 12149]]
CFTC Regulation 1.3(k), aggregated and netted for operational
convenience and will pay or be paid such netted amount. The proposed
rule change makes clear that, notwithstanding the consolidated
settlement, the member will remain obligated to GSD for the full amount
of its funds-only settlement amount.
4. Submission of Locked-In Trades from NYPC
The current GSD rules allow for submission of ``locked-in trades''
(i.e., trades that are deemed compared when the data on the trade is
received from a single source) \32\ submitted by a locked-in trade
source on behalf of a GSD member. Currently, designated locked-in trade
sources are Federal Reserve Banks on behalf of the Treasury Department,
Freddie Mac, and GCF-Authorized Inter-Dealer Brokers for GCF Repo
transactions. Under the proposed rule change, GSD Rule 6C, Locked-In
Comparison, will be amended to include NYPC as an additional locked-in
trade source. This is necessary because there will be futures
transactions cleared by NYPC that will proceed to physical delivery.
NYPC will submit the trade data as a locked-in trade source for
processing through FICC, identifying the GSD member that had authorized
FICC to accept the locked-in trade from NYPC. Once these transactions
are submitted to FICC, they will no longer be futures, but rather will
be in the form of buys or sells eligible for processing by GSD. As will
be the case with other locked-in trade submissions accepted by FICC,
the GSD member designated in the trade information must have executed
appropriate documentation evidencing to FICC its authorization of NYPC.
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\32\ The term ``Locked-In Trade'' means a trade involving
Eligible Securities that is deemed a compared trade once the data on
such trade is received from a single, designated source and meets
the requirements for submission of data on a locked-in trade
pursuant to GSD's rules, without the necessity of matching the data
regarding the trade with data provided by each member that is or is
acting on behalf of an original counterparty to the trade. The data
regarding a locked-in trade are provided to FICC by a locked-in
trade source that has been authorized by a member that is a party to
the trade to provide such data to FICC.
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5. Deletion of the Category 1/Category 2 Distinction
The proposed rule change will delete the legacy characterization of
certain types of members as either ``Category 1'' or ``Category 2,'' a
distinction that currently applies to ``Dealer Netting Members,''
``Futures Commission Merchant Netting Members'' and ``Inter-Dealer
Broker Netting Members'' at GSD. Historically, the two categories were
used to margin lower capitalized members (i.e., Category 2) at a higher
rate. Following FICC's adoption of the VaR methodology for GSD in
2006,\33\ FICC has determined that the distinction between Category 1
and Category 2 members is no longer necessary. Rather than margin
netting members at higher rates solely due to a single static
capitalization threshold, FICC is able, by use of the VaR margin
methodology, to margin netting members at a higher rate by applying a
higher confidence level against any netting member, which, regardless
of size, FICC has determined poses a higher risk.
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\33\ Securities Exchange Act Release No. 55217 (January 31,
2007), 72 FR 5774.
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With the deletion of the Category 1/Category 2 distinction, Section
1 of GSD Rule 13, Funds-Only Settlement, is proposed to be changed to
provide that all netting members could receive forward mark adjustment
payments, subject to FICC's general discretion to withhold credits that
would be otherwise due to a distressed netting member.
6. Amendment of CME Agreement
The proposed NYPC Arrangement will necessitate an amendment to the
CME Agreement to clarify that the NYPC Arrangement will take priority
over the CME Arrangement when determining residual FICC positions that
will be available for cross-margining with the CME. As a result, only
those FICC positions that are not able to be cross-margined with NYPC
positions under the NYPC Arrangement will generally be considered for
cross-margining with the CME. In addition, when calculating and
presenting liquidation results under the CME Agreement, the amendment
will provide that FICC's liquidation results will include FICC's
liquidation results in combination with NYPC's liquidation results
because the NYPC Agreement will provide for a right of first offset
between FICC and NYPC. The CME Agreement showing the proposed changes
was filed as an attachment to the proposed rule change as part of
Exhibit 5.
D. Summary of Other Proposed Changes to Rule Text
In GSD Rule 1, Definitions, the following definitions are proposed
to be added, revised or deleted:
The terms ``Broker Account'' and ``Dealer Account'' will be added
to the text of the GSD Rules. A ``Broker Account'' is an account that
is maintained by an inter-dealer broker netting member, or a segregated
broker account of a netting member that is not an inter-dealer broker
netting member. An account that is not a Broker Account is referred to
as a Dealer Account.
``Coverage Charge'' will be revised to refer to the additional
charge with respect to the member's Required Fund Deposit (rather than
its VaR Charge) which brings the member's coverage to a targeted
confidence level.
``Current Net Settlement Positions'' will be corrected to clarify
its current intent, that it is calculated with respect to a certain
business day and not necessarily on that day, since it may be
calculated after market close on the day prior to its application
(i.e., before or after midnight between the close of business one day
and the open of business on the next day).
``Excess Capital Differential'' will be corrected to refer to the
amount by which a member's VaR Charge exceeds its excess capital,
instead of by reference to the amount by which its required clearing
fund deposit exceeds its excess capital.
``Excess Capital Premium Calculation Amount'' will be deleted
because, with the introduction of VaR methodology, the calculation is
no longer applicable. The terms ``Excess Capital Differential'' and
``Excess Capital Ratio'' will be amended to delete archaic references
to ``Excess Capital Premium Calculation Amount'' and to refer instead
to the comparison of a member's capital calculation to its VaR Charge.
In addition, the text of Section 14 of GSD Rule 3 will be amended to
provide that the ``Excess Capital Premium'' charge applies to any type
of entity that is a GSD netting member rather than limiting its
applicability to only the specified types formerly identified in the
text.
``Excess Capital Ratio'' will be amended to mean the quotient
resulting from dividing the amount of a member's VaR Charge by its
excess net capital.
``GSD Margin Group'' will be added to refer to the GSD accounts
within a Margin Portfolio.
``Margin Portfolio'' will be added to refer to the positions
designated by the member as grouped for cross-margining, subject to the
rules set forth in GSD Rule 4. ``Dealer Accounts'' and ``Broker
Accounts'' cannot be combined in a common Margin Portfolio. A
``Sponsoring Member Omnibus Account'' cannot be combined with any other
accounts.
``Unadjusted GSD Margin Portfolio Amount'' will be added to define
the amount calculated by GSD with regard to a Margin Portfolio, before
application of premiums, maximums or minimums.
[[Page 12150]]
It includes the VaR Charge and the coverage charge for GSD. In the case
of a Cross-Margining Participant of GSD, the Unadjusted GSD Margin
Portfolio Amount also will include the cross-margining reduction, if
any.
The terms ``Category 2 Gross Margin Amount,'' ``Margin Adjustment
Amount,'' ``Repo Volatility Factor,'' and ``Revised Gross Margin
Amount'' will be deleted from GSD Rule 1 since they are no longer used
elsewhere in the GSD Rules. The Schedule of Repo Volatility Factors
will be deleted because it is no longer applicable.
In Section 2 of GSD Rule 3, Ongoing Membership Requirements, the
requirement that GCF counterparties submit information relating to the
composition of their NFE-related accounts,\34\ will be amended to
require the submission of such information periodically, rather than on
a quarterly basis. GSD currently requires this information every other
month and by this change, FICC could institute periodic reporting on a
schedule that is appropriate at such time, in response to current
conditions. This has the potential to help tailor the frequency of
reporting based on market conditions and thereby facilitate the risk
management of the clearing agency.
---------------------------------------------------------------------------
\34\ The term ``NFE-Related Account'' means each securities
account and deposit account maintained by a GCF Clearing Agent Bank
for an Interbank Pledging Member in which the GCF Clearing Agent
Bank has, pursuant to agreement with the Interbank Pledging Member
or by operation of law, a security interest or right of setoff
securing or supporting the payment of obligations of such Interbank
Pledging Member to the Bank, including each such account to which
such Interbank Pledging Member's Prorated Interbank Cash Amount is
debited. See GSD Rule 1, Definitions.
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In Section 9 of GSD Rule 4, Clearing Fund and Loss Allocation,
concerning the return of excess deposits and payments, FICC's
discretion to withhold the return of excess clearing fund to a member
that has an outstanding payment obligation to FICC will be changed from
being based on FICC's determination that the member's anticipated
transactions or obligations over the next 90 calendar days may be
reasonably expected to be materially different than those of the 90
prior calendar days, under the current rule, to being based on FICC's
determination that the member's anticipated transactions or obligations
in the near future may be reasonably expected to be materially
different than those in the recent past. In addition, technical and
clarifying changes are proposed to be made to the rules and cross-
references to rule sections contained throughout. The rules have been
reviewed by FICC and proposed to be corrected as needed to reflect the
correct rule section references as originally intended.
III. Comments
The Commission received thirteen comments to the proposed rule
change and four response letters responding to comments.\35\ Nine
commenters supported the proposed rule.\36\ Of this group, seven
commenters generally stated that the cross-margining proposal benefits
competition by permitting ``open access'' to cross-margining.\37\ In
addition, six commenters argued that the proposed rule change permits
risk minimization \38\ and promotes transparency.\39\
---------------------------------------------------------------------------
\35\ See supra notes 3 and 4.
\36\ Letter from Adam C. Cooper, Senior Managing Director and
Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from
Gary DeWaal, Senior Managing Director and Group General Counsel,
Newedge USA, LLC (December 21, 2010); Letter from John A. McCarthy,
General Counsel, GETCO (December 21, 2010); Letter from Donald J.
Wilson, Jr., DRW Trading Group (December 21, 2010); Letter from
James B. Fuqua and David Kelly, Managing Directors, Legal, UBS
Securities, LLC (December 20, 2010); Letter from John Willian,
Managing Director, Goldman Sachs (December 17, 2010); Letter from
Ronald Filler, Professor of Law and Director of the Center on
Financial Services Law, New York Law School (December 8, 2010);
Letter from Douglas Engmann, President, Engmann Options, Inc.
(December 6, 2010); and Letter from Jack DiMaio, Managing Director,
Morgan Stanley (December 2, 2010).
\37\ Letter from Jack DiMaio, Managing Director, Morgan Stanley
(December 2, 2010); Letter from Ronald Filler, Professor of Law and
Director of the Center on Financial Services Law, New York Law
School (December 8, 2010); Letter from John Willian, Managing
Director, Goldman Sachs (December 17, 2010); Letter from James B.
Fuqua and David Kelly, Managing Directors, Legal, UBS Securities,
LLC (December 20, 2010); Letter from Adam C. Cooper, Senior Managing
Director and Chief Legal Officer, Citadel, LLC (December 21, 2010);
Letter from Gary DeWaal, Senior Managing Director and Group General
Counsel, Newedge USA, LLC (December 21, 2010); and Letter from John
A. McCarthy, General Counsel, GETCO (December 21, 2010).
\38\ Letter from Jack DiMaio, Managing Director, Morgan Stanley
(December 2, 2010); Letter from Douglas Engmann, President, Engmann
Options, Inc. (December 6, 2010); Letter from Ronald Filler,
Professor of Law and Director of the Center on Financial Services
Law, New York Law School (December 8, 2010); Letter from John A.
McCarthy, General Counsel, GETCO (December 21, 2010); Letter from
James B. Fuqua and David Kelly, Managing Directors, Legal, UBS
Securities, LLC (December 20, 2010); and Letter from Donald J.
Wilson, Jr., DRW Trading Group (December 21, 2010).
\39\ Letter from Jack DiMaio, Managing Director, Morgan Stanley
(December 2, 2010); Letter from Ronald Filler, Professor of Law and
Director of the Center on Financial Services Law, New York Law
School (December 8, 2010); Letter from James B. Fuqua and David
Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20,
2010); Letter from Adam C. Cooper, Senior Managing Director and
Chief Legal Officer, Citadel, LLC (December 21, 2010); Letter from
John A. McCarthy, General Counsel, GETCO (December 21, 2010); and
Letter from Donald J. Wilson, Jr., DRW Trading Group (December 21,
2010).
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Three commenters opposed the proposed rule, absent changes to
mitigate what they identified as anti-competitive features.\40\ One
commenter recommended further study of the rule and its risk
methodology, but agreed with the commenters opposing the proposed rule
change on the grounds that the rule should permit only non-exclusive
arrangements that promote competition.\41\ The commenters against the
proposed rule change generally stated that the cross-margining scheme
is anti-competitive and raises risk management issues. These commenters
raised concerns or provided comments related to the following major
aspects of the cross-margining proposal: (1) The effect on competition;
(2) risk management; and (3) the effect on efficiency and costs. FICC
responded to these comments in three comment letters that it
submitted.\42\
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\40\ Letter from William H. Navin, Executive Vice President and
General Counsel, The Options Clearing Corporation (December 21,
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of
ELX Futures, LP (December 15, 2010); and Letter from John C. Hiatt,
Chief Administrative Officer, Ronin Capital (December 10, 2010).
\41\ Letter from Joan C. Conley, Senior Vice President &
Corporate Secretary, NASDAQ OMX (December 21, 2010).
\42\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011); Letter from
Michael Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael
Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 27, 2011).
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A. Effect on Competition
Many of the commenters' concerns with respect to competition
stemmed from FICC having an exclusive agreement to enter into a direct
arrangement for ``one-pot'' cross-margining with NYPC.\43\ NYPC is
jointly owned by NYSE Euronext and DTCC. DTCC is the parent company of
FICC. NYSE Liffe is the global derivatives business of the NYSE
Euronext. These affiliations combined with the exclusive nature of the
direct arrangement raised concerns for these commenters.
---------------------------------------------------------------------------
\43\ Letter from William H. Navin, Executive Vice President and
General Counsel, The Options Clearing Corporation (December 21,
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of
ELX Futures, LP (December 15, 2010); Letter from John C. Hiatt,
Chief Administrative Officer, Ronin Capital (December 10, 2010); and
Letter from Joan C. Conley, Senior Vice President & Corporate
Secretary, NASDAQ OMX (December 21, 2010).
---------------------------------------------------------------------------
With regard to allowing other parties direct access to cross-
margining, FICC argued that it is neither operationally feasible nor
prudent to establish a framework of multiple, competing ``one-
[[Page 12151]]
pots'' with multiple, competing DCOs under this arrangement.\44\ Among
other things, such an arrangement would result in FICC clearing members
that are members of multiple DCOs cross-margining their futures
positions against different segments of their portfolios at FICC,
rather than having the risk of their positions being measured
comprehensively.\45\ FICC stated that it believes that the attendant
risk of delays and errors in processing would substantially increase
systemic risk as clearing members continuously moved positions at FICC
from one cross-margin pot to another in order to maximize their margin
savings.\46\ For example, there is the potential that operational
issues of managing such movements across multiple systems would create
risks in the settlement process by adding complexities associated with
linking and monitoring the use of multiple one cross-margin pot
arrangements. Furthermore, FICC stated that the existence of multiple
``one-pots'' would likely greatly complicate the liquidation of a
cross-margining participant that was in default at FICC and NYPC,
thereby increasing systemic risk.\47\
---------------------------------------------------------------------------
\44\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011).
\45\ Id.
\46\ Id.
\47\ Id.
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Commenters recognized that other DCOs (i.e., DCOs other than NYPC)
will have the ability to obtain indirect access to the cross-margining
arrangement by entering into a Limited Purpose Participant (``LPP'')
agreement and becoming an LPP of NYPC. Commenters raised concerns about
the potential for this type of indirect access, citing concerns about
the requirements to agree to be bound by the rules of NYPC, agree to an
allocation of clearing fees, and contribute to the NYPC guaranty fund
in an amount equal to the contribution made by NYSE Euronext.\48\
---------------------------------------------------------------------------
\48\ Letter from William H. Navin, Executive Vice President and
General Counsel, The Options Clearing Corporation (December 21,
2010); Letter from Richard D. Marshall, Ropes & Gray on behalf of
ELX Futures, LP (December 15, 2010); Letter from John C. Hiatt,
Chief Administrative Officer, Ronin Capital (December 10, 2010); and
Letter from Joan C. Conley, Senior Vice President & Corporate
Secretary, NASDAQ OMX (December 21, 2010).
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FICC responded to these comments.\49\ Specifically, FICC stated
that, while DCOs that are LPPs clearing through NYPC would need to
abide by NYPC's rules, NYPC's intention is that there would be separate
requirements (including with respect to margin deposits and guaranty
fund contributions applied) to the LPP, on the one hand, and the LPP's
members, on the other, unless: (i) NYPC and the LPP separately agree to
allocate those amounts to the LPP and its members, or (ii) a clearing
member of NYPC is also a clearing member of an LPP.\50\ FICC and NYPC
also represented that the NYPC rules would apply to a LPP but not to
the members of the LPP, unless such members are otherwise clearing
members of NYPC.\51\ In addition, FICC noted that NYPC Rule 801 is
designed to permit maximum flexibility in structuring the admission of
LPPs, as it is contemplated that any such admission would be subject to
substantial negotiation between NYPC and the prospective LPP regarding
the operational mechanics of margin deposits and related subjects.\52\
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\49\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011) and Letter from
Michael Bodson, Executive Managing Director, Fixed Income Clearing
Corporation; Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael
Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 27, 2011).
\50\ Id.
\51\ Letter from Michael Bodson, Executive Managing Director,
Fixed Income Clearing Corporation and Walt Lukken, Chief Executive
Officer, New York Portfolio Clearing, LLC (February 27, 2011).
\52\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011) and Letter from
Michael Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 7, 2011).
---------------------------------------------------------------------------
In addition, FICC has represented to the Commission that the fees
NYPC charges LPPs will be determined on a case-by-case basis based on
the services provided to recoup operational and other costs that NYPC
incurs in integrating the new LPP.\53\ Moreover, FICC and NYPC
clarified and affirmatively represented that the limited purpose
participant agreements will be individually negotiated and that ``the
Guaranty Fund contribution that will be required by NYPC from any
Limited Purpose Participant will be determined by risk-based factors
without regard to whether such contribution amount is more or less than
the amount contributed to the NYPC Guaranty Fund by NYSE
Euronext''.\54\
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\53\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011); Letter from
Michael Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 7, 2011); and Letter from Michael
Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 27, 2011).
\54\ Letter from Michael Bodson, Executive Managing Director,
Fixed Income Clearing Corporation and Walt Lukken, Chief Executive
Officer, New York Portfolio Clearing, LLC (February 7, 2011) and
Letter from Michael Bodson, Executive Managing Director, Fixed
Income Clearing Corporation and Walt Lukken, Chief Executive
Officer, New York Portfolio Clearing, LLC (February 27, 2011).
---------------------------------------------------------------------------
Three commenters also noted that under the proposed structure, it
may take up to two years before other DCMs are permitted to clear at
NYPC or before other DCOs might be given indirect access in order to
participate in the NYPC Arrangement, which may cause commercial
impairment.\55\ Two other commenters, however, argued that the delay is
not unduly burdensome on competition,\56\ with one in particular
explaining that ``[a]ny new arrangement needs the requisite time to
ensure that it satisfies all of the underlying concerns and issues that
may occur with any new concept''.\57\ FICC responded, saying that the
transition period is necessary to complete implementation, systems
integration, and testing, among other things, and that it and NYPC have
pledged to open the arrangement to other participants as soon as
operationally feasible.\58\ FICC also stated that attempting to
integrate a pre-existing clearinghouse directly into the ``one-pot''
cross-margining arrangement would by necessity be even more difficult
and likely more costly than the integration between FICC and NYPC,
which was created in order to cross-margin positions with FICC.\59\ In
[[Page 12152]]
addition, FICC has previously stated that NYPC has committed that it
will complete the process to allow one or more DCMs or DCOs to be
admitted and integrated into the ``one-pot'' cross-margining
arrangement as soon as feasible, but no later than 24 months from the
start of operations.
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\55\ Letter from Richard D. Marshall, Ropes & Gray on behalf of
ELX Futures, LP (December 15, 2010); Letter from William H. Navin,
Executive Vice President and General Counsel, The Options Clearing
Corporation (December 21, 2010); and Letter from Joan C. Conley,
Senior Vice President & Corporate Secretary, NASDAQ OMX (December
21, 2010).
\56\ Letter from Gary DeWaal, Senior Managing Director and Group
General Counsel, Newedge USA, LLC (December 21, 2010) and Letter
from Ronald Filler, Professor of Law and Director of the Center on
Financial Services Law, New York Law School (December 8, 2010).
\57\ Letter from Ronald Filler, Professor of Law and Director of
the Center on Financial Services Law, New York Law School (December
8, 2010).
\58\ FICC represented that ``[f]ollowing the announcement of
NYPC, FICC, the NYPC management team and senior management of NYSE
Euronext have repeatedly reached out to [The Options Clearing
Corporation], as well as other DCOs and DCMs, to initiate the
process of integrating such other organizations into the `single
pot'. While those efforts have not yet been productive, FICC and
NYPC remain committed to expanding the `single pot' to include other
DCOs and DCMs.'' Letter from Douglas Landy, Allen & Overy on behalf
of the Fixed Income Clearing Corporation (January 4, 2011). See also
supra Section II.B., at 16.
\59\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011); and Letter from
Michael Bodson, Executive Managing Director, Fixed Income Clearing
Corporation and Walt Lukken, Chief Executive Officer, New York
Portfolio Clearing, LLC (February 7, 2011).
---------------------------------------------------------------------------
The nine commenters in favor of the proposed rule change generally
argued that the rule change will increase competition in trade
execution and clearing which, in turn, will encourage innovation,
efficiency, and improved choices.\60\ Furthermore, FICC also indicated
that its proposal promotes competition. Specifically, FICC stated that
``[u]nlike the traditional `vertical' relationship between futures
exchanges and their affiliated * * * DCOs * * *, NYPC has been uniquely
structured * * * to allow unaffiliated DCOs and * * * DCMs * * * `open
access' to the benefits of the `single pot' cross-margining arrangement
as soon as operationally feasible, subject to only certain object,
reasonable and non-discriminatory criteria''.\61\ FICC also stated that
the current market for clearing U.S. dollar-denominated interest rates
is dominated by one entity and that its approach has the potential to
introduce competition in this market.\62\
---------------------------------------------------------------------------
\60\ See, e.g., Letter from John Willian, Managing Director,
Goldman Sachs (December 17, 2010); Letter from Ronald Filler,
Professor of Law and Director of the Center on Financial Services
Law, New York Law School (December 8, 2010); and Letter from Adam C.
Cooper, Senior Managing Director and Chief Legal Officer, Citadel,
LLC (December 21, 2010).
\61\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011).
\62\ Id.
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B. Risk Management
Five commenters believed that the proposal would increase the
transparency of risks across asset classes and allow regulators to
better monitor and assess risk.\63\ These commenters supported the
proposed rule's use of the Value at Risk (VaR) methodology, because it
is well understood, has been extensively tested, and relies on
historical information to simulate the market.\64\ Moreover, two
commenters noted that ``one-pot'' margining decreases the risk for
market participants because it allows for the offset of risk between
U.S. Treasury futures and U.S. Treasury cash bonds.\65\ Additionally,
two commenters believed that the proposal allows for a greater portion
of financial instruments to be centrally cleared, which, among other
things, reduces overall risk.\66\
---------------------------------------------------------------------------
\63\ Letter from Jack DiMaio, Managing Director, Morgan Stanley
(December 2, 2010); Letter from John A. McCarthy, General Counsel,
GETCO (December 21, 2010); Letter from James B. Fuqua and David
Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20,
2010); Letter from Ronald Filler, Professor of Law and Director of
the Center on Financial Services Law, New York Law School (December
8, 2010); and Letter from Donald J. Wilson, Jr., DRW Trading Group
(December 21, 2010).
\64\ Letter from Jack DiMaio, Managing Director, Morgan Stanley
(December 2, 2010); Letter from John A. McCarthy, General Counsel,
GETCO (December 21, 2010); Letter from James B. Fuqua and David
Kelly, Managing Directors, Legal, UBS Securities, LLC (December 20,
2010); Letter from Ronald Filler, Professor of Law and Director of
the Center on Financial Services Law, New York Law School (December
8, 2010); and Letter from Donald J. Wilson, Jr., DRW Trading Group
(December 21, 2010).
\65\ Letter from Donald J. Wilson, Jr., DRW Trading Group
(December 21, 2010) and Letter from John A. McCarthy, General
Counsel, GETCO (December 21, 2010).
\66\ Letter from Adam C. Cooper, Senior Managing Director and
Chief Legal Officer, Citadel, LLC (December 21, 2010) and Letter
from John A. McCarthy, General Counsel, GETCO (December 21, 2010).
---------------------------------------------------------------------------
Two commenters, however, raised concerns about risk management,
stating that because cross-margining allows for greater leverage than
standard margining, in particular during periods of market stress and
extreme volatility, the proposed rule may increase systemic risk.\67\
FICC responded by stating that ``the NYPC-FICC margin model does not
necessarily increase leverage and may, in fact, reduce leverage in
highly risky portfolios with limited hedges.''\68\ FICC further
explained that, ``[a]t the same time, the NYPC-FICC model can offer
margin reductions for hedged portfolios because it more accurately
estimates true economic risk by taking into account the benefits of
highly correlated, offsetting positions in a single portfolio.''\69\
---------------------------------------------------------------------------
\67\ Letter from Joan C. Conley, Senior Vice President &
Corporate Secretary, NASDAQ OMX (December 21, 2010) and Letter from
John C. Hiatt, Chief Administrative Officer, Ronin Capital (December
10, 2010).
\68\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011).
\69\ Id.
---------------------------------------------------------------------------
One commenter suggested that the VaR method for calculating margin
requirements should be tested further.\70\ This commenter also
suggested that the scenario-based Standard Portfolio Analysis of Risk
(``SPAN'') method be considered and tested in comparison to VaR. FICC's
response noted that the proposed VaR methodology is based on a common
method of historical simulation and that it has conducted risk-related
testing, including sensitivity tests, back testing of the model's
validity, and stress tests of the sufficiency of the guaranty fund.\71\
---------------------------------------------------------------------------
\70\ Letter from Joan C. Conley, Senior Vice President &
Corporate Secretary, NASDAQ OMX (December 21, 2010).
\71\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011).
---------------------------------------------------------------------------
One commenter requested that documentation of previous
consideration of the risk aspects of the proposal be made public.\72\
In response, FICC provided a discussion and analysis of its VaR
methodology compared to SPAN.\73\ FICC explained that because it needs
to measure the risk of combined portfolios for futures and cash
positions, it believes that a historical VaR-based margin model
provides a more accurate estimate of portfolio risk than SPAN.\74\ FICC
noted, however, that because it is standard practice for the futures
industry to use SPAN to calculate and monitor margin requirements, it
will make available SPAN formatted calculations of its VaR-based
customer risk parameters to clearing members and their customers. FICC
also noted that in initially listing NYPC-clearing contracts, NYSE
Liffe U.S. will use, among other factors, SPAN-formatted input
parameters to establish minimum customer initial margin requirements
for each NYPC-cleared interest rate contract and intra- and inter-
commodity spreads.\75\
---------------------------------------------------------------------------
\72\ Letter from Alex Kogan, Vice President and Deputy General
Counsel, NASDAQ OMX (January 10, 2011).
\73\ Letter from Michael Bodson, Executive Managing Director,
Fixed Income Clearing Corporation and Walt Lukken, Chief Executive
Officer, New York Portfolio Clearing, LLC (February 7, 2011). The
public record contains information regarding testing that went to
the subject of risk management. The Commission also received from
FICC proprietary, highly confidential information, including
information about individual portfolios. This non-public
information, in addition to the public information submitted in
support of the rule proposal, supported the Commission's conclusion
that the proposal is consistent with the Act, but was not included
in the public record because of its sensitivity.
\74\ Id.
\75\ Letter from Alex Kogan, Vice President and Deputy General
Counsel, NASDAQ OMX (January 10, 2011).
---------------------------------------------------------------------------
C. Effect on Efficiency and Costs
Four commenters stated that the proposal promotes the reduction of
risk that will lead to margin and capital efficiencies and lower
costs.\76\ One
[[Page 12153]]
commenter believed that ``one-pot'' margining would increase cash flow
and margin efficiencies for certain clearing members.\77\ Two
commenters also stated that the ``one-pot'' approach will reduce
delivery costs because it offers direct delivery of expiring futures
contracts into cash bonds held at FICC, which will minimize fails and
squeezes and improve price convergence and stress on the settlement
system.\78\ Additionally, two commenters that were opposed to the
cross-margining agreement as proposed also expressed their general
support for ``one-pot'' cross-margining on the ground that it reduces
risk while facilitating more efficient uses of capital markets.\79\
---------------------------------------------------------------------------
\76\ Letter from Gary DeWaal, Senior Managing Director and Group
General Counsel, Newedge USA, LLC (December 21, 2010); Letter from
Adam C. Cooper, Senior Managing Director and Chief Legal Officer,
Citadel, LLC (December 21, 2010); Letter from Ronald Filler,
Professor of Law and Director of the Center on Financial Services
Law, New York Law School (December 8, 2010); and Letter from James
B. Fuqua and David Kelly, Managing Directors, Legal, UBS Securities,
LLC (December 20, 2010).
\77\ Letter from John Willian, Managing Director, Goldman Sachs
(December 17, 2010).
\78\ Letter from Jack DiMaio, Managing Director, Morgan Stanley
(December 2, 2010) and Letter from Donald J. Wilson, Jr., DRW
Trading Group (December 21, 2010).
\79\ Letter from John C. Hiatt, Chief Administrative Officer,
Ronin Capital (December 10, 2010) and Letter from William H. Navin,
Executive Vice President and General Counsel, The Options Clearing
Corporation (December 21, 2010).
---------------------------------------------------------------------------
According to FICC's response, the proposed rule streamlines the
delivery process for U.S. Treasury futures, which will improve
operational efficiency and decrease systemic settlement risk.\80\ FICC
also stated that the proposal should increase liquidity by providing
market participants with an alternate venue for trading U.S. dollar-
denominated interest rate futures contracts.\81\
---------------------------------------------------------------------------
\80\ Letter from Douglas Landy, Allen & Overy on behalf of the
Fixed Income Clearing Corporation (January 4, 2011).
\81\ Id.
---------------------------------------------------------------------------
IV. Discussion
The Commission has carefully considered the proposed rule change
and the comments thereto and the Commission finds that the proposed
rule change is consistent with the requirements of the Act and the
rules and regulations thereunder, including Sections 17A(a)(2)(A)(ii)
\82\ and 17A(b)(3)(A), (F) and (I) of the Act.\83\
---------------------------------------------------------------------------
\82\ 15 U.S.C. 78q-1(b)(2)(A)(ii). This provision directs the
Commission to use its authority to facilitate the establishment of
coordinated facilities for clearance and settlement of transactions
in securities and contracts of sale for future delivery.
\83\ 15 U.S.C. 78q-1(b)(3)(A), (F) and I. In approving the
proposed rule change, the Commission considered the proposal's
impact on efficiency, competition, and capital formation. 15 U.S.C.
78c(f).
---------------------------------------------------------------------------
The proposed rule change provides for modifications to certain risk
management related processes and definitions under GSD's rules,
including changes to the loss allocation methodology, intraday
margining, categories of membership, and related definitional changes.
The Commission believes that these changes to GSD's rules are
consistent with Sections 17A(b)(3)(A) and (F) of the Act because they
should help facilitate and promote the prompt and accurate clearance
and settlement of securities transactions, and help assure the
safeguarding of securities and funds under FICC's control or for which
it is responsible. In particular, the Commission believes that these
changes to GSD's rules, by virtue of strengthening FICC's risk
management and related operations, should result in a more timely,
accurate, and efficient system of settlement.
In addition, the proposed rule change would provide for a cross-
margining arrangement between certain positions in GSD and NYPC. The
Commission's staff has closely evaluated the proposed cross-margining
arrangement including the risk management, competition and efficiency
issues raised by the proposed rule change (as discussed below) against
the requirements of the Act, including Sections 17A(b)(3)(F) and (I) of
the Act. Based on our staff's analysis, and taking into consideration
the matters discussed throughout, including the representations
discussed below, the Commission finds the proposed rule change is
consistent with the Act.
A. Risk Management
Section 17A(b)(3)(F) of the Act requires that the rules of a
clearing agency be designed to promote the prompt and accurate
clearance and settlement of securities transactions and assure the
safeguarding of securities and funds in the custody or control of the
clearing agency or for which it is responsible.\84\ The Commission has
historically supported and approved cross-margining at clearing
agencies and has previously recognized the potential benefits of cross-
margining systems, which include freeing capital through reduced margin
requirements, reducing clearing costs by integrating clearing
functions, reducing clearing organization risk by centralizing asset
management and harmonizing liquidation procedures.\85\ The Commission
has encouraged cross-margining arrangements as a way to promote more
efficient risk management across product classes.\86\ Cross-margining
arrangements may be consistent with Section 17A(b)(3)(F) in that they
may strengthen the safeguarding of assets through effective risk
controls that more broadly take into account offsetting positions of
participants in both the cash and futures markets, and promote prompt
and accurate clearance and settlement of securities through increased
efficiencies.
---------------------------------------------------------------------------
\84\ 15 U.S.C. 78q-1(b)(3)(F).
\85\ See, e.g., Securities Exchange Act Release No. 27296
(September 26, 1989), 54 FR 41195 (approving proposed rule changes
establishing cross-margining between The Options Clearing
Corporation and the Chicago Mercantile Exchange) and Securities
Exchange Act Release No. 26153 (October 3, 1988), 53 FR 39561
(approving proposed rule changes concerning cross-margining between
The Options Clearing Corporation and the Intermarket Clearing
Corporation). Previously, the Interim Report of the President's
Working Group on Financial Markets (May 1988) recommended that the
SEC and CFTC facilitate cross-margining programs among clearing
organizations. In addition, the Bachmann Task Force, which was
formed by the Commission in response to the 1987 Market Break,
presented its findings to the Commission in May 1992 that included,
among other things, a recommendation that cross-margining programs
among clearing agencies be implemented or expanded. See Securities
Exchange Act Release No. 31904 (February 23, 1993), 58 FR 11806
(March 1, 1993).
\86\ See Securities and Exchange Act Release No. 44301, 66 FR
28297 (May 11, 2001) (order approving a ``two-pot'' cross-margining
proposal between FICC's predecessor and CME). In addition, the
Interim Report of the President's Working Group on Financial Markets
(May 1988) also recommended that the SEC and CFTC facilitate cross-
margining programs among clearing organizations.
---------------------------------------------------------------------------
As set forth in the proposal, FICC will perform margin calculations
using VaR methodology with a 99 percent confidence level and 3-day
liquidation for cash positions and 1-day liquidation for futures, using
historical information for the prior year (250 trading days for futures
and 252 for cash positions) and the margin calculations will employ a
front weighted mechanism that places a greater emphasis on more recent
observations. FICC will also conduct daily back testing and assess an
additional coverage component charged to participants if the back tests
show insufficient coverage. In the event of unusual market conditions,
FICC or NYPC could at any time require additional margin provided such
requirements are consistent with the standards in Section 17A of the
Exchange Act. The Commission believes these actions assist in the
promotion under the proposed cross-margining arrangement of prompt and
accurate clearance and settlement of securities transactions and help
assure the safeguarding of securities and funds consistent with the
requirements under Section 17A(b)(3)(F) of the Act because they would
facilitate appropriate risk management by FICC by providing flexibility
and promoting ongoing monitoring of risk.\87\
---------------------------------------------------------------------------
\87\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
The proposal also contains provisions for managing risk in the
event of a
[[Page 12154]]
member default. The NYPC Agreement provides for the sharing of losses
by FICC and NYPC in the event that the ``one-pot'' portfolio margin
deposits of a defaulting participant are not sufficient to cover the
losses resulting from the liquidation of that participant's trades and
positions. In the event of a member default, the proposal requires that
FICC and NYPC would liquidate posted margin as a single portfolio,
which will allow them to preserve the value of the assets posted as
collateral. In addition, FICC and NYPC are providing financial
guarantees to each other in the event the available collateral is
insufficient. These features of the proposed rule change would help to
ensure that FICC is able to meet its settlement obligations in the
event of default. As a result, the Commission believes that the
proposal would promote the prompt and accurate clearance and settlement
of securities transactions and assure the safeguarding of securities
and funds in a manner consistent with Section 17A(b)(3)(F) of the
Act.\88\
---------------------------------------------------------------------------
\88\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
The Commission has previously noted that cross-margining systems
entail certain risks.\89\ For instance, even in normal market
conditions, products that have been highly correlated in the past may
diverge and may diverge even more so in extreme market conditions. Such
a breakdown in correlation might lead to inadequate clearing margins or
losses upon a liquidation. To address these concerns, as noted in the
description of the proposed rule change and in FICC's response letters,
FICC has performed testing of the VaR margining model. This included
sensitivity tests of the model to changing market conditions, back
tests of sample portfolios to check model validity, stress tests of
sample portfolios to test the sufficiency of the NYPC guaranty fund,
and back tests to verify the sufficiency of coverage after the FICC-
NYPC cross-margining reductions are applied.
---------------------------------------------------------------------------
\89\ Securities Exchange Act Release No. 26153 (October 3,
1988), 53 FR 39561.
---------------------------------------------------------------------------
The Commission takes commenters' concerns about risk management
seriously. As discussed below, to provide the Commission with enhanced
ability to monitor FICC's risk management, FICC has represented and
undertaken to make continuing risk analysis reports, discussed below,
to the Commission. This ongoing reporting should also help FICC conduct
its own monitoring of the NYPC Arrangement. In addition, FICC is
subject to the Commission's ongoing examination program, which examines
registered clearing agencies with respect to their risk management
systems and other aspects of their operations. The Commission believes
FICC's prior analysis, as discussed above, as well as FICC's commitment
to provide additional reports on a periodic basis will promote the
prompt and accurate clearance and settlement of securities transactions
and help assure the safeguarding of securities and funds in a manner
consistent with Section 17A(b)(3)(F) of the Act.
B. Competition
Section 17A(b)(3)(F) of the Act requires that the rules of a
clearing agency are not designed to permit unfair discrimination in the
admission of participants or among participants in the use of the
clearing agency.\90\ Section 17A(b)(3)(I) of the Act requires that the
rules of the clearing agency do not impose any burden on competition
not necessary and appropriate in furtherance of the purposes of the
Exchange Act.\91\
---------------------------------------------------------------------------
\90\ 15 U.S.C. 78q-1(b)(3)(F).
\91\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------
The Commission has carefully considered the comments and the
responses submitted to the Commission. With respect to commenters'
concerns regarding the exclusive nature of the agreement to enter into
a direct arrangement for ``one-pot'' cross-margining with NYPC, the
Commission believes that FICC has raised valid concerns regarding the
potential for greater risk arising from connections to multiple DCOs.
The Commission believes that the NYPC Arrangement, and FICC's
representations in its responses, discussed above, regarding how
indirect access would operate in practice, would provide increased
potential for indirect access to the cross-margining arrangement by
entering into a LPP agreement and becoming an LPP of NYPC.
The Commission believes that the proposed FICC indirect access
arrangement would provide a viable option for those seeking to access
the ``one-pot'' cross-margining arrangement because it would be open to
all DCOs and DCMs and would contain membership criteria that are
commensurate with risks associated with accessing the ``one-pot''
cross-margining arrangement. Accordingly, the Commission believes the
proposed cross-margining arrangement is not designed to permit unfair
discrimination in the admission of participants or among participants
in the use of the clearing agency consistent with Section
17A(b)(3)(F).\92\
---------------------------------------------------------------------------
\92\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
The Commission acknowledges that the admission and integration of
other DCMs or DCOs will not be immediate. However, the Commission
believes that, in light of existing technological limitations, FICC has
raised valid concerns regarding the operational feasibility of
providing multiple links for direct access to the cross-margining
arrangement at this time. These potential operational risks associated
with managing such an arrangement, such as maintaining appropriate
account of the positions of participants and calculating appropriate
margin, must be weighed against the desire for greater direct access
immediately.
The Commission notes that FICC has previously indicated that NYPC
has committed that it will complete the process to allow one or more
DCMs or DCOs to be admitted and integrated into the ``one-pot'' cross-
margining arrangement as soon as feasible, but no later than 24 months
from the start of NYPC's operations. FICC has stated that the
transition period is necessary to complete implementation, systems
integration, and testing, among other things, and that it would open
the arrangement to other participants as soon as operationally
feasible.\93\ The Commission believes that the operational issues,
including those cited by FICC, would need to be resolved prior to
admitting a DCM or DCO as an LPP. The Commission believes that this
aspect of the proposal would not impose any burden on competition not
necessary and appropriate in furtherance of the purposes of the
Exchange Act consistent with Section 17A(b)(3)(I) of the Act.
---------------------------------------------------------------------------
\93\ FICC represented that following the announcement of NYPC,
FICC, the NYPC management team and senior management of NYSE
Euronext have been in discussions with other DCOs and DCMs to
initiate the process of integrating such other organizations into
the ``one-pot.'' While those efforts have not yet been productive,
FICC and NYPC remain committed to expanding the ``one-pot'' to
include other DCOs and DCMs. Letter from Douglas Landy, Allen &
Overy on behalf of the Fixed Income Clearing Corporation (January 4,
2011).
---------------------------------------------------------------------------
Moreover, the Commission notes that FICC has stated that the
proposal would provide market participants with an alternate venue for
trading U.S. dollar-denominated interest rate futures contracts,
thereby potentially helping to increase competition in this market. The
Commission believes that these pro-competitive features of the proposal
are consistent with the Act.
The Commission takes seriously commenters' concerns regarding
competition. As discussed below, FICC has represented and undertaken to
provide the Commission with
[[Page 12155]]
information about the LLP agreements concerning the proposed cross-
margining arrangements.
The Commission believes FICC's commitment to provide ongoing
information with respect LLP agreements would help to evaluate its
efforts to facilitate indirect access and would thereby help to ensure
that the proposal would not impose any burden on competition not
necessary and appropriate in furtherance of the purposes of the
Exchange Act, consistent with Section 17A(b)(3)(I) of the Act.\94\ The
Commission anticipates that this information will be primarily used for
the limited purpose of identifying any instances in which there is
potential non-compliance with the terms of this order or the
representations made by FICC.
---------------------------------------------------------------------------
\94\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------
The Commission has considered the concerns presented by commenters
and has determined that the benefits of the proposal outweigh any anti-
competitive effects of the proposal. The Commission believes that the
proposal would not impose any burden on competition not necessary and
appropriate in furtherance of the purposes of the Exchange Act
consistent with Section 17A(b)(3)(I) of the Act.\95\
---------------------------------------------------------------------------
\95\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------
C. Effect on Efficiency and Costs
As previously discussed, both FICC and those commenting on the
proposed rule change expect that the cross-margining proposal will
reduce costs, including delivery costs, and increase cash flows through
margin efficiencies. The Commission believes that the NYPC Arrangement
has the potential to increase efficiencies by allowing clearing
agencies to streamline the delivery process, employ common and
coordinated risk management and margin methodologies, and lower costs
for market participants.
A ``two-pot'' arrangement allows for offsets and lowered margin
based on correlations in a members' cleared positions at different
clearinghouses; however, there is not a unified arrangement for risk
management or loss allocations.\96\ The ``two-pot'' cross-margining
arrangements approved by the Commission in the past, including one
between FICC and CME, have allowed clearinghouses to allow credit
against the margin requirement for offsetting positions cleared at
another clearinghouse, but each clearinghouse maintained and managed
separate pools of collateral. The ``one-pot'' arrangement would offer
greater margin reductions than a ``two-pot'' arrangement.
---------------------------------------------------------------------------
\96\ See Securities and Exchange Act Release No. 44301, 66 FR
28297 (May 11, 2001) (approving a ``two-pot'' cross-margining
proposal between FICC's predecessor and CME).
---------------------------------------------------------------------------
As result of these benefits in facilitating a more accurate and
cost-effective system for settlement, the Commission believes that the
proposal would promote the prompt and accurate clearance and settlement
of securities transactions and help assure the safeguarding of
securities and funds in a manner consistent with Section 17A(b)(3)(F)
of the Act.\97\
---------------------------------------------------------------------------
\97\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
D. Additional Reporting
As noted above, FICC has represented that it will provide certain
information and reports to the Commission on an ongoing basis in order
to facilitate ongoing monitoring of the cross-margining arrangement and
thereby help ensure compliance with the standards in Section 17A of the
Act.\98\ In particular, with respect to information pertaining to risk
matters, the Commission believes that these reports would assist the
Commission in its efforts to monitor risk management practices under
the cross-margining arrangement by providing information to help
confirm that the actual performance of the models and systems are
consistent with those anticipated during tests prior to launch.
Specifically, FICC has agreed to provide the following information upon
the proposed rule change becoming effective:
---------------------------------------------------------------------------
\98\ Letter from Michael Bodson, Executive Managing Director,
Fixed Income Clearing Corporation and Walt Lukken, Chief Executive
Officer, New York Portfolio Clearing, LLC (February 27, 2011).
---------------------------------------------------------------------------
For the first 250 trading days upon the proposed rule
change becoming effective, FICC will provide the Commission staff with
quarterly reports that itemize divergences between CME prices and NYSE
Liffe prices for ``look-alike contracts.'' \99\
---------------------------------------------------------------------------
\99\ ``Look-alike contracts'' refers to contracts that have
similar economic features but are traded separately on CME and NYSE
Liffe.
---------------------------------------------------------------------------
Semi-annually, FICC will provide the Commission staff with
reports summarizing the sensitivity of the model used for the NYPC
Agreement and the collected margin to the model's assumptions and
established parameters.
Quarterly, FICC will provide the Commission staff with
detailed portfolio analyses of members participating in the NYPC
Arrangement.
Monthly, FICC will provide the Commission staff with
reports summarizing the details of: (1) Any instances in which the
account of a member participating in the NYPC Agreement experienced a
loss that exceeded its margin requirement and the magnitude of such
loss; (2) FICC's analysis of the sufficiency of NYPC's guaranty fund in
conjunction with NYPC; and (3) FICC's analysis of daily correlations
between the futures and cash products that are subject to the NYPC
Arrangement.
FICC will provide the Commission staff with DTCC's
periodic default simulations that factor in members' participation in
the NYPC Agreement.
For 24 months upon the proposed rule change becoming
effective, FICC will provide the Commission staff with information on a
quarterly basis regarding potential LPPs, including progress on
negotiations and discussions of agreements or potential agreements with
potential LPPs.
FICC will provide the Commission all agreements entered
into between NYPC and any LPPs, as well as all amendments to such
agreements, including, but not limited to, those regarding changes in
the fee arrangements.
V. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in particular Section 17A of the Act \100\ and the rules and
regulations thereunder.
---------------------------------------------------------------------------
\100\ 15 U.S.C. 78q-1.
---------------------------------------------------------------------------
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-FICC-2010-09) be, and hereby
is, approved.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-4836 Filed 3-3-11; 8:45 am]
BILLING CODE 8011-01-P