On October 30, 2015, National Securities Clearing Corporation (“NSCC”) filed with the Securities and Exchange Commission (“Commission”) proposed rule change SR-NSCC-2015-007 pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”),^[1] and Rule 19b-4 thereunder,^[2] to amend NSCC's Rules and Procedures (“Rules”) ^[3] to allow certain users of NSCC's Alternative Investment Product Services (“AIP”) to settle at the sub-account level and to make related technical changes and corrections to the Rules, as more fully described below. The proposed rule change was published for comment in the Federal Register on November 10, 2015.^[4] The Commission did not receive any comment letters on the proposed rule change. For the reasons discussed below, the Commission is granting approval of the proposed rule change.

I. Description of the Proposed Rule Change

The following is a description of the proposed rule change, as provided by NSCC:

Background. In 2008, the Commission approved NSCC's proposed rule change to establish AIP, a non-guaranteed processing platform for alternative investment products such as hedge funds, funds of hedge funds, commodities pools, managed futures, Start Printed Page 79369and real estate investment trusts.^[5] AIP facilitates, among other things, processing activities such as subscriptions and redemptions, distributions, position reporting, and account maintenance relating to alternative investment products and settles related payments (“AIP Payments”).

Settlement of AIP Payments is done on a prefunded basis. On each date for which settlement will occur (“Settlement Date”), an AIP participant (“AIP Member”) that is in a debit position for such day must satisfy its full debit balance before NSCC will settle any contra-side credit positions with respect to such AIP Member. NSCC simply passes AIP Payments from one AIP Member to the contra-side AIP Member without netting and without guaranteeing payment, and settlement of AIP Payments is segregated from all other money settlement at NSCC.

Participation in AIP is governed by Rule 53 of NSCC's Rules. A party seeking to be an AIP Member is required to enter into a separate AIP membership agreement with NSCC, even if it is otherwise a participant of other NSCC services.

AIP Members are divided into two categories—“AIP Manufacturers” and “AIP Distributors”. AIP Manufacturers act on behalf of, or under authority of, the sponsor, general partner, or other party responsible for the creation or manufacturing of an eligible alternative investment product (“Eligible AIP Product”). AIP Manufacturers are generally the fund entities themselves (“Funds”). AIP Distributors act on behalf of, or under authority of, a customer or other investor in an Eligible AIP Product. AIP Distributors are generally the broker/dealers whose clients invest in Eligible AIP Products.

Fund Administrators. Within the alternative investments industry, there are parties on the creation/manufacturing side of transactions known as “fund administrators”. Fund administrators are not the Funds themselves, but rather, agents for the Funds. Where a Fund engages a fund administrator to act on the Fund's behalf, it is typically the fund administrator that handles all of the transaction processing for that Fund.

Within AIP, a fund administrator is a party engaged under contract to provide administrative services with respect to one or more Eligible AIP Products and is eligible to be an AIP Member as an AIP Manufacturer (“AIP Fund Administrator”). In general, AIP Fund Administrators process AIP transactions with respect to their various Fund clients by creating separate sub-accounts within AIP, each of which is attributable to a specific Fund client. In this structure, the Fund client generally would not be an AIP Member.

Under the current AIP Rules, AIP Fund Administrators are responsible for all activities related to their sub-accounts. These activities include, for example, submitting, reviewing, and confirming order instructions, reviewing and confirming settlement statements, and making AIP Payments. With respect to making AIP Payments, the Rules provide that on Settlement Date all sub-account obligations roll up to the AIP Fund Administrator's primary AIP account. These obligations are then presented to the AIP Fund Administrator's settlement bank for gross debit settlement and gross credit settlement.

Because AIP Fund Administrators are responsible for settlement of AIP Payments, an AIP Fund Administrator in a debit position on Settlement Date must assure that each applicable Fund client has timely delivered payment to such AIP Fund Administrator's settlement bank. To the extent that a single Fund client fails to deliver its payment on Settlement Date (and the AIP Fund Administrator is not otherwise able to cover such Fund's shortfall), NSCC is required to reverse all of the AIP Fund Administrator's contra-side credit positions for the day, including the contra-side credit positions attributable to Funds that actually did pay.

In recent months, NSCC has learned from several fund administrators interested in becoming AIP Members that the responsibility to make AIP Payments at NSCC is a responsibility that fund administrators generally do not undertake outside of AIP. In the current processing environment outside of AIP, fund administrators perform all transaction processing functions for their Funds, but they generally do not control money settlement.

As explained by certain fund administrators to NSCC, the current AIP Payment structure as applied to AIP Fund Administrators has slowed adoption of AIP by the fund administrator community.

Proposed Rule Change. To address this matter, NSCC has proposed to permit AIP Fund Administrators, at their discretion, to create sub-accounts that settle separately from their primary AIP accounts, as well as from their other AIP sub-accounts, (“AIP Settling Sub-Accounts”).

An AIP Fund Administrator choosing to create an AIP Settling Sub-Account will designate to NSCC the applicable Fund client with responsibility for settlement of AIP Payments with respect to such AIP Settling Sub-Account. Such designated Fund will not be an AIP Member (“AIP Non-Member Fund”). Each such AIP Non-Member Fund will enter into a standard agreement pursuant to which an NSCC-approved AIP Settling Bank will perform settlement services directly for the AIP Non-Member Fund (“Appointment of AIP Settling Bank and AIP Settling Bank Agreement”).

Under the proposal, AIP Fund Administrators will remain responsible for all activities with respect to their AIP Settling Sub-Accounts, except that AIP Fund Administrators will not be responsible for settling AIP Payments. For example, AIP Fund Administrators will remain responsible for order processing applicable to their AIP Settling Sub-Accounts, including submitting, reviewing, and confirming order instructions. In addition, AIP Fund Administrators will be responsible for informing their AIP Non-Member Funds of their respective daily AIP Payment obligations. All reporting, liability, and indemnification obligations to NSCC under NSCC's Rules will remain with the AIP Fund Administrator.

As is the case today, settlement of all AIP Payments will be done on a prefunded basis. NSCC will not net or guarantee any AIP Payments with respect to AIP Settling Sub-Accounts, and all settlement of AIP Payments (including those of AIP Non-Member Funds) will continue to be segregated from all other money settlement at NSCC.

Prior to NSCC approving any AIP Settling Sub-Account, NSCC will require the applicable AIP Fund Administrator to enter into documentation and/or agreements, or otherwise procure documentation and/or agreements, in such form as required by NSCC from time to time, which will contain:

• The AIP Fund Administrator's acknowledgement and agreement that it will be responsible for all matters, activities, liabilities, and obligations applicable to AIP Members under the Rules with respect to such AIP Settling Sub-Account, except for settlement of AIP Payments;
• the AIP Fund Administrator's agreement to indemnify NSCC for any loss, liability, or expense sustained by NSCC in connection with, arising from, or related to such AIP Settling Sub-Account, including with respect to the Start Printed Page 79370Foreign Account Tax Compliance Act (“FATCA”); ^[6]

• the AIP Fund Administrator's agreement that it will be responsible for (A) all charges incurred and payments due under Rule 26 (Bills Rendered) for the processing of AIP Settling Sub-Account transactions through AIP and (B) any other charges that may be incurred with respect to such AIP Settling Sub-Account under Rule 24 (Charges for Services Rendered);
• the AIP Fund Administrator's designation of the AIP Non-Member Fund with responsibility for making AIP Payments with respect to such AIP Settling Sub-Account;
• the AIP Non-Member Fund's consent and approval with respect to such designation;
• the AIP Fund Administrator's agreement of its obligation to notify NSCC of changes in condition to the AIP Non-Member Fund that would otherwise require notice to NSCC under Rule 2B (Ongoing Membership Requirements and Monitoring) or Rule 20 (Insolvency);
• the AIP Fund Administrator's agreement of its obligation to notify the applicable AIP Non-Member Fund of such AIP Non-Member Fund's daily AIP Payment balance; and
• the AIP Non-Member Fund's appointment of an AIP Settling Bank, and such AIP Settling Bank's agreement to act as AIP Settling Bank for such AIP Non-Member Fund.

In addition, the applicable AIP Fund Administrator will need to obtain from the applicable AIP Non-Member Fund tax documentation in such form as required by NSCC from time to time, and with respect to any AIP Non-Member Fund that is treated as a non-U.S. entity for U.S. federal income tax purposes, the AIP Fund Administrator will need to provide NSCC with an executed FATCA certification from such AIP Non-Member Fund in the form approved by NSCC.

On a going-forward basis with respect to FATCA, AIP Fund Administrators will need to obtain from their AIP Non-Member Funds periodic tax documentation, including FATCA certifications to the extent applicable, and provide such documentation to NSCC. Failure to provide such tax documentation, including FATCA certifications, in the manner and timeframes set forth by NSCC from time to time will result in revocation of NSCC's approval, in NSCC's sole and absolute discretion, of such AIP Settling Sub-Account.

Under the proposal, AIP Fund Administrators will be required to indemnify NSCC for any loss, liability, or expense sustained by NSCC in connection with, arising from, or related to FATCA in respect of their AIP Settling Sub-Accounts. The FATCA-related provisions in this proposed rule change are substantially similar to the current provisions in the Rules governing how NSCC monitors and treats its non-U.S. members with respect to FATCA.

In connection with this proposal, NSCC will amend the following Rules:

• Rule 1. Definitions