[Federal Register Volume 61, Number 49 (Tuesday, March 12, 1996)]
[Notices]
[Pages 10045-10048]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-5845]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36933; File No. SR-GSCC-96-01]
Self-Regulatory Organizations; Government Securities Clearing
Corporation; Notice of Filing of a Proposed Rule Change Relating to the
Enhancement of Risk Management Processes
March 6, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on January 5, 1996,
Government Securities Clearing Corporation (``GSCC'') filed with the
Securities and Exchange Commission (``Commission'') the proposed rule
change (File No. SR-GSCC-96-01) as described in Items I, II, and III
below, which items have been prepared primarily by GSCC. The Commission
is publishing this notice to solicit comments on the proposed rule
change from interested persons.
\1\ 15 U.S.C. 78s(b)(1) (1988).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The purpose of the proposed rule change is to modify GSCC's risk
management processes.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, GSCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. GSCC has prepared summaries, set forth in sections (A),
(B), and (C) below, of the most significant aspects of such
statements.\2\
\2\ The Commission has modified the text of the summaries
prepared by GSCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
As a part of GSCC's continuous process of reviewing its risk
management mechanism, GSCC is seeking approval to make various
enhancements and revisions to that mechanism. The impetus for certain
of the enhancements and revisions arose out of the design of the risk
management process for GSCC's newly implemented netting service for
repurchase agreements (``repos'') and as the result of recommendations
made by Commission staff during their inspection of GSCC last year.
Each of the proposed changes to GSCC's risk management process is
described in detail below.
(1) Change in the Clearing Fund Formula: Funds Adjustment Component
A netting member's clearing fund requirement is based on a formula
designed to take into account the two basic risks posed to GSCC by
netting members. These risks are: (1) that a member might not pay a
funds-only settlement amount due to GSCC and (2) that a member might
not deliver or take delivery of securities that comprise a net
settlement position. There are three components to the clearing fund
deposit requirement: (1) the funds adjustment component, (2) the
receive/delivery settlement component, and (3) the repo volatility
component. The sum of the three components is a member's total clearing
fund deposit requirement.
The first component of the clearing fund is the funds adjustment
component, which addresses the potential risk that a member might not
pay a funds-only settlement amount due to GSCC. Historically, this
component has represented about ten percent of the total clearing fund
requirement. The funds adjustment component is 125% of the average of a
member's ten largest funds-only settlement amounts measured on an
absolute basis during the most recent seventy-five business days.
Because GSCC did not have an historical data base, the use of the
additional twenty-five percent cushion was introduced at the start of
the netting system in 1989 as a conservative measure designed to ensure
that GSCC's original margin process was a prudent one. GSCC now
believes that this cushion is no longer necessary because the funds
adjustment component recently was made more conservative with revisions
to take into account the ten largest funds amounts over the most recent
seventy-five business days.\3\ However, under the proposed rule change
GSCC will retain the right to reinstitute at its discretion all or a
part of this cushion for a temporary period. For example, GSCC might
reinstitute this cushion under volatile market conditions.
\3\ Prior to the implementation of GSCC's netting service for
repos, GSCC's rules required computation of the average of a
member's absolute funds amounts over the prior twenty business days.
Securities Exchange Act Release No. 36491 (November 17, 1995), 60 FR
61577 (order approving proposed rule change).
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Moreover, GSCC believes that the use of an average of the ten
largest amounts leads to an overly conservative measure of funds
settlement exposure. Thus, GSCC proposes to revise the funds adjustment
component to require 100% of the average of the twenty largest funds-
only settlement amounts during the most recent seventy-five business
days.\4\
\4\ This change will be made to both paragraphs (b) and (d) of
Rule 4, Section 2 of GSCC's rules. Paragraph (b) applies to bank
netting members, Category 1 dealer netting members, Category 1
futures commission merchant netting members, Category 2 inter-dealer
broker netting members, government securities issuer netting
members, insurance company netting members, and registered
investment company netting members. Paragraph (d) applies to
Category 2 dealer netting members and Category 2 futures commission
merchant netting members.
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(2) Change in the Clearing Fund Formula: Receive/Deliver Settlement
Component
The second component of the clearing fund requirement is the
receive/deliver settlement component, which is based on the size and
nature of a member's net settlement positions. The margin collected on
net settlement positions is determined by applying margin factors that
are designed to estimate daily security price movements. The factors
are expressed as percentages and are determined by historical daily
price volatility.\5\ The product of a security's settlement value and
its corresponding margin factors is used as proxy for the estimated
amount of loss to which GSCC is potentially exposed from price changes.
\5\ See Section 4 below for a discussion of GSCC's margin
factors.
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There are four potential receive/deliver contribution amounts
computed each day for GSCC netting members other than Category 2 dealer
or Category 2 future commission merchant members.\6\ The four amounts
are compared daily and the largest amount is included in a member's
clearing fund
[[Page 10046]]
requirement. The potential contribution amounts are:
\6\ GSCC's method of calculating the receive/deliver settlement
component for Category 2 dealer and Category 2 futures commission
merchant members is set forth below.
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(i) Post-Offset Margin Amount (``POMA''): The POMA reflects offsets
of gains against losses in liquidating a member's positions that may be
expected based on historical experience. The POMA essentially is a
member's total gross margin (i.e., GSCC's margin factors multiplied by
the dollar value of a member's current outstanding net settlement
position) taking into account allowable offset percentages.\7\
\7\ Margin amounts on receive (long) and deliver (short)
positions are allowed to offset each other. The extent to which an
offset is allowed is determined by product and the degree of
similarity in time remaining to maturity.
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(ii) Average POMA: The average POMA is based, in the ordinary
course, on the member's ten highest POMA amounts occurring in the most
recent seventy-five business days, including the current day's POMA
amount.
(iii) Adjusted POMA: The adjusted POMA is calculated the same as
the POMA with the exception of excluding all trades that are scheduled
to settle on the current day. This is done based on the assumption that
those trades will settle on the current day; thus, calculating POMA in
this manner will more accurately reflect GSCC's settlement exposure
during the current day.
(iv) Liquidation Amount: This is a floor amount equalling fifty
percent of the total gross margin on all long and short positions
without offsets.
The liquidation amount is a conservative measure designed to ensure
that if the margin offsets ordinarily allowed in calculating the
receive/deliver component do not reflect actual market conditions
during a liquidation period, GSCC will still have a sufficient level of
collateral protection. In other words, this minimum requirement
protects against the risk that during a liquidation period the yield
curve will be aberrational. In such a situation, collection of a
minimum amount of margin based on a gross calculation ensures that GSCC
will have sufficient collateral to cover liquidation losses.
GSCC believes that the percentage used to compute the liquidation
amount should be lowered from fifty percent to twenty-five percent. The
imposition of a fifty percent floor (i.e., fifty percent of the total
margin on all long and short positions without offsets) has proven to
be an unduly high minimum. In particular, for a member that engages in
trading activity on a fully-hedged basis, a fifty percent floor
effectively negates the benefits afforded by being fully hedged. GSCC
believes that a twenty-five percent floor amount is sufficient to
protect GSCC from the risk that its margin offsets will not reflect
actual market conditions during a liquidation period.
Moreover, GSCC believes that the use of an average of the ten
largest POMA amounts in calculating the average POMA leads to an overly
conservative measure of securities settlement exposure. Thus, GSCC
proposes to use an average of the twenty largest POMA amounts during
the most recent seventy-five business days.
GSCC also is proposing to delete sections (2)(g)(i) and (2)(g)(ii)
of Rule 4 regarding alternative formulas for the receive/deliver
settlement component of the required clearing fund deposit. GSCC has
not found the alternative calculation under subsection (g)(i), which
disregards when-issued trades that have been issued, to be useful and
subsection (g)(ii) has been made obsolete by the changes approved in
GSCC's filing pertaining to its repo netting service.\8\
\8\ Supra note 3.
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With respect to Category 2 dealer or Category 2 futures commission
merchant members, the receive/deliver settlement component is the
larger of (1) the member's total gross margin without offsets, (2) the
member's total gross margin without offsets and excluding positions due
to settle that day, or (3) the average of the member's largest ten
gross margin amounts over the most recent seventy-five business days.
For the third calculation, GSCC proposes to use the average of the
largest twenty gross margin amounts over the most recent seventy-five
business days.
(3) Change in the Clearing Fund Formula: Repo Volatility Component
The third component of the clearing fund requirement is the repo
volatility component. This component was recently added to GSCC's
clearing fund formula to cover securities' settlement exposure posed by
repo activity. The repo volatility component is the greater of (1) the
product of the repo volatility factor and the market value of the
member's repo transactions taking into account allowable offset
percentages (``repo offset amount'') or (2) the average of a member's
ten highest repo offset amounts over the most recent seventy-five
business days. GSCC proposes to revise the second element of this
calculation to take the average of a member's twenty highest repo
offset amounts over the most recent seventy-five business days.
(4) Providing GSCC With Discretion, within Parameters, to Lower Margin
Factors
GSCC's Membership and Standards Committee (``Committee') reviews on
an ongoing basis the appropriateness of its margin factors \9\ by
examining third-party price volatility data and GSCC's own short-term
and long-term data covering ninety-five and ninety-nine percent of all
price movements. However, GSCC is not allowed under its current rules
to lower any of its margin factors without first obtaining Commission
approval through a formal rule filing process.
\9\ As defined in GSCC's rules, margin factors and Category 2
margin factors are percentages, which GSCC publishes from time to
time, representing variations weighted by maturity and product type.
These margin factors are used in GSCC Rule 4, Section 2 to calculate
the receive/deliver settlement component of the required fund
deposit for GSCC's members.
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GSCC believes that it needs flexibility to lower a margin factor
without first completing the formal rule filing process. Thus, GSCC
proposes to revise its rules to permit the Committee to lower a margin
factor subject to a predefined limitation if the Committee determines
it appropriate based on its review of historical price volatility data
and if the GSCC Board of Directors approves such a lower margin factor.
The predefined limitation would provide that GSCC could reduce a margin
factor to a level that is no lower than the higher of (1) the price
volatility for that remaining maturity category taking into account
ninety-five percent of all movements covering the last calendar quarter
or (2) the price volatility for that remaining maturity category taking
into account ninety-five percent of all movements covering the last
calendar year. With respect to the margin factors for Category 2 dealer
members and futures commission merchant members, the limitation would
provide that GSCC could reduce a margin factor to a level that is no
lower than the higher of (1) the price volatility for that remaining
maturity category taking into account ninety-nine percent of all
movements covering the last calendar quarter or (2) the price
volatility for that remaining maturity category taking into account
ninety-nine percent of all movements covering the last calendar year.
(5) Revision of Certain Margin Factors for Zero-Coupon Government
Securities Other Than Treasury Bills (``Zeros'')
As noted above, GSCC's margin factors are based on an assessment of
historical daily price volatility data. GSCC reviews the accuracy of
those
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margin factors by consideration of third-party price volatility data
and its own short-term and long-term data covering ninety-five and
ninety-nine percent of all price movements. Zeros require different
margin factors than other Treasury securities because zeros generally
are subject to greater price volatility than are other Treasury
securities with the same maturity.
The applicable margin percentages for zeros range from percentages
that are the same as those for other Treasury securities with respect
to shorter-term maturities to two-and-a-half times that applicable to
other Treasury securities with respect to longer-term maturities. These
differences initially were based on the differences in the amount of
haircut factors between zeros and other Treasury securities found in
the United States Treasury Department's liquid capital requirements for
government securities brokers and dealers.
GSCC believes that its current applicable margin factors for zeros
in the three longest remaining maturity classes are too high.\10\ The
current margin factor for zeros with a remaining maturity of seven to
ten years is 1.870 percent, which is well above the price volatility
that GSCC's internal data show for that category under any measure.
Measured against GSCC's data at the ninety-nine percent level over the
past two years, the applicable margin factor is roughly thirty-three
basis points higher. Thus, GSCC proposes to lower the applicable margin
factor for the seven to ten years remaining maturity category to 1.50
percent.
\10\ GSCC's margin factor schedule for zeros is contained in
Exhibit B to GSCC's filing. A copy of the filing and all exhibits is
available for copying and inspection in the Commission's Public
Reference Room.
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The margin factor for zeros with a remaining maturity of ten to
fifteen years is 2.813 percent, which is well above the price
volatility that GSCC's internal data show for that category under any
measure. Measured against GSCC's data at the ninety-nine percent level
over the past two years, the applicable margin factor is almost a point
higher. Thus, GSCC proposes to lower the applicable margin factor for
the ten to fifteen years remaining maturity category to 1.813 percent.
The margin factor of 3.625 percent for zeros with a remaining
maturity of fifteen years or greater, the longest maturity category,
also appears to be too high when compared to the price volatility that
GSCC's internal data show for that category. Again, measured against
GSCC's data at the ninety-nine percent level over the past two years,
the applicable margin factor is eighty-nine basis points higher. Thus,
GSCC proposes to lower the applicable margin factor for the fifteen
years and higher remaining maturity category to 2.625 percent.
(6) Introduction of a Tiered Surveillance Status Mechanism
GSCC proposes to place members that pose a heightened level of
potential risk to GSCC on various levels of surveillance status in
order to facilitate GSCC's ability to protect itself and its members.
At the conclusion of their recent inspection of GSCC, Commission staff
suggested that, in line with what many other clearing agencies have in
place, GSCC establish different classes of surveillance for its
members. GSCC believes this suggestion to be an appropriate one because
it believes that expanding surveillance classes will enable it to
appropriately categorize the degree of risk posed by a member and to
react more swiftly to changes in a member's condition. Members will
also have greater understanding of the specific actions GSCC may take.
GSCC's current rules require that a member be placed on
surveillance status if one or more of a number of circumstances is
present, including but not limited to a significant reorganization or
change in control or management of the member. In addition, GSCC may
place a member on surveillance status if one or more of a number of
factors, such as a member experiencing a condition that could
materially affect its financial or operational capability so as to
potentially increase GSCC's exposure to loss or liability, is present.
GSCC proposes to use three surveillance categories. Under the
proposed rule change, a member will be placed on Class 1 surveillance
status if one or more of a number of factors pertaining to its
financial condition is present, if it has been placed on surveillance
status by another self-regulatory organization, or if it has been
upgraded from Class 2 surveillance status within the past three
calendar months. The financial condition factors that will result in
Class 1 surveillance status include, but are not limited to (1) a
member incurring recent significant net losses, (2) a member's required
fund deposit obligation representing a significant portion of its net
worth or net capital, and (3) a member experiencing any condition that
could materially affect its financial or operational capacity. Class 1
surveillance status will result in GSCC more thoroughly monitoring a
member's financial condition and activities and will provide GSCC with
discretion to require a member to make more frequent financial
disclosures, including interim and/or pro forma reports.
GSCC will place a netting member on proposed Class 2 surveillance
status if one or more of a number of factors is present, including but
not limited to (1) any element of a member's capital position falls
below the minimum requirements, (2) a member has been upgraded from
Class 3 surveillance status within the last three calendar months, (3)
a member temporarily experiences are inability to meet its securities
settlement obligations to GSCC in a timely fashion, and (4) a member's
designated examining authority or appropriate regulatory agency has a
pending action or investigation of the member that could call into
question the member's ability to meet its obligations to GSCC. In
addition to the consequences resulting from placement on Class 1
surveillance status, a member placed on Class 2 surveillance status
will be required to maintain a required fund deposit in excess of the
amount ordinarily required, as permitted under GSCC's rules.
A GSCC netting member will be placed on Class 3 surveillance status
if GSCC is considering taking action under GSCC Rule 18 (Ceasing to Act
for a Member) or GSCC Rule 20 (Insolvency of a Member).\11\ A GSCC
netting member on Class 3 surveillance status shall be placed on a
final notification list. A netting member will remain on such final
notification list until the conditions(s) that resulted in its
assignment to Class 3 surveillance status have improved to an extent
that GSCC deems appropriate to support reassignment of the member to
Class 2 surveillance status.
\11\ Under Rule 18 (Cleasing to Act for a Member), GSCC may
cease to act for a member upon notice to such member for such
reasons as: (1) the member has failed to perform its obligations to
GSCC or materially violated any GSCC rule, procedure, or agreement,
(2) the member has failed to pay GSCC any payment required, (3) the
member no longer meets its admissions or continuance standards, or
(4) the member has been responsible for fraudulent or dishonest
conduct. Under Rule 20 (Insolvency of a Member), GSCC will cease to
act for a member if such member meets one of several tests of
insolvency (e.g., such member files a petition seeking relief under
the Bankruptcy Code).
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(7) Simplification of the Clearing Fund Deficiency Call Mechanism
GSCC's rules currently permit GSCC to make clearing fund deficiency
calls on a same day basis under the following four circumstances: (1) a
member's current day's required clearing fund deposit exceeds by
twenty-five percent the value of its clearing fund collateral,
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(2) a member's current day's required clearing fund deposit level
exceeds by more than $250,000 the value of its clearing fund
collateral, (3) a member is on surveillance status and its required
clearing fund deposit as of the current day exceeds the value of its
clearing fund collateral, or (4) a member's ``clearing fund funds-only
settlement amount,'' which excludes clearance difference, invoice
amount, and other miscellaneous amounts, for the current day exceeds by
more than twenty-five percent its average daily clearing fund funds-
only settlement amount over the most recent twenty business days.\12\
\12\ The clearance difference is the dollar difference between
GSCC's system price for a settlement obligation and the actual value
at which the settlement obligation was settled. The invoice amount
means all fees that a member owes GSCC.
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Over the years, the fourth circumstance, a twenty-five percent jump
in the member's clearing fund funds-only settlement amount, which could
represent a relatively small dollar amount, has not proven to be
necessary and has become obsolete as a practical matter. At the
conclusion of their recent inspection of GSCC, Commission staff
suggested that GSCC should either monitor the funds-only deficiency
call requirements or file with the Commission a proposed rule change
eliminating it. GSCC believes that the funds-only deficiency call
aspect of the clearing fund is unnecessary and should be eliminated.
Moreover, because GSCC is proposing the tiered surveillance status
mechanism, GSCC believes that a clearing fund deficiency call, pursuant
to which GSCC calls for any amount of deficiency, that is based on a
member being on surveillance status should be invoked only if a member
is on Class 2 or Class 3 surveillance status. Finally, since 1989 when
the netting system was implemented, GSCC's rules have provided that
GSCC automatically may make a clearing fund deficiency call at the
beginning of each month. Given the adequacy of the same day deficiency
call mechanism outlined above, GSCC believes that this monthly
deficiency call mechanism is no longer appropriate and is therefore
proposing to delete this provision.
(8) Elimination of the Noon Deadline for Satisfaction of Clearing Fund
Deficiency Calls
GSCC issues by telephone call followed by telefax notices calls for
additional clearing fund deposits by 9:00 a.m. The exact time that each
telephone call is made is recorded. Under GSCC's current rules, a
member has until the later of two hours after the receipt of a clearing
fund deficiency call or noon to satisfy the call.
Receipt of clearing fund margin as early in the day as possible is
a fundamental principle behind optimal risk management. GSCC's long
term goal is to develop an automated mechanism pursuant to which it
will be in receipt of clearing fund collateral by the time that the
securities Fedwire opens in the morning, which is currently at 8:30
a.m.
As an interim step toward achieving this goal, GSCC is proposing to
eliminate the 12:00 p.m. alternative deadline for satisfaction of a
clearing fund deficiency call and to require a member to satisfy a
deficiency call within two hours after it is received. The practical
effect of this change is that, in the ordinary course, a member will
have to satisfy a deficiency call by approximately 11:00 a.m. In order
to ensure that the elimination of the noon deadline does not produce an
unduly harsh effect on members, GSCC also is proposing that a clearing
fund deficiency call does not need to be satisfied before 10:00 a.m.
regardless of when the call actually is made.
GSCC believes the proposed rule change will enhance GSCC's risk
management processes in a prudent manner that is consistent with
minimizing operational burdens on GSCC netting members and with
maximizing the members' liquidity. Thus, GSCC believes the proposed
rule change is consistent with the Section 17A of the Act and the rules
and regulations thereunder applicable to a self-regulatory
organization.\13\
\13\ 15 U.S.C. 78q-1 (1988).
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(B) Self-Regulatory Organization's Statement on Burden on Competition
GSCC does not believe that the proposed rule will have an impact on
or impose a burden on competition.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants, or Others
Comments on the proposed rule change have not yet been solicited.
GSCC members will be notified of the rule filing and comments will be
solicited by an important notice. GSCC will notify the Commission of
any written comments received by GSCC.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within thirty-five days of the date of publication of this notice
in the Federal Register or within such longer period (i) as the
Commission may designate up to ninety days of such date if it finds
such longer period to be appropriate and publishes its reasons for so
finding or (ii) as to which the self-regulatory organization consents,
the Commission will:
(a) by order approve such proposed rule change or
(b) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street NW., Washington, DC 20549. Copies
of the submission, all subsequent amendments, all written statements
with respect to the proposed rule change that are filed with the
Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Section, 450 Fifth Street NW.,
Washington, DC 20549. Copies of such filing also will be available for
inspection and copying at the principal office of GSCC. All submissions
should refer to the file number SR-GSCC-96-01 and should be submitted
by April 2, 1996.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\14\
\14\ 17 CFR 200.30-3(a)(12) (1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-5845 Filed 3-11-96; 8:45 am]
BILLING CODE 8010-01-M
