[Federal Register Volume 59, Number 78 (Friday, April 22, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-9710]
[[Page Unknown]]
[Federal Register: April 22, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33911; File No. 600-27]
Self-Regulatory Organizations; Clearing Corporation for Options
and Securities; Filing of Amendment to Application for Exemption From
Registration as a Clearing Agency
April 15, 1994.
On October 7, 1993, the Clearing Corporation for Options and
Securities (``CCOS'')\1\ filed with the Securities and Exchange
Commission (``Commission'') an amendment to its application for
exemption from registration as a clearing agency\2\ pursuant to section
17A of the Securities Exchange Act of 1934 (``Act''),\3\ and rule
17Ab2-1 thereunder.\4\ The Commission is publishing this notice to
solicit comments from interested persons concerning CCOS's amended
exemption application. In preparing submissions on this matter,
commentators are urged to review the text of the CCOS Release, attached
as appendix A to this release,\5\ and CCOS's revised application,
rules, and procedures, which are available from the Commission's Public
Reference Room as described below. Commentators are advised not to rely
solely on the terms of this release in preparing their comments.
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\1\CCOS filed its application for exemption from registration as
a clearing agency on December 14, 1992. See Securities Exchange Act
Release No. 32481 (June 16, 1993), 58 FR 34105 [File No. 600-27]
(``CCOS Release'') attached as Appendix A to this release.
\2\Letter from Dennis Dutterer, Executive Vice President and
General Counsel, Board of Trade Clearing Corporation (``BOTCC''), to
Jonathan Katz, Secretary, Commission (October 6, 1993). Letter from
Fred Grede, Vice President, Board of Trade of the City of Chicago
(``CBOT''), to Brandon Becker, Director, Division of Market
Regulation (``Division''), Commission (October 6, 1993).
\3\15 U.S.C. 78q-1 (1988).
\4\17 CFR 240.17Ab2-1 (1922).
\5\Supra note 1.
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I. Introduction
In its application for exemption from registration as a clearing
agency, CCOS\6\ set forth its proposal to provide clearance and
settlement services for government securities transactions executed
through Chicago Board Brokerage, Inc. (``CBB''), a wholly-owned
subsidiary of the Board of Trade of the City of Chicago (``CBOT'').\7\
Shortly after notice of the application appeared in the Federal
Register, the CBOT terminated its business relationship with EJV
Partners, L.P. (``EJV''), which was to provide the CBOT with a screen-
based proprietary trading system.\8\
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\6\CCOS is a wholly-owned subsidiary of Board of Trade Clearing
Corporation (``BOTCC'') which provides clearing services for futures
and commodities transactions executed on the Board of Trade of the
City of Chicago.
CCOS previously filed two applications for registration as a
clearing agency. In its first application, filed on October 14,
1988, and subsequently withdrawn, CCOS proposed to clear exchange-
traded options issued by The Options Clearing Corporation (``OCC'').
See Securities Exchange Act Release No. 27083 (August 1, 1989), 54
FR 32410. In the second application, filed on October 21, 1991, CCOS
proposed to clear over-the-counter options on government securities.
This application also has been withdrawn. Letter from Dennis
Dutterer, General Counsel, CCOS, to Jonathan Kallman, Associate
Director, Division of Market Regulation, Commission (December 11,
1992).
\7\CBB will execute trades in government securities (unmatured,
marketable debt securities in book-entry form that are direct
obligations of the United States Government).
\8\Letter from Frederick J. Grede, Vice President, CBOT, to
Brandon Becker, Acting Director, Division, Commission (June 30,
1993).
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Substantially, CBOT, through CBB, created a proprietary electronic
trading system which will perform the same functions in the system as
those originally proposed to be performed by EJV. On October 6, 1993,
CBOT informed the Commission of its intention to move forward with its
proposal to offer electronically brokered cash transactions in U.S.
Government securities and related products through CBB.\9\
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\9\Supra note 2.
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II. Description of the Amended Proposal
A. Registration of CBB
The original business plan proposed by the CBOT called for CBB to
succeed to the broker-dealer registration of EJV. CBOT now intends to
register CBB as a U.S. Government securities broker pursuant to Section
15C of the Act\10\ and to proceed with CBB's membership with the
National Association of Securities Dealers (``NASD'') as required by
such Section.\11\
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\10\15 U.S.C. 78o-5 (1988).
\11\15 U.S.C. 78o-5(e)(1) (1988).
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As described more fully in the CCOS Release, CBB's business will be
limited to acting as an intermediary for U.S. Government securities
transactions paired through the computer system.\12\ The system will
permit the trading of cash securities, independently and in conjunction
with CBOT futures on cash securities (also known as ``basis
contracts''),\13\ and repurchase and reverse repurchase agreement
contracts involving cash securities (``Dollar Rolls'')\14\ in cash
securities. Under the CBB proposal, therefore, CBOT traders in cash
securities will be able to buy and sell securities underlying CBOT
futures contracts and through Dollar Rolls execute trades that help
finance positions and promote inventory management.
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\12\For a detailed description of the products traded through
the CBB trading system, refer to the CCOS Release, supra note 1, at
34105 and 34106.
\13\A basis trade is a trade in which the participants agree to
simultaneously buy/sell cash securities against the offsetting
equivalent CBOT Treasury futures contract. The basis represents the
price differential between a cash security and the futures delivery
price.
\14\In a Dollar Roll transaction, the seller of the contract
delivers notes or bonds to the buyer in exchange for cash.
Settlement occurs the same day. At the time of execution, the seller
and buyer also agree to reverse the transaction at a price that
includes a financing interest amount, with settlement occurring the
next day.
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CCOS will clear all transactions executed through CBB. CCOS's
application for exemption, filed on Form CA-1, includes rules,
procedures, and guidelines for the clearance and settlement of
government securities. BOTCC, as sole owner and parent of CCOS, will
guarantee CCOS's obligations arising under CCOS's rules, and the
clearance and settlement services of CCOS will be modeled after
established procedures currently utilized by BOTCC.\15\
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\15\See CCOS Release, supra note 1.
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B. Development of Computer Facilities by CBB
Undet the amended application, CBB will create, operate, and
maintain the computer system that enables quotations to be entered and
executed. CBB has developed trade matching software for U.S. Treasury
bills, notes, and bonds, including when-issued securities, basis
trades, and Dollar Rolls. The trade matching algorithm will be based on
time priority according to price.
Under the terms of the proposal any CCOS participant or affiliate
of a CCOS participant who is also a CBOT member or member firm will be
able to obtain a CBB trading terminal.\16\ Each CCOS participant will
be required to enter into an agreement with CBB setting forth the terms
and conditions of access to and use of CBB's terminals.\17\ A terminal
operator will be able to view the video display to see the prices and
quantities of anonymous bids and offers in the marketplace available
for trading and to review its orders or trading activity.
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\16\Participation in CCOS will be limited to members of BOTCC
and members of the CBOT that are affiliated with members of BOTCC.
See CCOS Release, supra note 1, note 16.
\17\Only CBOT individual members, employees of individual
members, and employees of CBOT member firms will be permitted to
operate terminals. Each terminal will be uniquely identified in its
communication with the central site, and each terminal operator will
be assigned an identification number. CBB will maintain complete,
time-sequenced electronic audit trails on all orders entered on, and
all transactions executed through, the CBB trading system. The
recorded activity will indicate, for a given order or transaction,
the identity of the terminal operator entering, changing, or
cancelling orders, the time such entry or change was effected, and
the date, time, volume, security, and price of each transaction
executed through the trading system.
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CBB is developing several methods for market participants to access
the CBB trading system.\18\ CBB proposes to: (1) Provide CBOT
workstation terminals which will access the CBB trading system and
include other market information and trading systems available through
the CBOT;\19\ (2) provide an interface between CBB's central computer
and a CBOT member's or member firm's internal computer network; and (3)
provide access through an interface with quotation vendors.\20\
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\18\See draft no-action letter on exchange registration from
Mark Young, Kirkland & Ellis, to Brandon C. Becker, Esq., Director,
Division, Commission, (December 1, 1993).
\19\The CBB trading system is based on a modification of the
CBOT's Project A trading system. Project A, available to CBOT
members, is an electronic order entry facility developed for trading
over a local area network (for example, within the CBOT building)
the CBOT's futures contracts, options on futures contracts, and
other financial products. The Project A system is designed to
facilitate trading by active order matching or through the posting
of bids/offers on an electronic bulletin board.
\20\Quotation vendors will offer CBB trading screens and order
entry capability through their terminals, which are served by
national telecommunications networks. CBB will contract on a non-
exclusive basis with one or more quotation vendors, each having
interactive capabilities, to carry the CBB system for use by CBOT
members and member firms.
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III. Public Interest Statement
CCOS and BOTCC believe that the only changes the CBB business plan
since the time of CCOS's application are that (1) the electronic
trading system software utilized by CBB has been developed by CBB,
rather than purchased from EJV, and (2) the terminals through which the
trading system may be accessed will be via CBOT suppled work stations,
via a direct connection to a member firm's internal computer network,
or via a vendor distribution system as described above.\21\ CCOS
represents that their procedures for clearance and settlement of CBB
transactions and their membership criteria have not changed since the
time of publication of the notice of filing of CCOS's application to
the Commission. Therefore, CCOS believes that it is appropriate at this
time for the Commission to consider its application for exemption from
registration as a clearing agency.
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\21\Supra note 2.
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IV. Solicitation of Comments
You are invited to submit written data, views, and arguments
concerning the foregoing application by May 23, 1994. Such written
data, views, and arguments will be considered by the Commission in
deciding whether to grant CCOS's request for exemption from
registration.
In the CCOS Release the Commission requested that commentators
address certain questions regarding the effect of the CCOS exemptive
application upon the national clearance and settlement system.
Specifically, the Commission invited commentators to address whether:
(10) the Commission should require an applicant for exemption from
registration as a clearing agency to meet standards substantially
similar to those required of registrants to assure that the fundamental
goals of the Act (i.e., safe and sound clearance and settlement) are
not undermined, (2) registration of CCOS would result in increased
competition among broker-dealers, including greater access to the
government securities market by persons other than primary dealers, and
among clearing agencies in the clearing of transactions in government
securities, (3) the proposal would impose any burden on competition
that is inappropriate under the Act, (4) CCOS's application raises the
question of whether the establishment of multiple government securities
clearing corporations is consistent with Section 17A of the Act,
including whether one-account settlement could be attained with
multiple clearing agencies and the effect of market stress on a
multiple clearing system, (5) the manner in which multiple clearing
facilities for cash securities and affiliated clearing facilities for
cash securities and futures contracts on those securities could
efficiently integrate those systems, (6) the proposed margin
calculations and procedures adequately address the risks of the
proposal, (7) relying on BOTCC as guarantor of CCOS's obligations,
rather than a clearing fund or similar alternatives, ensures system
liquidity, and (8) an order granting an exemption should contain
certain clearing volume limits.\22\
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\22\For a detailed analysis of these issues, see the CCOS
Release, supra note 1, at 34108.
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The Commission is concerned that because of the termination of the
CBOT/EJV business relationship, commentators did not address the
systemic concerns raised in the above questions during the previous
comment period. Therefore, the Commission again invites the
commentators to address the questions raised above and those raised in
the CCOS Release.
Persons desiring to make written submissions should file six copies
thereof with the Secretary, Securities and Exchange Commission, 450
Fifth Street NW., Washington, DC 20549. Reference should be made to
File No. 600-27. Copies of the application and all written comments
will be available for inspection at the Commission's Public Reference
Room.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
Appendix A
Securities and Exchange Commission
[Release No. 34-32481; File No. 600-27]
Self-Regulatory Organizations; Clearing Corporation for Options and
Securities; Filing of Application for Exemption From Registration as a
Clearing Agency
June 16, 1993.
On December 14, 1992, the Clearing Corporation for Options and
Securities (``CCOS'')\1\ filed with the Securities and Exchange
Commission (``Commission'' or ``SEC'') an application for exemption
from registration as a clearing agency pursuant to section 17A of the
Securities Exchange Act of 1934 (``Act'')\2\ and rule 27Ab2-1
thereunder.\3\ The Commission is publishing this notice to solicit
comments from interested persons.
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\1\CCOS is a wholly-owned subsidiary of the Board of Trade
Clearing Corporation (``BOTCC'') which provides clearing services
for futures and commodities transactions executed on the Board of
Trade of the City of Chicago (``CBOT'').
CCOS previously filed two applications for registration as a
clearing agency. In its first application, filed on October 14,
1988, CCOS proposed to clear exchange-traded options issued by The
Options Clearing Corporation. See Securities Exchange Act Release
No. 27083 (August 1, 1989), 54 FR 32410. That application
subsequently was withdrawn. Letter from Dennis Dutterer, Executive
Vice-President and General Counsel, BOTCC, to Jerry Carpenter,
Branch Chief, Division of Market Regulation, Commission (November 6,
1991). In the second application, filed on October 21, 1991, CCOS
proposed to clear over-the-counter options on government securities.
This application also has been withdrawn. Letter from Dennis
Dutterer, General Counsel, CCOS, to Jonathan Kallman, Associate
Director, Division of Market Regulation, Commission (December 11,
1992).
In this regard, the Commission staff will discuss the issues
raised by this application, which involves transactions in and
clearing of related cash government securities and futures
positions, with the Commodity Futures Trading Commission, the Board
of Governors of the Federal Reserve System and the Department of the
Treasury. This release does not address the application of the
Commodity Exchange Act to issues discussed in this release.
\2\15 U.S.C. 78q-1 (1988).
\3\17 CFR 240.17Ab2-1 (1992).
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I. Introduction
CCOS is proposing to provide clearance and settlement services for
government securities transactions executed through Chicago Board
Brokerage, Inc. (``CBB'').\4\ CCOS's application for exemption, filed
on Form CA-1, includes rules, procedures, and guidelines for the
clearance and settlement of government securities. BOTCC, as sole owner
and parent of CCOS, will guarantee CCOS's obligations arising under
CCOS's rules, and the clearance and settlement services of CCOS will be
modeled after established procedures currently utilized by BOTCC.
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\4\ CBB will be a registered broker-dealer under the Act and is
a wholly-owned subsidiary of the CBOT. As discussed below, CBB will
execute trades in government securities (unmatured, marketable debt
securities in book-entry form that are direct obligations of the
United States Government).
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CCOS is seeking an exemption from registration as a clearing agency
to permit CCOS to provide what it believes to be an innovative and
important service related to the futures markets and the market for
U.S. Treasury securities (``cash securities''). CCOS intends to file an
application for registration as a clearing agency in the near
future.\5\
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\5\The Commission will publish notice of that filing in
accordance with section 19(a)(1) of the Act at the appropriate time.
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II. Description of Proposal
A. Trade Clearance and Settlement
As noted above, CCOS is proposing to provide clearance and
settlement facilities for trades executed by CBB and its customers in
the CBB trading system. The CBB trading system is designed to offer
CBOT members an opportunity to execute a customized package of
transactions related to Treasury futures contracts currently traded on
the CBOT. CBB will execute the transaction as riskless principal,
becoming the counterparty both to the buyer and to the seller. All
trades will be effected through the CBB's electronic network.\6\
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\6\Each participant of CBB will obtain trading terminals having
a CPU, video display monitor, specialized keypad, and a printer,
which will be linked by datalines to a central computer facility
operated by EJV Partners, L.P. (``EJV''). In order to obtain a
terminal, the CCOS participant or non-CCOS CBOT member will be
required to enter into a ``customer agreement'' with CBB, which sets
out the terms and conditions of access to and use of the terminals.
In addition, an employee of a CCOS participant firm or a non-CCOS
CBOT member or its employee obtaining a terminal will be required to
obtain a certification that the CCOS participant clearing its
transactions will be responsible for the acts of the CCOS
participant employee, non-CCOS CBOT member, or non-CCOS CBOT member
employee. Because each terminal is uniquely identified in its
communications with the central site, CBB will know the identity of
the customer entering each order through a terminal, i.e., the
identity of the CCOS participant, CCOS participant employee, non-
CCOS CBOT member, or non-CCOS CBOT member employee to which the
terminal has been made available. CCOS participants or non-CCOS CBOT
members may establish agent terminals designed to enter quotations
for multiple customers who are identified by subaccount numbers. CBB
will maintain complete, time-sequenced electronic audit trails on
all orders entered on, and all transactions executed through, the
system. The recorded activity will indicate, for a given order or
transaction, the identity of the customer entering, changing or
cancelling orders, and the time and terminal through which such
entry or change was effected, and the date, time, volume, security,
customer, and price of each transaction executed through the system.
Upon execution of an order, the customer will receive an electronic
confirmation of the transaction, which can be printed out in hard
copy on a dedicated printer connected to the customer's terminal.
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The system will permit the trading of cash securities,
independently and in conjunction with CBOT futures on cash securities
(also known as ``basis contracts''),\7\ and repurchase and reverse
repurchase agreement contracts involving cash securities (``Dollar
Rolls'')\8\ in cash securities. Under the CBB proposal, therefore, CBOT
traders in cash securities will be able to buy and sell securities
underlying CBOT futures contracts and through Dollar Rolls execute
trades that help position and inventory management.
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\7\A basis trade is a trade in which the participants agree to
simultaneously buy/sell cash securities against the offsetting
equivalent CBOT Treasury futures contract. The basis represents the
price differential between a cash security and the futures delivery
price.
\8\In a Dollar Roll transaction, the seller of the contract
delivers notes or bonds to the buyer in exchange for cash.
Settlement occurs the same day. At the same time of execution, the
seller and buyer also agree to reverse the transaction at a price
that includes a financing interest amount, with settlement occurring
the next day.
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The cash securities listed for purchase or sale will consist of
Treasury bills (with more than fourteen days to maturity), notes, and
bonds, in their various maturities, deliverable under financial futures
contracts traded on the CBOT. The settlement date for outright purchase
and sale transactions will be the next business day, except for when-
issued (``WI'') securities,\9\ which will settle on the day of issuance
by the U.S. Treasury.
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\9\CBB will offer WI securities for forward purchase and sale.
WI securities are those securities that the U.S. Treasury has
announced it will sell in a public auction on a specific date in the
near future or that have been auctioned but not settled. WI
securities trade in the secondary market from the time the U.S.
Treasury announces their scheduled auction through the actual
issuance of the securities. The Treasury announces the auction date,
the maturity date of the securities, and the par amount to be
auctioned. WI securities trade on the basis of yield to first call,
instead of price, because the coupon rate for the securities is not
determined until the auction.
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The system will permit users to execute basis trades as a single
transaction where the price will reflect the spread in basis points
between the futures contract and the underlying cash securities; the
cash securities will be priced at a certain number of basis points
above or below the futures contract.\10\
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\10\The futures leg of the basis trade will take the last
reported trade price from the CBOT trading floor as the futures
transaction price. The transaction ticket for the cash leg of basis
trades will include the commission charges and accrued interest.
Settlement for the cash leg will occur on the next business day in
the same manner as outright cash trades.
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Dollar Roll transactions are designed to facilitate the financing
of cash securities or the loaning of excess funds in exchange for cash
securities.\11\ Dollar Rolls will result in the creation of two
simultaneous outright cash trades. For trades executed during the
morning session, the first leg will be for same day (``T'') settlement
and the second leg will be for next day (``T+1'') settlement. Dollar
Rolls executed in the afternoon session will settle the first leg on
T+1 and the second leg on the following business day (``T+2). CBB will
have one trading session for Dollar Rolls from the opening of trading,
8 a.m. to 11 a.m., and an afternoon session for Dollar Rolls from 3:15
p.m. to 5 p.m.\12\
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\11\The CBB terminals will list the Dollar Roll spreads by
bidding and offering financing rates reflecting the annualized
interest rate paid or received on the transaction. The transaction
amount or value price on the trade date will reflect the settlement
value of the first leg of the Dollar Roll. The settlement value is
the funds required to make or take delivery of the security. The
transaction amount for the second leg of the Dollar Roll will
reflect the fact that the holder of the overnight bond will not earn
the coupon interest during the term of the transaction.
\12\Unless otherwise noted, all times stated are Eastern
Standard Time.
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Under the proposal, CBB will submit computer matched trades to CCOS
on a real time basis so that trade data executed through CBB
immediately flows to CCOS. CCOS will perform all clearance and
settlement functions for transactions in cash securities, including:
Delivery versus payment processing, position consolidation, and
original and variation margin calculation and processing as discussed
below. BOTCC will enter into a cross-margining agreement with CCOS that
will allow common participants to combine cash securities and futures
positions for cross-margining purposes.\13\ BOTCC will act as guarantor
of CCOS's obligations arising under CCOS's rules and will provide
collection and payment services for CCOS variation and original margin
payments.
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\13\All cash securities positions traded through CBB will be
held in the participants cross-margin account at CCOS. Futures
positions generated by CBB basis trades for proprietary accounts are
automatically placed in the cross-margin account at BOTCC while
futures positions from customer basis trades executed through CBB by
participants will not be permitted to be placed in the cross-margin
account but will be transferred to the participants' BOTCC customer
account. Participants may allocate futures from their BOTCC
proprietary futures account to their BOTCC/CCOS cross-margin account
to hedge unsettled cash securities, thereby reducing risk and
original margin requirements.
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CCOS will net for each participant all delivery obligations of the
same CUSIP number. All delivery versus payment calculations will be
monitored and controlled by CCOS, and the delivery instructions sent to
the settlement bank (The Bank of New York) will reflect the daily
settlement value marked to the market. Delivery and payment will occur
through the Fedwire system. Thus, all CCOS participants must establish
clearing arrangements with a bank having access to Fedwire. CCOS will
carry forward any fails to deliver securities on a cumulative basis,
after making those obligations to market value and collecting, as
necessary, additional variations margin.
The settlement prices for cash securities will be based upon the
cash market indications at the close of futures trading (3 p.m.) plus
the accrued interest amounts for each security.\14\ CCOS will mark all
net cash deliverable positions\15\ to the settlement values.
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\14\Initially, the cash market indications for settlement prices
will be provided by EJV.
\15\The net cash deliverable position will reflect all
outstanding cash positions, including outright trades, cash legs
from basis trades, and Dollar Rolls. These positions will be
reported to members by CUSIP number and settlement date. CCOS will
have two daily processing cycles for determining net cash positions,
mid-day and end of day. A participant with a same day delivery
requirement because of a Dollar Roll transaction will be considered
to have delivered in that position and the net cash deliverable
position for that security will not be included in the mid-day
original margin calculations. Any failed same day delivery
obligations will be accounted for in the end of day processing
cycle.
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B. System Safeguards
(1) Participation Standards
Participants in CCOS will be required to meet initial and
continuing financial and operational standards, as determined by the
CCOS board of directors and administered by CCOS management. CCOS will
monitor each participant's financial condition as measured by its
financial stability, the level and quality of its earnings, and other
generally accepted measures of liquidity, capital adequacy, and
profitability. In addition, CCOS will require each member to maintain
personnel and facilities adequate to ensure the expeditious and orderly
transaction of business with CCOS or other participants. Participation
in CCOS will be limited to members of BOTCC and members of the CBOT
that are affiliated with members of BOTCC.\16\
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\16\BOTCC's by-laws require BOTCC members to be CBOT members,
approved by the CBOT board of directors for BOTCC membership. In
addition, the BOTCC board of directors sets, from time to time,
BOTCC membership requirements, including, but not limited to,
financial and operational requirements, continuing compliance with
CBOT and BOTCC rules, financial and other reporting, and such other
factors as the BOTCC board may consider necessary or appropriate in
assessing an applicant's suitability for participation in BOTCC.
BOTCC also has the authority to require additional capital on a
discretionary basis and parental guarantees on member proprietary
positions. See, e.g., BOTCC By-Law 401.
Minimum financial requirements for CBOT futures commission
merchants (``FCMs'') include Adjusted Net Capital (as defined in
CBOT's rules) of the greater of $250,000 or 4 percent of the funds
required to be segregated and the foreign futures and options
secured amount pursuant to the Commodities Exchange Act, 7 U.S.C. 1,
et seq. (1988), exclusive of the market value of commodity options
purchased by option customers on or subject to the rules of a
contract market up to the amount of customer funds in such option
customer's account, plus an amount equal to guarantee deposits with
clearing organizations, other than the CBOT, to the extent those
assets cannot be used for margin purposes. The minimum financial
requirements for CBOT broker-dealer/FCM members are similar to those
for FCMs, although the broker dealers/FCMs also are subject to
Commission rule 15c3-1(a), 17 CFR 240.15c3-1(a) (1992), limitations.
CBOT Rules, Chapter 2, Rule 201.
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(2) Margin Payment/Collection
CCOS proposes to adopt, as one of its principal safeguards, a
practice of collecting original and variation margin on participant
obligations. CCOS proposes to adopt, in essence, the margin calculation
and payment time frames currently used by BOTCC in connection with its
clearance of CBOT futures contracts, modified to address specific
aspects of the government securities market. Thus, for risk management
purposes, CCOS\17\ will convert cash securities to futures contract
equivalents and then calculate original and variation margin. CCOS will
calculate margin requirements at least twice daily, reflecting activity
from 8 a.m. to 1:30 p.m. and activity from 1:30 p.m. to 5 p.m. CCOS\18\
will collect margin deficiencies from participants at 4 p.m. and 7:40
a.m. on T+1, and will retain the authority to collect additional margin
at any time.
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\17\BOTCC, as facilities manager, will perform all margin
calculations pursuant to a cross-margining agreement on positions in
the cross-margining account for the benefit of both CCOS and BOTCC.
\18\BOTCC, as facilities manager, will perform all margin
collection/payment functions on behalf of CCOS. CCOS will collect
commissions and settlement payments through its agent, the Bank of
New York.
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Original margin is a performance bond on all positions that will be
delivered and not otherwise offset before delivery. The performance
bond for all trades generally will be collected at 7:40 a.m. on T+1.
The second requirement, variation margin, is a mark to the market
payment, collected on a twice daily basis to account for changes in the
value of the positions before the delivery process.
Original margin requirements will be calculated at 2:30 p.m. for
trades executed from the 8 a.m. opening until 1:30 p.m. The original
margin will be updated at 4 a.m. on T+1 to include trades executed from
1:30 p.m. on T until 4 a.m. on T+1, \19\ and the total original margin
requirement will be collected at 7:40 a.m. on T+1. In the event a
clearing member fails to perform obligations to CCOS, the original
margin will be used to cover any financial liabilities which may result
from the failed obligation.
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\19\Up until 4 a.m., CCOS will permit transactions executed on
the Globex Trading System to be included in the cross-margin account
for the regular 7:40 a.m. original and variation margin pay/collect.
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For mid-day processing at 3 p.m., CCOS will establish a settlement
value for cash securities trades executed between 8 a.m. and 1:30 p.m.
CCOS will mark new positions from their transaction value, established
at the execution of the trade, to the settlement value, \20\ reflecting
gains or losses in the interim period, and CCOS will mark open
positions that were previously marked to the prior day's settlement
value to the new settlement value.\21\ CCOS will calculate each
participant's variation margin pay/collect amount and transmit the data
to BOTCC for margin payment or collection. Payment or collection
amounts for each participant will include the combined variation
effects of the cash and futures positions in the participant's cross-
margined account. Participants will pay or collect midday variation
margin in same-day funds by 4 p.m. each day, through their settlement
banks. BOTCC will pay out 80% of variation gains in excess of original
margin deficits\22\ and will collect 100% of variation losses.
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\20\Settlement values will reflect the settlement price
established twice a day (obtained from EJV) and will include accrued
interest, but will not include commissions and finance charges from
Dollar Rolls.
\21\The transaction value provided by CBB to CCOS will include
the accrued interest paid or received on each transaction. For
normal deliveries the accrued interest at the time of the
transaction and at marking to market are the same amount, but for
failed deliveries the seller will have to pay the incremental
accrued interest for each day the fail continues. The daily
variation margin payments will include this incremental accrued
interest.
\22\CCOS will withhold distribution of any variation margin gain
from participants with original margin requirement deficits.
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Trades executed from 1:30 p.m. through the end of the day's trading
session, 5 p.m., will be marked to the 3 p.m. settlement value, and the
variation margin on the entire position will be calculated at the end
of the day. Participants will pay or collect the second variation
margin obligation the following morning at 7:40 a.m. CCOS will send
delivery instructions for normal settlement of cash securities
transactions executed on T to the participants' settlement banks at
11:30 a.m. on T+1.\23\
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\23\Participants may transact Dollar Rolls (with same-day
settlement for the first leg) between 8 a.m. and 11 a.m. on T+1 to
offset delivery obligations due to settle on T+1.
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(3) Margin Calculation
CCOS believes cross-margined cash securities and futures products
have essentially the same market and credit risks. Therefore, in
establishing the original margin (or performance bond) for cash
securities it clears, CCOS will use the original margin rates for
futures contracts\24\ established by the Board of Governors of BOTCC
following recommendations of the BOTCC Margin Committee.\25\
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\24\BOTCC collects clearing member margin on a portfolio, or
net, basis, reflecting the overall risk to the clearing corporation
associated with the totality of contracts in that clearing member's
portfolio. BOTCC uses a portfolio-based simulation model, the
Standard Portfolio Analysis (``SPAN'') system, which establishes
parameters to collect original margins based on the simulated losses
of clearing member portfolios under various scenarios.
\25\The BOTCC Margin Committee is comprised of five of the nine
Governors of the BOTCC Board of Governors. All nine Governors are
owners of officers of BOTCC clearing member firms. The BOTCC Margin
Committee meets once a month or at the call of the BOTCC Board
Chairman or the Margin Committee Chairman. The Committee bases its
recommendation upon review by BOTCC and CBOT staff of the conditions
of the market place, including: statistical analysis of central
tendencies, dispersion, and correlations between price changes of
different commodities. Additionally, the Committee draws upon the
experiences of its members and uses their judgment to predict market
conditions in the near future. From this information, the Margin
Committee will typically set margin rates that cover approximately
the 95th percentile of absolute daily price changes over the
previous one, three, and six month periods.
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Original margin represents a performance bond that both buyers and
sellers must post when entering the market to assure that their
respective contractual obligations will be satisfied. In order to
margin cash securities and futures positions in a parallel fashion,
CCOS will convert cash securities to their futures-equivalents prior to
original margin determination. CCOS will convert cash securities
positions to future-equivalents based upon conversion factors, as
published by the CBOT, for the nearest futures delivery month and the
futures contract par amounts (face values).\26\ CCOS will net the
futures-equivalent positions of all cash securities deliverable into
each futures contract to produce a net cash futures-equivalent position
for each futures contract.\27\ An example of the effect of the proposed
margin system on a hypothetical portfolio is attached as Exhibit A.
\26\The formula for the conversion of cash securities is:
Since bonds being delivered into futures contract obligations
will have greater or lesser value than the futures, the conversion
factor is a means of equating bonds with various coupons and
maturity dates with the standard bond set by BOTCC. The standard
bond, which is equal to the corresponding future, has an 8% coupon
and a conversion factor of 1.
For example, assume there are three bonds, Bond X, Bond Y, and
Bond Z. Bond X is the standard bond having an 8% yield to maturity
and conversion factor of 1 (Bond X is equal to the corresponding
future). Bond Y is worth 1.5 times Bond X and Bond Z is worth 1.75
times Bond X (Bonds Y and Z could have greater coupon rates or
longer periods to maturity). If the future is trading at 85 then
Bond X is worth 85 and Bond Y is worth 1.5 times 85. Therefore, 1.5
is the conversion factor for Bond Y and 1.75 is the conversion
factor for Bond Z. In order to determine the number of futures that
equate with Bond Y, the face amount of Bond Y is multiplied by the
conversion factor, producing the futures value amount. The futures
value amount when divided by 100,000 (each futures contract equals
$100,000) yields the number of futures contracts equal to the bond.
\27\Futures on cash securities act as an index of the many bonds
deliverable into them. Treasury bonds (``T-bonds'') having at least
fifteen years remaining to maturity are deliverable into the T-bond
future. Ten-year Treasury notes (``T-notes'') must have maturities
between six and one-half and ten years to be deliverable into the
ten-year T-note future. Five-year T-note futures accept Treasury
notes with time to maturity between four years; three months and
five years, three months. Two-year notes having maturities between
one year, nine months and two years are deliverable into the two-
year T note future.
Cash Par Amounts X Conversion Factor
Futures-Equivalents= ----------------------------------------------------
Futures Par Amount
(4) Credit Enhancement
In addition to collecting margin from participants for open
positions, CCOS proposes to rely on the assets and credit of its
parent, BOTCC, to meet any liquidity demands CCOS may incur. Under the
proposed system, BOTCC will guarantee all of CCOS's obligations to
participants arising under CCOS's rules. CCOS intends for the BOTCC
guarantee to take the place of a clearing fund composed of participant
contributions of cash or liquid securities.\28\
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\28\BOTCC, as a commodities clearing corporation, guarantees the
settlement of all futures and options contracts traded on the CBOT
and cleared by BOTCC. BOTCC will extend this guarantee to the
obligations of CCOS. BOTCC has total shareholders' equity of over
$110 million, including current assets of over $109 million with the
large majority in U.S. Treasury bills and notes. Its current
liabilities are approximately $3.5 million. In addition, BOTCC has
credit enhancement facilities in place in the form of lines of
credit totalling $300 million. See 1992 BOTCC Annual Report [File
No. 600-27].
As a general rule, the Commission has recommended that a
clearing agency have a clearing fund which (1) is composed of
contributions based on a formula applicable to all users; (2) is in
cash or highly liquid securities; and (3) is limited in the purpose
for which it may be used. Securities Exchange Act Release No. 16900
(June 17, 1980), 45 FR 41920. Its use should be limited to
protecting participants and the clearing agency from participant
defaults and unusual, significant clearing agency losses. Id.
The Commission has permitted a clearing agency, Delta Government
Options Corp. (``Delta''), to register without a clearing fund.
There, the Commission relied on other factors to determine that
Delta's risk management system was adequate despite the lack of a
clearing fund. See Securities Exchange Release No. 26450 (January
12, 1989), 54 FR 2010.
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III. Public Interest Statement
CCOS believes that granting CCOS an exemption from clearing agency
registration during the period before full registration is granted is
critical to enabling CBB to enter the cash government securities
business. CCOS maintains that the CCOS/CBB business plan will provide
increased access to the cash securities markets through an integrated
electronic transaction and margin system, which, CCOS believes, lowers
transaction costs, creates processing and cash flow efficiencies,
provides credit enhancement, ensures fairness and price transparency,
and provides a complete audit trail. CCOS asserts that these
efficiencies are created because of the computerization that will
eliminate back-office paperwork and shorten settlement cycles by
decreasing the time required for order entry, trade matching, netting,
and telecommunication to the appropriate clearing agency.
CCOS believes that the CCOS/CBB trading and clearance systems will
enable persons other than primary dealers to participate in the
government securities market while controlling counterparty risk. Also,
the CCOS/CBB system will preserve a key feature of the existing
interdealer broker system: anonymous trading without substantial
counterparty risk.
CCOS believes further that the ability to net (cross-margin)
original and variation margin with respect to futures positions cleared
at BOTCC and cash securities positions cleared at CCOS will eliminate
duplicative performance bond requirements that do not reflect
collective market risk, exemplifying the type of link mandated by
section 17A(a)(1)(D) of the Act.\29\ Furthermore, CCOS believes that
these links are consistent with Congress's direction to the SEC in the
Market Reform Act of 1990\30\ to facilitate linked or coordinated
facilities for clearance and settlement of securities, options,
futures, options on futures, and commodity options. Also, by applying
same-day margining and cash flow conventions of the futures market to
cash transactions, CCOS believes it will further ``the development of a
modern, nationwide system for the safe and efficient handling of
securities transactions in a manner which best serves the financial
community and investing public.''\31\ Finally, because the SEC will
impose and monitor certain volume limits during the period CCOS
operates under exemption from registration, CCOS believes that its
operations will not present increased risk to the marketplace.
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\29\15 U.S.C. 17A(a)(1)(D)(1988).
\30\Market Reform Act of 1990, Pub. L. No. 101-432, 104 Stat.
963 (1990) (``Market Reform Act'').
\31\Conference Report to Accompany S. 249, H.R. Rep. No 229,
94th Cong., 1st Sess. 102 (May 19, 1975).
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IV. Specific Request for Comments
A. Statutory Standards
Section 17A of the Act directs the Commission to develop a national
clearance and settlement system through, among other things, the
registration and regulation of clearing agencies. The statutory scheme
contemplates that clearing agencies not only provide clearance and
settlement functions consistent with statutory goals, but also that
those clearing agencies, as self-regulatory organizations, exercise
certain regulatory functions in furtherance of other statutory goals.
In fostering the development of a national clearance and settlement
system generally and in overseeing clearing agencies in particular,
section 17A authorizes and directs the Commission to promote and
facilitate certain goals with due regard for: The public interest, the
protection of investors, the safeguarding of securities and funds, and
maintenance of fair competition among brokers, dealers, clearing
agencies, and transfer agents.\32\ Further, section 17A, as amended by
the Market Reform Act, directs the Commission to use its authority to
facilitate the establishment of linked or coordinated facilities for
clearance and settlement of transactions in securities, securities
options, contracts of sale for future delivery and options thereon, and
commodity options.\33\
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\32\For legislative history concerning Section 17A of the Act,
See, e.g., Report of Senate Comm. on Housing and Urban Affairs,
Securities Acts Amendments of 1975: Report to Accompany S. 249, S.
Rep. No. 75, 94th Cong., 1st Sess. 4 (1975); Conference Comm. Report
to Accompany S. 249, Joint Explanatory Statement of Comm. of
Conference, H.R. Rep. No. 229, 94th Cong., 1st Sess. 102 (1975).
\33\Market Reform Act of 1990, section 5, amending section
17A(a)(2) of the Securities Exchange Act of 1934, 15 U.S.C. 78q-1
(1990).
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Section 17A(b)(1) of the Act authorizes the Commission to exempt
applicants from some or all of the requirements of section 17A if it
finds such exemptions are consistent with the public interest, the
protection of investors, and the purposes of Section 17A, including the
prompt and accurate clearance and settlement of securities transactions
and the safeguarding of securities and funds. Historically, the
Commission has never exercised its authority to exempt an applicant
entirely from the requirements of section 17A of the Act. The
Commission has, however, granted newly registered clearing agencies
narrowly drawn, temporary exemptions from specific statutory
requirements imposed by section 17A, in a manner that achieves
statutory goals.\34\
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\34\See e.g., order approving Government Securities Clearing
Corporation's (``GSCC'') temporary registration as a clearing agency
where the Commission temporarily exempted GSCCC from compliance with
section 17A(b)(3)(C) of the Act. Securities Exchange Act Release No.
25749 (May 24, 1988), 53 FR 19839.
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The Commission recognizes that clearing agencies, more than other
self-regulatory organizations, pose systemic safety and soundness
concerns. Accordingly, the Commission has published standards for
clearing agency registration and exercises significant continuing
oversight of all aspects of clearing agency operations and
functions.\35\ The market crash in October 1987 and decline in October
1989 demonstrated the central role of clearing agencies in U.S.
securities markets in reducing risk, improving efficiency, and
fostering investor confidence in the markets.\36\
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\35\See Securities Exchange Act Release Nos. 16900 (June 17,
1980), 45 FR 41920 (announcement of standards for the registration
of clearing agencies (``Standards Release'')) and 20221 (September
23, 1983), 48 FR 45167 (omnibus order granting full registration as
clearing agencies to The Depository Trust Company, Stock Clearing
Corporation of Philadelphia, Midwest Securities Trust Company, The
Options Clearing Corporation, Midwest Clearing Corporation, Pacific
Securities Depository, National Securities Clearing Corporation, and
Philadelphia Depository Trust Company). See also Section 19 of the
Act, 15 U.S.C. 78s (1988), and rule 19b-4, 17 CFR 240.19b-4 (1992),
setting forth certain procedural requirements for registration and
continuing Commission oversight of clearing agencies and other
selfregulatory organizations.
\36\Gerald Corrigan, President of the Federal Reserve Bank of
New York (``FRBNY''), noted: ``[T]he greatest threat to the
stability of the financial system as a whole [during the 1987 market
break] was the danger of a major default in one of these clearing
and settlement systems.'' Luncheon Address: Perspectives on Payment
System Risk Reduction by E. Gerald Corrigan, President, FRBNY,
reprinted in the U.S. Payment System: Efficiency, Risk and the Role
of the Federal Reserve 129-30 (1990).
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In light of the foregoing, the Commission preliminarily believes it
is appropriate for applicants requesting exemption from clearing agency
registration to meet the standards substantially similar to those
required of registrants to assure that the fundamental goals of the Act
(i.e., safe and sound clearance and settlement) will not be undermined.
Thus, the Commission invites commentators to address whether the
Commission should apply those standards, subject to appropriate
modifications, in considering CCOS's application for exemption from
clearing agency registration while assuring achievement of the goals of
section 17A of the Act.
The Commission also invites commentators to address whether
granting the proposed exemption would further the goals of section 17A
and whether attaching specific conditions to that exemption, if any,
would be appropriate to further specific statutory goals. Specifically,
would granting the exemption further the development of a national
clearance and settlement system, promote linked and coordinated
clearing facilities (among options, futures, and securities), and
promote the maintenance of fair competition?
B. Fair Competition
Section 17A of the Act requires the Commission, in exercising its
authority under that Section, to have due regard for the maintenance of
fair competition among clearing agencies.\37\ In addition, no clearing
agency may be registered, if its rules ``impose any burden on
competition not necessary or appropriate in furtherance of the
purposes'' of the federal securities laws.\38\ The Commission therefore
must consider an applicant's likely affect on competition and on the
nation's securities markets in its review of any application to
register as a clearing agency.\39\ Accordingly, to the extent that
approval of CCOS's application for exemption from registration will
restrain competition and, at the same time, benefit other statutory
goals, the Commission must balance those benefits against the resulting
restraint on competition. The Commission emphasizes that within the
constraints of this balancing test, the Commission consistently has
demonstrated its strong preference for eliminating barriers to
competition.Where possible, the Commission has looked to regulatory or
market discipline to create an atmosphere where competition may be
expanded.
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\37\15 U.S.C. 78q-1(a)(2) (1988).
\38\15 U.S.C. 78q-1(b)(3)(I) (1988).
\39\See Bradford National Clearing Corporation v. S.E.C., 590
F.2nd 1085 (D.C. Cir., 1978). The court noted:
To the extent the legislation history provides any guidance to
the Commission in taking competition concerns into consideration in
its deliberations on the national clearing system, it merely
requires the [Commission] to ``balance'' those concerns against all
others that are relevant under the statute. Id at 1105.
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Consistent with this approach, the Commission invites commentators
to address whether registration of CCOS would result in increased
competition among broker-dealers, including greater access to the
government securities market by persons other than primary dealers, and
among clearing agencies, such as GSCC, in the clearing of transactions
in government securities.\40\ Such competition may result in the
development of improved systems capabilities, new services offered, and
perhaps lower prices to participants.
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\40\Currently, the only registered clearing agency that offers a
centralized, automated system for the clearance and settlement of
trades in cash government securities is GSCC. GSCC offers comparison
and netting services to members and functions as a risk assessment,
credit risk reduction, and risk containment facility for eligible
trades in government securities that are submitted to GSCC for
comparison and netting. See Securities Exchange Act Release No.
25749 (May 24, 1988), 53 FR 19639 (order approving the temporary
registration of GSCC as a clearing agency).
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The Commission invites commentators to address whether the proposal
would impose any burden on competition that is inappropriate under the
Act. In particular, would CCOS's ability to offer cross-margin
facilities to members for inter-market trades involving cash securities
and futures have such a result if GSCC cannot offer its members cross-
margin facilities on the same terms and conditions as CCOS offers its
members? If such a result would ensue, what if any steps should the
Commission take to facilitate a level field of competition between CCOS
and other clearing agencies? For example, should the Commission take
steps to ensure that GSCC is given reasonable access to the open
interest in particular futures or futures options products held by
BOTCC or to any cross-lien arrangement for cash securities and futures
products entered into between BOTCC and CCOS?
C. Common Clearing of Government Securities
As stated above, section 17A directs the Commission to develop a
national system for the prompt and accurate clearance and settlement of
securities transactions. In carrying out this responsibility, the
Commission is authorized and ordered to facilitate the establishment of
linked or coordinated facilities for the clearance and settlement of
securities, securities options, contracts of sale for future delivery
and options thereon, and commodity options.\41\ This is largely
because, as the Act states, ``the linking of all clearance and
settlement facilities and the development of uniform standards and
procedures for clearance and settlement will reduce unnecessary costs
and increase the protection of investors and persons facilitating
transactions by and on behalf of investors.''\42\
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\41\15 U.S.C. 78q-1(a)(2)(A)(ii) (1988).
\42\15 U.S.C. 78q-1(a)(1)(D) (1988). Past Commission actions
support this approach. For example, in 1973, the Commission directed
the exchanges to develop a centralized system for the clearance and
settlement of standardized options either through the formation of a
resulting single clearing entity or through multiple interfaced
entities. See Securities Exchange Act Release No. 11144 (December
19, 1974), 39 FR 45333. (The exchanges proposed and the Commission
approved the establishment of OCC as the sole entity for the
clearance and settlement of standardized options.) The Commission
believed the resulting single entity approach was consistent with
Commission policy favoring one-account settlement. See Securities
Exchange Act Release No. 10631 (February 7, 1974), 39 FR 9717.
The Commission next addressed the structure of the national
system for corporate debt and equity securities traded on exchanges,
through NASDAQ facilities, and over-the-counter. In 1977, the New
York Stock Exchange, American Stock Exchange, and the National
Association of Securities Dealers clearing facilities merged into
one entity, the National Securities Clearing Corporation (``NSCC'').
In balancing the goal of clearing organization competition against
enhanced broker-dealer competition, the Commission chose to place
greater emphasis on the latter and to permit the proposed merger to
occur, subject to the condition, among others, that NSCC establish
interfaces, without fees, with other competing clearing
organizations in support of the one-account settlement concept.
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CCOS's application, in effect, raises the question of whether the
establishment of multiple government securities clearing corporations
is consistent with section 17A of the Act and one-account settlement.
The introduction of multiple clearing agencies into the government
securities markets could increase the risks entailed in liquidating
defaulting participants. One of the benefits of a single clearing
agency is centralized default administration. Accordingly,
fragmentation of the government securities clearance and settlement
system, particularly in light of the netting of government securities
by GSCC, could impede the prompt resolution of member defaults.\43\ As
the October 1987 break illustrated, an unexpected market move may cause
a clearing member to default on its obligations to its clearing
organization. Based on its experience in October 1987 and October 1989,
the Commission believes that coordinating the prompt resolution of such
a default is critical to maintaining the stability of a clearing
corporation and its members.\44\
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\43\Expeditious transfer of customer accounts, for example, may
be more difficult with two government securities clearing agencies.
This is but one example of areas where coordination will be more
difficult.
\44\See Division of Market Regulation, Market Analysis of
October 13 and 16, 1989, Chapter 5 (December 1990).
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In addition, the Commission seeks comment on whether or not one-
account settlement can be achieved if CCOS's application is approved.
Specifically, the Commission seeks comment on whether or not the
different forms of netting by GSCC and CCOS\45\ would preclude one-
account settlement. Therefore, the Commission requests comment on
whether it should approve or deny the CCOS application, which, if
granted, would result in multiple clearing facilities for government
securities.
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\45\In its effort to manage systemic risk in the clearance and
settlement of government securities, GSCC seeks to reduce net
settlement positions of participants by netting offsetting
government securities transactions in the same CUSIP number, thereby
eliminating delivery obligations. CCOS intends to hedge futures
positions held by participants with the participant's futures-
equivalent cash government securities which have not settled,
thereby recognizing for margining purposes the offsetting risks of
the positions.
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Commentators should discuss applicable law and the costs and
benefits of single versus multiple clearing facilities for government
securities, including whether the risk exposure to individual clearing
organizations would be increased by the fragmentation in the netting of
cash securities. Finally, commentators should address the effects that
market stress (e.g., high volume and volatility) likely would have on
such a multiple clearing system.
D. Linkage of Multiple Clearing Systems
Section 17A(a)(2)(A)(ii) of the Act\46\ specifically requires the
Commission to ``facilitate the establishment of a national system of
linked or coordinated facilities for clearance and settlement of
transactions in securities, securities options, contracts of sale for
futures delivery and options thereon, and commodity options.'' The
Commission requests comment on the manner in which multiple clearing
facilities for cash securities and affiliated clearing facilities for
cash securities and futures contracts on those securities could
efficiently integrate those systems. Commentators should address,
without limitation: the manner in which clearing organizations would
assure payment of obligations to other clearing organizations, the
manner in which multiple clearing systems should respond to common
member defaults and the default of a clearing organization, the manner
in which multiple clearing systems should allocate costs associated
with integration and services performed for one another, and the manner
in which multiple clearing systems should operate net money settlement
with their members and among themselves.
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\46\15 U.S.C. 78q-1(a)(2)(A)(ii) (1991).
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Specifically, the Commission asks that commentators address,
without limitation, the proposed margin calculations and procedures,
operational safeguards, and legal and other policy issues related to
linking these markets. In this regard, commentators are asked to state
specifically any benefits or risks the proposed system may pose to the
clearance and settlement of government securities.
E. Risk Management
As described in detail above, CCOS will treat cash securities, for
risk management purposes, as futures contract equivalents, and then
calculate original and variation margin. Consistent with this approach,
CCOS intends to cross-margin cash securities positions it clears with
futures contracts cleared by BOTCC. Commentators are asked to consider
the proposed margin calculations and procedures, and address the
perceived benefits and risks of the proposal. The Commission also seeks
comment on whether, during the exemptive period, the Commission should
require that CCOS impose margin rate floors below which the margin
rates may not be lowered. The margin rate floors would apply to all
original and maintenance margin rates for all futures, futures-
equivalent cash securities, and basis spreads, and include limits on
intercommodity spread credits provided by CCOS. Further, the Commission
invites commentators to address whether, given the unique role of BOTCC
as a clearing agency for the futures contract market, it would be
prudential and appropriate for BOTCC to represent that it will maintain
minimum levels of margin during the exemptive period to insure safety
and soundness in the clearance and settlement of government securities.
The CCOS application would expand the group of participants trading
in the government securities market. As discussed above, CCOS
participants and non-CCOS CBOT members will be able to access the cash
market through terminals located on the floor of the CBOT. Commentators
are asked to address the perceived benefits and risks associated with
expanding the base of participants in the government securities market.
Commentators also should address the perceived risks posed to the
national clearance and settlement system from permitting participants
with relatively smaller capital bases than at present to trade in
government securities.\47\
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\47\Supra note 16 and accompanying text.
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Like other clearing corporations, CCOS will assume all counterparty
credit risk by guaranteeing all matched trades executed through CBB.
The Commission believes that a clearing agency should be an adequately
funded entity capable of providing the guarantee and performing risk
management functions. While section 17A does not set standards for
clearing agency capitalization, the Commission has required other
clearing agencies to meet certain minimum requirements.\48\ As
discussed above, the Commission generally recommends that a clearing
agency have a clearing fund, use of which is limited to protecting
participants and the clearing agency from participant defaults and
unusual, significant clearing agency losses.\49\ In lieu of such
clearing fund, BOTCC proposes to guarantee all of CCOS's obligations
arising under CCOS's rules, and CCOS, therefore, proposes to rely on
the assets and credit of its parent, BOTCC, to meet any liquidity
demands CCOS may incur.\50\ Commentators are asked to address the
perceived risks of relying on BOTCC as guarantor of CCOS's obligations,
rather than a clearing fund or similar alternatives to ensure system
liquidity. Specifically, the Commission seeks comment on appropriate
levels of capitalization for CCOS and whether the BOTCC guarantee is
sufficient, considering the extent of BOTCC's guaranteed obligations in
the futures contract markets and other obligations, to meet the
Commission's standards ensuring the safeguarding of securities and
funds.
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\48\E.g., prior to its original temporary registration, GSCC
represented to the Commission that the capital from its initial
stock offering was intended to exceed $5 million. In addition to its
contributed capital, GSCC maintains a clearing fund designed to: (1)
Have on deposit from each netting member cash or other collateral
sufficient to satisfy a loss as a result of that member's default
and subsequent close-out of settlement positions; (2) maintain total
assets in an amount sufficient to satisfy potential losses to GSCC
resulting from the default of more than one member; and (3) ensure
that GSCC has sufficiently liquidity at all times to meet its
payment and delivery obligations. Securities Exchange Act Release
No. 25740 (May 24, 1988), 53 FR 19839 and 27006 (July 7, 1989), 54
FR 29798.
\49\Supra note 28.
\50\Although most clearing agencies employ some form of risk
mutualization among participants, risk mutualization is not mandated
by the Act. In those cases where the Commission has not required a
clearing fund or risk mutualization, there have been credit
enhancement facilities maintained by such clearing agency. See
Securities Exchange Act Release No. 27611 (January 12, 1990), 55 FR
1890 [File No. 600-24] (order granting temporary registration as a
clearing agency to Delta Government Options Corporation).
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Finally, given the heightened concerns of safety and soundness in
the approval of an application for exemption from registration as a
clearing agency, the Commission seeks comment on whether an order
granting an exemption should contain certain clearing volume limits.
Such limits could provide a measure of protection during the exemptive
period so that the clearance and settlement system for government
securities would not be subject to unnecessary risks. Specifically,
commentators should address the structure of such volume limits and the
appropriate level of such limits.
V. Solicitation of Comments
You are invited to submit written data, views, and arguments
concerning the foregoing application by July 23, 1993. Such written
data, views, and arguments will be considered by the Commission in
deciding whether to grant CCOS's request for exemption from
registration. Persons desiring to make written submissions should file
six copies thereof with the Secretary, Securities and Exchange
Commission, 450 Fifth Street, NW., Washington, DC 20549. Reference
should be made to File No. 600-27. Copies of the application and all
written comments will be available for inspection and copying at the
Commission's Public Reference Room, 450 Fifth Street, NW., Washington,
DC 20549.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\51\
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\51\17 CFR 200.30-3(a)(16) (1992).
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Jonathan G. Katz,
Secretary.
Exhibit A
As an example of the original margin calculation, assume a
participant had both cash securities and futures contract positions in
30-year T-bonds and futures contract positions in 10-year T-notes, as
follows:
T-bonds
Long 100 30-year T-bonds with an 8% annual yield (cash securities)
Long 75 futures contracts, expiring in June, 1993, on 30-year T-
bonds with an 8% annual yield
Short 80 futures contracts, expiring in September, 1993, on 30-year
T-bonds with an 8% annual yield
Short 20 futures contracts, expiring in December, 1993, on 30-year
T-bonds with an 8% annual yield
Long 10 futures contracts, expiring in March, 1994, on 30-year T-
bonds with an 8% annual yield
T-notes
Short 150 futures contracts, expiring in March, 1994, on 10-year T-
notes with an 8% annual yield
First, BOTCC will examine the 30-year T-bond futures and 30-year T-
bond futures-equivalent positions:
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Mar.
Month 0 June Sept. Dec. (1994)
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+100.................................. +75 -80 -20 +10
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The Month 0 futures are the cash securities stated as futures-
equivalent positions, which are assumed, for this example, to convert
1:1 into futures positions. BOTCC will net the monthly futures and cash
futures-equivalent positions to arrive at a net futures position
(100+75-80-20+10=85).\1\ Next, the margin amount per future set by the
BOTCC Margin Committee (currently, $1,500/30-year T-bond future) is
multiplied by the net futures/futures-equivalent position.\2\
\1\Since bonds being delivered into futures contract obligations
will have greater or lesser value than the futures, the conversion
factor is a means of equating bonds with various coupons and
maturity dates with the standard bond set by BOTCC. The standard
bond, which is equal to the corresponding future, has an 8% coupon
and a conversion factor of 1. See supra note 27.
\2\The commodity margin rate is the same for long or short
positions, so the charge for a fixed number of contracts will be the
same regardless of market position. For cash securities positions,
the charge will apply to the positions after the conversion to
futures-equivalents.
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(A) +85 x $1,500=$127,500
The $127,500 is defined by BOTCC as the Maximum Loss on the
participant's position in 30-year T-bonds and futures on 30-year T-
bonds.
Second, BOTCC will examine the participant's 10-year T-note and T-
note futures position. As stated above, the participant has a 10-year
T-note position of -150 March futures. Assume that the BOTCC Margin
Committee has set a margin requirement of $1,000/10-year T-note future.
The presumed ``Maximum Loss'' on the 10-year T-note futures would be:
(B) 150 x $1,000=$150,000
Third, BOTCC will calculate an additional risk margin, accounting
for futures spreads (i.e., intermonth netting) of 30-year T-bond
futures positions, to reflect divergence in the correlation among
futures contracts with different delivery dates. Excluding Month 0 T-
bond futures-equivalents,\3\
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\3\The Month 0 futures are the futures-equivalents of the cash
30-year T-bonds, after conversion, pursuant to the above formula.
Supra note 26. Because the positions generally are subject to next-
day delivery and have been accounted for in other parts of the
margin calculation process, BOTCC has excluded these positions from
the intermonth spread additional margin calculations.
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Mar.
(June) 1994 Sept. Dec.
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+75 +10 versus...... -80 -20
= +85 versus...... -100
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there is a total of 85 T-bond futures spreads in the intermonth netting
and 15 naked short T-bond futures positions. Assuming the BOTCC Margin
Committee has set a risk margin for intermonth spreads at $100 per
spread, the additional margin for the intermonth spreads will be:
(C) 85 x $100=$8,500 (included in the final margin requirement)
Fourth, BOTCC will determine if any basis spreads exist in 30-year
T-bond futures by matching T-bond futures with the cash futures-
equivalent positions. In this example, the remaining -15 T-bond futures
(naked short positions) are now offset against the cash futures-
equivalents\4\ to determine the margin for any basis spreads that exist
in the portfolio. This reflects the potential divergence between cash
and futures positions.
\4\+100 from the example above.
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-15 (T-bond futures) versus +100 (Month 0 futures [cash T-bonds])
Because there are more than 15 Month 0 futures contracts to offset
the -15 futures contracts, there are 15 basis spreads for which,
currently, the BOTCC Margin Committee has set a $50 per spread basis
risk margin requirement.
(D) 15 x $50 = $750 (included in final margin requirement)
Fifth, BOTCC then conducts the same analysis for 10 year T-note
futures. Because the portfolio in this example does not include cash or
multi-month futures positions in 10 year T-notes, this step yields no
change in margin requirements.
Sixth, BOTCC will determine if the exposure in T-bond and T-note
futures and futures-equivalent positions interact to reduce overall
portfolio exposure. Thus, BOTCC will compare the participant's net
commodity positions\5\ in 30-year T-bonds and 10-year T-notes and
provide a margin credit\6\ for any offsets due to correlated short or
long cash positions and short or long futures positions.\7\ For
purposes of this example, assume that the BOTCC Margin Committee has
calculated a 1:2 correlation in price volatility between futures on 30
year T-bonds and futures on 10 year T-notes (i.e., futures on the 30-
year T-bonds are twice as volatile as, and are positively correlated
with, futures on 10 year T-notes).\8\ In the example above, this
operation results in 75 spreads between the futures-equivalents of the
30 year T-bonds and the futures-equivalents of the 10-year T-notes.
\5\The net commodity positions in T-bonds or T-notes are the
positions remaining after the intermonth futures spreads and
futures/futures-equivalents basis spreads have been netted out of
the T-bond or T-note positions.
\6\BOTCC will examine all of the clearing member's positions,
including the five-year T-notes and two-year T-notes that the member
holds. In the above example, the clearing member holds only 30 year
T-bonds, futures on 30-year T-bonds, and futures on 10 year T-notes.
\7\In order to establish the intercommodity spread credit, BOTCC
staff analyzes the correlations between the various bills, notes,
and bonds deliverable into the futures to determine their respective
relationships. BOTCC and CCOS will review the margin rates on a
monthly basis, and as needed, to respond to changes in market
conditions.
\8\BOTCC would pair each long position in one 30-year T-bond to
two short positions in 10-year notes.
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+85 30 year T-bonds versus -150 10-year T-notes
= +85 T-bonds versus -75 T-bonds (two 10-year T-notes = 1 30 year T-
bond)
= 75 spreads, +10 outright T-bond futures-equivalents
Thus, 75 T-bond futures-equivalents and 150 T-note futures are
eligible for intercommodity spread credits. To address the potential
for divergence in assumed correlations, BOTCC reduces the allowable
credit by applying a ten percent deduction against the applicable
original margin requirement. Thus, the intercommodity spread credit in
the above example would be:
(E) 75 x $1350 = $101,250 (T-note futures offset on T-bond futures)
(F) 150 x $900 = $135,000 (T-bond futures offset on T-note futures)
Summary: the margin requirement would be:
(A) $127,500 (Maximum Loss on +85 T-bonds, including cash positions on
T-bonds)
(B) $150,000 (Maximum Loss on -150 T-notes, including cash positions on
T-notes)
(C) $8,500 (85 intermonth T-bond futures spreads, not including cash
positions on T-bonds)
(D) $750 (15 basis spreads [naked futures versus cash])
(E) -$101,205 (30-year T-bond margin credit, applying T-note futures
positions to reduce futures margin requirements)
(F) -$135,000 (10-year T-note margin credit, applying T-bond futures
and cash positions to offset T-note futures margin requirements)
=$50,500 Total Margin Requirement
[FR Doc. 94-9710 Filed 4-21-94; 8:45 am]
BILLING CODE 8010-01-M
