01-10391. Self-Regulatory Organizations; Government Securities Clearing Corporation; Order Approving a Proposed Rule Change Relating to Enhancements to the GCF Repo Service and Clarifying Certain Risk Management Practices of the Service

April 20, 2001.

On June 5, 2000, the Government Securities Clearing Corporation (“GSCC”) filed with the Securities and Exchange Commission (“Commission”) and on July 13, 2000, amended a proposed rule change (File No. SR-GSCC-00-05) pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”).^[1] Notice of the proposal was published in the Federal Register on December 4, 2000.^[2] No comments letters were received. For the reasons discussed below, the Commission is approving the proposed rule change.

I. Description

GSCC introduced its GCF Repo Service in November 1998.^[3] The GCF Repo Service allows GSCC's non-inter-dealer broker netting members to trade general collateral repos involving U.S. Government securities throughout the day without requiring trade for trade settlement on a delivery versus payment basis.

GSCC has been activating the generic CUSIP numbers representing the securities that are eligible for GCF Repo processing in stages. U.S. Treasury securities with a maturity of ten years or less and U.S. Treasury securities with a maturity of thirty years or less were the first products to be made eligible for GCF Reprocessing. At the beginning of this year, GSCC also began accepting non-mortgage-backed agency securities for GCF Repo processing and more recently began accepting mortgage-backed agency securities (“MBS”) for GCF Repo processing.^[4]

Having gained the experience of operating the GCF Repo Service for more than two years, GSCC is now enhancing the service in certain ways in order to make it more responsive to its members' needs and to clarify certain risk management practices, each in a manner consistent with market practice.

(i) Authority To Deliver Comparable or U.S. Treasury Securities

The first enhancement by GSCC applies to the collateral allocation obligations of securities lenders ^[5] in GCF Repo transactions. Securities lenders will now be permitted to satisfy their collateral allocation requirements ^[6] in connection with their GCF Repo activity with, in addition to “comparable securities” ^[7] and cash, U.S. Treasury securities (i.e., bills, notes, or bonds). Market participants consider comparable securities to be acceptable substitutes because securities that fall within the same generic CUSIP number tend to have the same level of liquidity. U.S. Treasury securities are also acceptable substitutes securities because of their high level of liquidity.

The second enhancement by GSCC applies where the securities borrower due to reasons beyond its control and despite its exercising best efforts is not able to return in a timely manner the securities that were delivered on the day before by the securities lender. In such a situation, the securities borrower will now have the right to return (1) comparable securities, (2) U.S. Treasury bills, notes, or bonds, or (3) cash. The securities borrower will be responsible make the securities lender whole (through GSCC) for any actual damages directly suffered by the securities lender as a result of its not receiving back the same securities that it originally loaned.

(ii) Insolvency Situation Involving Mortgage-Backed Securities

The third enhancement by GSCC clarifies its risk management procedures associated with the CGF Repo Service to reflect the nature of MBS and MBS market practice. In the event of a securities borrower's insolvency, it may be impractical or even impossible for GSCC to obtain the identical types of MBS that were originally lent. Moreover, MBS market practice in such a situation is that securities lenders in repurchase transactions would not expect to receive the same MBS back.

GSCC's Rule 22, section 4 is being amended to give GSCC the authority in an insolvency situation, where MBS were the underlying collateral, to delivery back to a securities lender comparable securities or U.S. Treasury bills, notes, or bonds. Alternatively, the rule will permit GSCC to give a securities lender the right to close out the transaction by buying comparable securities or U.S. Treasury bills, notes, or bonds in return for a cash payment by GSCC equal to the value of the securities it bought. However, if GSCC determines that the price paid by the securities lender is unreasonably high, GSCC will be entitled to pay the securities lender a reasonable price as determined by an independent third party pricing source for the comparable securities or U.S. Treasury bills, notes, or bonds.

II. Discussion

Section 17A(b)(3)(F) ^[8] of the Act requires that the rules of a clearing agency be designed to promote the prompt and accurate clearance and settlement of securities transactions and to assure the safeguarding of securities and funds which are in the custody or control of the clearing agency or for which it is responsible. The Commission believes that the proposed rule change is consistent with these obligations because it should further enable GSCC to help facilitate the prompt and accurate clearance and settlement of GCF repos involving U.S. Government securities and to remove impediments to and help perfect the mechanism of the national clearance and settlement system for securities transactions.

III. Conclusion

On the basis of the foregoing, the Commission finds that the proposal is consistent with the requirements of the Act and in particular with the requirements of Section 17A of the Act and the rules and regulations thereunder.

It is therefore ordered, pursuant to section 19(b)(2) of the Act, that the proposed rule change (File No. SR-GSCC-00-05) be and hereby is approved.

For the Commission by the Division of Market Regulation, pursuant to delegated authority.^[9]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  Securities Exchange Act Release No. 43626 (November 27, 2000), 65 FR 75750.

3.  In 1998, the Commission approved a rule change that allowed GSCC to implement the GCF Repo Service on an intrabank basis. Securities Exchange Act Release No. 40623 (October 30, 1998), 63 FR 59831 (November 5, 1998) [File No. SR-GSCC-98-02]. In 1999, the Commission approved a rule change that allowed GSCC to implement the interbank phase of the GCF Repo Service. That enhancement has enabled participating dealers to engage in GCF Repo trading with participating dealers that use a different clearing bank. Securities Exchange Act Release No. 41303 (April 16, 1999), 64 FR 20346 (April 26, 1999) [File No. SR-GSCC-99-01].

4.  On March 20, 2000, GSCC activated the generic CUSIP number representing Federal Home Loan Mortgage Corporation and Federal National Mortgage Association fixed-rate MBS.

5.  As provided in GSCC's Rule 46, the use of borrowing and lending terminology in this proposed rule change filing and in GSCC's rules and agreements shall not be deemed to affect the intent of members as to their characterization of their transactions in agreements entered into by the members with each other or with third parties with respect to such transactions.

6.  “Collateral Allocation Obligation” is defined in GSCC's Rules as “the obligation of a Netting Member to allocate securities or cash for the benefit of the Corporation to secure such Member's GCF Net Funds Borrower Position.”

7.  In its Rules, GSCC has defined the term “Comparable Securities” to mean “a security or securities that are represented by a particular Generic CUSIP Number, any other security or securities that are represented by the same Generic CUSIP Number.”

8.  15 U.S.C. 78q-1(b)(3)(F).

9.  17 CFR 200.30-3(a)(12).