[Federal Register Volume 59, Number 90 (Wednesday, May 11, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-11339]
[[Page Unknown]]
[Federal Register: May 11, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33984; File No. SR-GSCC-94-1]
Self-Regulatory Organizations; Government Securities Clearing
Corp.; Order Approving Proposed Rule Change Relating to the Comparison
and Netting of Members' Treasury Auction Purchases
May 2, 1994.
On January 26, 1994, Government Securities Clearing Corporation
(``GSCC'') filed with the Securities and Exchange Commission
(``Commission'') a proposed rule change pursuant to section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act'').\1\ On February 18, 1994,
GSCC filed Amendment No. 1 to the proposed rule change.\2\ The
Commission published notice of the proposed rule change in the Federal
Register on March 10, 1994.\3\ The Commission received one comment
letter in response to this notice.\4\ As discussed below, the
Commission is approving the proposed rule change.
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\1\15 U.S.C. 78s(b) (1988).
\2\Letter from Jeffrey F. Ingber, General Counsel, GSCC to Jack
Drogin, Branch Chief, Division of Market Regulation, Commission
(February 15, 1994).
\3\Securities Exchange Act Release No. 33703 (March 2, 1994), 59
FR 11345.
\4\Letter from Gerald Murphy, Fiscal Assistant Secretary, U.S.
Department of the Treasury to Jonathan G. Katz, Secretary,
Commission (April 5, 1994).
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I. Description
The proposed rule change modifies GSCC's rules to allow GSCC to
accept and report data on proprietary purchases of Treasury notes,
bills, and bonds made at auction by members of GSCC's netting system;
to net the purchases with when-issued trades of such members in the
member securities; and to deliver purchased securities through GSCC's
clearing mechanism (the ``auction takedown system''). GSCC has
established links with the Federal Reserve Banks of New York, Chicago,
and San Francisco in order to provide the auction takedown system, and
will establish links with other Federal Reserve Banks as needed. GSCC
intends to implement the auction takedown system in the Spring of 1994.
The proposed rule change also authorizes GSCC to establish a
mechanism for accepting data on members' trades in eligible securities
from sources such as exchanges and other clearing corporations on a
``locked-in'' basis. This means that GSCC members would be obligated to
accept trades as reported by such sources and GSCC would treat such
data, under its rules, as if they were the successful results of GSCC's
comparison of trade data submissions from buying and selling members.
1. The Auction Takedown Service
a. Eligible Securities
Only auction purchases meeting two conditions are eligible for
inclusion in GSCC's auction takedown system. First, the purchase must
be of a security with an issue date one or more business days after the
auction date. Second, only proprietary purchases are eligible. The
auction bid submitted to the Federal Reserve Ban must not include a
customer's or client's name on the tender form or on an attachment to
the tender form.\5\
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\5\Even if the client or customer is a GSCC netting member, the
trade will still be ineligible.
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b. Necessary Authorizations
Prior to its first eligible auction purchase, a GSCC member must
authorize GSCC to receive data on the member's auction purchase from
the applicable Federal Reserve Bank.\6\ If a GSCC netting member does
not provide the authorization, GSCC would not allow the participant to
remain a netting member. The GSCC member also must provide to the
applicable Federal Reserve Bank an authorization to provide to the
applicable Federal Reserve Bank an authorization to provide GSCC with
the data on the member's auction purchase and an authorization to
deliver the auction purchase to GSCC's agent bank.\7\
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\6\The applicable Federal Reserve Bank would be the bank to
which the GSCC member intends to submit its bid.
\7\Currently, The Bank of New York has been designated as agent
bank for Treasury notes; Chemical Bank has been designated as agent
bank for all other products.
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C. Receipt of Data by GSCC
In the afternoon or evening of the day of a U.S. Department of
Treasury (``Treasury'') auction, the Federal Reserve Banks will
transmit to GSCC information, on a per-CUSIP basis, regarding which
netting members received auction awards of eligible securities and the
amount and value of those awards at each yield. The auction award data
will be deemed to be a compared trade; the contra-party will not submit
any data on the trade. GSCC will report the auction trade to the
purchasing member as part of the daily comparison output, and the trade
will be binding on the member at that time.\8\
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\8\Procedures will be established that will provide the Federal
Reserve Banks with a unilateral capability to cancel incorrect data
and to provide new, correct data, as necessary. A member can
generate a cancellation and correction request to the Federal
Reserve Banks if it believes an error had been made. The requested
adjustment will be made only if it is acted upon by a Federal
Reserve Bank.
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d. Netting
After the auction award is reported to the GSCC member, the
position will go directly into GSCC's netting system. GSCC will treat
the award, for settlement purposes, in the same manner as a compared
trade which will be netted with a member's compared secondary market
trades in the same CUSIP to establish net settlement positions. GSCC
will then report to the member the net position (deliver, receive, or
take no action) and net payment obligation. Once netted, GSCC will be
obligated to accept from the applicable Federal Reserve Bank delivery
of each member's auction purchase and pay for such purchase, through
its agent banks. Pending delivery on issue date, GSCC will collect
clearing fund margin and forward mark allocation payment\9\ amounts
based on the net settlement position taking into account auction
purchases. In addition, GSCC will collect clearance difference amounts
on an intra-day basis for any money differences that arise as a result
of the pairing off of auction purchases with fail obligations.\10\
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\9\In connection with this filing, GSCC is changing its formula
for calculating the forward mark allocation (``FMA'') payment
obligation. Except for category 1 inter-dealer broker netting
members, who do not have an FMA payment obligation, all netting
members will have their FMA payment obligation calculated based on
the entire debit mark.
\10\This money difference will arise if the average auction
price is higher than the market value, with the result that the
settlement value will be set at the average auction price. In such a
case, if the net long position for the auction securities is paired
off with a fail net short position in the same CUSIP (which would
have a settlement value equal to the lower market value), there will
be a money difference reflecting an amount owed to GSCC by the
member.
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e. Delivery
Each Federal Reserve Bank will deliver the auction purchases to the
clearing bank designated by GSCC for such purpose. Early in the day on
issue date, GSCC will provide its agent banks with instructions for
receipt and delivery so that the auction purchases can be received
against payment from the Federal Reserve Banks and redelivered to GSCC
members against payment automatically and virtually instantaneously.
GSCC will pay the Federal Reserve Banks for the auction awards at
the award price. GSCC will redeliver the auction awards to GSCC members
against payment of the settlement value,\11\ equal to the greater of
the system (market) value for the position or the average auction price
for such auction purchase. This adjustment is necessary to permit GSCC
to net auction awards with when-issued and forward settling trades in
the same security.
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\11\The settlement value, a new concept, is the system (market)
value plus a delivery differential adjustment amount. In most
instances, the delivery differential adjustment amount will be zero,
GSCC will establish a higher delivery differential adjustment amount
only under two circumstances. If the system (market) value is less
than the average auction price, the delivery differential adjustment
amount will be increased so that the settlement value equals the
average auction price. In addition, GSCC may adjust the delivery
differential adjustment amount if the member is subject to higher
than normal surveillance status and if, in the opinion of senior
GSCC management, the potential for such member to fail to meet its
settlement obligations to GSCC is higher than normal. See Letter
from Jeffrey F. Ingber, General Counsel, GSCC to Jack Drogin, Branch
Chief, Commission (February 15, 1994). GSCC agrees that, to the
extent practicable, it will consult with the Commission prior to
adjusting the delivery differential adjustment amount for a member
who is on surveillance status. GSCC will follow up any oral
notification with a written notification and will continue to
consult with the Commission during the time that GSCC exercises this
authority. Memorandum to File from Christine Sibille, Attorney,
Commission (April 25, 1994).
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The normal GSCC delivery process should provide members with timely
delivery of their auction awards to the extent that members have net
long positions consisting of auction securities. Because members could
be flat or short with respect to other GSCC members and long with
respect to non-GSCC dealers or their customers, GSCC will provide a
mechanism for ensuring timely delivery of needed auction purchases to a
member who, as a result of its secondary market trading, will have on
issue date a net short or flat position, or a long position that is
smaller than the amount of auction purchases that it requires.\12\
Under this procedure, no later than the evening of the second business
day prior to issue date,\13\ each such member can request that GSCC
deliver to it auction purchases made by such member on a CUSIP-by-CUSIP
basis (``Priority Delivery Request''). GSCC will split such member's
existing net settlement position into a long position equal to the
level of the requested delivery, and an offsetting short position. For
purposes of calculating a member's required clearing fund deposit, a
priority delivery request will be treated as if it were a net long
position if it is greater than the member's actual net long position.
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\12\GSCC will monitor the use of this mechanism to ensure that
only members who need immediate delivery of auction securities are
requesting the priority delivery.
\13\For auctions that are held on the business day immediately
prior to issue date, the request must be made by no later than on
the auction date.
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GSCC will establish the following auction award delivery
priorities: first to members to fulfill Priority Delivery Requests;
next to members with net long positions to the extent comprised of
auction purchases; and then to members with net long positions that
remain unfilled, on an equal basis, in $50 million increments.\14\
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\14\The maximum par amount of securities that can be delivered
over FedWire is $50 million. GSCC delivers the securities at the
maximum amount for operational ease, to provide a more efficient
method to distribute securities.
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f. Participant Failure
In the event that a member with an auction award fails, on or prior
to issue date, GSCC could incur a loss above the amount of collateral
it holds from that member in liquidating the member's positions. The
Treasury will not be liable for assessment for any loss that occurs as
a result of the auction purchase. Instead, pursuant to its arrangement
with the Treasury, GSCC will have the right to refuse delivery from a
Federal Reserve Bank on issue date of all or a portion of the auction
purchases of a GSCC member if certain conditions exist.
A netting member who made the auction purchase in a CUSIP must
remain in a long position in that CUSIP. GSCC must have reasonable
cause to believe, based on the information it has received, that the
member cannot or will not timely take delivery of and fully pay for
auction purchase amounts due it from GSCC. GSCC must have determined
from its analysis and prevailing market conditions that there is
reasonable cause to believe that, if it were to liquidate the member's
position, GSCC would incur a loss that would not be covered by the
margin deposited by the member with GSCC and/or profits from the
liquidation of other positions of the member. GSCC can specify the
amount of auction purchases on which it will not take delivery, which
amount may not exceed the member's net long position in that CUSIP.
GSCC must notify the appropriate Federal Reserve Bank, in a
mutually acceptable manner, of its exercise of this right by no later
than 8:30 a.m. New York time on the relevant issue date. The failing
member will remain responsible for the payment of such securities
pursuant to the terms established by the Treasury.
If GSCC incurs a residual loss as the result of the liquidation of
a member's auction purchase, the loss will be allocated in the same
manner as any other allocation of loss. The loss will be spread among
all of the netting members that the failed member did business with on
or prior to the day of default.
2. Locked-In Trades
The proposed rule change establishes a facility permitting GSCC to
treat trade data received from designated sources other than a Federal
Reserve Bank, such as exchanges or clearing corporations, as locked-in
trades.\15\
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\15\Proposals to extend this facility to organizations other
than Federal Reserve Banks should be submitted for Commission review
under section 19(b) of the Act prior to establishing links with
other locked-in trade sources.
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a. Reporting of Locked-In Trade Data
GSCC will accept trade data from a locked-in trade source without
matching it with data provided by a member. GSCC will report these
locked-in trades to members as part of its daily comparison output. For
purposes of GSCC's rules, locked-in trades will be considered as
compared trades and will be as valid, binding, and enforceable as
comparisons issued based on a match of corresponding data submitted to
GSCC by two members.
Each member that makes an eligible locked-in trade will be
obligated to provide GSCC with authorization for GSCC to receive data
on the locked-in trade from the locked-in trade source. A locked-in
trade source can correct or delete a previously submitted trade by
providing appropriate instructions to GSCC. If the locked-in trade
source is not a party to the trade, GSCC may delete or correct the data
upon receipt of matching instructions from each member that is a party
to the trade.
b. Netting
Subject to the terms and conditions that GSCC agrees to with the
locked-in trade source, GSCC may exclude any locked-in trade from its
netting system. Each netting member that makes a locked-in trade that
is eligible for netting and settlement by GSCC must provide GSCC and
the locked-in trade source with authorization for GSCC to receive and
the locked-in trade source to transmit data on the locked-in trade.
3. Other Revisions
Under GSCC's rules, a forward settling trade is eligible for GSCC's
netting system only if the trade settles within less than a certain
number of days after comparison by GSCC. For example, only trades that
settle fifteen days or less after comparison currently are eligible for
GSCC's netting system. The proposed rule change amends GSCC Rule 11,
section 2 to permit GSCC to establish the maximum number of business
days between comparison and settlement by a separately published
schedule. GSCC will file with the Commission, pursuant to section
19(b)(3)(A) of the Act, any proposals to change this time period.\16\
GSCC's rules also have been amended to allow GSCC to net fail deliver
obligations and fail receive obligations with any other receive
obligations and deliver obligations.
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\16\Memorandum to File from Christine Sibille, Attorney,
Commission (April 25, 1994).
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II. Comments
As noted above, in response to the notice published in the Federal
Register, the Treasury provided the Commission with comments in support
of the proposal. The Treasury believes that including Treasury auction
purchases in a multilateral netting system could be beneficial to the
efficiency of the government securities market. In addition, the
Treasury believes that the proposal would enable GSCC to improve its
risk management by providing a more complete picture of its members'
positions.
III. Discussion
The Commission believes the proposed rule change is consistent with
section 17A of the Act, and, therefore, is approving the proposal.
Specifically, the Commission believes the proposal is consistent with
section 17A(b)(3)(F)\17\ of the Act in that it promotes the prompt and
accurate clearance and settlement of securities transactions, fosters
cooperation and coordination with persons engaged in clearance and
settlement of securities transactions, and removes impediments to the
national system for the prompt and accurate clearance and settlement of
securities transactions.
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\17\15 U.S.C. 78q-1(b)(3)(F) (1988).
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In the 1992 Joint Report on the Government Securities Market
(``Joint Report''), the Commission, the Treasury, and the Board of
Governors of the Federal Reserve System recommended several
enhancements to GSCC's system.\18\ One such enhancement was the
inclusion of auction take-down activity in GSCC's netting system, since
the benefits of netting would increase as more trades are included in
the net. The Joint Report concluded that if the auction takedown
proposal were implemented, ``additional information on the overall
distribution process required to settle Treasury auction purchases and
on the true net settlement positions of members during a when-issued
period would be available at GSCC. GSCC's proposal is especially
significant in light of the risk to the Treasury resulting from the
auction settlement process and the use of autocharge agreements. GSCC's
proposal would reduce the risk to the Treasury to the extent that GSCC
assumes responsibility for auction purchases that are netted against
when-issued sales.''\19\
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\18\U.S. Department of Treasury, Board of Governors of the
Federal Reserve System, and Securities and Exchange Commission,
Joint Report on the Government Securities Marketplace (January
1992). The recommendations are (1) automated comparison of
repurchase agreements; (2) inclusion of auction take down activity
and yield-based trades in GSCC's netting system; (3) increase in
categories of GSCC membership; and (4) confirmation systems for non-
dealer, institutionalized customers.
\19\Joint Report at 30. With this approval, all but two of the
recommended enhancements to GSCC's system will have been
implemented. Only the first recommendation, automated comparison of
repurchase agreements, and the last recommendation, confirmation
systems for institutionalized customers, have not been implemented.
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The proposal provides a more efficient method of clearing and
settling auction securities. GSCC members will be able to access
information on the securities awarded to them through GSCC's reporting
system, and will have the securities delivered and paid for through
GSCC's clearance system. The processing required will be reduced since
the Federal Reserve Banks will provide information and securities to,
and receive payment from, one source, GSCC, for all GSCC members. By
channeling the payment and delivery obligations through one source (and
reducing those obligations through netting), the clearance process will
be made more efficient.
Currently, the proposal only covers purchases of Treasury
securities that settle one or more business days after the auction
date. This limitation is needed because of the limitations in GSCC's
system. However, the number of Treasury securities that settle on the
same day as auction date is so small that this limitation should not
have a significant effect on the national clearance system.\20\
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\20\During all of 1993 and 1994, no Treasury securities have
settled on the same day as the auction date. Memorandum to File from
Christine Sibille, Attorney, Commission (April 25, 1994).
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In addition, the proposal only covers proprietary purchases. If a
GSCC member were to fail, GSCC would still accept auction awards to the
extent covered by the GSCC member's short position. If a GSCC member's
customer purchases were included in the proposal, there is a
possibility that a customer's purchase would be used to satisfy the
failed member's short position rather than delivered to the customer.
Once the auction takedown proposal has been implemented, there will be
opportunities to study means of including customer trades without undue
risk to the customer. Until such time, the Commission believes that it
is reasonable to exclude customer trades.\21\
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\21\Approximately 15% of the securities awarded to GSCC members
are customer purchases. Memorandum to File from Christine Sibille,
Attorney, Commission (April 25, 1994).
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The proposal would change GSCC's settlement pricing to accommodate
introduction of auction positions. These changes will serve two
functions. First, it will ensure that GSCC never delivers auction
purchases for less than the amount it paid for the securities. Second,
it will provide GSCC with a risk control measure when a member is
subject to higher than normal surveillance status. This should help
GSCC address the risk of liquidity problems, and enhance GSCC's ability
to safeguard funds and securities.
The proposal also provides a general mechanism for GSCC to accept
locked-in trade data from sources other than a Federal Reserve Bank. By
accepting the trades directly from a locked-in trade source (such as an
exchange), the process of clearing and settling the locked-in trade is
made more efficient. The GSCC member does not have to duplicate input
of the data, submitting the data once to the locked-in trade source and
once to GSCC. Instead, the information flows directly to GSCC, thereby
lessening the risk of incorrect or incomplete submissions, or
unconfirmed trades.
The proposal extends the benefits of GSCC's centralized, automated
netting system to netting members' auction securities purchases. By
including auction securities in GSCC's netting system, the level of
potential netting is increased and the number of required movements of
securities are reduced.\22\ Netting of auction securities also may have
the effect of increasing a member's liquidity. Previously, a GSCC
member with a short position would have its required margin payments
calculated based on its short position, even if it had an offsetting
long position in auction purchases. Once the positions are netted, the
member's margin payments will be calculated based on the position after
taking into account the auction purchases, perhaps creating a lower
margin payment. The additional liquidity may assist in the prompt and
accurate clearance and settlement of securities transactions. In this
manner, the proposal removes impediments to the national system for the
prompt and accurate clearance and settlement of securities
transactions, and fosters cooperation and coordination with persons
engaged in clearance and settlement of securities transactions.
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\22\In March 1994, GSCC's netting system received $289 billion
in daily average buy/sell dollars. This amount was netted to result
in $65 billion in average daily receive and deliver obligations. In
effect, GSCC netted out approximately 77% of the dollar obligations
of members.
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IV. Conclusion
For the reasons stated above, the Commission finds that the
proposed rule change is consistent with section 17A of the Act.
It is therefore ordered, Pursuant to section 19(b)(2) of the Act,
that the proposed rule change (SR-GSCC-94-01) be, and hereby is,
approved.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-11339 Filed 5-10-94; 8:45 am]
BILLING CODE 8010-01-M
