[Federal Register Volume 61, Number 129 (Wednesday, July 3, 1996)]
[Notices]
[Pages 34912-34915]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-16922]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37368; File No. SR-GSCC-96-01]
Self-Regulatory Organizations; Government Securities Clearing
Corporation; Order Approving a Proposed Rule Change Relating to the
Enhancement of Risk Management Processes
June 25, 1996.
On January 5, 1996, the Government Securities Clearing Corporation
(``GSCC'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change (File No. SR-GSCC-96-01)
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 March 13, 1995.\2\ No comment letters were received. For
the reasons discussed below, the Commission is granting approval of the
proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ Securities Exchange Act Release No. 36933 (March 6, 1996),
61 FR 10045.
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I. Description
As part of GSCC's continuous process of reviewing its risk
management mechanism, GSCC has made various enhancements and revisions
to that mechanism. The design of the risk management process for GSCC's
newly implemented netting service for repurchase agreements (``repos'')
and recommendations made by Commission staff during their inspection of
GSCC last year provided the impetus for certain of the enhancements and
revisions. Each of the changes to GSCC's risk management process is
described in detail below.
A. Change in the Clearing Fund Formula
1. Funds Adjustment Component
There are three components to a netting member's clearing fund
deposit requirement: (1) the funds adjustment component, (2) the
receive/deliver settlement component, and (3) the repo volatility
component. The sum of the three components is a member's total clearing
fund deposit requirement. The first component of the clearing fund, the
funds adjustment component, addresses the potential risk that a member
might not pay a funds-only settlement amount due to GSCC.\3\
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\3\ Historically, this component has represented about ten
percent of the total clearing fund requirement.
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Prior to this amendment, the funds adjustment component was 125% of
the average of a member's ten largest funds-only settlement amounts
measured on an absolute basis during the most recent seventy-five
business days.\4\ Under the proposed rule change, the funds adjustment
component is now 100% of the average of the member's twenty largest
funds-only settlement amounts during the most recent seventy-five
business days.\5\ However, GSCC retains the right to reinstitute at its
discretion
[[Page 34913]]
all or a part of the twenty-five percent cushion for a temporary
period. For example, GSCC might reinstitute this cushion during
volatile market conditions.
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\4\ Prior to the implementation of GSCC's netting service for
repos, GSCC's rules required computation of the average of a
member's absolute funds amounts over the prior twenty business days.
Securities Exchange Act Release No. 36491 (November 17, 1995), 60 FR
61577 (order approving proposed rule change).
\5\ This change has been made to both paragraphs (b) and (d) of
Rule 4, Section 2 of GSCC's rules. Paragraph (b) applies to bank
netting members, Category 1 dealer netting members, Category 1
futures commission merchant netting members, Category 2 inter-dealer
broker netting members, government securities issuer netting
members, insurance company netting members, and registered
investment company netting members. Paragraph (d) applies to
Category 2 dealer netting members and Category 2 futures commission
merchant netting members.
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2. Receive/Deliver Settlement Component
The second component of the clearing fund requirement is the
receive/deliver settlement component, which is based on the size and
nature of a member's net settlement positions. The receive/deliver
component for GSCC netting members other than Category 2 dealer or
Category 2 future commission merchant members \6\ is the largest of the
following four calculations based on a member's gross margin:\7\
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\6\ GSCC's method of calculating the receive/deliver/settlement
component for Category 2 dealer and Category 2 futures commission
merchant members is set forth below.
\7\ Gross margin is the product of GSCC's margin factors
multiplied by the dollar value of a member's current outstanding net
settlement position. GSCC's margin factors are designed to estimate
daily security price movements, are expressed as percentages, and
are determined by historical daily price volatility. See Section 4
below for a discussion of GSCC's margin factors.
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(1) Post-Offset Margin Amount (``POMA''): The POMA essentially is a
member's total gross margin taking into account allowable offset
percentages.\8\
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\8\ Margin amounts on receive (long) and deliver (short)
positions are allowed to offset each other. The extent to which an
offset is allowed is determined by product and the degree of
similarity in time remaining to maturity.
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(2) Average POMA: Prior to this amendment, the average POMA
typically was based on a member's ten highest POMA amounts occurring in
the most recent seventy-five business days, including the current day's
POMA amount. Under the proposed rule change, GSCC will now use an
average of the twenty largest POMA amounts during the most recent
seventy-five business days.
(3) Adjusted POMA: The adjusted POMA is calculated the same way as
the POMA with the exception of excluding all trades that are scheduled
to settle on the current day.\9\
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\9\ This is done based on the assumption that those trades will
settle on the current day; thus, calculating POMA in this manner
will more accurately reflect GSCC's settlement exposure during the
current day.
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(4) Liquidation Amount: This is a floor amount which previously
equalled fifty percent of the total gross margin on all long and short
positions without offsets. The proposed rule change lowers this amount
to twenty-five percent.
The proposed rule change also deletes sections (2)(g)(i) and
(2)(g)(ii) of Rule 4 regarding alternative formulas for the receive/
deliver settlement component of the required clearing fund deposit.
GSCC rarely used the alternative calculation under subsection (g)(i),
which disregards when-issued trades that have been issued. Subsection
(g)(ii) has been made obsolete by the changes approved in GSCC's filing
pertaining to its repo netting service.\10\
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\10\ Supra note 4.
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With respect to Category 2 dealer or Category 2 futures commission
merchant members, the receive/deliver settlement component was the
largest of (1) the member's total gross margin without offsets, (2) the
member's total gross margin without offsets and excluding positions due
to settle that day, or (3) the average of the member's largest ten
gross margin amounts over the most recent seventy-five business days.
GSCC has revised the third calculation to use the average of the
largest twenty gross margin amounts over the most recent seventy-five
business days.
3. Repo Volatility Component
The third component of the clearing fund requirement is the repo
volatility component. This component was recently added to GSCC's
clearing fund formula to cover securities' settlement exposure posed by
repo activity. The repo volatility component was the greater of (1) the
product of the repo volatility factor and the market value of the
member's repo transactions taking into account allowable offset
percentages (``repo offset amount'') or (2) the average of a member's
ten highest repo offset amounts over the most recent seventy-five
business days. GSCC has revised the second element of this calculation
to take the average of a member's twenty highest repo offset amounts
over the most recent seventy-five business days.
B. Providing GSCC With Discretion, Within Parameters, To Lower Margin
Factors
GSCC's Membership and Standards Committee (``Committee'') reviews
on an ongoing basis the appropriateness of its margin factors \11\ by
examining third-party price volatility data and GSCC's own short-term
and long-term data covering ninety-five and ninety-nine percent of all
price movements. However, prior to this amendment, GSCC was not allowed
to lower any of its margin factors without first obtaining Commission
approval through a formal rule filing process.
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\11\ As defined in GSCC's rules, margin factors and Category 2
margin factors are percentage, which GSCC publishes from time to
time, representing variations weighted by maturity and product type.
These margin factors are used in GSCC Rule 4, Section 2 to calculate
the receive/deliver settlement component of the required fund
deposit for GSCC's members described above in Section 2.
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GSCC has revised its rules to permit the Committee to lower a
margin factor subject to a predefined limitation if the Committee
determines it appropriate based on its review of historical price
volatility data and if the GSCC Board of Directors approves such a
lower margin factor. With respect to GSCC netting members other than
Category 2 dealer members and futures commission merchant members, the
predefined limitation permits GSCC to reduce a margin factor to a level
that is no lower than the higher of (1) the price volatility for that
remaining maturity category taking into account ninety-five percent of
all movements during the last calendar quarter or (2) the price
volatility for that remaining maturity category taking into account
ninety-five percent of all movements during the last calendar year.
With respect to the margin factors for Category 2 dealer members and
futures commission merchant members, the limitation provides that GSCC
can reduce a margin factor to a level that is no lower than the higher
of (1) the price volatility for that remaining maturity category taking
into account ninety-nine percent of all movements during the last
calendar quarter or (2) the price volatility for that remaining
maturity category taking into account ninety-nine percent of all
movements during the last calendar year.
C. Revision of Certain Margin Factors for Zero-Coupon Government
Securities Other Than Treasury Bills (``Zeros'')
As noted above, GSCC's margin factors are based on an assessment of
historical daily price volatility data. Zeros require different margin
factors than other Treasury securities because zeros generally are
subject to greater price volatility than are other Treasury securities
with the same maturity.\12\ The applicable margin percentages for zeros
range from percentages that are the same as those for other Treasury
securities with respect to shorter-term maturities to percentages that
are two-and-a-half times the percentages applicable to other Treasury
securities with respect to long-term maturities.\13\
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\12\ GSCC's margin factor schedule for zeros is contained in
GSCC's filing. A copy of the filing is available for copying and
inspection in the Commission's Public Reference Room.
\13\ These differences initially were based on the differences
in the amount of haircut factors between zeros and other Treasury
securities found in the United States Treasury Department's liquid
capital requirements for government securities brokers and dealers.
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[[Page 34914]]
Prior to this filing, the margin factors for zeros in several
categories were well above the price volatility that GSCC's internal
data show for such categories under any measure. GSCC has lowered the
applicable margin factor for zeros in the seven to ten years remaining
maturity category from 1.870 percent to 1.50 percent. GSCC has lowered
the applicable margin factor for the ten to fifteen years remaining
maturity category from 2.813 percent to 1.813 percent. GSCC has lowered
the applicable margin factor for the fifteen years and higher remaining
maturity category from 3.625 percent to 2.625 percent.
D. Introduction of a Tiered Surveillance Status Mechanism
GSCC is placing members that pose a heightened level of potential
risk to GSCC in various classes of surveillance status instead of in
one surveillance status.\14\ GSCC's rules required that a member be
placed on surveillance status if one or more of a number of
circumstances is present. These circumstances include, but are not
limited to, a significant reorganization or change in control or
management of the member. In addition, GSCC could place a member on
surveillance status if one or more of a number of factors, such as a
member experiencing a condition that could materially affect its
financial or operational capability so as to potentially increase
GSCC's exposure to loss or liability, was present.
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\14\ At the conclusion of their recent inspection of GSCC,
Commission staff suggested that, in line with what many other
clearing agencies have in place, GSCC should establish different
classes of surveillance for its members.
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The proposed rule change establishes three surveillance categories.
A member will be placed on Class 1 surveillance status if one or more
of a number of factors pertaining to its financial condition is
present,\15\ if it has been placed on surveillance status by another
self-regulatory organization, or if it has been upgraded from Class 2
surveillance status within the past three calendar months. Class 1
surveillance status will result in GSCC more thoroughly monitoring a
member's financial condition and activities and will provide GSCC with
discretion to require a member to make more frequent financial
disclosures, including interim and/or pro forma reports.
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\15\ The financial condition factors that will result in Class 1
surveillance status include but are not limited to (1) a member
incurring recent significant net losses, (2) a member's required
fund deposit obligation representing a significant portion of its
net worth or net capital, and (3) a member experiencing any
condition that could materially affect its financial or operational
capacity.
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GSCC will place a netting member on Class 2 surveillance status if
one or more of a number of factors is present. These factors include
but are not limited to (1) any element of a member's capital position
falls below the minimum requirements, (2) a member has been upgraded
from Class 3 surveillance status within the last three calendar months,
(3) a member temporarily experiences an inability to meet its
securities settlement obligations to GSCC in a timely fashion, and (4)
a member's designated examining authority or appropriate regulatory
agency has a pending action against or investigation of the member that
could call into question the member's ability to meet its obligations
to GSCC. In addition to the consequences resulting from placement on
Class 1 surveillance status, a member placed on Class 2 surveillance
status will be required to maintain a required fund deposit in excess
of the amount ordinarily required, as permitted under GSCC's rules.
A GSCC netting member will be placed on Class 3 surveillance status
if GSCC is considering taking action under GSCC Rule 18 (Ceasing to Act
for a Member) or GSCC Rule 20 (Insolvency of a Member).\16\ A GSCC
netting member on Class 3 surveillance status will be placed on a final
notification list. A netting member will remain on such final
notification list until the condition(s) that resulted in its
assignment to Class 3 surveillance status have improved to an extent
that GSCC deems appropriate to support reassignment of the member to
Class 2 surveillance status.
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\16\ Under Rule 18 (Ceasing to Act for a Member), GSCC may cease
to act for a member upon notice to such member for such reasons as:
(1) the member has failed to perform its obligations to GSCC or
materially violated any GSCC rule, procedure, or agreement, (2) the
member has failed to pay GSCC any payment required, (3) the member
no longer meets its admissions or continuance standards, or (4) the
member has been responsible for fraudulent or dishonest conduct.
Under Rule 20 (Insolvency of a Member), GSCC will cease to act for a
member if such member meets one of several tests of insolvency
(e.g., such member files a petition seeking relief under the
Bankruptcy Code).
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E. Simplification of the Clearing Fund Deficiency Call Mechanism
GSCC's rules permit GSCC to make clearing fund deficiency calls on
a same day basis under the following four circumstances: (1) a member's
current day's required clearing fund deposit exceeds by twenty-five
percent the value of its clearing fund collateral, (2) a member's
current day's required clearing fund deposit level exceeds by more than
$250,000 the value of its clearing fund collateral, (3) a member is on
surveillance status and its required clearing fund deposit as of the
current day exceeds the value of its clearing fund collateral, or (4) a
member's ``clearing fund funds-only settlement amount,'' which excludes
clearance difference, invoice amount, and other miscellaneous amounts,
for the current day exceeds by more than twenty-five percent its
average daily clearing fund funds-only settlement amount over the most
recent twenty business days.\17\
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\17\ The clearance difference is the dollar difference between
GSCC's system price for a settlement obligation and the actual value
at which the settlement obligation was settled. The invoice amount
means all fees that a member owes GSCC.
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The fourth circumstance, a twenty-five percent jump in the member's
clearing fund funds-only settlement amount, has rarely been used and is
now eliminated.\18\ A clearing fund deficiency call that is based on a
member being on surveillance status can now be invoked only if a member
is on Class 2 or Class 3 surveillance status. Finally, because GSCC has
the authority to make clearing fund deficiency calls on a same day
basis, GSCC's rule permitting GSCC automatically to make a clearing
fund deficiency call at the beginning of each month has been deleted.
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\18\ At the conclusion of their recent inspection of GSCC,
Commission staff suggested that GSCC should either monitor the
funds-only deficiency call requirements or file with the Commission
a proposed rule change eliminating it.
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F. Elimination of the Noon Deadline for Satisfaction of Clearing Fund
Deficiency Calls
By 9:00 a.m., GSCC issues by telephone calls followed by telefax
notices calls for additional clearing fund deposits by 9:00 a.m. The
exact time that each telephone call is made is recorded. Prior to this
filing, a member had until the later of two hours after the receipt of
a clearing fund deficiency call or noon to satisfy the call.
GSCC's long term goal is to develop an automated mechanism pursuant
to which it will be in receipt of clearing fund collateral by the time
that the securities Fedwire opens in the morning, which is currently at
8:30 a.m. As an interim step toward achieving this goal, GSCC is
eliminating the noon alternative deadline for satisfaction of clearing
fund deficiency call and is requiring a member to satisfy a deficiency
call within two hours after it is received. The practical effect of
this change is that, in the ordinary course, a member will have to
satisfy a deficiency call by approximately 11:00 a.m.
[[Page 34915]]
However, a clearing fund deficiency call does not need to be satisfied
before 10:00 a.m. regardless of when the call actually is made.
II. Discussion
Section 17A(b)(3)(F) \19\ of the Act requires that the rules of a
clearing agency be designed 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 GSCC's proposed
rule change is consistent with the requirements of Section 17A(b)(3)(F)
because the proposal, by enhancing and revising GSCC's risk management
mechanism, should help ensure that the mechanism accurately reflects
GSCC's risk and provides CSCC appropriate risk protection while
increasing members' liquidity and minimizing the operational burdens on
GSCC netting members.
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\19\ 15 U.S.C. Sec. 78q-1(b)(3)(F) (1988).
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Specifically, based upon its assessment of historical data, GSCC
has found that certain components of its clearing fund formula are
overly conservative. Therefore, GSCC is revising the Average POMA
calculation of the receive/deliver component, the funds adjustment
component, and the repo volatility component of its clearing fund
formula to utilize the twenty largest, rather than the ten largest,
POMA amounts, funds-only settlement amounts, and repo offset amounts
during the most recent seventy-five business days. GSCC also is
modifying the funds adjustment component of its clearing fund formula
to eliminate the twenty-five percent cushion in the component's
calculation. Because GSCC will retain the right to reinstitute at its
discretion all or part of the twenty-five percent cushion for a
temporary period, GSCC will be able to react quickly to changing market
conditions. GSCC also is lowering the liquidation amount of the
receive/deliver component of its clearing fund requirement from fifty
percent to twenty-five percent of the total gross margin on all long
and short positions without offsets. GSCC believes that, based on
historical performance, the twenty-five percent floor should provide
sufficient protection to GSCC from the risk that its margin offsets
will not reflect actual market conditions during a liquidation period
while enabling members that engage in activity on a fully hedged basis
to receive the benefits afforded by being fully hedged. Because these
modifications are based upon GSCC's assessment of historical data, the
changes should ensure appropriate risk protection for GSCC, while
providing members with increased liquidity.
GSCC also is revising its rules to permit its Membership and
Standards Committee to lower a margin factor subject to a predefined
limitation if the Committee determines it appropriate based on its
review of historical price volatility and if GSCC's Board of Directors
approves such a lower margin factor. The Committee reviews the
appropriateness of its margin factors on an ongoing basis. Thus, the
proposed rule change should provide GSCC with the flexibility to lower
margin factors more readily for the benefit of its members without
compromising GSCC's risk protection. The limitation on the Committee's
ability to lower margins (95% of all movements during the last quarter
or year) should ensure that GSCC will always have a sufficient level of
protection. GSCC also is lowering certain margin factors for zeros to
reflect more accurately GSCC's needs based upon GSCC's data at the
ninety-nine percent level over the past two years. Accordingly, members
will not be subject to margin requirements that exceed GSCC's current
needs.
In addition, GSCC is introducing a tiered surveillance status
mechanism. The new surveillance mechanism should enable GSCC to monitor
more effectively the potential risk posed by its members and to react
more swiftly to changes in a member's condition. Finally, as a step
toward GSCC's goal to develop an automated mechanism by which GSCC will
receive clearing fund collateral by the time that the securities
Fedwire opens, GSCC is eliminating the noon alternative deadline for
satisfaction of a clearing fund deficiency call and to require a member
to satisfy a deficiency call within two hours after it is received. By
increasing the efficiency of GSCC risk management processes, the tiered
surveillance mechanism and the modifications to GSCC's clearing fund
deficiency call rules should help GSCC fulfill its obligation to
safeguard securities and funds which are in its custody or control or
for which it is responsible.
III. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in particular 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-96-01) be and hereby is
approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\20\
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\20\ 17 CFR 200.30-3(a)(12)(1995).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-16922 Filed 7-2-96; 8:45 am]
BILLING CODE 8010-01-M
