[Federal Register Volume 61, Number 161 (Monday, August 19, 1996)]
[Notices]
[Pages 42925-42927]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-21054]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37548; File No. SR-GSCC-96-05]
Self-Regulatory Organizations; Government Securities Clearing
Corporation; Notice of Filing of Proposed Rule Change Relating to
Clearing Fund Collateral and Loss Allocation Provisions
August 9, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on May 28, 1996, the
Government
[[Page 42926]]
Securities Clearing Corporation (``GSCC'') filed with the Securities
and Exchange Commission (``Commission'') the proposed rule change as
described in Items I, II, and III below, which items have been prepared
primarily by GSCC. GSCC amended this filing on July 25, 1996.\2\ The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1) (1988).
\2\ Letter from Karen Walraven, Vice President and Associate
Counsel, GSCC, to Jerry W. Carpenter, Assistant Director, Division
of Market Regulation, Commission (July 22, 1996).
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
GSCC proposes to modify its rules and related information to expand
the types of securities that are deemed eligible for clearing fund
collateral and to redefine the concept of current trading activity for
loss allocation purposes.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, GSCC included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. GSCC has prepared summaries, set forth in sections A, B,
and C below, of the most significant aspects of such statements.\3\
---------------------------------------------------------------------------
\3\ The Commission has modified the text of the summaries
prepared by GSCC.
---------------------------------------------------------------------------
A. Self-Regulatory Organization's Statement of the Purpose of, and the
Statutory Basis for, the Proposed Rule Change
1. Clearing Fund Collateral
GSCC proposes to expand the types of securities that are deemed
eligible for clearing fund collateral to include all eligible netting
securities. The purpose of the clearing fund is (i) to have on deposit
from each netting member assets sufficient to satisfy any losses that
might be incurred by GSCC or its members as the result of default by a
member and the resultant close out of that member's settlement
positions; (ii) to maintain a total asset amount sufficient to satisfy
potential losses to GSCC and its members resulting from the failure of
more than one member; and (iii) to ensure that GSCC has sufficient
liquidity at all times to meet its payment and delivery obligations.
GSCC Rule 4 requires each netting member to make and to maintain a
deposit to the clearing fund, and Section 4 thereof prescribes the form
that a netting member's clearing fund deposit must take. Currently,
there are three types of eligible clearing fund collateral: cash,
eligible Treasury securities, and eligible letters of credit. An
eligible Treasury security is defined as an unmatured, marketable debt
security in book-entry form that is a direct obligation of the U.S.
government. In practice, GSCC accepts only treasury bills, notes, and
bonds as collateral.\4\ Conversely, GSCC currently processes a broad
range of securities (i.e., eligible netting securities) through the
netting system. GSCC proposes to expand the types of securities that
will be deemed acceptable forms of clearing fund collateral \5\ to
include all securities that are eligible for the netting system (e.g.,
any non-mortgage-backed security, including zero-coupon securities,
issued or guaranteed by the U.S., a U.S. government agency or
instrumentality, or a U.S. government-sponsored corporation). GSCC
believes that the risks associated with this broader range of
government securities are minimal and can be managed in an appropriate
fashion, as discussed below.
---------------------------------------------------------------------------
\4\ Currently, only coupon bearing Treasury notes and bonds are
eligible as clearing fund collateral. See Securities Exchange Act
Release No. 33237 (December 1, 1993), 58 FR 63414.
\5\ At this time no change is proposed with respect to the cash
and letters of credit eligible for clearing fund deposits.
---------------------------------------------------------------------------
GSCC believes that an expansion of acceptable clearing fund
collateral will benefit its members by providing them with more
flexibility in meeting their clearing fund obligations and that the
expansion will enable GSCC to maximize the liquidity of the clearing
fund at risk levels that are not significantly higher than those
present under the current definition. The securities in the eligible
netting security category are eligible for settlement on a book-entry
basis over the Fedwire, are liquid, and are not subject to a high
degree of price volatility. Nonetheless, GSCC intends to limit
liquidity and price volatility risks by applying an appropriate haircut
percentage to each type of security accepted as clearing fund
collateral. The haircut will be at least equal to the haircut GSCC
takes on eligible Treasury securities,\6\ and in no event will the
haircut be lower than that applied to the relevant security by GSCC's
liquidity bank.
---------------------------------------------------------------------------
\6\ Section 4 of GSCC Rule 4 provides that eligible Treasury
securities with a remaining maturity of greater than one year and
less than ten years are subject to a three percent haircut while
securities with a remaining maturity of ten years or greater are
subject to a five percent haircut. GSCC does not propose to change
these existing haircut provisions at this time.
---------------------------------------------------------------------------
Furthermore, pursuant to action by its Board of Directors, under
the proposed rule change GSCC will retain the right to refuse to accept
particular types of collateral for liquidity or other reasons. Such
refusal could arise under a variety of circumstances such as GSCC's
liquidity bank's reluctance to accept a certain type of security as
collateral for an extension of credit.
2. Loss Allocation
Rule 20, Section 4(c) of GSCC's rules provides that upon a member's
default GSCC will close out the positions of the defaulting member. If
the close out of all the defaulting member's positions results in GSCC
incurring a loss, that loss will be allocated pursuant to GSCC Rule 4.
Under Section 8 of Rule 4, GSCC looks first to the defaulting
member's clearing fund collateral. If the defaulting member's
collateral does not fully cover GSCC's loss, GSCC determines the
proportion of the remaining loss that arose in connection with non-
brokered (i.e., direct) transactions and the proportion that rose in
connection with brokered transactions. Brokered transactions are
categorized as either brokered transactions involving only members or
brokered transactions involving a nonmember on one side of the trade.
To the extent a remaining loss is determined to arise in connection
with direct transactions, the loss is allocated pro rata among netting
members other than interdealer brokers based on the dollar value of the
trading activity of each such netting member with the defaulting member
netted and novated on the day of default. If the loss is determined to
arise in connection with member brokered transactions, GSCC allocates
ten percent of the loss to the interdealer broker netting members on an
equal basis regardless of the level of trading activity of each such
broker with the defaulting member. The remainder of the loss is divided
pro rata among all other netting members based upon the dollar value of
each netting member's trading activity through interdealer brokers with
the defaulting member netted and novated on the day of default. If the
loss is determined to arise in connection with nonmember brokered
transactions, GSCC allocates ten percent of the loss to the interdealer
broker netting members on an equal basis regardless of the level of
trading activity of each such broker with the defaulting member. The
remainder of the loss is allocated pro rata among the
[[Page 42927]]
Category 2 interdealer broker netting members that were parties to such
nonmember brokered transactions based upon the dollar value of each
such broker member's trading activity with the derfaulting member
netted and novated on the day of default.\7\
---------------------------------------------------------------------------
\7\ Category 1 interdealer brokers act exclusively as brokers
and trade only with netting members and with certain grandfathered
nonmember firms. Category 2 interdealer brokers are permitted to
have up to ten percent of their business with nonnetting members
other than grandfathered nonmembers.
---------------------------------------------------------------------------
An important principle in the loss allocation process is the
definition of ``trading activity with the defaulting member netted and
novated on the day of default.'' \8\ GSCC's rules define this as
trading activity with a defaulting member submitted by a netting member
that was compared, entered the net, and was novated on the business day
on which the failure of the defaulting member to fulfill its
obligations to GSCC occurred. However, if the aggregate level of such
trading activity is less than the dollar value amount of the defaulting
member's securities liquidated pursuant to GSCC's close out procedure,
the term will encompass trading activity going back as many days as is
necessary to reach a level of activity that is equal to or greater than
the dollar value amount of such liquidated securities.
---------------------------------------------------------------------------
\8\ GSCC Rule 4, Section 8(a)(v).
---------------------------------------------------------------------------
GSCC proposes to modify its loss allocation procedures by
redefining the concept of ``trading activity with the defaulting member
netted and novated on the day of default'' to capture a level of
trading activity that is at least five times the dollar value amount of
the securities of the defaulting member that are liquidated. The five-
fold multiple is based on the approximate netting factor of eighty
percent. Historically, the aggregate transactions processed through
GSCC's netting system net down to approximately twenty percent of the
aggregate transactional volume (i.e., for approximately every five
transactions that enter the netting process, only one needs to be
settled through the movement of securities and cash).
GSCC's current approach to loss allocation focuses on the date on
which a transaction is netted and novated by GSCC and this will
continue to be the case. However, with the advent of netting of
repurchase agreements (``repos'') and the resultant increase in the
number of relatively longterm transactions introduced into the netting
process, GSCC has reevaluated its loss allocation process with a view
toward better taking into account the duration of netted transactions.
The proposed approach does not take into account the duration of
the trade (i.e., t he time between trade date and settlement date).
Rather, GSCC seeks a balance between assessing transactions based
purely on when they were entered into versus taking into account their
duration by expanding the amount of trading that will be encompassed
for loss allocation purposes. GSCC believes this will have the effect
of establishing a greater incentive for members to assess the
creditworthiness of counterparties.
GSCC believes the proposed rule change is consistent with its
obligations under Section 17A of the Act \9\ because by broadening the
range of securities acceptable as clearing fund collateral and by
modifying the loss allocation procedures to encompass more trades, GSCC
will facilitate member transactions and will cause members to assess
the creditworthiness of their counterparties based on duration of
transactions. This should promote the prompt and accurate clearance and
settlement of securities transactions.
---------------------------------------------------------------------------
\9\ 15 U.S.C. 78q-1 (1988).
---------------------------------------------------------------------------
B. Self-Regulatory Organization's Statement on Burden on Competition
GSCC does not believe that the proposed rule change will have an
impact or impose a burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Comments on the proposed rule change have not yet been solicited or
received. Members will be notified of the rule filing, and comments
will be solicited by an important notice. GSCC will notify the
Commission of any written comments received by GSCC.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within thirty-five days of the date of publication of this notice
in the Federal Register or within such longer period (i) as the
Commission may designate up to ninety days of such date if it finds
such longer period to be appropriate and publishes its reasons for so
finding or (ii) as to which the self-regulatory organization consents,
the Commission will:
(A) By order approve such proposed rule change or
(b) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street N.W., Washington, D.C. 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. Sec. 552, will be available for inspection and copying in
the Commission's Public Reference Section, 450 Fifth Street N.W.,
Washington, D.C. 20549. Copies of such filing will also be available
for inspection and copying at the principal office of GSCC. All
submissions should refer to File No. SR-GSCC-96-05 and should be
submitted by September 9, 1996.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\10\
---------------------------------------------------------------------------
\10\ 17 CFR 200.30-3(a)(12) (1995).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-21054 Filed 8-16-96; 8:45 am]
BILLING CODE 8010-01-M
