01-21164. Self-Regulatory Organizations Government Securities Clearing Corporation; Order Approving a Proposed Rule Change Relating to Permitting Clearing Fund Offsets for Category 2 Dealer Netting Members and Category 2 Futures Commission Merchants

August 16, 2001.

On July 31, 2000, the Government Securities Clearing Corporation (“GSCC”) filed with the Securities and Exchange Commission (“M” a proposed rule change (File No. SR-GSCC-00-08) 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 January 11, 2001.^[2] No comment letters were received. For the reasons discussed below, the Commission is approving the proposed rule change.

I. Description

GSCC has established two membership categories, “category 1” and “category 2,” for dealers and futures commission merchants (“FCMs”) that want to participate in GSCC's netting system. GSCC established category 2 membership for dealers and FCMs that meet all of GSCC's requirements for participating in the netting system but have less net worth than GSCC's category 1 members. The minimum net worth requirement for category 1 members is $50 million, and the minimum net worth requirement for category 2 members is $25 million.^[3]

While category 2 members have a lower net worth threshold than category 1 members, category 2 members currently have a more stringent clearing fund requirement under GSCC Rule 4, Section 2(d). Specifically, the clearing fund requirement for category 2 members is calculated (i) without the benefit of any of the offsets across opposite net settlement positions ^[4] that are permitted for category 1 members and (ii) with margin factors set at the 99 percent-of-movements confidence level.^[5] (Margin factors for a category 1 member are set at the 95 percent confidence level.) In addition, if a category 2 member elects to receive credit forward margin amounts ^[6] in its daily funds-only settlements, its margin factors are set at levels that are based on the greater of: (i) the category 2 margin factors or (ii) margin factors adjusted to reflect GSCC's historical two-day price volatility data covering 95 percent of all movements.^[7]

GSCC currently has no active category 2 members. GSCC believes that certain entities that meet the eligibility requirements for category 2 membership and that recognize the many benefits of GSCC's netting system have not applied for membership because they consider the liquidity burden associated with the current clearing fund calculation for category 2 members to be too onerous. In order to broaden the availability of GSCC's netting services, GSCC proposes to allow for offsets in the clearing fund calculation for category 2 members. The current prohibition of offsets for category 2 members was implemented years ago as a conservative measure designed to avoid any risk arising from the creation of the category 2 level. Now, after many years of experience in conducting risk assessments, netting, and calculating margin, GSCC believes that prohibiting offsets is overly conservative and punitive. In addition, expanding the roster of GSCC netting members should also enhance the netting benefits for the existing members that currently trade with potential category 2 members.

Recognizing that category 2 members have smaller net worth bases and may therefore be deemed to pose a greater risk of default than category 1 members, the margin factors applied to category 2 members will continue to be set at the 99 percent confidence level (versus 95 percent for category 1 members). Furthermore, category 2 members will still be required to make an election regarding the receipt of forward margin. By permitting certain offsets for category 2 members and at the same time maintaining the more stringent margin factor requirements, GSCC will collect sufficient margin from category 2 members while expanding the range of netting members in a prudent manner.

II. Discussion

The Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder and particularly with the requirements of Section 17A(b)(3)(F) ^[8] of the Act. Section 17A(b)(3)(F) 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 finds that GSCC's rule change meets these requirements because it should result in additional broker-dealers and banks becoming GSCC netting members, which will promote the prompt and accurate clearance and settlement of securities transactions. In addition, by maintaining the more stringent margin factor requirements for category 2 members, GSCC should collect sufficient margin from duly approved category 2 members to allow GSCC to assure the safeguarding of securities and funds even while permitting certain offsets for category 2 members.

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 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-00-08) be, and hereby is, approved.

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

Jonathan G. Katz,

Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  Securities Exchange Act Release No. 43793 (Jan. 3, 2001), 66 FR 2465 (Jan. 11, 2001).

3.  Both categories have identical requirements for minimum excess net or liquid capital of $10 million.

4.  This means that GSCC does not allow category 2 members to offset long positions against short positions.

5.  This means that the category 2 margin factors are based on GSCC's historical daily price volatility data covering 99 percent of all movements.

6.  A credit forward margin amount refers to GSCC's daily process of computing a member's collateral by marking to market the member's transactions that will settle in the future. The result will produce a net credit or a net debit. If the member has a net credit, it can elect to have GSCC pay it the value of the net credit. It the member has a net debt, it must pay GSCC.

7.  A category 2 member that elects to receive credit forward margin amounts will have higher margin factors than a category 2 member that does not make that election.

8.  15 U.S.C. 78q-1(b)(3)(F).

9.  17 CFR 200.30-3(a)(12).