[Federal Register Volume 64, Number 165 (Thursday, August 26, 1999)]
[Notices]
[Pages 46737-46741]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-22118]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41766; File No. SR-GSCC-98-04]
Self-Regulatory Organizations; Government Securities Clearing
Corporation; Order Approving a Proposed Rule Change Relating to the
Establishment of a Cross-Margining Program
August 19, 1999.
On November 16, 1998, the Government Securities Clearing
Corporation (``GSCC'') filed with the Securities and Exchange
Commission (``Commission'') a proposed rule change (File No. SR-GSCC-
98-02) 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 February 10, 1999.\2\ The Commission received five comment
letters from four commenters.\3\ For the reasons discussed below, the
Commission is approving the proposed rule change.\4\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 41019 (February 3,
1999), 64 FR 6727.
\3\ Letters from Dennis A. Dutterer, President and Chief
Executive Officer, Board of Trade Clearing Corporation (March 3,
1999 and May 18, 1999); Sal Ricca, President, GSCC (April 19, 1999);
George F. Haase, Jr., President, New York Clearing Corporation
(April 23, 1999); and Scott C. Rankin, Vice President and Assistant
General Counsel, The Bond Market Association (July 23, 1999).
\4\ The Commission also notes that the Commodity Futures Trading
Commission (``CFTC'') has approved New York Clearing Corporation's
proposal to enter into a cross-margining arrangement with GSCC.
Letter from David Van Wagner, Acting Associate Director, Division of
Trading and Markets, CFTC to George F. Haase, Jr., President, New
York Clearing Corporation.
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I. Description
Under the rule change, GSCC will establish a cross-margining
program with futures clearing organizations (``FCOs'').\5\ GSCC will
begin cross-margining with the New York Clearing Corporation (``NYCC'')
\6\ and intends to set up cross-margining arrangements with other
FCOs.\7\
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\5\ Under the rule change, the term FCO is defined in GSCC's
Rules as a clearing organization for a board of trade designated as
a contract market under Section 5 of the Commodity Exchange Act that
has entered into a cross-margining agreement with GSCC. This will
include NYCC and any other futures clearing organization with which
GSCC establishes a cross-margining arrangement.
\6\ Until January 15, 1999, NYCC was known as the Commodity
Clearing Corporation.
\7\ Each FCO that participates in cross-margining with GSCC will
have a separate cross-margining agreement with GSCC. According to
GSCC, each of these agreements will have essentially similar terms,
and no preference will be given by GSCC to one FCO or its members
over another. GSCC will file proposed rule changes for all proposed
cross-margining arrangements with other FCOs, setting forth any
difference in a proposed new cross-margining arrangement from the
cross-margining arrangements with NYCC and any other approved cross-
margining arrangements.
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A. General Description of the Cross-Margining Program
Under the rule change, cross-margining will be available to any
GSCC member that is a member of or that has an affiliate \8\ that is a
member of an FCO that has entered into a cross-margining agreement with
GSCC. Any such member (or pair of affiliated members) may elect to have
its margin requirements at both clearing organizations calculated based
upon the net risk of its cash and forward positions at GSCC and its
offsetting positions in related futures contracts carried at the FCO.
Cross-margining is intended to lower the cross-margining participant's
(or pair of affiliated members') overall margin requirement.
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\8\ The term affiliate will be defined in each cross-margining
agreement between GSCC and an FCO. Under the form agreement between
GSCC and NYCC that GSCC included with its filing, ``affiliate''
means a clearing member of one clearing organization that (1)
directly or indirectly controls, (2) is directly or indirectly
controlled by, or (3) is under common control with a clearing member
of another clearing organization. Ownership of 10% or more of the
common stock of an entity is deemed control of the entity under the
definition.
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GSCC and each FCO will determine which of their members are
eligible to participate in the cross-margining program. In order to be
a GSCC cross-margining participant, a member must either (a) also be a
member of an FCO or (b) have an affiliate that is a member of an
FCO.\9\ In addition, the GSCC member (and its affiliate, if applicable)
must sign an agreement under which it agrees to be bound by the cross-
margining agreement and which allows GSCC or an FCO to apply the
member's (or its affiliate's) margin collateral to satisfy any
obligation of GSCC to an FCO (or vice versa) that results from the
default of the member (or its affiliate).
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\9\ The GSCC cross-margining arrangement will be applicable on
the futures side only to positions in a proprietary account of a
cross-margining participant (or its affiliate) at an FCO. The
arrangement will not apply to positions in a customer account at an
FCO that would be subject to segregation requirements under the
Commodity Exchange Act.
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Margining based on the net risk of correlated positions will be
carried out through an arrangement under which GSCC and the FCO agree
to share the proceeds from correlated positions and supporting
collateral. Under this arrangement, each clearing organization will
hold and manage its own collateral.
GSCC will offset each cross-margining participant's residual margin
amount at GSCC against the offsetting residual margin amounts of the
participant (or its
[[Page 46738]]
affiliate) at each FCO pro rata based upon the residual margin amount
available at each.\10\ GSCC and each FCO may then reduce the amount of
collateral that they collect to reflect the offsets between the cross-
margining participant's positions at GSCC and its (or its affiliate's)
futures positions at an FCO. If more than one FCO is cross-margining
with GSCC for a cross-margining participant, the participant's long or
short position in government securities at GSCC will be apportioned pro
rata among its offsetting short or long positions (if any) at each
FCO.\11\
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\10\ All possible offsets among positions carried by a cross-
margining participant within a single clearing organization will be
carried out before any offsets are carried out between GSCC and the
FCO.
\11\ For example, if a cross-margining participant has a $9
million residual short margin amount at GSCC and residual long
margin amounts in the same product of $8 million at FCO 1 and $4
million at FCO 2, GSCC will use two-thirds of the $9 million margin
amount ($6 million) for offset against the participant's FCO 1
activity and one-third of the $9 million margin amount ($3 million)
for offset against FCO 2 activity.
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Each clearing organization will guarantee the cross-margining
participant's (or its affiliate's) performance to the other clearing
organization up to a specified maximum amount. Each clearing
organization's guaranty will be backed by the positions and margin
deposits of its cross-margining participant. The amount of the guaranty
will ordinarily be equal to the amount of the offsetting residual
margin used to reduce the cross-margining participant's margin
requirement.
GSCC will issue a guaranty to each FCO with respect to a cross-
margining participant (or its affiliate) in an amount based on the pro
rata allocation among the FCOs of the participant's residual margin
amounts. In the event of a default and liquidation of a cross-margining
participant, the loss sharing arrangements as between GSCC and each FCO
will be based on the same pro rata shares. Loss sharing between
clearing organizations will be subject to a cap.
B. Summary of the Operation of the Cross-Margining Program
Data Exchange: GSCC and each FCO will exchange daily position and
margin data for each cross-margining participant (or pair of affiliated
members) with respect to each product eligible for cross-margining.
Collateral Management: Margin collateral will be collected,
maintained, valued, and returned separately by GSCC and each FCO
according to its own rules and procedures. GSCC will not maintain
cross-margining accounts for a cross-margining participant separate
from the cross-margining participant's regular account at GSCC, and
there will be no separate collateral pool at GSCC for cross-margining
activity.
Unified Margin Calculation: GSCC will agree with each of the FCOs
on the particular products cleared by each that are sufficiently price
correlated to be eligible for cross-margining treatment (e.g., cash
positions in two-year Treasury notes and futures on two-year Treasury
notes). Such products will be referred to as ``eligible products'' and
a cross-margining participant's long or short positions in eligible
products will be called ``eligible positions.'' GSCC and FCO will agree
upon a common margin formula including the percentage of principal
amount to be used as the base margin calculation on each long or short
position in each eligible product, any disallowance factors to be
applied when offsetting long and short margin amounts in different
eligible products, and the minimum charges for offsetting
positions.\12\
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\12\ According to GSCC, an appropriate conversion method will be
agreed upon to equate the size of futures and cash positions for
offset purposes.
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Coordinated Mark to Market Process: GSCC and each FCO will
coordinate their daily mark to market and variation margin processes.
If a cross-margining participant does not pay its debit mark or make a
required clearing fund or margin deposit to one clearing organization
on a particular business day, the other will be so informed and will
not pay out to that participant (or its affiliate) any credit mark or
clearing fund or margin withdrawal relating to cross-margined
positions.
Daily Calculation of Cross-Margining Reduction and Cross-
Guaranties: On each business day, GSCC will complete its own internal
margining process for buy-sell, repo, and Treasury auction transactions
for each cross-margining participant (including to the extent permitted
in GSCC's rules the setting off or netting of GCF repo transactions
with other activity).\13\ Each FCO will perform an equivalent internal
process for each of its cross-margining members by offsetting long
margin amounts against short margin amounts for futures and options on
futures contracts that are eligible products to the extent specified in
the FCO's rules.\14\
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\13\ For a description of GSCC's GCF Repo service, refer to
Securities Exchange Act Release No. 40623 (October 30, 1998), 63 FR
59831 [File No. SR-GSCC-98-02] (order approving proposed rule
change).
\14\ For example, on each business day, GSCC and NYCC each will
calculate for each cross-margining participant an initial margin
requirement with respect to eligible positions. This calculation
will be done independently based upon an agreed upon method without
the other clearing corporation's review. However, GSCC and NYCC will
review generally each other's margining process on a periodic basis,
and each will have the obligation to inform the other of any
material changes to its margining process.
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After completing the internal margining process, each clearing
organization may have ``residual'' long or short margin amounts for a
member in various eligible products. The residual long or short margin
amount is the amount of long or short margin (i.e., margin with respect
to a long position or a short position) that has not been ``used up''
in the internal offsetting process.\15\
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\15\ A margin amount may be ``used up'' whether or not there has
been a full offset against it. For example, assume that a GSCC
member has a $1 million gross margin requirement on a short position
in the 10-year note (offset class F) that is offset against a $1
million gross margin requirement on a long position in the long bond
(offset class G). Because there is a 20% disallowance on offsets
between classes F and G, the member has a $200,000 margin
requirement after the offset. However, both $1 million margin
amounts have now been entirely used up, and nothing is available for
further offset either within GSCC or for cross-margining with an
FCO.
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Each FCO will inform GSCC how much residual long or short margin
amount in each eligible product that the FCO intends to make available
for cross-margining offsets on that day for each cross-margining
participant. GSCC then will determine the amount of the long or short
residual margin offered by each FCO that GSCC can offset against the
participant's short or long residual margin amounts at GSCC for
purposes of determining the cross-margining reduction.\16\ GSCC will
inform each FCO of the cross-margining reduction as between GSCC and
that FCO for each cross-margining participant. The cross-margining
reduction is the amount by which GSCC and the FCO may each
appropriately reduce its cross-margining participant's margin
requirement to reflect the cross-margining offset.\17\
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\16\ The cross-margining reduction is determined by the residual
margin amounts made available by an FCO and ``used'' by GSCC in
determining the amount of the cross-guaranties. It does not depend
upon the amount, if any, by which either GSCC or an FCO actually
reduces a cross-margining participant's margin requirement. In other
words, after an offer by an FCO of $1 million in residual margin and
acceptance by GSCC of that amount for offset, the cross-margining
reduction would be $1 million, and the base amount of the cross-
guaranties would be fixed at that amount. However, either clearing
organization might nevertheless decide to reduce the cross-margining
participant's clearing fund or margin requirement by less than $1
million or not at all. In any event, the cross-margining reduction
under the cross-margining agreement would still be $1 million. The
clearing organization would simply have made a determination to hold
more collateral without affecting the amount of the guaranty it
receives from the other clearing organization.
\17\ If a cross-margining participant has eligible positions at
more than one participating FCO, the participant's total margin
reduction at GSCC will be the sum of the cross-margining reductions
between GSCC and each FCO.
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[[Page 46739]]
As a result, the maximum cross-margining reduction that a cross-
margining participant will receive will be determined by the amount of
residual margin taken by GSCC. For example, if an FCO offers $1 million
in residual short margin for a particular member in 2-year note futures
and if GSCC sets all of that amount off against a $2 million cash
position in the 2-year note, then the cross-margining reduction amount
will be $1,000,000 for GSCC and $1,000,000 for the FCO.
Under the anticipated terms of the cross-margining agreements
between GSCC and each participating FCO, GSCC will be deemed to have
extended its guaranty of a cross-margining participant's (or its
affiliate's) obligation to each FCO in a base amount equal to the
cross-margining reduction for that participant. Similarly, each
participating FCO will be deemed to have extended its guaranty of the
cross-margining participant's (or its affiliate's) obligation to GSCC
in the same base amount. For example, if GSCC has a residual short
margin amount for a cross-margining participant of $10 million in a
product which is offset against an FCO's residual long margin amount of
$4 million, then the base amount of the cross-guaranties is $4 million,
and GSCC can reduce the participant's margin requirement for that
product to $6 million because the FCO will have guaranteed $4
million.\18\
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\18\ As noted above, GSCC and each FCO will retain the right to
reduce a cross-margining participant's clearing fund or margin
requirement by less than the amount of the cross-margining reduction
or not to reduce it at all.
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Each clearing organization will represent to the other that it will
margin a cross-margining participant's positions such that the amount
of margin is adequate to cover the cross-margining participant's
obligations to that clearing organization including the obligation to
reimburse any payment under the guaranty. In addition, on any day that
is a business day for an FCO and not for GSCC or vice versa, the gross-
guaranties as they existed on the immediately preceding business day
will remain in effect. It shall be the responsibility of the clearing
organization that is open for business on such day to adjust its margin
requirements with respect to cross-margining participants to cover such
cross-margining participants' obligations.\19\
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\19\ The cross-margining participant's margin or clearing fund
deposit will remain fixed at the clearing organization that is
closed, and the closed clearing organization must therefore continue
to rely on the guaranty based on the previous day's cross-margining
reduction. However, the clearing organization that is open
ordinarily will be able to assess and collect additional margin or
clearing fund deposits if needed to reflect updated positions in the
participant's account on its own books as well as the fixed guaranty
obligation that is still outstanding to the other clearing
organization.
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Default of a Cross-Margining Participant: Liquidation and Loss-
Sharing: If a cross-margining participant becomes insolvent and its
eligible positions are liquidated by GSCC and the FCO(s), GSCC and each
FCO will calculate its ``net loss'' or ``net surplus'' from the
liquidation.\20\ GSCC and each FCO will use their best efforts to
coordinate the liquidation of eligible positions so that offsetting or
hedged positions can be closed out simultaneously. GSCC and each FCO
may unilaterally elect not to terminate or suspend and liquidate the
eligible positions of its cross-margining participant. However, a
clearing organization that does so will remain liable to the other on
this guaranty. In addition, a clearing organization that elects not to
liquidate the eligible positions of a defaulting participant will be
deemed to have no net loss and no net surplus.
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\20\ Under the form agreement between GSCC and NYCC that GSCC
included with its filing, net surplus and net loss are calculated as
follows:
In the event that (i) the sum of ``available margin'' and any
proceeds of eligible positions realized by such clearing
organization (including securities deliverable to and amounts
receivable with respect to securities deliverable by such cross-
margining participant in settlement of eligible positions) and any
mark to market payments or other settlement amounts due from such
clearing organization with respect to eligible positions exceeds
(ii) the sum of the mark to market payments or other settlement
amounts owed to such clearing organization with respect to or as a
result of the closeout of eligible positions (including securities
deliverable by or amounts payable with respect to securities
deliverable to such cross-margining participant with respect to
eligible positions) plus any interest expense, fees, commissions, or
other costs reasonably incurred in such closeout or otherwise
arising from such eligible positions, then the amount of such excess
shall be deemed to be the net surplus. In the event that the sum
referred to in clause (i) of the preceding sentences is less than
the amount referred to in clause (ii), the difference shall be the
net loss.
``Available margin'' is defined as the amount of clearing fund
deposits, margin, or other collateral remaining after satisfaction
of all obligations of the cross-margining participant to the
clearing organization other than obligations arising from eligible
positions.
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In the event a cross-margining participant is liquidated, if either
GSCC or an FCO has a net loss and the other has a smaller net loss, no
net loss, or a net surplus, then the one with the larger net loss
(``worse-off party'') is entitled to receive a payment from the other
(``better-off party'') that equalizes its losses. The amount of this
equalizing payment will be capped at the least of: (1) The ``maximum
guaranty amount'' of the better-off party; (2) if the better-off party
has a net loss, an amount that together with its net loss equals its
total cross-margining reduction; or (3) the worse-off party's net loss.
Generally, the guaranty arising from the cross-margining reduction
will be a cap on the amount of loss that either GSCC or an FCO can
incur as the result of a default by a participating member (or its
affiliate) to the other. The ``maximum guaranty amount'' of GSCC or the
FCO will exceed the amount of the cross-margining reduction only to the
extent that the better-off party has funds of the participant remaining
(i.e., a ``net surplus'') after satisfying all other obligations of the
participant to the better-off party.\21\
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\21\ Where a cross-margining participant had eligible positions
at more than one FCO, GSCC's net loss or net surplus for purposes of
the cross-margining agreement between GSCC and any one FCO will be a
portion of GSCC's aggregate net loss or net surplus from all
eligible positions and available margin at GSCC that is equal to the
portion of the residual margin at GSCC that was offset against the
residual margin at that FCO. For example, assume that FCO 1 and FCO
2 each offer GSCC $2 million in residual short margin based on a
$200 million short position in futures on the 10-year note. If GSCC
has only $2 million in residual long margin, it would ``take'' $1
million residual from each FCO for offset purposes. If GSCC incurs a
$10 million loss in liquidating the $200 million futures position,
GSCC's ``net loss'' for purposes of its agreement with FCO 1 would
ordinarily be half of that or $5 million. However, the cross-
margining agreements will also contain provisions permitting further
contribution by FCO 1 if FCO 1's net surplus exceeds $5 million and
FCO 2 contributes less than $5 million.
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C. Information Specific to the Current Form Agreement Between GSCC and
NYCC
Participation in the Cross-Margining Program: Any netting member of
GSCC other than an interdealer broker will be eligible to participate.
Any clearing member of NYCC will be eligible to participate.
Positions subject to Cross-margining: The products that will
initially be eligible for cross-margining at GSCC are its offset
classes for the 2-year note, 5-year note, 10-year note, and 30-year
bond and at NYCC are its 2-year note, 5-year note, 10-year note, and
30-year bond futures products. Residual margin amounts will be applied
only within the same ``offset class'' (e.g., the 2-year note against
the 2-year note future). All eligible positions maintained by a cross-
margining participant in its account at GSCC and in its (or its
affiliate's) proprietary account at NYCC will be eligible for cross-
margining.
Unified Margin Factors: GSCC and NYCC will apply GSCC's margin
factors to eligible positions.
Daily Procedures: On each business day by midnight, NYCC will
inform
[[Page 46740]]
GSCC of the residual margin amounts it is making available. GSCC will
inform NYCC by 2:00 a.m. how much of these residual margin amounts it
will use.
D. GSCC Rule Changes
The rule change adds definitions relating to cross-margining to
GSCC Rule 1. These definitions correspond generally to certain terms
that will be defined in the cross-margining agreements.
The rule change amends Section 2 of GSCC Rule 4 to provide that the
required fund deposit otherwise calculated for a cross-margining
participant may be reduced at GSCC's sole discretion in an amount not
to exceed the sum of the cross-margining reductions calculated under
the various cross-margining agreements. The rule change amends Sections
5 and 6 of Rule 4 to clarify the application of those provisions in the
context of the cross-margining arrangements. Specifically, the
amendments provide tat GSCC may set off a cross-margining participant's
obligation to reimburse GSCC for the payment of a guaranty against any
asset of the participant that GSCC holds as collateral and against any
amounts due to the participant. Section 6 of Rule 4 is also amended to
provide that GSCC may apply a member's clearing fund deposits to
satisfy a loss without treating the member as insolvent. The rule
change also adds a provision to Section 2 of Rule 22 to specify that
GSCC may but is not required to treat a cross-margining participant as
insolvent if the member is declared to be insolvent by an FCO.
The rule change adds new Rule 43 to GSCC's rules to set forth How a
GSCC netting member may become a cross-margining participant and its
obligations as a cross-margining participant. Section 3 of Rule 43
provides that a cross-margining participant has the obligation to
reimburse GSCC for any amount that it pays to an FCO on behalf of the
participant (or its affiliated member) under a cross-margining
guaranty. Rule 43 also cross-references the corresponding provisions of
the cross-margining agreement which state that any obligations of a
defaulting cross-margining participant to the FCO will be netted
against any amounts held by or due to the participant as a result of
its positions at GSCC. As a result, a defaulting participant will be
entitled to receive from the close out of its positions and margin at
GSCC only what remains after netting out the sum of its obligations to
GSCC and the FCOs. Section 4 of Rule 43 provides that a cross-margining
participant may be treated as insolvent at the discretion of GSCC if
(1) the cross-margining participant is determined to be insolvent by an
FCO or (2) the cross-margining participant's affiliate is deemed to be
insolvent by an FCO and the cross-margining participant does not
immediately upon GSCC's demand deposit with GSCC the amount of GSCC's
cross-margining guaranty to the FCO.
II. Comment Letters
The Commission received five comment letters from four commenters
in response to GSCC's filing.\22\
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\22\ Supra note 3.
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A. Letters From the Board of Trade Clearing Corporation
The Board of Trade Clearing Corporation (``BOTCC'') submitted two
comment letters in response to GSCC's proposal. In its first comment
letter, BOTCC stated its specific concerns with GSCC's proposal.
BOTCC's second letter responded to some of the statements in GSCC's
comment letter (which is described below). In its comment letters,
BOTCC expressed concern with the structure of GSCC's proposed cross-
margining program and with the legal enforceability of some of the
payment mechanisms in the program.
BOTCC noted that GSCC's proposed cross-margining program differs
from existing cross-margining programs in that GSCC and participating
FCOs will each maintain their own collateral and will not pool cross-
margining positions and margin deposits on those positions in a jointly
controlled account. BOTCC stated that the primary protection against
loss in current cross-margining programs is the fact that participating
clearing organizations have a joint first priority lien on and security
interest in all positions in cross-margined accounts, all funds and
securities deposited to satisfy margin requirements, and all proceeds
resulting from the liquidation of the accounts.
BOTCC stated that it believes that the structure of GSCC's proposal
does not ensure that GSCC and the FCOs will have sufficient resources
to satisfy losses that might result from a default of a cross-margining
participant. BOTCC stated that GSCC's proposal does not provide for any
limitation on the amount of guaranties that GSCC and the FCOs can
extend to each other. In addition, BOTCC stated that under GSCC's
proposal, margin reductions would be backed by mutual unsecured
promises rather than by a pool of collateral controlled jointly by GSCC
and the FCOs.
BOTCC also expressed concern that certain provisions of GSCC's
proposed cross-margining program might not be enforceable under the
U.S. Bankruptcy Code against a cross-margining participant that had
filed a bankruptcy petition. Specifically, BOTCC stated that if GSCC
became obligated to pay an FCO in order to equalize losses resulting
from liquidating positions of a defaulting cross-margining participant,
it would not be permitted under the Bankruptcy Code to setoff the
participant's obligation to reimburse that amount to GSCC against any
assets GSCC was holding for the participant.
Section 362(a) of the Bankruptcy Code \23\ provides for a stay
(known as the ``automatic stay'') of all actions against a debtor that
has filed a bankruptcy petition for claims that arose before the
petition was filed. However, Section 362(b)(6) of the Bankruptcy Code
\24\ provides an exception to the automatic stay which permits a
clearing agency to setoff a mutual claim against the debtor for a
margin payment or a settlement payment arising out of securities
contracts against property that is held by or due from the clearing
agency to margin or guarantee securities contracts. BOTCC stated that
Section 362(b)(6) does not allow a clearing agency to setoff a pre-
petition debt against a post-petition claim. BOTCC believes that a
claim against the participant for reimbursement of an amount that GSCC
paid to an FCO would be a post-petition debt and that GSCC would not be
permitted under Section 362(b)(6) to setoff the reimbursement
obligation against assets of that participant that GSCC was holding
pre-petition (e.g., surplus margin deposits). In addition, BOTCC
believes that it is not clear that the reimbursement obligation is a
``margin payment'' or a ``settlement payment'' as defined in the
Bankruptcy Code \25\ because the obligation (a) is not a specific type
of margin payment, (b) would not secure the cross-margining
participant's already liquidated positions at GSCC, and (c) is not
closely related to the settlement process.
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\23\ 11 U.S.C. 362(a).
\24\ 11 U.S.C. 362(b)(6).
\25\ The term ``margin payment'' is defined in Sections 101,
741, and 761 of the Bankruptcy Code, 11 U.S.C. 101, 741, and 761.
The term ``settlement payment'' is defined in Sections 101 and 741
of the Bankruptcy Code, 11 U.S.C. 101 and 741.
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B. Letter from GSCC
GSCC submitted a comment letter in response to BOTCC's first
comment letter. With respect to BOTCC's statements on the structure of
its proposed cross-margining program,
[[Page 46741]]
GSCC stated that all cross-margining arrangements rely to some extent
on unsecured promises between clearing agencies. GSCC noted that it and
the FCOs can decide to reduce or eliminate the cross-margining
reduction for a particular member or for all members. In addition, GSCC
stated that it can increase the amount of collateral that a cross-
margining participant is required to deposit to support its obligation
to GSCC including GSCC's guaranty obligations to the FCOs. GSCC further
stated that it believes that the structure of its cross-margining
program has an advantage over traditional cross-margining programs in
that the total possible liability of GSCC to another clearing agency
can be precisely calculated at any given point in time.
With respect to BOTCC's statements regarding the enforceability
under the Bankruptcy Code of a cross-margining participant's obligation
to reimburse GSCC's payment of a guaranty to an FCO, GSCC stated that
the reimbursement obligation would be a pre-petition claim because it
would be a contingent contractual obligation that would arise at the
time the cross-margining participant becomes subject to the cross-
margin agreement. In addition, GSCC stated that it believes that the
reimbursement obligation is a margin payment or a settlement payment
because (a) it would be made in settlement of a debt owed to GSCC and
(b) because it would represent a reimbursement to GSCC of a payment
made to an FCO to meet variation margin and settlement obligations.
GSCC further stated that in the alternative the cross-margining
agreement is a ``netting contract'' under the Federal Deposit Insurance
Corporation Improvement Act of 1991 (``FDICIA'') \26\ and therefore is
not subject to automatic stay provisions of Section 362 of the
Bankruptcy Code.\27\
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\26\ 12 U.S.C. 4401-4407.
\27\ In its second comment letter, BOTCC responded to GSCC's
statements and reiterated its statements regarding the structure of
the proposed cross-margining program and the effect of the
Bankruptcy Code an a cross-margining participant's reimbursement
obligation. In addition, BOTCC stated that it believes that FDICIA
only permits the enforcement of a netting contract against a
bankrupt party if there is an applicable exception from the
automatic stay.
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C. Letter From NYCC
NYCC stated that it supports GSCC's proposal and that the GSCC
structure allows each clearing organization to use its own systems to
monitor risk without having to set up a different system to monitor
cross-margined positions. In addition, NYCC stated that all cross-
margining arrangements rely on the risk systems, default protections,
and the ability of a clearing organization to be able to fulfill its
obligations.
D. Letter From the Bond Market Association
The Bond Market Association (``BMA'') stated that it strongly
supports cross-margining arrangements like the one proposed by GSCC. In
addition, the BMA stated that it agrees with GSCC's conclusion that the
cross-margining program will benefit cross-margining participants by
lowering their margin requirements and thereby allowing them more
efficient use of collateral and reduced operational costs. Moreover,
the BMA stated that it ``is comfortable expressing its agreement with
GSCC's analysis of the FDICIA netting provisions and the Bankruptcy
Code as they relate to its proposed cross-margining arrangement.''
III. Discussion
Under Section 19(b) of the Act,\28\ the Commission is directed to
approve a proposed rule change of a clearing agency if it finds that
the proposed rule change is consistent with the Act and the rules and
regulations thereunder. Section 17A(b)(3)(F) of the Act\29\ requires
that the rules of a clearing agency be designed to assure the
safeguarding of securities and funds which are in the custody and
control of the clearing agency or for which it is responsible. Section
17A(a)(2)(A)(ii) of the Act\30\ directs the Commission to use its
authority under the Act to facilitate the establishment of linked or
coordinated facilities for the clearance and settlement of transactions
in securities, securities options, contracts of sale for future
delivery and options thereon, and commodity options.
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\28\ 15 U.S.C. 78s(b).
\29\ 15 U.S.C. 78q-1(b)(3)(F).
\30\ 15 U.S.C. 78q-1(a)(2)(A)(ii).
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The comment letters that the Commission received from BOTCC raised
questions about the structure of GSCC's proposed cross-margining
program and about the legal enforceability of certain provisions of the
program. GSCC stated in response that it believes that its cross-
margining program will be safe and prudent from a risk management
perspective and that its payment mechanisms will be enforceable against
a defaulting cross-margining participant.
The Commission believes that GSCC's proposal should adequately
limit GSCC's potential financial exposure to a defaulting cross-
margining participant.\31\ In particular, the Commission notes that
GSCC may reduce or eliminate the cross-margining reduction to any
cross-margining participant and that GSCC will be able to calculate
precisely its potential liability to FCOs with respect to each cross-
margining participant. Furthermore, the Commission has always viewed
properly structured cross-margining programs as a significant risk
reduction method because they reduce the extent to which clearing
organizations have to independently manage the risk associated with
some but not all of the components (ie., the futures or government
securities component) of a member's total portfolio. Therefore, the
cross-margining program is structured so that GSCC will continue to be
able to assure the safeguarding of securities and funds which are in
its custody or control or for which it is responsible.
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\31\ The Commission believes that the arguments in GSCC's
comment letter are persuasive. However, the Commission recognizes
that in a bankruptcy proceeding a court could reach a different
result.
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GSCC's proposal will also enable it to coordinate with the FCOs in
the management of risks associated with their members' (or affiliated
members') positions in government securities and in related futures
contracts. The cross-margining program should also result in increased
and better information sharing regarding the financial condition of
participating joint and affiliated members. Therefore, GSCC's proposal
should facilitate the establishment of linked or coordinated facilities
for the clearance and settlement of transactions in government
securities and in futures contracts.
IV. 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-98-04) be and hereby is
approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\32\
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\32\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-22118 Filed 8-25-99 8:45 am]
BILLING CODE 8010-01-M
