2015-23283. Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of Filing of Advance Notice To Enhance NSCC's Margining Methodology as Applied to Family-Issued Securities of Certain NSCC Members

September 11, 2015.

Pursuant to section 806(e)(1) of title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act entitled the Payment, Clearing, and Settlement Supervision Act of 2010 ^[1] (“Clearing Supervision Act”) and Rule 19b-4(n)(1)(i) ^[2] under the Securities Exchange Act of 1934 (“Act”), notice is hereby given that on August 14, 2015, National Securities Clearing Corporation (“NSCC”) filed with the Securities and Exchange Commission (“Commission”) the advance notice SR-NSCC-2015-803 (“Advance Notice”) as described in Items I and II below, which Items have been prepared by NSCC.^[3] The Commission is publishing this notice to solicit comments on the Advance Notice from interested persons.

I. Clearing Agency's Statement of the Terms of Substance of the Advance Notice

This Advance Notice consists of amendments to NSCC's Rules & Procedures (“Rules”) in order to enhance NSCC's margining methodology as applied to family-issued securities of those NSCC Members ^[4] that are placed on NSCC's “Watch List”, i.e. those Member [sic] who present a heightened credit risk to NSCC or have demonstrated higher risk related to their ability to meet settlement, as more fully described below.

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis for, the Advance Notice

In its filing with the Commission, NSCC included statements concerning the purpose of and basis for the Advance Notice and discussed any comments it received on the Advance Notice. The text of these statements may be examined at the places specified in Item IV below. NSCC has prepared summaries, set forth in sections A and B below, of the most significant aspects of such statements.

(A) Clearing Agency's Statement on Comments on the Advance Notice Received From Members, Participants, or Others

In November 2013, NSCC engaged in outreach to its Members by providing those Members with a description of the proposal and the results of an impact study showing the potential impact of this proposal on Members' Clearing Fund required deposits. NSCC did not receive any written comments relating to this proposal in response to this outreach. NSCC will notify the Commission of any written comments received by NSCC.

(B) Advance Notice Filed Pursuant to Section 806(e) of the Payment, Clearing and Settlement Supervision Act

Description of Change

NSCC is proposing to enhance its margin methodology as applied to the family-issued securities of its Members that are on its Watch List ^[5] by excluding these securities from the volatility component, or “VaR” charge, and then charging an amount calculated by multiplying the absolute value of the long net unsettled positions in that Member's family-issued securities by a percentage that is no less than 40%. The haircut rate to be charged would be determined based on the Member's rating on the credit risk rating matrix and the type of family-issued security submitted to NSCC. Fixed income securities that are family-issued securities would be charged a haircut rate of no less than 80% for firms that are rated 6 or 7 on the credit risk rating matrix, and no less than 40% for firms that are rated 5 on the credit risk rating matrix; and equity securities that are family-issued securities would be charged a haircut rate of 100% for firms that are rated 6 or 7 on the credit risk rating matrix, and no less than 50% for firms that are rated 5 on the credit risk rating matrix. NSCC would have the authority to adjust these haircut rates from time to time within these parameters as described in Procedure XV of NSCC's Rules without filing a proposed rule change with the Commission pursuant to section 19(b)(1) of the Act,^[6] and the rules thereunder, or an advance notice with the Commission pursuant to section 806(e)(1) of the Clearing Supervision Act,^[7] and the rules thereunder.

Anticipated Effect on and Management of Risk

As a central counterparty, NSCC occupies an important role in the securities settlement system by interposing itself between counterparties to financial transactions and thereby reducing the risk faced by participants and contributing to global financial stability. The effectiveness of a central counterparty's risk controls and the adequacy of its financial resources are critical to achieving these risk-reducing goals. In that context, NSCC continuously reviews its margining methodology in order to ensure the reliability of its margining in achieving the desired coverage. In order to be most effective, NSCC must take into consideration the risk characteristics specific to certain securities when margining those securities.

Among the various risks that NSCC considers when evaluating the effectiveness of its margining methodology are its counterparty risks and identification and mitigation of “wrong-way” risk, particularly specific wrong-way risk, defined as the risk that an exposure to a counterparty is highly likely to increase when the creditworthiness of that counterparty deteriorates.^[8] NSCC has identified an exposure to wrong-way risk when it acts as central counterparty to a Member with respect to positions in securities that are issued by that Member or that Member's affiliate. These positions are referred to as “family-issued securities.” In the event that a Member with unsettled long positions in family-issued securities defaults, NSCC would close out those positions following a likely drop in the credit-worthiness of the issuer, possibly resulting in a loss to NSCC.

Therefore, the overall impact of NSCC's proposal, as described above, on risks presented by NSCC would be to reduce NSCC's exposure to this type of wrong-way risk by enhancing its margin methodology as applied to the family-issued securities of its Members that are on its Watch List, and present a heightened credit risk to the clearing agency or have demonstrated higher risk related to their ability to meet settlement. NSCC believes a reduction in its exposures to wrong-way risk through a margining methodology that more effectively capture [sic] the risk characteristics of these positions would contribute to the goal of maintaining financial stability in the event of a Member default and reduce systemic risk overall. Because NSCC Members that are on its Watch List present a heightened credit risk to the clearing agency or have demonstrated higher risk related to their ability to meet settlement, NSCC believes that this charge would more effectively capture the risk characteristics of these positions and can help mitigate NSCC's exposure to wrong-way risk.

NSCC will continue to evaluate its exposures to wrong-way risk, specifically wrong-way risk presented by family-issued securities, including by reviewing the impact of expanding the application of the proposed margining methodology to the family-issued securities of those Members that are not on the Watch List. NSCC is proposing to apply the enhanced margining methodology to the family-issued securities of Members that are on the Watch List at this time because, as stated above, these Members present a heightened credit risk to the clearing agency or have demonstrated higher risk related to their ability to meet settlement. As such, there is a clear and more urgent need to address NSCC's exposure to wrong-way risk presented by these firms' family-issued securities. However, any future change to the margining methodology as applied to the family-issued securities of Members that are not on the Watch List would be subject to a separate proposed rule change pursuant to section 19(b)(1) of the Act,^[9] and the rules thereunder and an advance notice pursuant to section 806(e)(1) of the Clearing Supervision Act,^[10] and the rules thereunder.

Consistency with the Clearing Supervision Act. The objectives and principles of section 805(b)(1) of the Clearing Supervision Act specify the promotion of robust risk management, promotion of safety and soundness, reduction of systemic risks and support of the stability of the broader financial system.^[11] Rule 17Ad-22(b)(1), promulgated under the Act, requires NSCC to measure its credit exposures to its participants at least once a day and limit its exposures to potential losses from defaults by its participants under normal market conditions so that the operations of the clearing agency would not be disrupted and non-defaulting participants would not be exposed to losses that they cannot anticipate or control.^[12] Rule 17Ad-22(b)(2), promulgated under the Act, requires NSCC to use risk-based models for setting margin requirements.^[13]

By enhancing the margin methodology as applied to the family-issued securities of its Members that are on its Watch List the proposal would assist NSCC in collecting margin that more accurately reflects the risk characteristics of these securities, thereby limiting NSCC's exposures to potential losses from defaults by these Members under normal market conditions. By more closely capturing the risk characteristics of these positions, the proposed enhancement to the margining methodology would also assist NSCC in its continuous efforts to ensure the reliability and effectiveness of its risk-based margining methodology. In this way, the proposal would help NSCC, as a central counterparty, maintain effective risk controls, contributing to the goal of maintaining financial stability in the event of a Member default. Therefore, NSCC believes the proposal is consistent with the requirements of section 805(b)(1) of the Clearing Supervision Act and Rule 17Ad-22(b)(1) and (2), promulgated under the Act, cited above.

III. Date of Effectiveness of the Advance Notice, and Timing for Commission Action

The proposed change may be implemented if the Commission does not object to the proposed change within 60 days of the later of (i) the date that the proposed change was filed with the Commission or (ii) the date that any additional information requested by the Commission is received. NSCC shall not implement the proposed change if the Commission has any objection to the proposed change.

The Commission may extend the period for review by an additional 60 days if the proposed change raises novel or complex issues, subject to the Commission providing NSCC with prompt written notice of the extension. The proposed change may be implemented in less than 60 days from the date the Advance Notice is filed, or the date further information requested by the Commission is received, if the Commission notifies NSCC in writing that it does not object to the proposed change and authorizes NSCC to implement the proposed change on an earlier date, subject to any conditions imposed by the Commission.

NSCC shall post notice on its Web site of proposed changes that are implemented.

The proposal shall not take effect until all regulatory actions required with respect to the proposal are completed.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views and arguments concerning the foregoing, including whether the Advance Notice is consistent with the Clearing Supervision Act. Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form (http://www.sec.gov/​rules/​sro.shtml); or
• Send an email to [e-mail]. Please include File Number SR-NSCC-2015-803 on the subject line.

Paper Comments

• Send paper comments in triplicate to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-NSCC-2015-803. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/​rules/​sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the Advance Notice that are filed with the Commission, and all written communications relating to the Advance Notice 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. 552, will be available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of NSCC and on DTCC's Web site (http://dtcc.com/​legal/​sec-rule-filings.aspx). All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-NSCC-2015-803 and should be submitted on or before October 8, 2015.

By the Commission.

Brent J. Fields,

Secretary.

Footnotes

1.  12 U.S.C. 5465(e)(1).

2.  17 CFR 240.19b-4(n)(1)(i).

3.  On August 14, 2015, NSCC filed this Advance Notice as a proposed rule change (SR-NSCC-2015-003) with the Commission pursuant to section 19(b)(1) of the Act, 15 U.S.C. 78s(b)(1), and Rule 19b-4, 17 CFR 240.19b-4. A copy of the proposed rule change is available at http://www.dtcc.com/​legal/​sec-rule-filings.aspx.

4.  Terms not defined herein are defined in the Rules, available at http://dtcc.com/​~/​media/​Files/​Downloads/​legal/​rules/​nscc_​rules.pdf.

5.  As part of its ongoing monitoring of its membership, NSCC utilizes an internal credit risk rating matrix to rate its risk exposures to its Members based on a scale from 1 (the strongest) to 7 (the weakest). Members that fall within the higher risk rating categories (i.e. 5, 6, and 7) are considered on NSCC's “Watch List”, and may be subject to enhanced surveillance or additional margin charges, as permitted under NSCC's Rules. See Section 4 of Rule 2B and section I(B)(1) of Procedure XV of NSCC's Rules, supra Note 1 [sic].

6.  15 U.S.C. 78s(b)(1).

7.  12 U.S.C. 5465(e)(1).

8.  See Principles for financial market infrastructures, issued by the Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions 47 n.65 (April 2012), available at http://www.bis.org/​publ/​cpss101a.pdf.

9.  15 U.S.C. 78s(b)(1).

10.  12 U.S.C. 5465(e)(1).

11.  12 U.S.C. 5464(b)(1).

12.  17 CFR 240.17Ad-22(b)(1).

13.  17 CFR 240.17Ad-22(b)(2).