[Federal Register Volume 60, Number 186 (Tuesday, September 26, 1995)]
[Notices]
[Pages 49648-49653]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-23760]
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[[Page 49649]]
SECURITIES AND EXCHANGE COMMISSION
[Release No. 36252; File No. SR-GSCC-95-02]
Self-Regulatory Organizations; Government Securities Clearing
Corporation; Notice of Proposed Rule Change Relating to Netting
Services for the Non-Same-Day-Settling Aspects of Next-Day and Forward-
Settling Repurchase and Reverse Repurchase Transactions
September 19, 1995.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on August 1, 1995, the
Government 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. On August 29, 1995, and September 19,
1995, GSCC amended the filing.\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\ Letters from Jeffrey F. Ingber, General Counsel, GSCC, to
Christine Sibille, Senior Counsel, Division of Market Regulation,
Commission (August 24, 1995, and September 14, 1995).
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
GSCC proposes to modify its rules to begin implementing netting and
risk management services for the non-same-day-settling aspects of next-
day and forward-settling repurchase and reverse repurchase transactions
involving government securities as the underlying instrument
(``repos'').\3\
\3\ The text of the proposed revised rules is attached as
Exhibit A to File No. SR-GSCC-95-02 and is available for review in
the Commission's Public Reference Room.
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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.\4\
\4\ The Commission has modified the text of the summaries
prepared by GSCC.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and the
Statutory Basis for, the Proposed Rule Change
GSCC plans to offer its repo services in three phases. Phase I
involves providing comparison and netting services for next-day and
forward-settling repo transactions, Phase II will focus on providing
comparison, netting, and risk management services for open repos, and
Phase III will focus on providing intraday netting and risk management
services for same-day settling aspects of repo transactions.
In a previous rule filing the Commission approved the comparison
element of Phase I,\5\ and GSCC implemented its comparison service for
next-day and forward-settling repos on May 12, 1995. Currently, there
are forty members participating in this process. In this rule filing,
GSCC seeks the authority to implement the next stage of Phase I of its
repo services, which is providing netting and risk management services
for the non-same-day-settling aspects of next-day and term repo
transactions.\6\
\5\ Securities Exchange Act Release No. 35557 (March 31, 1995),
60 FR 17598 [File No. SR-GSCC-94-10] (order approving proposed rule
change relating to implementing a comparison service for repurchase
and reverse repurchase transactions involving government securities
as the underlying instrument).
\6\ Future phases will add the following repo services (not
necessarily in this order): (1) an intraday start leg settlement
service, (2) comparison, netting, and risk management services for
open repos including the tracking of rate changes, (3) the tracking
and facilitation of collateral substitutions, (4) enhanced
comparison services for forward-starting repos, (5) interest rate
protection for forward-starting repos, and (6) intra-day netting,
settlement, and risk management services for all same-day-settling
start and close legs.
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All non-same-day settling repo legs (i.e., the close leg of
overnight and term repos and the start leg of forward-settling repos)
in GSCC netting-eligible securities will be netted with regular buy/
sell (i.e., cash) activity and Treasury auction purchases in GSCC's
system. Thus, a participant's repo activity will be netted with its
cash activity and Treasury auction purchases to arrive at a single net
position in the security. Appropriate netting output, including the
breakdown of the repo versus the cash component of each net settlement
position, will be generated and distributed to participants.
GSCC believes that incorporating repos into GSCC's net will afford
its members and the marketplace in general a number of important
benefits, including the following: guaranteed settlement, enhanced risk
protection, reduction in funds wire transfer activity, elimination of
the bulk of the underlying collateral movements, reduction of daylight
overdraft charges, and provision of an automated coupon tracking
system.
The repo netting process will begin in test mode and then move into
``non-live'' production. Once the repo netting system is running
smoothly (i.e., when GSCC and participating members are satisfied with
the test results and generated output) and the Commission approves this
rule filing, GSCC will be ready to fully implement repo netting.
Netting implementation entails a number of rule changes including,
most notably, substantial modifications to GSCC's forward margin and
clearing fund procedures and methodologies. The necessary rule changes
are set forth below.
(1) Eligibility for Netting
GSCC netting members, other than interdealer broker netting
members, will be able to participate in repo netting upon being
designated by GSCC's Membership and Standards Committee as eligible for
such services.\7\ This determination of eligibility will be based on:
(1) satisfactory participation in the repo comparison service, (2)
demonstration by the member of its ability to meet its obligations with
regards to repos, and (3) execution by the member of documentation
provided by GSCC ensuring that the netting and settlement of its repos
is to be done in conformance with GSCC's rules.
\7\ Interdealer broker netting members will not be eligible for
GSCC's repo netting service during this first phase because
brokering in the repo market currently is done on a ``giveup'' basis
with interdealer brokers giving up the names of each counterparty to
the other counterparty and dropping completely out of the
transaction. The various issues related to GSCC's acting with its
interdealer broker members as principals with regard to repo
transactions will be addressed in the next repo netting rule filing.
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A single repo transaction could have two corresponding netting-
eligible settlements. In other words, both the start and the close legs
of a repo transaction may be netted if data on the repo is received and
compared by GSCC prior to the scheduled settlement date for the start
leg.
In order for a start leg or a close leg of a repo transaction to be
eligible for netting and settlement through the netting system, it must
meet various requirements: (1) the repo must be compared by GSCC, (2)
the number of business days between the scheduled settlement date for
the close leg and the business day on which the repo is submitted to
GSCC must not be greater than the maximum number of business days
established by GSCC which initially will be no more than 195
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calendar days,\8\ (3) netting of the leg must occur on or before its
scheduled settlement date (i.e., the leg cannot be a same-day settling
leg), (4) data on each side of the repo must be submitted to GSCC by
members designated as eligible to participate in the repo netting
process, (5) the underlying securities must be eligible for netting,
and (6) the maturity date of the underlying securities must be no later
than the scheduled settlement date of the leg. A forward-settling start
leg,\9\ if submitted to GSCC within 195 calendar days of the scheduled
settlement date for the close leg associated with that start leg, will
not be submitted into the netting system until the scheduled settlement
date for that start leg. At that time, it will drop into the net as
does any other trade, and its settlement will become guaranteed by
GSCC. A forward-settling close leg, if submitted within 195 calendar
days of its scheduled settlement date, will not be submitted to the
netting system until the scheduled settlement date for the associated
start leg.
\8\ Supra note 2. The September 19, 1995 letter amended the
maximum number of business days between the scheduled settlement
date for the close leg and the date on which the repo is submitted
from 364 days to 195 calendar days.
\9\ A forward-settling start leg is a start leg that is
submitted one or more business days prior to its scheduled
settlement date.
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(2) Netting Process
As noted above, each night a participating repo netting member's
eligible repo transactions will be netted with its regular buy/sell
cash activity and Treasury auction purchases in the same CUSIP to
establish a single net position in the security. For netting purposes,
the settlements associated with repo start legs and reverse repo close
legs will be treated as short positions. The settlements associated
with repo close legs and reverse repo start legs will be treated as
long positions. The difference between a member's total shore activity
and its total long activity within a CUSIP is its net position in the
CUSIP.
While netting will result in the establishment of a single net
position for each participant in each of its active securities, GSCC
will provide each participant with a breakdown of its net positions by
reporting for each security: (1) The net buy/sell position, (2) the net
repo position, and (3) the total net position. A participant's forward
settling net position for a security is recalculated on a daily basis.
Forward settling net positions automatically convert into deliver or
receive obligations on their scheduled settlement dates.
(3) Settlement
GSCC conducts two settlement processes on a daily basis: a morning
funds-only settlement process and a day-long securities settlement. For
securities settlement, each netting member is obliged to deliver to or
to receive from GSCC its net deliver or receive obligation in a given
CUSIP that is generated as a result of the netting process. Securities
settlement for repo legs will not differ from securities settlement for
regular buy/sell activity.
For funds-only settlement, amounts pertaining to repos will be
added to amounts pertaining to regular buy/sell activity and Treasury
auction purchases and will be reported within the existing categories.
In addition, the daily net funds-only settlement amount for each
netting member will be adjusted to reflect certain changes to CGCC's
margining processes. With these changes, forward margin debits will be
paid through to the credit side, interest will be paid to members with
forward margin debits and will be paid by members with forward margin
credits [as discussed below in Section (7)], and forward debit margin
obligations will be satisfied on a cash-only basis.
(4) Coupon Protection
In a repo transaction, when the start leg is initiated, securities
are moved from the account of the funds borrower (i.e., the long side
for the close leg) to the account of the funds lender (i.e., the short
side for the close leg) in exchange for a negotiated cash amount.
Securities remain in the account of the funds lender until the
settlement of the close leg takes place. However, the funds lender is
not entitled to any coupon payments made while the securities are in
its possession. In order to ensure that coupon payments related to the
underlying collateral are collected by the appropriate party, GSCC will
automatically pass the coupon payment from the funds lender (the holder
of the securities) to the funds borrower when the repo term crosses a
coupon payment date.
The coupon payments that are made by the issuer directly to the
funds lender's clearing bank on coupon date therefore will be passed
through to the funds borrower by GSCC on coupon date when appropriate.
On the coupon payment date, GSCC will pass the coupon payment from the
funds lender (short side) to the funds borrower (long side) when (1)
the coupon date is after the repo start date and (2) the repo
settlement date is on or after the coupon date. GSCC's current
procedures for paying coupon on all fail obligations will not change
and will apply to fail obligations arising from repos as well.
(5) Collateral Substitution
In this initial phase of repo netting, GSCC will not perform
collateral substitutions on an automated basis. However, GSCC will
facilitate the ability of participants to make collateral substitutions
by allowing them to designate new underlying collateral for a repo
transaction through use of the ``cancel and correct'' feature of its
comparison system. GSCC's operations staff will manually process the
collateral substitution as it does now for clearing fund securities
margin. An automated facility for performing repo collateral
substitutions will be provided as part of a future phase of repo
services.
(6) Guarantee of Settlement
When GSCC nets repo transactions, it interposes itself between the
two submitting participants for transaction settlement purposes as it
does for cash transactions. For example, in the case of a repo close
leg, GSCC will interpose itself between the participant that submitted
the repo (the long participant for the close leg) and the participant
that submitted the corresponding reverse (the short participant for the
close leg). In doing so, GSC assumes contraparty responsibility and
guarantees settlement of all repos that enter its netting system,
including the return of the underlying collateral to the funds borrower
and both the return of principal (repo start amount) and the payment of
interest to the term of the repo transaction to the funds lender.
Again, forward-settling repo start legs are eligible for netting
but are not netted or guaranteed until they reach scheduled settlement
date. Forward-settling repo close legs are not guaranteed until the
settlement date of the associated start leg.
(7) Forward Margin
Because GSCC guarantees the settlement of all transactions once
they are compared and netted, forward settling net positions are
marked-to-the-market daily, and participating members are assessed
forward margin accordingly in their daily funds settlement.\10\ A
member's required margin will continue to be recalculated daily;
therefore, each day, the previous day's debit/credit will be reversed
and a new forward margin obligation established.
\10\ Because forward-settling start legs are not guaranteed
until the scheduled settlement date, such transactions are not
margined.
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Margin for cash trades will continue to be calculated by marking
each
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transaction to-the-market using the following formula:
Market Value=GSCC Price x Par Amount+Accrued Coupon Interest
Calculated to Scheduled Settlement Date
The resulting value is then subtracted from contract value to calculate
the appropriate margin amount.
One significant change to the daily forward margin process for both
cash and repo trades is that credit margin amounts will be used to
fully offset debit margin amounts across CUSIPs with any remaining
credits being paid out to participants in funds settlement. There will
be the following exceptions to this pay-through policy: (1) As an
initial measure, until GSCC is able to more extensively assess the
risks that arise from paying through debit forward margin amounts to
the credit side, GSCC will limit members' right to collect credit
forward margin amounts to bank and category one dealer netting members
that have been active in the netting system for at least sixty days,
(2) if a member has been awarded Treasury securities at auction, GSCC's
obligation to pay to such member a credit forward margin payment will
be limited by the amount of debit forward margin payment(s) that under
GSCC's rules the Federal Reserve Banks are not obligated to pay to
GSCC, and (3) GSCC may suspend a member's right to collect credit
forward margin if the member is placed on surveillance.
Another fundamental change to the daily forward margin process is
that because credit margins will now be paid through, only cash may be
used to post margin. Members will no longer be able to post collateral
in advance in lieu of their cash forward margin obligations. Moreover,
to take into account differences between the repo market and the when-
issued cash market, including the fact that the liquidation process for
repos involves a cost-of-carry element, forward margin calculations for
repos will differ from those of cash market trades.
To margin a forward settling repo close leg to-the-market, GSCC
will begin by calculating market value, using the following formula:
Market Value=GSCC Price x Par Amount+Accrued Coupon Interest
Calculated to Current Date
The market value calculated will be subtracted from the repo's
contract value \11\ to establish a debit or credit collateral mark.
Next, the repo financing mark for the transaction will be calculated.
The rationale for including such a component is that if the member in
the net short position (reverse side) fails, GSCC will replace the
position by buying securities and putting them out on repo in the
market and thus will incur a financing cost. Conversely, if the member
in the net long position (repo side) fails, GSCC will replace the
position by selling securities obtained by doing a reverse repo in the
market and thus will create interest income potential. Therefore, GSCC
will compute the financing mark and will include it in the clearing
margin calculation. The formula used to calculate the financing mark
will be:
\11\ The contract value of the repo is the dollar value at which
the close leg is to be settled.
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Financing Mark=Market Value of Repo x GSCC Repo Rate x Number of
Days to Scheduled Settlement Date360
The financing mark will be debited to the reverse (short) side and
will be credited to the repo (long) side.
The total forward margin for repos will be calculated using the
following formula:
Total Forward Margin=Collateral Mark+Financing Mark
The debit and credit margins calculated for the individual
transactions comprising the participant's net settlement position will
then be added together. As noted above, credit margins will offset
debit margins. A participant's total forward margin will be the
mathematical sum of the individual debit and credit margins calculated
across all securities and across all settlement dates.
It should be noted that the GSCC repo rate used in margin
calculations will be tailored to each individual repo transaction. GSCC
will determine if the collateral underlying the repo is general or
specific.\12\ For general collateral repos, GSCC will use the remaining
term of the repo to determine the appropriate market repo rate. For
specific collateral repos, GSCC will determine the specific repo rate
by CUSIP and the remaining term of the repo. GSCC will use multiple
market sources to obtain repo rates which will be monitored on a daily
basis.
\12\ General collateral repos refer to repo transactions that do
not specify the underlying collateral by a CUSIP number while
specific collateral repos indicate by CUSIP number what the
underlying security must be in a given transaction.
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In designing the repo netting system, GSCC sought not to affect
adversely the economics of the repo. Therefore, GSCC will pay interest
on margin amounts collected and will charge interest on margin amounts
paid on a daily basis using the effective Fed Funds rate. Because there
will be a single margining process for all forward net settlement
positions, interest will be paid on all debit forward margin payments
and interest will be collected on all credit forward margin payments
including margin payments relating to cash buy/sell trades.
It should be noted that GSCC's margining process effectively
provides a daily repricing service that operates on a cash rather than
a collateral basis. Therefore, participants will not need to build
margin into the original value of the repo but rather should price the
repo at the current market value. GSCC's margining and repricing
services will provide a standardized approach for moving repo cash
collateral with interest.
(8) Clearing Fund
GSCC's clearing fund was established to require each participant to
collateralize its calculated exposure to ensure that GSCC has
sufficient assets at all times to provide orderly settlement by meeting
its payment and delivery obligations even if one or more of its
participants became insolvent. Consistent with these objectives, the
following changes will be made to the clearing fund in conjunction with
repo netting implementation.
(a) Clearing Fund Calculations Will Include Repo Activity.
The net settlement positions used in clearing fund calculations
will include the net of all cash and repo activities.
(b) Change in the Clearing Fund Calculation.
Currently, the funds settlement risk component of the clearing fund
calculation and the securities settlement risk component of the
clearing fund calculation each takes into account the average of a
member's settlement activity over the most recent twenty business days.
To better take into account the exposure presented by a member during
periods of relatively high volume and activity (e.g., quarterly
refunding periods), each calculation will be changed to take into
account the average of a member's most active ten days over the most
recent seventy-five business days.\13\
\13\ This change will be made to both the general rules on
clearing fund deposits and the specific rules for Category 2 dealer
netting members and Category 2 futures commission merchants.
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(c) Clearing Fund Calculations Will Anticipate the Settlement of
the Current Day's Activities.
The current clearing fund formula for any particular day fails to
take into account the fact that certain trades that comprise net
settlement positions are scheduled to settle on that day and that their
settlement will change the nature of those positions. In this sense,
the
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clearing fund adjusts to the changing nature of a member's net
settlement positions one business day late.
To adjust for this, the clearing fund formula will be modified to
anticipate any exposure resulting from the clearance of the present
day's settlement transactions. Specifically, a member's outstanding net
settlement positions for clearing fund purposes will be calculated
alternately by disregarding and including the amount of securities
underlying positions that are scheduled to settle that day. Thus, the
portion of the clearing fund formal that reflects securities settlement
exposure will be calculated by taking the average offset margin amount
\14\ or, if greater, the greatest of the following three calculations:
(1) Fifty percent of that day's gross margin amount, (2) one hundred
percent of that day's offset margin amount calculated by disregarding
the amount of securities underlying such positions that are scheduled
to settle that day, or (3) one hundred percent of that day's offset
margin amount calculated as it is today.\15\
\14\ The offset margin amount is the gross margin (the dollar
value of a member's net settlement positions multiplied by the
appropriate margin factors) as reduced by offsetting short and long
positions based on maturity date and par amount. The average offset
margin, as discussed above in (b), will take the average of offset
margin from the ten most active days over the previous seventy-five
days.
\15\ Currently, securities settlement exposure is calculated as
the greater of the average offset margin amount or 50% of the gross
margin amount.
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The calculation of the securities settlement exposure for a
Category 2 dealer netting member or a Category 2 futures commission
merchant netting member also is being revised to require such member to
deposit the greatest of (1) such member's average gross margin amount
based on the average of the ten most active days over the most recent
seventy-five days, (2) such member's gross margin amount, or (3) such
member's gross margin amount calculated by disregarding positions
settling that day.
(d) Addition of Repo Rate Volatility.
A new component of the clearing fund formula will reflect the
historical daily volatility in repo rates and its impact on the
financing component of net settling positions involving repo activity.
Specifically, GSCC will apply a set of percentages (``repo volatility
factors'') to repos that constitute net settlement positions as
necessary to cover the securities' settlement exposure posed by such
repo activity. These percentages will be derived based on GSCC's
research, which has been conducted with the assistance of its members,
on historical repo rate volatility including repo market participants'
analytics and raw data itself. GSCC is building and will maintain its
own data base on the historical daily volatility of repo rates.
A member will be required to add to its clearing fund requirement
the greater of (1) the product of the repo volatility factors and the
market value of the member's repo transactions reduced by offsetting
short and long positions based on maturity date and par amount
(``offset repo volatility amount'') or (2) the average of a member's
ten highest offset repo volatility amounts over the most recent
seventy-five days.
(e) Return of Excess Clearing Fund.
Participants will have the ability to submit requests for the
return of excess collateral on a monthly basis, as opposed to on a
quarterly basis. This change is being made for a number of reasons. One
is to help position GSCC to better accommodate market initiatives such
as NSCC's Collateral Management Service, which facilitates market
participants' management of their margin balances at clearing
organizations and which ultimately will allow those market participants
to move margin amounts from one clearing organization to another in an
automated fashion. This change also responds to members' requests to
make excess funds available more frequently.
(9) Loss Allocation
GSCC conducted an extensive review of its loss allocation
procedures in conjunction with repo netting implementation and
determined that the existing loss allocation procedures remain adequate
and appropriate. Loss allocation, whether related to regular buy/sell
activity or repo activity, will continue to be a function of the extent
of a member's activity with the defaulting member done prior to the
default.
(10) Obligation to Submit Trades
GSCC will amend its Rule 11, Section 3, to state that such rule,
which requires a netting member to submit all eligible trades to GSCC
for comparison and netting, is not applicable to a netting member's
repo transactions. Rule 18, Section 4, will be added to require a repo
netting member to submit for comparison and netting all repo trades
eligible for netting to either GSCC, another Commission registered
clearing agency, or to a clearing agency exempted by the Commission
from clearing agency registration.
GSCC believes that the proposed rule changes are consistent with
the requirements of Section 17A of the Act and specifically with
17A(b)(3)(A) and (F) \16\ because the proposed rule changes will allow
GSCC to expand in a prudent manner its existing netting, settlement,
and risk management services to a broader range of Government
securities transactions and thus will facilitate the prompt and
accurate clearance and settlement of securities transactions.
\16\ 15 U.S.C. 78q-1(b)(3) (A) and (F) (1988).
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B. Self-Regulatory Organization's Statement on Burden on Competition
GSCC does not believe that the proposed rule 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, DC 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. 552, will be
[[Page 49653]]
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-95-02 and should be submitted by October 17, 1995.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\17\
\17\ 17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-23760 Filed 9-25-95; 8:45 am]
BILLING CODE 8010-01-M
