[Federal Register Volume 69, Number 3 (Tuesday, January 6, 2004)]
[Notices]
[Pages 712-714]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-220]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49003; File No. SR-FICC-2003-10]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving Proposed Rule Change To Amend the Fixed Income Clearing 
Corporation's Cross-Margining Agreements With the Chicago Mercantile 
Exchange, BrokerTec Clearing Company, and the Board of Trade Clearing 
Corporation and To Eliminate the Cross-Margining Agreement with the New 
York Clearing Corporation

December 29, 2003.

I. Introduction

    On October 6, 2003, the Fixed Income Clearing Corporation 
(``FICC'') filed with the Securities and Exchange Commission 
(``Commission'') and on December 11, 2003, amended \1\ proposed rule 
change SR-FICC-2003-10 pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'').\2\ Notice of the proposal was published 
in the Federal Register on November 21, 2003.\3\ For the reasons 
discussed below, the Commission is approving the proposed rule change.
---------------------------------------------------------------------------

    \1\ The amendment was technical in nature and did not require 
republication of the notice of filing.
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ Securities Exchange Act Release No. 48796 (November 17, 
2003), 68 FR 65753.
---------------------------------------------------------------------------

II. Description

    FICC is seeking to amend its cross-margining agreements with the 
Chicago Mercantile Exchange (``CME''), BrokerTec Clearing Company 
(``BCC''), and the Board of Trade Clearing Corporation (``BOTCC'') and 
to eliminate its cross-margining agreement with the New York Clearing 
Corporation (``NYCC'').

1. New Cross-Margining Agreement With CME

    Through its Government Securities Division (``GSD''), FICC has a 
cross-margining arrangement with CME.\4\ FICC is proposing to terminate 
its existing cross-margining agreement with CME and to enter into a new 
cross-margining agreement with the CME (``New FICC-CME Agreement'') to 
reflect the fact that, as of January 2, 2004, the CME will begin 
clearing certain Treasury and Agency futures contracts and options on 
such futures contracts that are traded on the Chicago Board of Trade 
(``CBOT'') and that are currently cleared by BOTCC. Under the New FICC-
CME Agreement, the FICC products that will be eligible for cross-
margining will be Treasury securities that fall into the GSD's offset 
classes A through G and GCF Repo Treasury securities with equivalent 
remaining maturities and non-mortgage-backed Agency securities that 
fall into the GSD's offset classes e and f and GCF Repo non-mortgage-
backed Agency securities with equivalent remaining maturities. The CME 
products that will be eligible for cross-margining will be of two 
types: (i) The products currently eligible under the existing 
arrangement between FICC and CME which are Eurodollar futures contracts 
with ranges in maturity from 3 months to 10 years and options on such 
future contracts cleared by CME and (ii) the CBOT products which are 
Two-Year Treasury Note Futures contracts and options thereon, Five-Year 
Treasury Note Futures contracts and options thereon, Ten-Year Treasury 
Note Futures contracts and options thereon, Thirty-Year Treasury Bond 
Futures contracts and options thereon, Five-Year Agency Note Futures 
contracts and options thereon, and Ten-Year Agency Note Futures 
contracts and options thereon to be cleared by CME.
---------------------------------------------------------------------------

    \4\ Securities Exchange Act Release No. 44301 (May 11, 2001), 66 
FR 28207 (May 22, 2001) [File No. SR-GSCC-00-13].
---------------------------------------------------------------------------

    No significant changes are being proposed to the existing FICC-CME 
cross-margining arrangement other than the addition of the CBOT 
products and certain FICC products as discussed in more detail below. 
The key aspects of the cross-margining arrangement, most notably, the 
calculation of the cross-margining reduction and the loss sharing 
provisions in the event of a participant default are not being amended.

2. Key Proposed Changes to the Existing Cross-Margining Agreement 
Between FICC and CME

    The addition of the CBOT products has necessitated new definitions 
for ``CBOT Eligible Products,'' ``CME Eligible Products,'' and ``FICC 
Eligible Products,'' as well as Offset Class tables for these products 
in Appendix B of the agreement.
    Appendix B of the FICC-CME Agreement is also being amended to 
include FICC's GCF Repo Treasury and non-mortgage-backed Agency 
products in the cross-margining arrangement.\5\ By the effective date 
of the New FICC-CME Agreement, FICC will be margining its GCF Repo 
Treasury and non-mortgage-

[[Page 713]]

backed Agency products based upon the specific underlying collateral, 
as opposed to the current system of margining these products based upon 
the longest maturity of eligible underlying collateral.\6\ Therefore, 
these GCF Repo products can now be included in the cross-margining 
arrangement because they will no longer be margined at a generic rate 
but rather at a specific rate based on the actual underlying Treasury 
and Agency collateral.
---------------------------------------------------------------------------

    \5\ This amendment is also being proposed for the BCC cross-
margining arrangement as discussed below.
    \6\ Because of a previous inability to obtain timely data on the 
actual instruments posted in support of GCF Repo positions, the GSD 
has calculated affected members' clearing fund requirements based 
upon the assumption that collateral providers have assigned to each 
generic CUSIP the most volatile (i.e., the longest maturity) 
collateral eligible. The GSD has been in the process of developing 
improvements to the current margining methodology. By the effective 
date of the proposed rule change, the GSD will be able to identify 
the specific CUSIP posted in calculating a member's clearing fund 
requirement related to its Treasury and Agency GCF Repo activity.
---------------------------------------------------------------------------

    As is the case with the current agreement between FICC and CME, the 
parties provide in the New FICC-CME Agreement that they will agree from 
time to time in a separate writing on the disallowance factors that 
will be used in the cross-margining arrangement. The disallowance 
factors that will be used upon implementation of the new arrangement 
are the ones set forth as examples in Appendix B to the New FICC-CME 
Agreement. The disallowance factors between FICC eligible products and 
CME eligible products (i.e., Eurodollar products) have not changed. A 
new disallowance factor table has been added for cross-margining of 
FICC eligible Treasury and Agency products with CBOT Treasury and 
Agency eligible products.\7\
---------------------------------------------------------------------------

    \7\ FICC has computed and tested disallowance factors that will 
be applicable to each potential pair of positions being offset.
---------------------------------------------------------------------------

    Appendix C of the current agreement, which sets forth the 
methodology for converting CME eligible products into Treasury cash 
equivalents for purposes of ultimately calculating the cross-margining 
reduction, has been made into Appendix C1, and a new Appendix C2, which 
contains the methodology for converting the CBOT eligible products into 
Treasury cash equivalents, has been added. This methodology is 
identical to the methodology contained in the BOTCC and BCC cross-
margining agreements.
    The existing agreement between FICC and CME provides for a 
``Maximization Payment'' which is a cross-guaranty provision that sets 
forth the mechanism for a clearing organization with a remaining 
surplus after all guaranty payments in relation to cross-margining have 
been made (``Aggregate Net Surplus'') to distribute funds to one or 
more cross-margining partners with remaining losses. The New FICC-CME 
Agreement will make it clear that: (i) The Maximization Payment is also 
a guaranty payment (albeit outside of cross-margining, arising out of 
the ``Maximization Payment Guaranty'') and (ii) the defaulting member 
would have a reimbursement obligation with respect to such payment 
(``Maximization Reimbursement Obligation''). This means that should a 
clearing organization become obligated to pay the Maximization Payment, 
it may rely on the defaulting member's collateral to do so.\8\
---------------------------------------------------------------------------

    \8\ The new guaranty provisions with respect to the Maximization 
Payment Guaranty will be identical to the ones in the current cross-
margining agreement between FICC and BCC. In order to protect the 
clearing organizations in the event that a court determines that any 
amount of a Maximization Reimbursement Obligation may not be 
recovered by the clearing organization that made a Maximization 
Payment pursuant to a Maximization Payment Guaranty, a provision has 
been added (Section 8C(c)) to the New FICC-CME Agreement to provide 
that the payee clearing organization will be expected to return that 
amount. This protective provision is also in the BCC cross-margining 
agreement.
---------------------------------------------------------------------------

    A provision has been added to the New FICC-CME Agreement to take 
into account that a regulator or other entity having supervisory 
authority over FICC or CME may for safety and soundness purposes direct 
the clearing organization not to liquidate a defaulting member or to 
partially liquidate such member. In order to prevent the affected 
clearing organization from being penalized under the agreement for 
failing to liquidate or partially liquidating the member in this type 
of situation, the last two paragraphs of Section 7(d) of the New FICC-
CME Agreement will provide that the affected clearing organization 
would be deemed to have a cross-margin gain equal to the base amount of 
the guaranty (i.e., cross-margining reduction) or a pro rated amount of 
the base amount of the guaranty in a partial liquidation scenario.
    A sentence has been added to Section 7(h) making clear that the 
clearing organizations have security interests in the ``Aggregate Net 
Surplus,'' a large component of which would be the collateral and 
proceeds of positions of a defaulting member, as security for any 
reimbursement obligation including any maximization reimbursement 
obligation that may arise on the part of a defaulting member.
    Language has been added to the cross-margining participant 
agreements in Appendices D and E in order to further protect the 
clearing organizations by making clear that the clearing organizations 
have a security interest in the Aggregate Net Surplus and that a 
participant will have a reimbursement obligation in the event that a 
clearing organization becomes obligated to make a maximization payment. 
Participants in the current arrangement between FICC and CME and those 
in the arrangement between FICC and BOTCC to the extent they are not 
the same are being asked to reexecute the revised participant 
agreements in order to make them subject to the provisions of the New 
FICC-CME Agreement.\9\
---------------------------------------------------------------------------

    \9\ Cross-margining is available to any FICC GSD netting member 
(with the exception of inter-dealer broker netting members) that is, 
or that has an affiliate that is, a member of a Participating CO. 
The FICC member (and its affiliate, if applicable) sign an agreement 
under which it (or they) agree to be bound by the cross-margining 
agreement between FICC and the Participating CO and which allows 
FICC or the Participating CO to apply the member's (or its 
affiliate's) margin collateral to satisfy any obligation of FICC to 
the Participating CO (or vice versa) that results from a default of 
the member (or its affiliate). Ownership of 50 percent or more of 
the common stock of an entity indicates control of the entity for 
purposes of the definition of ``affiliate.''
---------------------------------------------------------------------------

3. Key Proposed Changes to FICC's Cross-Margining of CBOT Products

    Because FICC is currently cross-margining its products with certain 
CBOT products pursuant to its agreement with BOTCC and because these 
CBOT products will be cross-margined pursuant to the proposed New FICC-
CME Agreement, it is important to note the key differences between the 
cross-margining of the CBOT products under the existing arrangement 
with BOTCC and under the proposed new arrangement with the CME.
    The minimum margin factor under FICC's cross-margining arrangement 
with BOTCC is 50 percent. FICC and CME have agreed to a minimum margin 
factor of 25 percent to apply to the cross-margining of CBOT products 
versus FICC products. This is the same minimum margin factor as is used 
in the current cross-margining arrangement with the CME with respect to 
the eligible Eurodollar products and is the same minimum margin factor 
used in the arrangement with BCC.
    The New FICC-CME Agreement provides for inter-offset class cross-
margining whereas the BOTCC arrangement is limited to intra-offset 
class cross-margining. The new agreement is consistent with the 
approach in the existing arrangements between FICC and both CME and 
BCC.
    The current agreement between FICC and CME provides that in order 
to determine the gain or loss from the liquidation of the positions 
that were cross-margined resulting from a default

[[Page 714]]

of a member, only the proceeds from the side of the market that was 
offset pursuant to the agreement at the last margin cycle are 
considered. In the New FICC-CME Agreement, this approach will be 
extended to the CBOT products in order to provide consistency in the 
liquidation methods.

4. Amendments 1, 2, and 3 to the FICC-BCC Cross-Margining Agreement

    FICC is proposing to amend its cross-margining agreement with BCC 
with Amendment 3 to the agreement.\10\ Amendment 3 will (i) add FICC's 
GCF Repo Treasury and non-mortgage-backed Agency products to the 
arrangement, (ii) add FICC's non-mortgage-backed Agency offset classes 
e and f, and (iii) amend the contingency procedures between the 
clearing organizations (contained in Appendix I of the agreement) to 
provide that FICC will not wait past 12 a.m. Eastern time for the BCC 
cross-margining file in order to run its cross-margining system. With 
respect to (ii), FICC has determined that even though BCC does not 
currently clear non-mortgage-backed Agency futures, the parties can 
still cross-margin FICC's Agency products against BCC's Treasury 
products given that the agreement provides for inter-offset class 
cross-margining using the appropriate correlation factors. With respect 
to (iii), the operational procedures provide that FICC will wait until 
3:00 a.m. Eastern time for the BCC file which is the same cut-off time 
for all of its other cross-margining partners. However, FICC has 
determined that the 3:00 a.m. Eastern time cut-off, which is 
significantly later than the GSD's normal cross-margining processing 
time, should only be used for extreme situations where not including a 
particular file would be disruptive to members. Currently, this would 
not be anticipated to be the case for a BCC file because of BCC's files 
relatively low historical impact.\11\ Therefore, FICC has determined 
that it would be more prudent from a risk management perspective to 
adopt a cut-off time of 12:00 a.m. Eastern time for receipt of BCC 
files.
---------------------------------------------------------------------------

    \10\ Securities Exchange Act Release No. 45656 (March 27, 2002), 
67 FR 15646 (April 2, 2002) [File No. SR-GSCC-2002-01].
    \11\ The operational and contingency procedures contained in the 
FICC-BCC agreement provide that in the event FICC does not receive 
BCC's file by the cut-off time, FICC will calculate the applicable 
cross-margining reductions assuming that BCC submitted a file with 
no positions available for cross-margining which may result in 
margin calls for the affected participants by both FICC and BCC. 
These margin calls would not be disruptive to members because the 
cross-margining reductions in the program with the BCC are not 
anticipated to be large amounts.
---------------------------------------------------------------------------

    As part of this proposed rule change filing, FICC will include 
Amendments 1 and 2 that were previously made with respect to its 
existing cross-margining agreement with BCC. The purpose of Amendment 1 
was to update the list of products being cross-margined. The purposes 
of Amendment 2 were to remove references to the cross-margining 
agreement with NYCC from Appendix A in which the parties are required 
to list other outstanding cross-margining arrangements and to update 
the notice provision.

5. Amendments 1 and 2 to the FICC-BOTCC Cross-Margining Agreement

    As in the case of the BCC agreement, FICC will include as part of 
this proposed rule change filing Amendments 1 and 2 that were 
previously made with respect to its existing cross-margining 
arrangement with BOTCC.\12\ The purposes of Amendment 1 were to update 
the list of products being cross-margined, add an appendix setting 
forth operational contingency procedures, clarify procedures to be used 
if one clearing organization discovers a calculation error, correct 
cited Bankruptcy Code language, correct language in one of the 
participant agreements, and refine the timing of the effectiveness of 
changes to the cross-margining reduction. The purpose of Amendment 2 
was to remove references to the cross-margining agreement with NYCC 
from Appendix A.
---------------------------------------------------------------------------

    \12\ FICC currently has a cross-margining agreement in place 
with BOTCC through which certain CBOT products are cross-margined 
with certain FICC products. Securities Exchange Act Release No. 
45335 (January 25, 2002), 67 FR 4768 (January 31, 2001) [File No. 
SR-GSCC-2001-03]. BOTCC recently announced that it will become the 
clearing corporation for Eurex. In the next few weeks, FICC will 
determine the status of its cross-margining arrangement with BOTCC 
and will submit a proposed rule change filing addressing changes to 
the existing agreement, if necessary.
---------------------------------------------------------------------------

6. Removal of NYCC Cross-Margining Agreement From the GSD's Rules

    FICC is removing its cross-margining agreement with NYCC \13\ from 
the GSD's rules. That arrangement has been dormant for some time and 
the parties have agreed that should they determine to reinstitute 
cross-margining, they will enter into a new cross-margining agreement 
that will be similar to FICC's other cross-margining agreements. At 
that time, FICC would file the appropriate proposed rule change with 
the Commission.
---------------------------------------------------------------------------

    \13\ Securities Exchange Act Release No. 41766 (August 19, 
1999), 64 FR 46737 (August 26, 1999) [File No. SR-GSCC-98-04].
---------------------------------------------------------------------------

III. Discussion

    Section 17A(b)(3)(F) of the Act requires that the rules of a 
clearing agency be designed to facilitate the safeguarding of 
securities and funds which are in its custody or control or for which 
it is responsible and in general will protect investors and the public 
interest.\14\ The Commission finds that FICC's proposed rule change is 
consistent with this requirement because it continues FICC's cross-
margining program which provides members with significant benefits, 
such as greater liquidity and more efficient use of collateral in a 
prudent manner, and enhances FICC's overall risk management process.
---------------------------------------------------------------------------

    \14\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

IV. 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 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-FICC-2003-10) be and hereby 
is approved.
---------------------------------------------------------------------------

    \15\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

    For the Commission by the Division of Market Regulation, pursuant 
to delegated authority.\15\

Jill M. Peterson,
Assistant Secretary.
[FR Doc. 04-220 Filed 1-5-04; 8:45 am]
BILLING CODE 8010-01-P