Federal Register / Vol. 85, No. 231 / Tuesday, December 1, 2020 / Notices 77281 

1 15 U.S.C. 78s(b)(1). 

2 17 CFR 240.19b–4. 

3Securities Exchange Act Release No. 88474 

(March 25, 2020), 85 FR 17910 (March 31, 2020) 

(SR–NSCC–2020–003) (‘‘Notice’’). NSCC also filed 

the proposal contained in the Proposed Rule 

Change as advance notice SR–FICC–2020–802 

(‘‘Advance Notice’’) with the Commission pursuant 

to Section 806(e)(1) of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act entitled the 

Payment, Clearing, and Settlement Supervision Act 

of 2010 (‘‘Clearing Supervision Act’’). 12 U.S.C. 

5465(e)(1); 17 CFR 240.19b–4(n)(1)(i). Notice of 

filing of the Advance Notice was published for 

comment in the Federal Register on April 15, 2020. 

Securities Exchange Act Release No. 88615 (April 

9, 2020), 85 FR 21037 (April 15, 2020) (SR–NSCC– 

2020–802). On May 15, 2020, the Commission 

issued a request for information regarding the 

Advance Notice. See Commission’s Request for 

Additional Information, available at https://

www.sec.gov/rules/sro/nscc-an/2020/34-88615- 

request-for-info.pdf. On September 9, 2020, NSCC 

submitted its response thereto, which it then 

amended on October 16, 2020. See Response to 

Commission’s Request for Additional Information, 

available at https://www.sec.gov/rules/sro/nscc-an/ 

2020/34-88615-response-to-request-for-info.pdf; 

Letters from James Nygard, Director and Assistant 

General Counsel, NSCC (September 9 and October 

16, 2020), available at https://www.sec.gov/ 

comments/sr-nscc-2020-802/srnscc2020802- 

7753722-223190.pdf and https://www.sec.gov/ 

comments/sr-nscc-2020-802/srnscc2020802- 

7915013-224474.pdf. On November 6, 2020, the 

Commission published a notice of no objection to 

the Advance Notice. Securities Exchange Act 

Release No. 90367 (November 6, 2020), 85 FR 73099 

(November 16, 2020). The proposal contained in the 

Proposed Rule Change and the Advance Notice 

shall not take effect until all regulatory actions 

required with respect to the proposal are 

completed. 

4Comments are available at https://www.sec.gov/ 

comments/sr-nscc-2020-003/srnscc2020003- 

7108527-215929.pdf. 

5 15 U.S.C. 78s(b)(2). 

6Securities Exchange Act Release No. 88885 (May 

15, 2020), 85 FR 31007 (May 21, 2020) (SR–NSCC– 

2020–003). 

7Securities Exchange Act Release No. 89145 

(June 24, 2020), 85 FR 39244 (June 30, 2020) (SR– 

NSCC–2020–003). 

8Securities Exchange Act Release No. 89949 

(September 22, 2020), 85 FR 60854 (September 28, 

2020) (SR–NSCC–2020–003). 

9Terms not defined herein are defined in NSCC’s 

Rules and Procedures (‘‘Rules’’), available at http:// 

www.dtcc.com/∼/media/Files/Downloads/legal/ 

rules/nscc_rules.pdf. See Rule 4 (Clearing Fund) 

and Procedure XV (Clearing Fund Formula and 

Other Matters) of the Rules. 

10Under NSCC’s Rules, a default would generally 

be referred to as a ‘‘cease to act’’ and could 

encompass a number of circumstances, such as a 

member’s failure to make a Required Fund Deposit 

in a timely fashion. See Rule 46 (Restrictions on 

Access to Services), supra, note 9. 

11See Rule 46 (Restrictions on Access to 

Services), supra, note 9. 

tasks and critical and significant 

performance deficiencies, and (4) 

implement changes to support the 

reintegration of the generic 

fundamentals examination with the sitespecific initial licensing examination. 

To assist in understanding the changes 

in the draft NUREG, a supporting 

document that captures changes from 

Revision 11 to draft Revision 12 is 

available in ADAMS under Accession 

No. ML20325A254. 

Dated: November 25, 2020. 

For the Nuclear Regulatory Commission. 

Christian B. Cowdrey, 

Chief, Operator Licensing and Human Factors 

Branch, Division of Reactor Oversight, Office 

of Nuclear Reactor Regulation. 

[FR Doc. 2020–26460 Filed 11–30–20; 8:45 am] 

BILLING CODE 7590–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

Sunshine Act Meetings 

FEDERAL REGISTER CITATION OF PREVIOUS

ANNOUNCEMENT: To Be Published. 

PREVIOUSLY ANNOUNCED TIME AND DATE OF

THE MEETING: Wednesday, December 2, 

2020 at 2:00 p.m. 

CHANGES IN THE MEETING: The Closed 

Meeting scheduled for Wednesday, 

December 2, 2020 at 2:00 p.m. has been 

changed to Wednesday, December 2, 

2020 at 10:00 a.m. The following 

additional matter will also be 

considered during the Closed Meeting: 

• Disclosure of non-public information 

CONTACT PERSON FOR MORE INFORMATION: 

For further information and to ascertain 

what, if any, matters have been added, 

deleted or postponed, please contact 

Vanessa A. Countryman from the Office 

of the Secretary at (202) 551–5400. 

Dated: November 25, 2020. 

Eduardo A. Aleman, 

Deputy Secretary. 

[FR Doc. 2020–26550 Filed 11–27–20; 11:15 am] 

BILLING CODE 8011–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–90502; File No. SR–NSCC– 

2020–003] 

Self-Regulatory Organizations; 

National Securities Clearing 

Corporation; Order Approving a 

Proposed Rule Change To Enhance 

National Securities Clearing 

Corporation’s Haircut-Based Volatility 

Charge Applicable to Illiquid Securities 

and UITs and Make Certain Other 

Changes to Procedure XV 

November 24, 2020. 

On March 16, 2020, National 

Securities Clearing Corporation 

(‘‘NSCC’’) filed with the Securities and 

Exchange Commission (‘‘Commission’’) 

proposed rule change SR–NSCC–2020– 

003 (‘‘Proposed Rule Change’’) pursuant 

to Section 19(b)(1) of the Securities 

Exchange Act of 1934 (‘‘Act’’) 1 and Rule 

19b–4 thereunder.2 The Proposed Rule 

Change was published for comment in 

the Federal Register on March 31, 

2020.3 The Commission received 

comment letters on the Proposed Rule 

Change.4 On May 15, 2020, pursuant to 

Section 19(b)(2) of the Act,5 the 

Commission designated a longer period 

within which to approve, disapprove, or 

institute proceedings to determine 

whether to approve or disapprove the 

Proposed Rule Change.6 On June 24, 

2020, the Commission instituted 

proceedings to determine whether to 

approve or disapprove the Proposed 

Rule Change.7 On September 22, 2020, 

the Commission designated a longer 

period for Commission action on the 

proceedings to determine whether to 

approve or disapprove the Proposed 

Rule Change.8 For the reasons discussed 

below, the Commission is approving the 

proposed rule change. 

I. Description of The Proposed Rule 

Change 

A. Background 

NSCC provides clearing, settlement, 

risk management, central counterparty 

services, and a guarantee of completion 

for virtually all broker-to-broker trades 

involving equity securities, corporate 

and municipal debt securities, and unit 

investment trust transactions in the U.S. 

markets. A key tool that NSCC uses to 

manage its credit exposure to its 

Members is collecting an appropriate 

Required Fund Deposit (i.e., margin) 

from each Member.9 A Member’s 

Required Fund Deposit is designed to 

mitigate potential losses to NSCC 

associated with liquidation of the 

Member’s portfolio in the event of a 

Member default.10 The aggregate of all 

NSCC Members’ Required Fund 

Deposits (together with certain other 

deposits required under the Rules) 

constitutes NSCC’s Clearing Fund, 

which NSCC would access should a 

Member default and that Member’s 

Required Fund Deposit, upon 

liquidation, be insufficient to satisfy 

NSCC’s losses.11


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77282 Federal Register / Vol. 85, No. 231 / Tuesday, December 1, 2020 / Notices 

12See Procedure XV, supra note 9. 13Specifically, NSCC calculates the VaR Charge 

as the greatest of (1) the larger of two separate 

calculations that utilize the VaR model, (2) a gap 

risk measure calculation based on the largest nonindex position in a portfolio that exceeds a 

concentration threshold, which addresses 

concentration risk that can be present in a member’s 

portfolio, and (3) a portfolio margin floor 

calculation based on the market values of the long 

and short positions in the portfolio, which 

addresses risks that might not be adequately 

addressed with the other volatility component 

calculations. See Sections I.(A)(1)(a)(i) and 

I.(A)(2)(a)(i) of Procedure XV, supra note 9. 

14The OTC Bulletin Board is an inter-dealer 

quotation system that is used by subscribing 

members of the Financial Industry Regulatory 

Authority (‘‘FINRA’’) to reflect market making 

interest in eligible securities (as defined in FINRA’s 

Rules). See http://www.finra.org/industry/otcbb/otcbulletin-board-otcbb. 

15OTC Link is an electronic inter-dealer 

quotation system that displays quotes from brokerdealers for many over-the-counter securities. See 

https://www.otcmarkets.com. 

16NSCC represents that it utilizes multiple thirdparty vendors to price its eligible securities. NSCC 

believes that national securities exchanges covered 

by these third party vendors tend to list securities 

that exhibit liquid characteristics such as having 

more available public information, larger trading 

volumes and higher capitalization. See Notice, 

supra note 3, 85 FR at 17912. The exchanges that 

have established listing services that the vendors 

cover for this purpose are: New York Stock 

Exchange LLC, NYSE American LLC, NYSE Arca, 

Inc., The Nasdaq Stock Market and Cboe BZX 

Exchange, Inc. NSCC represents that Members’ 

Clearing Fund Summary reports, available through 

the DTCC Risk Portal, identify securities within 

their portfolio by the ticker symbol and indicate 

whether those securities are considered Illiquid 

Securities for purposes of the calculation of the 

Illiquid Charge. See id. 

17A security that is less amenable to statistical 

analysis generally lacks pricing or trading history 

upon which to perform statistical analysis. A 

security that is amenable to generally accepted 

statistical analysis only in a complex manner 

generally may have pricing or trading history, but 

further calculations upon the pricing or trading 

history would be required to perform statistical 

analysis. 

18Because the VaR model generally relies on 

predictability, this model may be less reliable for 

measuring market risk of securities that exhibit 

illiquid characteristics. 19NSCC currently calculates the volatility charge 

for IPOs, which have fewer than 31 business days 

of trading history over the past 153 business days, 

by applying a haircut of 15% and all other Illiquid 

Securities by applying a haircut of 20%. See Notice, 

supra note 3, 85 FR at 17915. 

20Specifically, the Illiquid Charge applies to 

Illiquid Positions as defined under NSCC’s Rules. 

The Rules specify the applicable thresholds that 

result in an Illiquid Position determination. For 

example, where a Member’s net buy position in an 

Illiquid Security exceeds a threshold no greater 

than 100 million shares, that position may become 

subject to the Illiquid Charge. However, NSCC’s 

rules also provide for certain offsets and credit risk 

considerations that will be considered when 

determining whether a position in an Illiquid 

Security should be considered an Illiquid Position 

and, thus, subject to the additional Illiquid Charge. 

See Rule 1 and Sections I.(A)(1)(h) and I.(A)(2)(f) of 

Procedure XV, supra note 9. 

21See Notice, supra note 3, 85 FR at 17912. See 

also Securities Exchange Act Release No. 80597 

(May 4, 2017), 82 FR 21863 (May 10, 2017) (SR– 

NSCC–2017–001) (order approving proposed rule 

change to describe the illiquid charge that may be 

imposed on Members). 

22See Notice, supra note 3, 85 FR at 17912. 

Each Member’s Required Fund 

Deposit consists of a number of 

applicable components, each of which 

is calculated to address specific risks 

faced by NSCC, as identified within 

NSCC’s Rules.12 Generally, the largest 

component of Members’ Required Fund 

Deposits is the volatility component. 

The volatility component is designed to 

reflect the amount of money that could 

be lost on a portfolio over a given period 

within a 99% confidence level. This 

component represents the amount 

assumed necessary to absorb losses 

while liquidating the portfolio. 

NSCC’s methodology for calculating 

the volatility component of a Member’s 

Required Fund Deposit depends on the 

type of security and whether the 

security has sufficient pricing or trading 

history for NSCC to robustly estimate 

the volatility component using 

statistical techniques. Generally, for 

most securities (e.g., equity securities), 

NSCC calculates the volatility 

component using, among other things, a 

parametric Value at Risk (‘‘VaR’’) model, 

which results in a ‘‘VaR Charge.’’ 13

However, the VaR model generally 

relies on predictability, and this model 

may be less reliable for measuring 

market risk of securities that exhibit 

illiquid characteristics. More 

specifically, the VaR model relies on 

assumptions that are based on historical 

observations of security prices. 

Securities that exhibit illiquid 

characteristics, which generally have 

low trading volumes or are not traded 

frequently, may not generate sufficient 

price observations to allow the VaR 

model to provide a precise estimate of 

market risk for such securities. 

Accordingly, for securities that do not 

have sufficient pricing or trading history 

to perform statistical analysis, NSCC 

applies a haircut to calculate the 

volatility component, in lieu of the VaRbased calculation. 

B. Current Practice for Determining 

Volatility Component for Illiquid 

Securities and UITs 

Two types of securities for which 

NSCC uses a haircut to calculate the 

volatility component are securities that 

NSCC deems to be ‘‘Illiquid Securities’’ 

and UITs. NSCC’s Rules currently 

define an Illiquid Security as a security 

that is (i) not traded on or subject to the 

rules of a national securities exchange 

registered under the Exchange Act, or 

(ii) an OTC Bulletin Board 14 or OTC 

Link issue.15 Based on its interpretation 

of that definition, NSCC considers 

securities that are not listed on the 

national securities exchanges, i.e., those 

exchanges which are covered by certain 

third party data/pricing vendors, to be 

Illiquid Securities.16 UITs are 

redeemable securities, or units, issued 

by investment companies that offer 

fixed security portfolios for a defined 

period of time. 

Under NSCC’s current rules, Illiquid 

Securities and UITs are subject to 

haircut-based charges to calculate the 

volatility component of a Member’s 

Required Fund Deposit based upon two 

distinct but related rationales. 

Specifically, Illiquid Securities are 

considered ‘‘securities that are less 

amenable to statistical analysis, such as 

OTC Bulletin Board or Pink Sheet issues 

or issues trading below a designated 

dollar threshold (e.g., five dollars),’’ and 

UITs are considered ‘‘securities that are 

amenable to generally accepted 

statistical analysis only in a complex 

manner.’’ 17 Based on these 

determinations, NSCC considers Illiquid 

Securities and UITs as categories of 

securities that tend to exhibit illiquid 

characteristics, such as low trading 

volumes or infrequent trading.18 NSCC 

therefore calculates the volatility 

component for these two categories of 

securities by multiplying the absolute 

value of a given position by a percentage 

that is (1) not less than 10% for 

securities that are less amenable to 

statistical analysis, including Illiquid 

Securities,19 and (2) not less than 2% for 

securities that are amenable to generally 

accepted statistical analysis only in a 

complex manner, including UITs. 

In addition to using the haircut-based 

volatility charge for Illiquid Securities, 

NSCC currently can also apply an 

additional charge (an ‘‘Illiquid Charge’’) 

for certain positions in Illiquid 

Securities that exceed volume 

thresholds set forth in the Rules.20

NSCC represents that the Illiquid Charge 

was designed to address a situation 

where the defaulting Member may have 

a relatively large position in an Illiquid 

Security, which would increase the risk 

that NSCC might face losses when 

liquidating the Member’s position in 

these securities due to the securities’ 

lack of marketability and other 

characteristics.21

NSCC states that it regularly assesses 

its market and credit risks, as such risks 

are related to its margin methodologies, 

to evaluate whether margin levels are 

commensurate with the particular risk 

attributes of each relevant product, 

portfolio, and market.22 Based on such 

assessments, NSCC seeks to refine its 

current approach to risk managing 

Member positions in Illiquid Securities 

and UITs. More specifically, NSCC 


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Federal Register / Vol. 85, No. 231 / Tuesday, December 1, 2020 / Notices 77283 

23The term ‘‘Family-Issued Security’’ means a 

security that was issued by a Member or an affiliate 

of that Member. See Rule 1, supra note 9. 

24NSCC has stated that the exchanges that would 

initially be specified securities exchanges are those 

listed in note 16. See supra note 16. 

25See Notice, supra note 3, 85 FR at 17913. Based 

on historic performances, NSCC believes the 

national securities exchanges that the vendors cover 

are appropriate for determining if a security 

exhibits characteristics of liquidity because such 

exchanges tend to list securities that exhibit liquid 

characteristics such as having more available public 

information, larger trading volumes, and higher 

capitalization. See id. 

26ADRs are securities that represent shares of 

non-U.S. companies that are held by a U.S. 

depository bank outside of the United States. Each 

ADR represents one or more shares of foreign stock 

or a fraction of a share. 

27Any changes to the micro-cap threshold would 

be subject to NSCC’s model risk management 

governance procedures as set forth in the Clearing 

Agency Model Risk Management Framework 

(‘‘Model Risk Management Framework’’). See 

Notice, supra note 3, 85 FR at 17914. See Securities 

Exchange Act Release No. 81485 (August 25, 2017), 

82 FR 41433 (August 31, 2017) (File No. SR–NSCC– 

2017–008) (describes the adoption of the Model 

Risk Management Framework of NSCC which sets 

forth the model risk management practices of 

NSCC) and Securities Exchange Act Release No. 

84458 (October 19, 2018), 83 FR 53925 (October 25, 

2018) (File No. SR–NSCC–2018–009) (amends the 

Model Risk Management Framework). NSCC would 

notify Members of any changes to the microcapitalization threshold by Important Notice. 

28See Notice, supra note 3, 85 FR at 17914. 

29See Notice, supra note 3, 85 FR at 17912. 

30The daily trading amount equals the daily 

trading volume multiplied by the end-of-day price. 

See id. 

proposes to (1) revise the definition of 

Illiquid Security, (2) adopt specific 

exclusions from the VaR model, and 

corresponding haircut-based methods 

for determining volatility components 

for positions in Illiquid Securities and 

UITs, (3) eliminate the existing Illiquid 

Charge, and (4) make certain conforming 

changes regarding municipal and 

corporate bonds and Family-Issued 

Securities.23

C. Proposed Revision to the Definition of 

Illiquid Security 

Under the Proposed Rule Change, 

NSCC proposes a new definition of 

Illiquid Security that would consist of 

three particular categories of securities. 

As noted further below, application of 

the new definition of Illiquid Security 

would capture a broader set of securities 

than the current definition. 

(i) Securities Not Listed on a Specified 

Securities Exchange 

The first category of the new 

definition of Illiquid Securities would 

include any security that is not listed on 

a ‘‘specified securities exchange.’’ For 

purposes of this definition, NSCC’s 

Rules would define a ‘‘specified 

securities exchange’’ as a national 

securities exchange that has established 

listing services and is covered by 

industry pricing and data vendors.24

NSCC would make the determination of 

whether a security falls in this category 

on a daily basis. NSCC represents that 

this new definition would reflect the 

process that it currently employs to 

determine whether a security is not 

traded on or subject to the rules of a 

national securities exchange registered 

under the Securities Exchange Act of 

1934, as amended.25

(ii) Micro-Capitalization Securities and 

ADRs Subject to an Illiquidity Ratio 

The second category of the new 

definition of Illiquid Securities would 

apply to certain securities that are listed 

on a specified securities exchange. 

Specifically, the types of securities that 

would potentially be considered as 

Illiquid Securities under this second 

category either (i) have a market 

capitalization that is considered by 

NSCC to be a micro-capitalization 

(‘‘micro-capitalization’’ or ‘‘micro-cap’’) 

as of the last business day of the prior 

month, or (ii) are American depositary 

receipts (‘‘ADRs’’).26 To determine 

whether these securities qualify as 

Illiquid Securities, NSCC would apply, 

on a monthly basis, an illiquidity ratio 

test to these two sets of securities. 

1. Micro-Capitalization Definition 

Initially, NSCC would define ‘‘microcapitalization’’ as market capitalization 

of less than $300 million. Changes to 

this threshold amount of $300 million 

would not be subject to any particular 

period of review, but would occur when 

NSCC determines changes may be 

appropriate.27 NSCC believes that using 

market capitalization to consider 

whether a security is illiquid, in 

conjunction with the illiquidity ratio 

test, is appropriate because securities 

with a market capitalization below a 

certain threshold tend to exhibit illiquid 

characteristics such as limited trading 

volumes and a lack of public 

information.28

2. ADRs 

With respect to ADRs, NSCC believes 

that subjecting these securities to the 

illiquidity ratio test to determine 

whether a particular ADR is an Illiquid 

Security is appropriate because the 

market capitalization of an ADR may be 

difficult to calculate. This is because of 

challenges associated with the day-today fluctuation of the conversion rate of 

an ADR into the relevant local security, 

which in turn makes it difficult to price 

the ADR.29 Without knowing the market 

capitalization of the ADR, it is therefore 

difficult to determine whether an ADR 

represents a non-micro-cap issuer. 

3. Application of the Illiquidity Ratio 

and the Illiquidity Ratio Test to MicroCap Securities and ADRs 

The proposal would define the 

illiquidity ratio for a security as the ratio 

of the security’s daily price return 

divided by the average daily trading 

amount 30 of such security over the prior 

20 business days. In addition, if NSCC 

is unable to retrieve data to calculate the 

illiquidity ratio for a security on any 

day, NSCC would use a default value for 

that day for the security (i.e., the 

security would be treated as illiquid for 

that day). 

In order to classify a micro-cap 

security or ADR as ‘‘illiquid,’’ NSCC 

then takes the illiquidity ratio 

calculated for these securities and 

applies an illiquidity ratio test. The test 

functions as follows: NSCC determines 

whether the security’s median 

illiquidity ratio of the prior six months 

exceeds a threshold that is set to the 

99th percentile of the illiquidity ratio of 

all non-micro-cap common stock using 

the prior six months of data. Where 

such a threshold is exceeded, NSCC will 

designate the relevant security as an 

Illiquid Security. NSCC performs this 

exercise, and thereby determines the set 

of micro-cap securities and ADRs to be 

considered Illiquid Securities, on a 

monthly basis. 

The illiquidity ratio test is designed to 

measure the level of a security’s price 

movement relative to its level of trading 

activity. For example, given the same 

dollar amount of trading activity, a 

larger price movement typically 

indicates less liquidity. Conversely, for 

price movement of a given magnitude, 

a smaller dollar amount of trading 

activity would indicate less liquidity. 

Securities that are exchange-traded 

products (‘‘ETPs’’) with market 

capitalization of less than $300 million 

could be classified as illiquid upon 

application of the illiquidity test. 

However, ETPs and ADRs would be 

excluded when calculating the 

illiquidity ratio threshold. ETPs are 

excluded because the underlying 

common stocks that make up the ETPs 

are already included in the calculation. 

ADRs are excluded because it is difficult 

to determine whether an ADR 

represents a non-micro-cap issuer. An 

ADR’s market capitalization may be 

difficult to calculate due to the fact that, 

as noted above, each ADR often converts 

to a different number of shares of a local 

security. The threshold used in the 

illiquidity ratio test will be determined 


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77284 Federal Register / Vol. 85, No. 231 / Tuesday, December 1, 2020 / Notices 

31See Notice, supra note 3, 85 FR at 17914. 

32The price level groupings would be subject to 

NSCC’s model risk management governance 

procedures set forth in the Model Risk Management 

Framework. See Notice, supra note 3, 85 FR at 

17915; see also Model Risk Management 

Framework, supra note 27. 

33NSCC states that the different treatment for 

Illiquid Securities that are sub-penny securities is 

appropriate because short positions in sub-penny 

securities have unlimited upside market price risk, 

as the price of a security may increase and could 

potentially subject NSCC to losses under its trade 

guaranty. NSCC further states the proposal would 

allow NSCC to calculate a haircut-based volatility 

charge that accounts for this risk of such price 

movements. Further, NSCC states that sub-penny 

securities are typically issued by companies with 

low market capitalization, and may be susceptible 

to market manipulation, enforcement actions, or 

private litigation. See Notice, supra note 3, at 85 FR 

at 17915; Letter from Timothy J. Cuddihy, Managing 

Director, DTCC Financial Risk Management 

(September 3, 2020) (‘‘NSCC Letter’’) at 10. 

34See Notice, supra note 3, 85 FR at 17915; see 

also Model Risk Management Framework, supra 

note 27. 

35See id. 

36 If NSCC needs to liquidate a defaulting 

Member’s portfolio, it may incur a transaction cost 

which represents bid-ask spreads. Bid-ask spreads 

account for the difference between the observed 

market price that a buyer is willing to pay for a 

security and the observed market price for which 

a seller is willing to sell that security. 

37Adjustments to the look-back period would be 

subject to NSCC’s model risk governance 

procedures set forth in the Model Risk Management 

Framework. See Notice, supra note 3, 85 FR at 

17915; see also Model Risk Management 

Framework, supra note 27. 

38See id. 

39NSCC represents that it also would remove the 

phrase ‘‘such as OTC Bulletin Board or Pink Sheet 

issues or issues trading below a designated dollar 

threshold (e.g., five dollars)’’ from the existing 

language relating to securities that are less 

amenable to statistical analysis. While this language 

was intended as an example of these types of 

securities, NSCC now believes that the example 

inadequately describes all of the securities that are 

less amenable to statistical analysis and may be 

misleading. See Notice, supra note 3, 85 FR at 

17912. 

40See Notice, supra note 3, 85 FR at 17916. 

41See id. 

by NSCC on a monthly basis using the 

prior six months of data. 

(iii) Securities With Limited Trading 

History 

The third category of the new 

definition of Illiquid Security would 

include securities that are listed on a 

specified securities exchange and, as 

determined by NSCC on a monthly 

basis, have fewer than 31 business days 

of trading history over the past 153 

business days on such exchange. NSCC 

represents that it has historically used 

such time period to identify initial 

public offerings (‘‘IPOs’’) which tend to 

exhibit illiquid characteristics due to 

their limited trading history, thereby 

making it an appropriate time period to 

use for the purposes of determining a 

security’s liquidity, and IPOs would 

likely constitute most of the securities 

that would fall into this category.31

D. Proposed Haircut-Based Volatility 

Charge Specifically Applicable to 

Illiquid Securities and UITs 

(i) Haircut-Based Volatility Charge 

Applicable to Illiquid Securities 

As proposed in the Notice, NSCC 

would expressly exclude Illiquid 

Securities when calculating the 

volatility component of a Required 

Fund Deposit using the VaR model and 

instead would apply a haircut-based 

volatility charge specifically to Illiquid 

Securities. To determine the appropriate 

volatility charge, NSCC would group 

Illiquid Securities by price level.32

NSCC generally would calculate one 

haircut-based volatility charge for short 

and long positions together. However, 

with respect to an Illiquid Security that 

is a sub-penny security, NSCC would 

calculate the haircut-based volatility 

charge for short positions and long 

positions separately.33

The haircut percentage applicable to 

each group of Illiquid Securities would 

be determined at least annually. The 

applicable percentage, and the decision 

of how often the applicable percentage 

is determined, would be subject to 

NSCC’s model risk management 

governance procedures set forth in the 

Model Risk Management Framework.34

NSCC states that a number of important 

considerations consistent with the 

model risk management practices 

adopted by NSCC could prompt more 

frequent haircut review, such as 

material deterioration of a Member’s 

backtesting performance, market events, 

market structure changes, and model 

validation findings.35

The haircut percentage would be the 

highest of the following percentages: (1) 

10%, (2) a percent benchmarked to be 

sufficient to cover the 99.5th percentile 

of the historical 3-day returns of each 

group of Illiquid Securities in each 

Member’s portfolio, and (3) a percent 

benchmarked to be sufficient to cover 

the 99th percentile of the historical 3- 

day returns of each group of Illiquid 

Securities in each Member’s portfolio 

after incorporating a fixed transaction 

cost equal to one-half of the estimated 

bid-ask spread.36 The look-back period 

for purposes of calibrating the 

applicable percentage would be no less 

than five years and would initially be 

five years to be consistent with the 

historical data set used in model 

development. The look-back period may 

be adjusted by NSCC as necessary 

consistent with the model risk 

management practices adopted by NSCC 

to respond to, for example, market 

events that impact liquidity in the 

market and Member backtesting 

deficiencies.37

(ii) Haircut-Based Volatility Charge 

Applicable to UITs 

Similar to its proposed approach to 

risk managing Illiquid Securities, NSCC 

would exclude UITs from calculating 

the volatility component of the Required 

Fund Deposit using the VaR model, and 

instead would assign a percentage to be 

used in the calculation of a haircutbased volatility charge. UITs are less 

suited to application of the VaR model 

because they generally have a limited 

trading history, which does not provide 

the type of pricing data that allows for 

application of the VaR model. NSCC 

would review the percentage used in 

this calculation at least annually. 

The haircut percentage applicable to 

UITs would be the highest of (1) 2%, 

and (2) the 99.5th percentile of the 

historical 3-day returns for the group of 

UITs within each Member’s portfolio 

using a look-back period of no less than 

5 years. The applicable percentage, and 

the decision of how often the applicable 

percentage is determined, would be 

subject to NSCC’s model risk 

management governance procedures set 

forth in the Model Risk Management 

Framework.38

(iii) Revisions to Description of 

Securities Not Amenable to Generally 

Accepted Statistical Analysis or 

Amenable to Statistical Analysis Only 

in a Complex Manner 

NSCC proposes to revise the existing 

language in its Rules relating to 

securities that are either less amenable 

to statistical analysis or amenable to 

statistical analysis only in a complex 

manner.39 Because Illiquid Securities 

and UITs would each have specific 

haircut-based volatility charges 

pursuant to the Proposed Rule Change, 

these sections would no longer apply to 

Illiquid Securities or UITs. Furthermore, 

NSCC represents that the proposed 

definition of Illiquid Security would 

effectively encompass all securities that 

are currently considered as securities 

that are less amenable to statistical 

analysis.40 However, NSCC believes that 

it should preserve this category of 

securities within its Rules because 

NSCC may find it necessary to calculate 

margin charges for certain securities that 

do not constitute Illiquid Securities or 

UITs and instead would continue to fall 

under this category. 

Further, NSCC represents that certain 

fixed income securities, such as 

preferred stocks,41 would continue to 


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42See id.; see also Model Risk Management 

Framework, supra note 27. 

43See Notice, supra note 3, 85 FR at 17917. 

44Sections I.(A)(1)(a)(ii) and I.(A)(2)(a)(ii) of 

Procedure XV, supra note 9. 

45Section I.(A)(1)(a)(iii) of Procedure XV, supra 

note 9. 

46 Id. In addition, the current Rules exclude 

‘‘family issued security’’ from the current definition 

of Illiquid Security, which is subject to Illiquid 

Charge, providing that the term is provided in 

Procedure XV, although Procedure XV does not 

provide such definition. 

47See Notice, supra note 3, 85 FR at 17917. 

48See Notice, supra note 3, 85 FR at 17913 and 

17917 n. 52. 

49 15 U.S.C. 78s(b)(2)(C). 

50 15 U.S.C. 78q–1(b)(3)(F). 

51 15 U.S.C. 78q–1(b)(3)(I). 

52 17 CFR 240.17Ad–22(e)(4)(i), (e)(6)(i), and 

(e)(23)(ii). 

53 15 U.S.C. 78q–1(b)(3)(F). 

fall into the category of securities that 

are amenable to statistical analysis only 

in a complex manner. Thus, these types 

of securities would still be subject to a 

haircut-based charge. The application of 

a haircut percentage to any new 

security, using these categories, would 

be subject to NSCC’s model risk 

management governance procedures set 

forth in the Model Risk Management 

Framework.42

E. Proposed Elimination of the Illiquid 

Charge 

NSCC proposes to eliminate the 

existing Illiquid Charge (and the 

corresponding definition of Illiquid 

Position), which may be imposed as an 

additional charge in the volatility 

component that is applied to Illiquid 

Securities as securities that are less 

amenable to statistical analysis. NSCC 

represents that because the current 

haircut-based volatility charge that is 

applied to Illiquid Securities uses fixed 

percentages for all such securities (15% 

for IPOs and 20% for the rest of Illiquid 

Securities), the Illiquid Charge was 

added to cover some of the risks that the 

current volatility charge did not cover. 

NSCC also represents that the proposal 

would address the risks presented by 

positions in Illiquid Securities more 

adequately than the Illiquid Charge, and 

that therefore the Illiquid Charge would 

no longer be needed.43

F. Proposed Conforming Changes 

NSCC proposes to make two 

conforming changes to harmonize the 

Rules in light of the proposed 

amendments discussed above. First, the 

current Rules state that securities less 

amenable to statistical analysis or 

amenable to statistical analysis only in 

a complex manner ‘‘other than 

municipal and corporate bonds’’ shall 

be excluded from the VaR Charge.44

NSCC believes that this drafting is 

unclear regarding whether municipal 

and corporate bonds are excluded from 

this section of the Rules. Moreover, the 

reference to municipal and corporate 

bonds is not necessary in this portion of 

the Rules because a different subsection 

of the Rules 45 provides separately for 

haircut-based volatility charges for 

municipal and corporate bonds. The 

proposal would therefore remove this 

reference to municipal and corporate 

bonds from this section of the Rules. 

Second, the Rules currently provide 

that Family-Issued Securities are 

excluded from calculation of the 

volatility component using the VaR 

model because the specific haircutbased volatility charge for such 

securities is provided in a separate 

subsection. However, the separate 

subsection only refers to ‘‘long Net 

Unsettled Positions in Family-Issued 

Securities.’’ 46 Based on the current 

drafting of the Rules, NSCC believes that 

it is unclear how positions in FamilyIssued Securities would be treated.47 In 

practice, NSCC states that currently, 

short positions in Family-Issued 

Securities whose volatility is less 

amenable to statistical analysis are 

subject to the haircut set forth in 

Sections I.(A)(1)(a)(ii) and I.(A)(2)(a)(ii) 

of Procedure XV, and those short 

positions in Family-Issued Securities 

that meet particular volume thresholds 

are subject to the Illiquid Charge.48

NSCC proposes to revise the Rules to 

expressly reference its current practice 

that long positions in Family-Issued 

Securities would be excluded from the 

VaR Charge but subject to the haircutbased volatility charge exclusively 

applicable to such securities in a 

separate provision of the Rules. In 

addition, determination of the 

appropriate margin for short positions 

in Family-Issued Securities would 

continue to be covered by the haircutbased volatility charge in Sections 

I.(A)(1)(a)(ii) and I.(A)(2)(A)(ii) as 

securities that are less amenable to 

statistical analysis. 

II. Discussion and Commission 

Findings 

Section 19(b)(2)(C) of the Act 49

directs the Commission to approve a 

proposed rule change of a selfregulatory organization if it finds that 

such proposed rule change is consistent 

with the requirements of the Act and 

rules and regulations thereunder 

applicable to such organization. After 

carefully considering the proposed rule 

change, the Commission finds that the 

proposed rule change is consistent with 

the requirements of the Act and the 

rules and regulations thereunder 

applicable to NSCC. In particular, the 

Commission finds that the proposed 

rule change is consistent with Sections 

17A(b)(3)(F) 50 and (b)(3)(I) 51 of the Act 

and Rules 17Ad–22(e)(4)(i), (e)(6)(i), and 

(e)(23)(ii) thereunder.52

A. Consistency With Section 

17A(b)(3)(F) of the Act 

Section 17A(b)(3)(F) of the Act 53

requires that the rules of a clearing 

agency, such as NSCC, be designed to: 

(i) Promote the prompt and accurate 

clearance and settlement of securities 

transactions; (ii) assure the safeguarding 

of securities and funds which are in the 

custody or control of the clearing agency 

or for which it is responsible; (iii) foster 

cooperation and coordination with 

persons engaged in the clearance and 

settlement of securities transactions; (iv) 

remove impediments to and perfect the 

mechanism of a national system for the 

prompt and accurate clearance and 

settlement of securities transactions; 

and (v) protect investors and the public 

interest. 

The Commission believes that the 

proposal is consistent with Section 

17A(b)(3)(F) of the Act for the reasons 

stated below. 

(i) Prompt and Accurate Clearance and 

Settlement and Safeguarding of 

Securities and Funds 

As described above in Section I.C, 

NSCC proposes to revise the definition 

of ‘‘Illiquid Securities’’ to provide 

additional specific objective criteria that 

would lead to a security being 

considered as an Illiquid Security, 

which would, in turn, broaden the 

scope of securities that would be 

considered as Illiquid Securities for 

assessing margin requirements. For 

example, NSCC would consider 

additional factors such as an issuer’s 

market capitalization and a defined 

illiquidity ratio to determine whether a 

security is illiquid, which would 

capture certain exchange-listed 

securities that the current rules do not 

include as Illiquid Securities. Therefore, 

the Commission believes that NSCC’s 

proposed new definition of Illiquid 

Securities is designed to more precisely 

identify securities with illiquid 

characteristics than the current 

methodology. 

Moreover, as described above in 

Section I.D, NSCC proposes to 

specifically exclude Illiquid Securities 

and UITs when calculating the volatility 

component of a Required Fund Deposit 

using the VaR model, and to change the 

haircut-based volatility component of 


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77286 Federal Register / Vol. 85, No. 231 / Tuesday, December 1, 2020 / Notices 

54Backtesting is an ex-post comparison of actual 

outcomes with expected outcomes derived from the 

use of margin models. See 17 CFR 240.17Ad– 

22(a)(1). 

55See Notice, supra note 3, 85 FR at 17915. As 

part of the Proposed Rule Change, NSCC filed 

Exhibit 3—NSCC Impact Studies, comparing the 

current and proposed methodologies. Pursuant to 

17 CFR 240.24b–2, NSCC requested confidential 

treatment of Exhibit 3. NSCC also filed the proposal 

contained in the Proposed Rule Change as Advance 

Notice. See supra note 3. Because the proposals 

contained in the Advance Notice and the Proposed 

Rule Change are the same, all information provided 

by NSCC regarding the improvements in backtesting 

coverage for other asset groups was considered 

regardless of whether the information submitted 

with respect to the Advance Notice or the Proposed 

Rule Change. 

56See Letter from Daniel Zinn, General Counsel 

and Cass Sanford, Associate General Counsel, OTC 

Markets Group Inc. (July 21, 2020) (‘‘OTC II Letter’’) 

at 2–3. 

the Clearing Fund formula that is 

applicable to positions in Illiquid 

Securities and UITs. Currently, in order 

to calculate the volatility component, 

fixed percentages are applied to two 

general categories of securities that 

encompass Illiquid Securities and UITs, 

i.e., (1) securities that are less amenable 

to statistical analysis, and (2) securities 

that are amenable to generally accepted 

statistical analysis only in a complex 

manner. The proposal would apply a 

specific percentage developed for 

Illiquid Securities and UITs. In 

addition, instead of using the current 

fixed haircut percentages for Illiquid 

Securities, the proposal would group 

such securities by price level and apply 

a different haircut percentage based on 

the specific price group. Illiquid 

Securities that are sub-penny securities 

would be separately grouped by long or 

short position to more accurately reflect 

different levels of risk presented by long 

and short positions of such securities 

(i.e., a higher level of risk is associated 

with the short positions in sub-penny 

securities). The proposal would also 

require NSCC to regularly assess 

appropriate haircut percentages to cover 

its credit risks. The Commission 

believes that by providing that the 

volatility component of margin for 

Illiquid Securities and UITs should be 

determined by applying haircuts 

tailored to specific groups of Illiquid 

Securities and to UITs, this change 

should result in margin amounts that 

are more commensurate with the risk 

attributes of these types of securities, 

thereby limiting NSCC’s credit exposure 

to Members holding positions in such 

securities. 

NSCC provided information regarding 

the impact of the proposed rule change 

on its backtesting coverage.54

Specifically, a recent impact study 

shows that the proposal would improve 

its backtesting coverage from 96.2% to 

99.5% for the asset group that exhibited 

the lowest average backtesting coverage 

percentages (i.e., short positions in subpenny securities and securities priced 

between one cent and one dollar).55 The 

Commission has reviewed NSCC’s 

analysis and agrees that its results 

indicate that NSCC’s proposal results in 

margin levels that better reflect the risks 

and particular attributes of the 

Member’s portfolio. 

In addition, as described in Section 

I.E, NSCC proposes to eliminate the 

existing Illiquid Charge. This existing 

charge would no longer be needed in 

light of the revised definition and 

haircut-based margin methodology 

described in Sections I.C and I.D, which 

would more precisely address the risk 

that the Illiquid Charge purported to 

cover. As described in Section I.F, 

NSCC proposes to make conforming 

changes to harmonize the Rules in light 

of the changes described in Sections I.C 

and I.D. The Commission believes that 

these changes are designed to provide 

clear and coherent Rules regarding the 

haircut-based volatility charge for 

Illiquid Securities and UITs. 

Taken together, the Commission 

believes that the Proposed Rule Change 

is designed to allow NSCC to collect 

margin more precisely tailored to the 

nature of the risks presented by 

positions in securities with illiquid 

characteristics than the current 

methodology, and in a manner that fully 

addresses NSCC’s applicable credit 

exposures. In turn, the proposal should 

help ensure that, in the event of a 

Member default, NSCC’s operation of its 

critical clearance and settlement 

services would not be disrupted because 

of insufficient financial resources. 

Accordingly, the Commission finds that 

NSCC’s proposal should help NSCC to 

continue providing prompt and accurate 

clearance and settlement of securities 

transactions in the event of a Member 

default, consistent with Section 

17A(b)(3)(F) of the Act. 

Moreover, by better limiting NSCC’s 

exposure to Members, the proposal is 

designed to help ensure that NSCC has 

collected sufficient margin from 

Members, so that non-defaulting 

Members would not be exposed to 

mutualized losses resulting from the 

default of a Member holding positions 

in Illiquid Securities and/or UITs. 

Accordingly, the Commission believes 

that by helping to limit non-defaulting 

Members’ exposure to mutualized 

losses, the proposal is designed to help 

assure the safeguarding of securities and 

funds which are in NSCC’s custody or 

control, consistent with Section 

17A(b)(3)(F) of the Act. 

One commenter asserts that the 

proposal does not promote the prompt 

and accurate clearance and settlement of 

securities transactions, and also does 

not assure the safeguarding of securities 

and funds which are in the custody or 

control of NSCC or for which it is 

responsible because (1) the haircutbased volatility charge fails to bring 

clarity and transparency, (2) NSCC 

failed to explain how the current 

formula leaves members exposed to 

default, and (3) NSCC failed to explain 

how the proposed methodology would 

limit exposure in the event of a Member 

default.56

The Commission disagrees with this 

comment. First, and as discussed further 

in Section II.E, the Commission believes 

that the Proposed Rule Change 

identifies what would constitute an 

Illiquid Security and describes how the 

haircut-based charge for Illiquid 

Securities and UITs would apply. 

Second, and as discussed further above, 

NSCC provided backtesting results to 

show that NSCC has a backtest coverage 

of 96.2% for the asset group that 

exhibited the lowest average backtesting 

coverage percentages (i.e., short 

positions in sub-penny securities and 

securities priced between one cent and 

one dollar), as compared to a backtest 

coverage of 99.5% under the Proposed 

Rule Change. As demonstrated by the 

backtesting analysis, under its current 

margin methodology, NSCC is not 

achieving its 99% targeted confidence 

level for asset groups that are Illiquid 

Securities. Based on its review of the 

Notice and the materials filed as part of 

the Proposed Rule Change, in 

conjunction with the Commission’s 

supervisory observations, the 

Commission believes that the proposed 

changes would better enable NSCC to 

collect margin commensurate with the 

different levels of risk that Members 

pose to NSCC as a result of their 

particular trading activity in Illiquid 

Securities and UITs. Finally, the 

Commission believes that the proposed 

changes would enable NSCC to collect 

margin that more accurately reflects the 

risk characteristics of Illiquid Securities 

and UITs by applying a haircut more 

precisely tailored to Illiquid Securities 

(grouped by price level and a long or 

short positions) and UITs, and therefore 

allow NSCC to be in a better position to 

absorb losses in connection with a 

Member default and manage its credit 

exposure to such Member. 


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57See OTC II Letter at 3. 

58This benefit may be particularly important 

since, as the Commission discussed elsewhere, 

small firms, which tend to be most financially 

constrained, may be disproportionately affected by 

downturns or tightening credit conditions. See 

Temporary Amendments to Regulation 

Crowdfunding, Securities Act Release No. 10781 

(May 4, 2020), 85 FR 27116, 27123 n. 40 (May 7, 

2020) (citing to Gabriel Perez-Quiros and Allan 

Timmermann, Firm Size and Cyclical Variations in 

Stock Returns, 55(3) Journal of Finance 1229–1262 

(2000) (showing that ‘‘small firms display the 

highest degree of asymmetry in their risk across 

recession and expansion states, which translates 

into a higher sensitivity of their expected stock 

returns with respect to variables that measure credit 

market conditions’’); Murillo Campello and Long 

Chen, Are Financial Constraints Priced? Evidence 

from Firm Fundamentals and Stock Returns, 42(6) 

Journal of Money, Credit, and Banking 1185–1198 

(2010) (finding that financially constrained firms’ 

business fundamentals are significantly more 

sensitive to macroeconomic movements than 

unconstrained firms’ fundamentals); Eugene Fama 

and Kenneth French, Common Risk Factors in the 

Returns on Stocks and Bonds, 3 Journal of 

Financial Economics 3–56 (1993)). 

59Letter from John Busacca, Founder, The 

Securities Industry Professional Association (April 

23, 2020) (‘‘SIPA Letter’’) at 3; Letter from James 

Snow, President, Wilson-Davis & Co., Inc. 

(November 20, 2020) (‘‘Wilson III Letter’’) at 5. The 

SIPA Letter also expresses concern regarding 

increased costs arising from regulatory and DTC 

requirements generally, as well as the results of SEC 

and FINRA trading suspensions. Id. at 3. Other 

commenters expressed similar concern regarding 

general increases in costs not related to this 

proposal. See also Letter from Kimberly Unger, The 

Security Traders Association of New York, Inc. 

(June 30, 2020) (‘‘STANY Letter’’) at 2–3; and Letter 

from James C. Snow, Chief Compliance Officer, 

Wilson-Davis & Co., Inc. (July 29, 2020) (‘‘Wilson 

II Letter’’) at 5. Such issue is not directed to the 

Proposed Rule Change and, accordingly, is beyond 

the scope of the Commission’s consideration. 

60See Letter from Charles F. Lek, Lek Securities 

Corporation (April 30, 2020) (‘‘Lek Letter’’) at 3; 

Letter from Daniel Zinn, General Counsel and Cass 

Sanford, Associate General Counsel, OTC Markets 

Group Inc. (June 26, 2020) (‘‘OTC I Letter’’) at 4; 

STANY Letter at 2. 

61See SIPA Letter at 3; Wilson II Letter at 2; 

Wilson III Letter at 4; OTC I Letter at 4. 

62See NSCC Letter at 10. 

63See id. 

(ii) Protection of Investors and the 

Public Interest 

The Commission believes that the 

proposal should help protect investors 

and the public interest by mitigating 

some of the risks presented by NSCC as 

a central counterparty. Because a 

defaulting member could place stresses 

on NSCC with respect to NSCC’s ability 

to meet its clearance and settlement 

obligations upon which the broader 

financial system relies, it is important 

that NSCC has a robust margin 

methodology to limit NSCC’s credit risk 

exposure in the event of a Member 

default. As described above, the 

Proposed Rule Change would revise the 

definition of an ‘‘Illiquid Security,’’ and 

the haircut-based methods for 

determining volatility components for 

positions in Illiquid Securities and 

UITs. These changes should help 

improve NSCC’s ability to calculate 

margin accurately to better produce 

margin that is more commensurate with 

the risks associated with its Members’ 

Illiquid Securities and UITs, and thus 

more effectively cover its credit 

exposures to its Members. By collecting 

margin that more accurately reflects the 

risk characteristics of such securities, 

NSCC would be in a better position to 

absorb and contain the spread of any 

losses that might arise from a Member 

default. Therefore, the proposal is 

designed to reduce the possibility that 

NSCC would need to call for additional 

resources from non-defaulting Members 

due to a Member default, which could 

inhibit the ability of these nondefaulting Members to facilitate 

securities transactions. Accordingly, the 

Commission believes that the proposal 

is designed to protect investors and the 

public interest by mitigating some of the 

systemic risks presented by NSCC as a 

central counterparty. 

One commenter states that the 

proposal does not protect investors 

because the increased costs will likely 

be passed on to retail shareholders of 

small firms.57 The Commission is not 

persuaded that the proposal will not 

protect investors solely because of the 

potential for increased costs that could 

be passed on to retail shareholders of 

small firms. While the proposal may 

result in an increase in the Required 

Fund Deposit for a Member who 

transacts in Illiquid Securities and UITs, 

such an increase is designed to allow 

NSCC to reduce the risks it faces 

associated with Illiquid Securities and 

UITs in the event of a Member default.58

As a result, NSCC should be more 

resilient so that it can satisfy its 

obligations as a central counterparty 

while reducing the possibility that 

NSCC would need to mutualize among 

non-defaulting Members any losses 

arising out of a Member default, which 

facilitates the protection of investors by 

helping to ensure that investors receive 

the proceeds from their securities 

transactions. 

Several commenters expressed 

concerns that the proposal would 

discourage entry to the public market by 

small and growing companies, hinder 

small business capital formation, 

negatively impact small company 

liquidity, and dissuade investors from 

trading in Illiquid Securities.59 Several 

commenters stated that the proposal 

will hurt small broker-dealers, which in 

turn will hurt small businesses, and is 

detrimental to small business capital 

formation needs.60 Several commenters 

stated that the proposal would negate 

the objectives of Regulations D, A+, and 

Crowdfunding, and negatively affect 

small business capital formation.61

In response, NSCC states that the 

Proposed Rule Change is not designed 

to advantage or disadvantage capital 

formation in any particular market 

segment.62 NSCC further states that the 

Proposed Rule Change focuses entirely 

on managing the clearance and 

settlement risk associated with 

secondary transactions in securities 

with illiquid characteristics as required 

by Section 17A of the Exchange Act, 

which is unaffected by those 

initiatives.63

First, with respect to the commenters 

who raised concerns regarding liquidity 

and capital formation, the Commission 

believes that limiting NSCC’s exposure 

to its Members by allowing NSCC to 

collect more accurate margin to manage 

its exposure to Illiquid Securities and 

UITs would benefit Members due to 

NSCC’s decreased exposure to losses 

resulting from a Member default. 

Effectively mitigating such risks would, 

in turn, reduce the likelihood that NSCC 

would have to call on its Members to 

contribute additional resources, which 

would otherwise could be used by its 

Members to facilitate securities 

transactions thereby providing liquidity 

to the securities markets. Thus, the 

Commission believes that NSCC’s 

proposal, by helping non-defaulting 

members preserve their financial 

resources, could promote liquidity 

provision in such circumstances 

because these resources would be 

available to facilitate securities 

transactions. 

The Commission acknowledges that 

the proposal could increase the margin 

required to be collected from a Member 

who transacts in Illiquid Securities and 

UITs, which, in turn, may cause such a 

Member to incur additional costs to 

access needed liquidity for meeting 

margin requirements. Despite these 

potential impacts, the Commission is 

not persuaded that the Proposed Rule 

Change would have a negative effect on 

small business capital formation such 

that it would be inconsistent with the 

public interest. To the extent that 

Members incur funding costs associated 

with additional margin, they may 

choose to distribute these costs across 

transactions in all securities for which 

they make markets rather than allocate 

those costs only to transactions in 

securities that require additional 

margin. Thus, the fact that Members 

have flexibility in how they allocate 


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64See Securities Exchange Act Release No. 78961 

(September 28, 2016), 81 FR 70786, 70866–67 

(October 13, 2016) (S7–03–14) (‘‘CCA Standards 

Adopting Release’’). 

65See, e.g., Viral Acharya and Lasse H. Pedersen, 

2005, Asset pricing with liquidity risk, 77 Journal 

of Financial Economics 375–410 (2005). 

66See, e.g., Yakov Amihud, Illiquidity and stock 

returns: Cross-section and time series effects, 5(1) 

Journal of Financial Markets 31–56 (2002); Joel 

Hasbrouck, Trading costs and returns for US 

equities: Estimating effective costs from daily data, 

64(3) The Journal of Finance 1445–1477 (2009); 

Robert. A. Korajczyk and Ronnie Sadka, Pricing the 

commonality across alternative measures of 

liquidity, 87(1) Journal of Financial Economics 45– 

72 (2008); and Michael J. Brennan, Tarun Chordia, 

Avanidhar Subrahmanyam and Qing Tong, Sellorder liquidity and the cross-section of expected 

stock returns, 105(3) Journal of Financial 

Economics 523–541 (2012). However, some studies 

do not find that more illiquid stocks have higher 

expected returns. See, e.g., Michael J. Brennan and 

Avanidhar Subrahmanyam, Market microstructure 

and asset pricing: On the compensation for 

illiquidity in stock returns, 41(3) Journal of 

Financial Economics 441–464 (1996); Matthew I. 

Spiegel and Xiaotong Wang, Cross-sectional 

variation in stock returns: Liquidity and 

idiosyncratic risk, Yale ICF Working Paper No. 05– 

13 (2005). 

67See OTC I Letter at 4; OTC II Letter at 2–3; 

Wilson II Letter at 6; Wilson III Letter at 1. 

68See OTC II Letter at 3. 

costs could mitigate negative impacts, if 

any, on the liquidity and capital 

formation of a particular subset of 

issuers. 

The Commission recognizes the 

possibility that, as a result of the 

proposed change, some Members may 

pass along some of the costs related to 

margin requirements such that they 

ultimately are borne, to some degree, by 

investors in Illiquid Securities. 

However, non-defaulting Members’ 

exposure to mutualized losses resulting 

from a Member’s default and any 

resulting disruptions to clearance and 

settlement absent the Proposed Rule 

Change may also increase costs to 

investors and potentially adversely 

impact market participation, liquidity, 

and access to capital by issuers, 

including issuers of Illiquid Securities. 

As a result, and as the Commission 

previously acknowledged, this proposed 

rule change may help reduce transaction 

costs in the markets NSCC clears, and 

reductions in counterparty default risk 

allow the corresponding portion of 

transaction costs to be allocated to more 

productive uses by market participants 

who otherwise would bear those costs.64

Moreover, as discussed in Section II.A(i) 

above, by helping to limit nondefaulting Members’ exposure to 

mutualized losses, the proposed rule 

change is designed to help assure the 

safeguarding of securities and funds of 

its Members that are in NSCC’s custody 

or control, consistent with Section 

17A(b)(3)(F). 

Further, the Commission is not 

persuaded by the commenters’ 

generalized statements on the potential 

impact on small business capital 

formation that could result from 

implementation of the Proposed Rule 

Change. The Commission acknowledges 

the possibility that, as the commenter 

asserted, issuers of securities in smaller 

companies may experience a reduction 

in liquidity because of the increased 

margin requirements applicable to 

transactions in Illiquid Securities. 

Nevertheless, the Commission believes 

that investors would not be discouraged 

from holding Illiquid Securities. The 

Commission understands that, in 

general, stock prices fall in response to 

a reduction in liquidity until such 

securities provide an adequate desired 

return for investors,65 and some studies 

indicate illiquid stocks pay investors a 

higher expected stock excess return to 

compensate for greater illiquidity.66

Thus, as long as stock prices can adjust 

to reflect the reduced liquidity, affected 

small issuers may still be able to attract 

capital from investors, albeit at a higher 

cost that appropriately reflects the risks 

inherent in the clearance and settlement 

of the securities they issue. Moreover, to 

the extent that investment decisions are 

driven by other factors, such as the 

future prospects of specific companies, 

there might be no decrease in access to 

capital or little change in cost. 

In addition, the commenters’ 

arguments ignore the potential benefits 

to small businesses when their 

securities are eligible for central clearing 

by NSCC. As do other clearing agencies, 

NSCC provides a number of services 

that mitigate risk, reduce costs, and 

enhance processing efficiencies for the 

securities markets, market participants, 

issuers (including small issuers), and 

investors. By reducing NSCC’s risk 

exposure to its members and thus the 

likelihood of its failure, the proposal 

helps ensure that NSCC would continue 

to provide such services, which would 

benefit securities markets, market 

participants, issuers (including small 

issuers), and investors. Thus, the 

commenters do not take into account 

any potential positive impacts on small 

business capital formation that may 

arise as a result of the Proposed Rule 

Change. 

Therefore, notwithstanding the 

potential unspecified impact on capital 

formation in smaller and less liquid 

markets, as described above, the 

Commission believes that, in light of the 

potential benefits to investors arising 

from the Proposed Rule Change and the 

resulting overall improved risk 

management at NSCC, i.e., the prompt 

and accurate clearance and settlement of 

securities transactions and the 

safeguarding of securities and funds 

based on the collection of margin 

commensurate with the risks presented 

by these securities, the Proposed Rule 

Change is designed to protect investors 

and the public interest, consistent with 

Section 17A(b)(3)(F) of the Act. 

(iii) Fostering Cooperation and 

Removing Impediments 

Several commenters asserted that the 

Proposed Rule Change is inconsistent 

with Section 17A(b)(3)(F) of the Act 

because the proposal neither addresses 

nor meets all of the elements prescribed 

in Section 17A(b)(3)(F).67 In response to 

these comments, the Commission 

acknowledges that Section 17A(b)(3)(F) 

of the Act requires a clearing agency’s 

rules to be designed to meet a number 

of objectives, as listed above. However, 

certain proposals may not necessarily 

directly implicate every aspect of 

Section 17A(b)(3)(F). Nevertheless, for 

the reasons discussed below, the 

Commission disagrees with the 

commenters that the Proposed Rule 

Change does not meet with the 

requirements of Section 17A(b)(3)(F) 

related to whether a clearing agency’s 

rules are designed to foster cooperation 

and coordination with persons engaged 

in the clearance and settlement of 

securities transactions, and to remove 

impediments to and perfect the 

mechanism of a national system for the 

prompt and accurate clearance and 

settlement of securities transactions. 

One commenter argues that the 

proposal will not foster cooperation and 

coordination between the various 

market participants engaged in 

processing transactions in Illiquid 

Securities because increased margin 

requirements will disadvantage smaller 

firms, exacerbating the trend of firms 

ceasing to provide liquidity in thinly 

traded stocks due to overly burdensome 

regulatory costs.68 As an initial matter, 

Section 17A(b)(3)(F) has a narrower 

scope than the issue raised by the 

commenter, in that it addresses 

cooperation and coordination with 

persons engaged in the clearance and 

settlement of securities transactions and 

not among market participants more 

broadly. Nevertheless, even when 

considering Section 17A(b)(3)(F) as it 

could apply to market participants more 

broadly, the Commission does not agree 

with the commenter’s argument that 

increased margin requirements could 

disadvantage smaller firms and is 

inconsistent with fostering cooperation 

and coordination with persons engaged 

in the clearance and settlement of 


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69See Section II.E infra. 

70See OTC II Letter at 3; Wilson III Letter at 1. 

71 15 U.S.C. 78q–1(b)(3)(F). 

72 15 U.S.C. 78q–1(b)(3)(I). 

73See Bradford National Clearing Corp., 590 F.2d 

1085, 1105 (D.C. Cir. 1978). 

74See Letter from Christopher R. Doubek, CEO, 

Alpine Securities Corporation (April 21, 2020) 

(‘‘Alpine Letter’’) at 2 and 3; SIPA Letter at 3; and 

Lek Letter at 2 and 3. 

75See OTC I Letter at 5. 

76See Alpine Letter at 2; STANY Letter at 2; OTC 

I Letter at 5; and Lek Letter at 2. 

77See Lek Letter at 2. Lek Letter and SIPA Letter 

also argue that the unfair burden on competition is 

due to the fact that DTCC’s board is almost entirely 

made up of representatives from large banks and 

other big-businesses. See Lek Letter at 3 and SIPA 

Letter at 2. This proposal does not change the 

composition of DTCC’s board, and the commenter 

does not provide specifics information regarding 

the composition of DTCC’s board and how it relates 

to this proposal. As discussed below, the impact of 

the proposed changes are determined by a 

Member’s portfolio composition and trading 

activity rather than a Member’s size or type. As 

addressed throughout, the Commission has 

concluded that the proposal does not impose any 

burden on competition not necessary or appropriate 

in furtherance of the Act. 

78See NSCC Letter at 4. 

79See NSCC Letter at 5. 

80 Id. 

securities transactions. This proposal 

would establish a clear and transparent 

methodology for determining the 

volatility component of margin for a 

particular class of securities that would 

apply to all NSCC Members in a 

uniform manner.69 The use of such a 

uniform methodology is essential to 

fostering and ensuring cooperation and 

coordination with persons engaged in 

the clearance and settlement of 

securities transactions because it 

provides a generally applicable and 

understood methodology established ex 

ante for determining margin for this 

particular class of securities. The 

collection of appropriately tailored 

margin pursuant to this methodology 

would, in turn, help decrease the 

likelihood that losses arising out of a 

Member default would exceed NSCC’s 

prefunded resources and threaten 

NSCC’s ability to continue providing 

clearance and settlement of securities 

transactions and to serve market 

participants as a central counterparty 

and, therefore, to provide an 

infrastructure for cooperation in the 

continued clearance and settlement of 

securities transactions. Therefore, the 

Commission believes that the Proposed 

Rule Change is consistent with fostering 

cooperation and coordination, as 

provided under Section 17A(b)(3)(F). 

The commenters further state that the 

proposal would not remove 

impediments to the national system for 

prompt and accurate clearance and 

settlement but would impose additional 

requirements and increase the already 

prohibitive transactional costs involved 

in clearing and settling OTC and small 

company stocks, making already thinly 

traded securities more illiquid.70 The 

Proposed Rule Change is designed to 

allow NSCC to better identify securities 

that present illiquid characteristics 

based on additional objective criteria 

and to impose tailored haircuts to 

determine the appropriate margin for 

such securities and UITs. These changes 

will, in turn, enable NSCC to collect 

margin more precisely tailored to the 

different levels of risk that Members 

pose to NSCC as a result of their 

particular trading activity in Illiquid 

Securities and UITs, resulting in more 

accurate clearance and settlement of 

securities transactions. The Commission 

believes that these improvements to the 

clearance and settlement of securities 

transactions are consistent with 

removing impediments to the national 

system for clearance and settlement, in 

that less precise margin determinations 

could constitute an impediment to 

NSCC’s continued ability to clear and 

settle securities transactions if losses 

arising out of a Member default were to 

exceed NSCC’s prefunded resources and 

threaten NSCC’s continued operation as 

a central counterparty for securities 

transactions. For these reasons, the 

Commission believes that this change is 

consistent with removing impediments 

to the national system of clearance and 

settlement, as provided under Section 

17A(b)(3)(F). 

For the reasons discussed above, the 

Commission believes that the Proposed 

Rule Change is consistent with the 

requirements of Section 17A(b)(3)(F) of 

the Act.71

B. Consistency With Section 17A(b)(3)(I) 

of the Act 

Section 17A(b)(3)(I) of the Act 

requires that the rules of a clearing 

agency do not impose any burden on 

competition not necessary or 

appropriate in furtherance of the Act.72

This provision does not require the 

Commission to find that a proposed rule 

change represents the least 

anticompetitive means of achieving the 

goal. Rather, it requires the Commission 

to balance the competitive 

considerations against other relevant 

policy goals of the Act.73

The Commission received various 

comments regarding the proposal’s 

impact on competition. Several 

commenters argued that the proposal 

would disproportionately affect smaller 

broker-dealer Members and small 

companies.74 One commenter 

acknowledged that the proposal would 

apply to all Members equally, but was 

concerned that the proposal is likely to 

disproportionately impact smaller 

Members and harm competition.75

Multiple commenters asserted that the 

proposal would discriminate against 

small Members because the proposal 

would demand higher margin, which 

would in turn raise the cost for 

liquidity.76 One commenter further 

contended that, while large bankaffiliated broker-dealer Members will 

not have a liquidity issue resulting from 

the proposal, other Members will have 

a liquidity issue under the proposal.77

In response, NSCC acknowledges that 

the proposal may result in an increase 

in the Required Fund Deposit for a 

Member effecting transactions in 

Illiquid Securities, and that it may also 

result in higher margin costs overall for 

Members whose business is 

concentrated in Illiquid Securities, 

relative to other Members with more 

diversified portfolios. However, NSCC 

states that the methodology for 

computing the margin requirement for a 

Member’s Required Fund Deposit under 

the proposal does not take into 

consideration the Member’s size or 

overall mix of business in liquid or 

illiquid securities, including micro-cap 

securities, relative to other Members. 

Any effect the proposal would have on 

a particular Member’s margin 

requirement is solely a function of the 

default risk posed to NSCC by the 

Member’s activity at NSCC—firm size or 

business model is not pertinent to the 

assessment of that risk.78 Accordingly, 

NSCC believes that the proposal does 

not discriminate against Members or 

affect them differently on either of those 

bases. 

NSCC states that it is required to 

manage clearance and settlement risk 

presented by each Member with respect 

to the particular securities products 

each Member transacts through the 

system by, among other things, 

collecting margin sufficient to cover the 

risk of default with respect to those 

trades with a high degree of confidence. 

Accordingly, each Member is primarily 

responsible for mitigating the risk 

associated with its own business.79

NSCC represents that the proposal is 

intended to provide a more robust 

assessment and coverage of the risk 

associated with volatility exhibited by 

Illiquid Securities that NSCC has 

identified through backtesting to the 

statutorily prescribed level.80 As 

contemplated by the Act and Rule 

17Ad–22, each Member would be 

responsible to provide margin 

commensurate with the default risk 


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81See CCA Standards Adopting Release, supra 

note 64, 81 FR at 70870. In addition, when 

considering the benefits, costs, and effects on 

competition, efficiency, and capital formation, the 

Commission recognized that a covered clearing 

agency, such as NSCC, might pass incremental costs 

associated with compliance on to its members, and 

that such members may seek to terminate their 

membership with that CCA. See id., 81 FR at 70865. 

Moreover, when considering similar comments 

related to a proposed rule change designed to 

address a covered clearing agency’s liquidity risk, 

the Commission concluded that the imposition of 

additional costs did not render the proposal 

inconsistent with the Exchange Act. See Securities 

Exchange Act Release No. 82090 (November 15, 

2017), 82 FR 55427, 55438 n. 209 (November 21, 

2017) (SR–FICC–2017–002). 

82These potential burdens are not fixed, and 

affected Members may choose to restructure their 

liquidity sources, costs of capital, or business 

model, thereby moderating the potential impact of 

the Proposed Rule Change. 

83See note 55. 

84 15 U.S.C. 78q–1(b)(3)(I). 

85 17 CFR 240.17Ad–22(e)(4)(i). 

86See Lek Letter at 1; STANY Letter at 1; OTC 

I Letter at 2. 

87See STANY Letter at 1; OTC I Letter at 2. 

88See NSCC Letter at 6. 

89 Id. at 5; 17 CFR 240.17Ad–22(e)(4)(i). NSCC 

also notes that this improvement in coverage level 

would allow it to meet the high degree of 

confidence referenced in Rule 17Ad–22(e)(4)(i). Id. 

posed by its business to NSCC under the 

proposal. 

The Commission acknowledges that 

the Proposed Rule Change could entail 

increased margin charges to some 

Members that would be borne by those 

Members. In considering the costs and 

benefits of the requirements of Rule 

17Ad–22(e)(6), the Commission 

expressly acknowledged in the CCA 

Standards Adopting Release that riskbased initial margin requirements may 

cause market participants to internalize 

some of the costs borne by the central 

counterparty as a result of large or risky 

positions and stated that confirming that 

margin models are well-specified and 

correctly calibrated with respect to 

economic conditions will help ensure 

that the margin requirements continue 

to align the incentives of a central 

counterparty’s members with the goal of 

financial stability.81 Nevertheless, in 

response to the comments that the 

proposal would disproportionately 

affect smaller broker-dealer Members or 

those broker-dealer Members that are 

not affiliated with large banks, the 

Commission believes that the impact of 

the proposed changes would be entirely 

determined by a Member’s portfolio 

composition and trading activity rather 

than a Member’s size or type. The 

Proposed Rule Change would calculate 

the volatility component of a Member’s 

Required Fund Deposit based on the 

risks presented by positions in Illiquid 

Securities, as described in Section I.C. 

To the extent a Member’s volatility 

component would increase under the 

Proposed Rule Change, that increase 

would be based on the securities held 

by the Member and NSCC’s requirement 

to collect margin to appropriately 

address the risk. 

In addition, as noted above, the 

Commission acknowledges that the 

impact of a higher margin requirement 

may present higher costs on some 

Members relative to others due to a 

number of factors, such as access to 

liquidity resources, cost of capital, 

business model, and applicable 

regulatory requirements. These higher 

relative burdens may weaken certain 

Members’ competitive positions relative 

to other Members.82 However, the 

Commission believes that such burden 

on competition stemming from a higher 

impact on some members than on others 

is necessary and appropriate. The 

Commission believes that NSCC is 

required to establish, implement, 

maintain and enforce written policies 

and procedures reasonably designed to 

cover its credit exposures to its 

participants by establishing a risk-based 

margin system that, at a minimum, 

considers, and produces margin levels 

commensurate with, the risks and 

particular attributes of each relevant 

product, portfolio, and market. NSCC’s 

members include a large and diverse 

population of entities. By participating 

in NSCC, each Member is subject to the 

same margin requirements, which are 

designed to satisfy NSCC’s regulatory 

obligation to manage the risk presented 

by its Members. As discussed in more 

detail in Section II.D below, this 

Proposed Rule Change is designed to 

ensure that NSCC collects margin that is 

commensurate with the risks presented 

by Illiquid Securities and UITs. 

Furthermore, NSCC has provided an 

impact study demonstrating that the 

proposal would raise the current lowest 

average backtesting coverage from 

96.2% to 99.5%.83 As noted above, the 

Commission has reviewed NSCC’s 

analysis and agrees that its results 

indicate that NSCC’s proposal results in 

margin levels that better reflect the risks 

and particular attributes of the 

Member’s portfolio and help NSCC 

achieve backtesting coverage that meets 

its targeted confidence level. In turn, the 

Commission believes that the Proposed 

Rule Change would help NSCC better 

maintain sufficient financial resources 

to cover its credit exposures to each 

Member in full with a high degree of 

confidence. By helping NSCC to better 

manage its credit exposure, the proposal 

would help NSCC better mitigate the 

potential losses to NSCC and its 

Members associated with liquidating a 

Member’s portfolio in the event of a 

Member default, in furtherance of 

NSCC’s obligations under Section 

17A(b)(3)(F) of the Act as shown in 

Section II.A. 

Therefore, for the reasons stated 

above, the Commission believes that the 

Proposed Rule Change is consistent 

with the requirements of Section 

17A(b)(3)(I) of the Act 84 because any 

competitive burden imposed by the 

proposal is necessary and appropriate in 

furtherance of the Act. 

C. Consistency With Rule 17Ad– 

22(e)(4)(i) 

Rule 17Ad–22(e)(4)(i) under the 

Exchange Act requires that each covered 

clearing agency establish, implement, 

maintain and enforce written policies 

and procedures reasonably designed to 

effectively identify, measure, monitor, 

and manage its credit exposures to 

participants and those arising from its 

payment, clearing, and settlement 

processes, including by maintaining 

sufficient financial resources to cover its 

credit exposure to each participant fully 

with a high degree of confidence.85

Several commenters question whether 

NSCC has adequately demonstrated that 

its proposal is consistent with Rule 

17Ad–22(e)(4)(i) under the Exchange 

Act by showing the insufficiency of 

NSCC’s current margin methodology 

and whether the increase in margin is 

necessary.86 Two commenters state that 

NSCC has not demonstrated that its 

current margin requirements are 

insufficient to cover credit risks to its 

Members.87

In response, NSCC states that the 

proposal is designed to provide a more 

accurate measure of the risks associated 

with Illiquid Securities and to cover in 

full the risks presented by Members to 

NSCC.88 To demonstrate why the 

proposed revision to its methodology for 

assessing margin on Illiquid Securities 

is necessary to address the risk 

presented by such securities, NSCC 

relies upon the results of recent 

backtesting analyses. Specifically, NSCC 

examines the backtesting coverage for a 

historical time period under both the 

current and proposed margin 

methodologies. Based on this analysis, 

NSCC represents that the proposal 

would help NSCC to address the risk 

presented by Illiquid Securities and that 

it would improve the lowest average 

backtesting coverage with respect to 

Illiquid Securities from 96.2% to 99.5% 

for the asset group that exhibited the 

lowest average backtesting coverage 

percentages (i.e., short positions in subpenny securities and securities priced 

between one cent and one dollar).89


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As stated above, the volatility component of the 

margin collected by NSCC is designed to reflect the 

amount of money that could be lost on a portfolio 

over a given period within a 99% confidence level, 

and NSCC has established a 99% target backtesting 

confidence level. See, e.g., Procedure XV, Section 

I.B(3), supra note 9. 

90See NSCC Letter at 5. 

91See NSCC Letter at 5–6. 

92See NSCC Letter at 6. 

93 17 CFR 240.17Ad–22(e)(4)(i). 

94 In addition, because the proposals contained in 

the Advance Notice and the Proposed Rule Change 

are the same, all information submitted by NSCC 

was considered regardless of whether the 

information submitted with respect to the Advance 

Notice or the Proposed Rule Change. See supra 

notes 3 and 55. 

95 17 CFR 240.17Ad–22(e)(4)(i). 

96 17 CFR 240.17Ad–22(e)(6)(i). 

97See Alpine Letter; OTC I Letter; STANY Letter; 

and Letter from Daniel Zinn, General Counsel and 

Cass Sanford, Associate General Counsel, OTC 

Markets Group Inc. (July 21, 2020) (‘‘OTC II 

Letter’’). 

98See OTC II Letter at 5; STANY Letter at 3. 

99See Lek Letter at 1; Wilson III Letter at 3. Lek 

also states that net capital should be considered 

solely as additional insurance for agency firms, and 

that NSCC should include the margin that Lek 

collects from its customers when computing Lek’s 

capital. Id. However, this issue is beyond the scope 

of this proposal and is not addressed herein. 

Further, one commenter argues that the Proposed 

Rule Change is also unwarranted because NSCC 

could address NSCC’s market risk exposure by 

modifying the settlement timeline. See Wilson III 

Letter at 4. According to the commenter, if the 

NSCC proposed rules that would eliminate the twoday settlement cycle in favor of immediate, sameday electronic settlement, the market risk exposure 

would be eliminated. See id. The Commission 

disagrees with the argument. The securities 

industry transitioned to the current two-day 

settlement cycle on September 5, 2017, only after 

a multi-year, industry-wide initiative and the 

Commission’s amendment of Rule 15c6–1. See 

Continued 

NSCC further states that its backtesting 

results and Member impact studies 

indicate that Illiquid Securities, 

particularly low-priced Illiquid 

Securities, are more likely to present 

additional risk.90

NSCC notes that the proposed 

changes to its methodology produce a 

more accurate haircut calculation by 

factoring in price levels, resulting in 

margin levels that better reflect the risks 

and particular attributes of Member 

portfolios.91 NSCC represents that the 

enhanced methodology for identifying 

Illiquid Securities and the calculation of 

the haircut-based volatility component 

applicable to these securities and UITs 

improve the risk-based methodology, 

which in turn, better manage its credit 

exposures to Members.92

The Commission believes that the 

proposal is consistent with Rule 17Ad– 

22(e)(4)(i) under the Exchange Act.93

Specifically, the proposal to revise the 

definition of Illiquid Securities would 

help NSCC to better identify securities 

that may present credit exposures 

unique to such securities for purposes of 

applying an appropriate margin charge. 

The proposal would provide additional 

criteria that use more objective factors to 

determine what constitutes an Illiquid 

Security. These factors consider a 

security’s listing status, trading history, 

and market capitalization, and would 

result in a more accurate classification 

of securities with illiquid characteristics 

being considered as Illiquid Securities. 

In addition, the proposal to base the 

calculation of the haircut-based 

volatility charge applied to positions in 

Illiquid Securities and UITs on those 

securities’ price level and risk profile 

would enable NSCC to collect and 

maintain sufficient and precisely 

calibrated resources to cover its credit 

exposures to each participant whose 

portfolio contains positions in Illiquid 

Securities and/or UITs with a high 

degree of confidence. The Commission 

has reviewed and analyzed NSCC’s 

analysis of the improvements in its 

backtesting coverage, and agrees that the 

analysis demonstrates that the proposal 

would result in better backtesting 

coverage and, therefore, less credit 

exposure to its Members. Finally, the 

proposal appropriately requires NSCC to 

review and determine the haircut 

percentages at least annually. 

Accordingly, the Commission believes 

that the proposal would enable NSCC to 

better manage its credit risks by 

allowing it to respond regularly and 

more effectively to any material 

deterioration of backtesting 

performances, market events, market 

structure changes, or model validation 

findings. 

In response to comments that NSCC 

has not demonstrated that current 

margin requirements are insufficient to 

cover credit risks to its Members, the 

Commission disagrees. In considering 

these comments, the Commission 

thoroughly reviewed and considered (i) 

the Proposed Rule Change, including 

the supporting exhibits that provided 

confidential information on the 

performance of the proposed revision to 

the definition of an Illiquid Security and 

the use of a revised haircut-based 

methodology applicable to both Illiquid 

Securities and UITs and backtesting 

coverage results; (ii) the comments 

received; and (iii) the Commission’s 

own understanding of the performance 

of the current margin methodology, with 

which the Commission has experience 

from its general supervision of NSCC, 

compared to the proposed margin 

methodology.94 Based on its review of 

these materials, the Commission 

believes that the proposal would, in 

fact, better enable NSCC to cover its 

credit exposure to Members and meet 

the applicable Commission regulatory 

requirements. Specifically, the 

Commission has considered the results 

of NSCC’s backtesting coverage 

analyses, which indicate that the 

current margin methodology results in 

backtesting coverage that does not meet 

NSCC’s targeted confidence level. The 

analyses also indicate that the proposal 

would result in improved backtesting 

coverage that meets NSCC’s targeted 

coverage level. Therefore, the 

Commission believes that the proposal 

would provide NSCC with a more 

precise margin calculation designed to 

meet the applicable regulatory 

requirements for margin coverage. 

Therefore, for the reasons discussed 

above, the Commission believes that the 

changes proposed in the Proposed Rule 

Change are reasonably designed to 

enable NSCC to effectively identify, 

measure, monitor, and manage its credit 

exposure to Members, consistent with 

Rule 17Ad–22(e)(4)(i).95

D. Consistency With Rule 17Ad– 

22(e)(6)(i) 

Rule 17Ad–22(e)(6)(i) under the 

Exchange Act requires that each covered 

clearing agency that provides central 

counterparty services establish, 

implement, maintain and enforce 

written policies and procedures 

reasonably designed to cover its credit 

exposures to its participants by 

establishing a risk-based margin system 

that, at a minimum, considers, and 

produces margin levels commensurate 

with, the risks and particular attributes 

of each relevant product, portfolio, and 

market.96

Several commenters suggest that the 

proposal does not reflect the actual risk 

attributes of the securities to which it 

would apply.97 For example, two 

commenters state that treating as 

Illiquid Securities all securities that are 

not listed on a ‘‘specified securities 

exchange,’’ which would be defined as 

a national securities exchange that has 

established listing services and is 

covered by industry pricing and data 

vendors, is not tailored to accurately 

capture securities that present the 

defined liquidation and marketability 

risks, noting that many large 

international companies’ securities are 

traded in the OTC marketplace.98 Two 

commenters state that the proposal is 

unwarranted because the existing 

margin has always been enough to cover 

a defaulting Member’s losses, and 

accordingly, the current margin should 

be enough to cover the risks presented 

by Members’ portfolios.99 One 


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Securities Exchange Act Release No. 78962 

(September 28, 2016), 81 FR 69240, 69254 (October 

5, 2016) (‘‘Discussion of Current Efforts To Shorten 

the Settlement Cycle in the U.S.’’); See Securities 

Exchange Act Release No. 80295 (March 22, 2017), 

82 FR 15564 (March 29, 2017). Therefore, the 

commenter’s suggestion that NSCC could 

unilaterally shorten the current two-day settlement 

to a same-day settlement cycle is not a feasible 

alternative to the Proposed Rule Change. 

100See STANY Letter at 3. 

101See SIPA Letter. 

102See Alpine Letter at 4. 

103See NSCC Letter at 8. 

104See NSCC Letter at 8–9. 

105See id. 

106See id. 

107See id. 

108See id. 

109See id. 

110See id. 

111See Lek Letter at 1; see also Wilson III at 3– 

4. 

112 17 CFR 240.17Ad–22(e)(6)(iii) (requiring a 

covered clearing agency to establish, implement, 

maintain and enforce written policies and 

procedures reasonably designed to cover its credit 

exposures to its participants by establishing a riskbased margin system that, at a minimum, calculates 

margin sufficient to cover its potential future 

exposure to participants in the interval between the 

last margin collection and the close out of positions 

following a participant default). 

commenter states that NSCC has not 

justified a $300 million market 

capitalization requirement for all 

exchange-listed stocks, and that this 

threshold does not consider the actual 

risks facing NSCC.100 Another 

commenter states that ETPs and ADRs, 

which are products typically offered by 

large banks and brokerages, are 

excluded from the definition of an 

Illiquid Security, and that such 

exclusion shows a bias against small 

Members.101 In addition, one 

commenter states that the proposal 

bears no relationship to a Member’s 

actual credit rating.102

In response to comments regarding 

treating as Illiquid Securities all 

securities that are not listed on a 

national securities exchange that has 

established listing services and is 

covered by industry pricing and data 

vendors, NSCC states that securities that 

trade on a national securities exchange 

tend to trade with greater frequency in 

higher volumes than other venues, and 

national securities exchanges are subject 

to price and volume reporting regimes 

that assure greater accuracy of price and 

volume information.103 NSCC further 

states that securities that are not listed 

on a national securities exchange may 

trade without being registered with the 

Commission and have less reliable price 

and volume information.104

In addition, NSCC explains that it 

included the second element of the 

criteria, ‘‘covered by industry pricing 

and data vendors,’’ to ensure that NSCC 

is able to access and utilize quality third 

party pricing data to derive returns in 

order to calculate the appropriate 

margin.105 NSCC further explains that 

the commercial availability of reliable 

information from independent, third 

party sources is critical to ensuring that 

NSCC can rely on end of day and 

intraday pricing in order to accurately 

manage risk positions consistent with 

its Rules.106 Accordingly, NSCC 

believes that the use of ‘‘specified 

securities exchange’’ as defined in the 

proposal is an appropriate basis for 

determining whether a security is an 

Illiquid Security.107

Regarding the comments that many 

large international companies’ securities 

are traded in the OTC marketplace, 

NSCC acknowledges that the proposed 

definition of Illiquid Securities would 

cover the securities of some large, wellcapitalized issuers not listed on a 

specified securities exchange.108

However, NSCC states that the proposal 

is designed to appropriately address risk 

in part by grouping Illiquid Securities 

by price level, and sub-penny securities 

by long or short position.109

Accordingly, not all Illiquid Securities 

would be given the same haircut or have 

the same margin requirements or result 

in a higher deposit than would be 

required under the current Rules.110

The Commission understands that, as 

described above, the proposal as a 

whole is designed to enable NSCC to 

more effectively address the risks 

presented by Members’ positions in 

securities with illiquid characteristics, 

including Illiquid Securities and UITs. 

As such, NSCC seeks to produce margin 

levels that are more commensurate with 

the particular risk attributes of these 

securities, including the risk of 

increased transaction and market costs 

to NSCC to liquidate or hedge due to 

lack of liquidity or marketability of such 

positions. The Commission believes that 

the proposal would improve NSCC’s 

ability to consider, and produce margin 

levels commensurate with, the risks and 

particular attributes of Illiquid 

Securities and UITs. 

First, by expanding and refining the 

definition of Illiquid Securities, the 

Commission believes that NSCC should 

be able to better identify those securities 

that may exhibit illiquid characteristics. 

Specifically, the proposal would ensure 

that three separate categories of 

securities are included in the definition 

of an Illiquid Security, and all three 

categories are calibrated to take into 

account specific and objective factors 

that are indicative of a security’s 

liquidity. For example, the second 

category of the proposed definition of an 

Illiquid Security would apply an 

illiquidity ratio to micro-cap securities 

and ADRs to get a more precise measure 

of their liquidity. Moreover, consistent 

with NSCC’s current practice for 

determining the margin for securities in 

an initial public offering, the third 

category of the proposed definition 

would consider the frequency of a 

security’s trading, to take into account 

that infrequent trading reduces the 

amount of price and volume 

information available to measure market 

risk. 

In addition, the Commission believes 

that the proposed changes to the 

haircut-based volatility charges to base 

the calculation on the price level and 

risk profile of the applicable security 

would help NSCC to more effectively 

measure the risks that are particular to 

Illiquid Securities and UITs. Based on 

its analysis of the backtesting and 

impact analyses and its understanding 

of the proposed definition of an Illiquid 

Security, the Commission believes that 

the differentiated haircut percentages 

are reasonably designed to cover NSCC’s 

exposures to Members more precisely 

and appropriately than the current fixed 

percentage approach because NSCC 

designed the variable haircut 

percentages to reflect specific risks 

presented by Illiquid Securities by price 

level and by UITs. The Commission also 

believes that it is reasonable to separate 

long and short positions of sub-penny 

securities in order to reflect the different 

risk levels presented by such positions. 

Taken together, the Commission 

believes that the proposal should permit 

NSCC to calculate a haircut-based 

volatility charge that is more 

appropriately designed to address the 

risks presented by the positions in 

Illiquid Securities and UITs. 

In response to the comments 

questioning whether the proposal is 

necessary because ‘‘the existing margin 

has always been enough to cover’’ 111 a 

defaulting Member’s losses, the 

Commission does not agree that the fact 

that margin has historically been 

sufficient to cover a defaulting 

Member’s losses obviates the need for 

the changes proposed in the Proposed 

Rule Change. As an initial matter, credit 

exposures are not measured only by 

those events that have actually 

happened, but also include events that 

could potentially occur in the future. 

For this reason, a risk-based margin 

system is required to cover potential 

future exposure to participants.112

Potential future exposure is, in turn, 

defined as the maximum exposure 

estimated to occur at a future point in 

time with an established single-tailed 


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113 17 CFR 240.17Ad–22(a)(13). 

114NSCC represents that the initial threshold is 

set at $300 million because it is based on prevailing 

thresholds for market capitalization categories in 

the industry. See NSCC Letter at 9; Notice, supra 

note 3, 85 FR at 17912 n. 24 (citing, as an example 

of the prevailing views, https://www.sec.gov/ 

reportspubs/investor-publications/investorpubs/ 

microcapstockhtm.html). 

115Securities Act Release No. 68124 (September 

16, 2020), 85 FR 68124, 68185 (October 27, 2020) 

(S7–14–19) (‘‘Publication or Submission of 

Quotations Without Specified Information’’). 

116See id. 

117See id. 

118See id. 

119See id. 

120The Alpine Letter also questions whether the 

Credit Risk Rating Matrix (‘‘CRRM’’) will continue 

to be used in the margin calculation for Illiquid 

Securities. See Alpine Letter at 3. NSCC responds 

that the calculation of the appropriate haircuts for 

Illiquid Securities, including calculation of the 

appropriate volume thresholds, does not consider 

the Member’s CRRM rating. The CRRM rating 

currently is used in determining the Illiquid 

Position subject to NSCC’s Illiquid Charge, which 

will be eliminated upon implementation of the 

proposal. See NSCC Letter at 7–8. Going forward, 

the CRRM would continue to be used in general 

credit risk monitoring of members, but would not 

be used for the determination of the volatility 

component of the margin for a particular security. 

See Securities Exchange Act Release No. 80734 

(May 19, 2017), 82 FR 24177 (May 25, 2017) (order 

approving proposed rule changes to enhance the 

CRRM). 

121 17 CFR 240.17Ad–22(e)(6)(i). 

122 17 CFR 240.17Ad–22(e)(23)(ii). 

123See Alpine Letter at 2; SIPA Letter at 4–5; OTC 

I Letter at 2–3; OTC II Letter at 3–4; Wilson II Letter 

at 7. Wilson II also asserts that NSCC has failed to 

meet the requirements of Rule 17Ad–22(e)(23)(iii) 

Continued 

confidence level of at least 99% with 

respect to the estimated distribution of 

future exposure.113 Thus, to be 

consistent with its regulatory 

requirements, NSCC must consider 

potential future exposure, which 

includes, among other things, losses 

associated with the liquidation of a 

defaulted member’s portfolio. As 

demonstrated by the backtesting 

analysis discussed above, under its 

current margin methodology, NSCC is 

not achieving its 99% targeted 

confidence level for asset groups that 

are Illiquid Securities. Based on its 

review of the Proposed Rule Change, in 

conjunction with the Commission’s 

supervisory observations, the 

Commission believes that the proposed 

changes would better enable NSCC to 

collect margin commensurate with the 

different levels of risk that Members 

pose to NSCC as a result of their 

particular trading activity in Illiquid 

Securities and UITs. Further, the 

Commission believes the amount of 

margin NSCC would collect under the 

proposed changes would help NSCC 

better manage its credit exposures to its 

Members and those exposures arising 

from its payment, clearing, and 

settlement processes. 

In response to the comment asserting 

that a $300 million market 

capitalization requirement for all 

exchange-listed stocks is not justifiable, 

the Commission disagrees with this 

interpretation of the proposal. Not all 

securities that fall under the market 

capitalization threshold under the 

proposal would be deemed to be Illiquid 

Securities or require a higher margin 

compared to the current Rules. As set 

forth in the proposal, the determination 

of whether a micro-cap security is an 

Illiquid Security does not rely solely on 

capitalization. By contrast, under the 

proposal, the initial determination of 

whether a security is a micro-cap 

security would employ a $300 million 

threshold,114 and a micro-cap security 

would then be subject to the illiquidity 

ratio test described in Section I.C(ii)3 

above to take into account the security’s 

liquidity and determine whether it is an 

Illiquid Security. Therefore, depending 

on the liquidity of the issuer, there 

could be instances where a security 

with less than $300 million in market 

capitalization would not constitute an 

Illiquid Security. 

In response to the comments stating 

that treating all securities that are not 

listed on a specified exchange as 

Illiquid Securities is not tailored to 

accurately capture securities that 

present the defined liquidation and 

marketability risks, the Commission 

disagrees. This proposal does not 

change the current categorization as 

Illiquid Securities of securities that are 

not listed on a specified securities 

exchange, because the current Rules 

define Illiquid Securities to include 

securities that are not traded on a 

national securities exchange. Further, 

the Commission believes that this 

distinction is appropriate. Securities 

that are quoted on the OTC market differ 

from those listed on national securities 

exchanges.115 In particular, the average 

OTC security issuer is smaller, and their 

securities trade less, on average, than 

securities traded on a national securities 

exchange.116 Moreover, issuers of 

quoted OTC securities tend to have a 

lower market capitalization than those 

with securities listed on a national 

securities exchange,117 and many 

quoted OTC securities are illiquid.118

Quoted OTC securities are characterized 

by significantly lower dollar trading 

volumes than listed stocks, even for 

securities of similar size as measured by 

market capitalization.119

In response to the comment that ETPs 

and ADRs are exempt from the 

definition of Illiquid Securities, the 

Commission disagrees. The Proposed 

Rule Change would not exclude all 

ETPs and ADRs by category from the 

definition of Illiquid Securities. Instead, 

the proposal would only exclude ETPs 

and ADRs when calculating the 

illiquidity ratio threshold for purposes 

of the second test under the definition 

of an Illiquid Security (i.e., the median 

of the illiquidity ratio threshold based 

on non-micro-cap common stocks). An 

ETP or an ADR could be determined to 

be an Illiquid Security, and NSCC 

would apply a haircut to ETPs and 

ADRs in the same manner as other 

Illiquid Securities. 

Finally, in response to the comment 

that the proposal bears no relationship 

to a Member’s actual credit rating, the 

Commission disagrees that such a 

relationship is necessary in order to 

design an accurate and appropriate 

margin methodology for the securities 

that a Member holds. Neither the 

proposal, nor NSCC’s margin 

methodology more broadly, is designed 

to calculate the volatility component 

based on a Member’s credit rating but 

rather on the risks presented by each 

security. Therefore, the Member’s credit 

rating is not relevant to the 

determination of the appropriate 

volatility component of the margin for a 

particular security.120

Accordingly, the Commission believes 

the proposal is consistent with Rule 

17Ad–22(e)(6)(i) under the Exchange 

Act because it is designed to assist 

NSCC in maintaining a risk-based 

margin system that considers, and 

produces margin levels commensurate 

with, the risks and particular attributes 

of portfolios that exhibit illiquid risk 

attributes.121

E. Consistency With Rule 17Ad– 

22(e)(23)(ii) 

Rule 17Ad–22(e)(23)(ii) under the 

Exchange Act requires each covered 

clearing agency to establish, implement, 

maintain, and enforce written policies 

and procedures reasonably designed to 

provide sufficient information to enable 

participants to identify and evaluate the 

risks, fees, and other material costs they 

incur by participating in the covered 

clearing agency.122

The majority of commenters express 

concerns regarding the method for 

determining the proposed volatility 

component for Illiquid Securities being 

confidential. Several commenters 

express concern that the proposal does 

not explain how the haircut-based 

volatility charge will be calculated and 

that the proposal does not allow 

Members to review the proposed margin 

equations, models, and calculations.123


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for failing to quantify the current inadequate market 

capitalization, median illiquidity ratios, and how 

those factors would be improved under the 

proposal. However, Rule 17Ad–22(e)(23)(iii) 

requires each covered clearing agency to establish, 

implement, maintain, and enforce written policies 

and procedures reasonably designed to publicly 

disclose relevant basic data on transaction volume 

and values. This rule does not require a covered 

clearing agency to disclose the specific information 

that the commenter seeks because the information 

described by the commenter is not the basic data 

on transaction volumes and values required by the 

rule. Moreover, NSCC publicly provides data on 

transaction volumes and values in its quantitative 

disclosures, which are available at https://

www.dtcc.com/legal/policy-and-compliance. 

124See Letter from James C. Snow, President/ 

CCO, Wilson-Davis & Co., Inc. (May 1, 2020) 

(‘‘Wilson I Letter’’) at 2–3; STANY Letter at 2; 

Wilson III Letter at 2. Wilson III also states that 

NSCC failed to meet the requirements of Rule 

17Ad–22(e)(23)(ii) and (iii), which requires a 

clearing agency to provide sufficient information to 

enable participants to identify and evaluate the 

risks, fees, and other material costs they incur by 

participating in the covered clearing agency and to 

publicly disclose relevant basic data on transaction 

volume and values, because NSCC has not 

undertaken the requisite studies or gathered 

sufficient data to fully understand the impact of the 

Proposed Rule Change. See Wilson III Letter at 3. 

The Commission disagrees with this comment. 

First, as described in more detail below, NSCC 

provides methods for Members to understand their 

respective margin requirements. See infra note 127 

and accompanying text. Second, as stated above, 

NSCC submitted to the Commission impact studies 

comparing the impact of the current and proposed 

methodologies on its Members, and provided 

additional information regarding the improvements 

in backtesting coverage for other asset groups in 

confidential exhibits. See supra notes 55 and 94. 

125See NSCC Letter at 6. 

126See id. 

127See id. 

128See id. 

129See id. 

130See id. 

131See id. 

132See NSCC Letter at 7. 

133See id. 

134See id. 

135See id. 

136See id. Wilson III states that unlike NSCC’s 

representation, only one impact study was received. 

See Wilson III Letter at 3. The Commission does not 

believe that NSCC’s purported failure to provide 

particular impact studies to all of its Members is a 

dispositive factor in determining whether the 

Proposed Rule Change is designed to be consistent 

with Rule 17Ad–22(e)(23)(ii). Rule 17Ad– 

22(e)(23)(ii) requires NSCC to provide sufficient 

information to enable participants to identify and 

evaluate the risks, fees, and other material costs 

they may incur. NSCC has (1) acknowledged that 

that the proposal may result in an increase in the 

Required Fund Deposit for a Member effecting 

transactions in Illiquid Securities, and that it may 

also result in higher margin costs overall for 

Members whose business is concentrated in Illiquid 

Securities, relative to other Members with more 

diversified portfolios, and (2) provided Members 

with a Portal that enables them to identify and 

evaluate their costs. 

137See NSCC Letter at 7. 

138See id. 

139See id. 

Other commenters state that the 

proposal is overly complicated and does 

not allow Members to predict the 

financial consequences and operating 

impacts of their activities, and the 

impact on their liquidity needs.124

In response, NSCC states that the 

language of the proposal is reasonably 

transparent and clear enough to enable 

Members to determine the Member’s 

Required Fund Deposit.125 NSCC states 

that the proposed parameters are 

definitive and non-discretionary to 

enable application on an algorithmic 

basis.126 For example, a security that is 

an ADR or has a micro-capitalization of 

less than $300 million would be subject 

to the illiquidity ratio test, which would 

be provided in the Rules, to determine 

whether it is an Illiquid Security. In 

addition, NSCC states that, because 

haircuts would be applied according to 

the price level of the Illiquid Securities, 

Members should be able to more easily 

determine the applied margin impact 

per the current market price of the 

security.127

NSCC also represents that it maintains 

the NSCC Risk Management Reporting 

application on the Participant Browser 

Service (‘‘PBS’’) and the NSCC Risk 

Client Portal (‘‘Portal’’) to improve 

transparency of Members’ Clearing 

Fund requirements.128 NSCC states that 

the PBS is a member-accessible website 

portal for accessing reports and other 

disclosures. NSCC further states that the 

Risk Management Reporting application 

enables a Member to view and 

download Clearing Fund requirement 

information and component details, 

including issue-level Clearing Fund 

information related to start of day 

volatility charges and mark-to-market, 

intraday exposure, and other 

components.129 NSCC represents that 

the application enables a Member to 

view, for example, a portfolio 

breakdown by asset type, including the 

amounts attributable to the parametric 

VaR model and the amounts associated 

with Illiquid Securities.130 NSCC also 

represents that Members are able to 

view and download spreadsheets that 

contain market amounts for current 

clearing positions and the associated 

volatility charges.131

In addition, NSCC represents that the 

Portal provides members the ability, for 

information purposes, to view and 

analyze certain risks relating to their 

portfolio, including calculators to assess 

the risk and clearing fund impact of 

certain activities and to compare their 

portfolio to historical and average 

values. For example, it allows Members 

to review both hourly and 15-minute 

intra-day snapshots to monitor 

fluctuations in the volatility and 

exposure in their portfolios to help 

Members to anticipate potential intraday margin calls. The intervals are 

available through 7:00 p.m. to provide 

additional reports that may help 

Members to forecast next-day margin 

requirements.132

NSCC further represents that it 

maintains the NSCC Client Calculator 

on the Portal that provides functionality 

to Members to enter ‘what-if’ position 

data and to recalculate their volatility 

charges to determine margin impact pretrade.133 NSCC specifically states that 

this calculator allows Members to see 

the impact to the volatility charge if 

specific transactions are executed, or to 

anticipate the impact of an increase or 

decrease to a current clearing 

position.134 NSCC represents that the 

Client Calculator portfolio detail can be 

downloaded to modify a current margin 

portfolio, and then allow Members to 

upload the portfolio to run a margin 

calculation, and permit Members to 

view position level outputs in order to 

make informed risk management and 

execution decisions.135

Finally, NSCC states that it conducted 

member outreach in connection with 

the proposal described in the Proposed 

Rule Change. NSCC represents that, in 

2019 and 2020, NSCC distributed three 

rounds of impact studies to Members 

impacted by the change to communicate 

revisions to the methodology and 

discuss specific portfolio impacts by 

reviewing charts and quantitative 

results.136 NSCC further represents that 

it has performed outreach to Members 

with details for this proposal for the 

past two years, which allowed Members 

to understand and ask questions about 

the proposal.137

NSCC states that it has also posted an 

NSCC Risk Margin Component Guide 

(‘‘Guide’’) on the Portal which provides 

descriptions of some of the components 

used in NSCC’s current risk-based 

methodology, including the volatility 

charges, mark-to-market charges, fail 

charges for CNS transactions, a charge 

for Family-Issued Securities to mitigate 

wrong way risk, a charge for Illiquid 

Positions, a charge to mitigate day over 

day margin differentials, a coverage 

component and a backtesting charge.138

NSCC represents that the Guide will be 

updated to reflect the changes in 

methodology set forth in the 

proposal.139

The Commission believes that the 

proposal is consistent with Rule 17Ad– 

22(e)(23)(ii) and is designed to provide 

sufficient information to enable 

Members to identify and evaluate the 

risks and other material costs they incur 

by participating in NSCC. The changes 

described in the proposal would be 


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140 17 CFR 240.17Ad–22(e). 

141See CCA Standards Adopting Release, supra 

note 64, 81 FR at 70845. 

142 17 CFR 240.17Ad–22(e)(23)(ii). 

143 15 U.S.C. 78q–1. 

144 15 U.S.C. 78s(b)(2). 

145 In approving the proposed rule change, the 

Commission considered the proposals’ impact on 

efficiency, competition, and capital formation. 15 

U.S.C. 78c(f). See also Section II.B. 

146 17 CFR 200.30–3(a)(12). 

1 15 U.S.C. 78s(b)(1). 

2 17 CFR 240.19b–4. 

reflected in NSCC’s Rules and therefore 

publicly available to NSCC’s Members 

and prospective members for 

application to their own portfolios. 

Specifically, the proposed rule text 

would reflect the two sets of changes in 

the proposal. First, the proposed rule 

text would define the types of securities 

that would constitute ‘‘Illiquid 

Securities’’ as three particular categories 

of securities, as described in Section 

I.C(i), (ii), and (iii). By reviewing the 

definitions of an Illiquid Security, 

NSCC’s members should be able to 

understand the types of factors that 

would cause a security to be considered 

an Illiquid Security, all of which are 

ascertainable, such as its trading history 

(including whether it is traded on an 

exchange or not and, if so, on which 

exchange), its market capitalization, and 

the type of security (i.e., whether it is an 

ADR). The specific parameters of the 

illiquidity ratio test would also be 

reflected in NSCC’s Rules, thereby 

enabling a Member to determine 

whether a security that is an ADR or has 

a micro-capitalization of less than $300 

million would be an Illiquid Security. 

Second, the proposed rule text would 

provide that NSCC would apply a 

haircut to Illiquid Securities to 

determine the appropriate volatility 

component, with Illiquid Securities 

grouped by price level to determine the 

appropriate haircut to apply to a 

particular security. The proposed rule 

text would further specify that the 

haircut percentage would be the highest 

of the three percentages as provided in 

Section I.D(i), and would be determined 

at least annually. Additionally, if a 

Member had questions with respect to a 

particular security, it could use the 

various client-facing tools described 

above to determine whether a security 

would be considered an Illiquid 

Security. Taken together, the 

Commission believes that the proposal, 

which would be reflected in NSCC’s 

Rules, in conjunction with the various 

client-facing tools, provides sufficient 

information to Members to understand 

the operation of the haircut-based 

volatility charges and how such charges 

would apply to particular transactions. 

The Commission further believes that 

NSCC provided sufficient information to 

Members to identify and evaluate the 

risks and other material costs they 

would incur due to securities with 

illiquid characteristics under the 

proposal. 

For these reasons, the Commission 

disagrees with the comments stating 

that the proposal lacks details and does 

not explain how the haircut-based 

volatility charge will be calculated, and 

that the proposal does not allow 

Members to predict the impact on their 

activities. The Commission 

acknowledges that, as some commenters 

have noted, the proposal does not 

provide or specify the actual models or 

calculations that NSCC would use to 

determine the appropriate haircut or 

what constitutes an Illiquid Security. 

However, when adopting the CCA 

Standards,140 the Commission declined 

to adopt a commenter’s view that a 

covered clearing agency should be 

required to provide, at least quarterly, 

its methodology for determining initial 

margin requirements at a level of detail 

adequate to enable participants to 

replicate the covered clearing agency’s 

calculations, or, in the alternative, that 

the covered clearing agency should be 

required to provide a computational 

method with the ability to determine the 

initial margin associated with changes 

to each respective participant’s portfolio 

or hypothetical portfolio, participant 

defaults and other relevant information. 

The Commission stated that 

‘‘[m]andating disclosure of this 

frequency and granularity would be 

inconsistent with the principles-based 

approach the Commission is taking in 

Rule 17Ad–22(e).’’ 141 Consistent with 

that approach, the Commission does not 

believe that Rule 17Ad–22(e)(23)(ii) 

would require NSCC to disclose its 

actual margin methodology, so long as 

NSCC has provided sufficient 

information for its Members to 

understand the potential costs and risks 

associated with participating in NSCC 

for clearing Illiquid Securities. 

For the reasons discussed above, the 

Commission believes that the proposals 

in the Proposed Rule Change would 

enable NSCC to establish, implement, 

maintain, and enforce written policies 

and procedures reasonably designed to 

provide sufficient information to enable 

Members to identify and evaluate the 

risks, fees, and other material costs they 

incur as NSCC’s Members, consistent 

with Rule 17Ad–22(e)(23)(ii).142

III. Conclusion 

On the basis of the foregoing, the 

Commission finds that the proposed 

rule change is consistent with the 

requirements of the Act and in 

particular with the requirements of 

Section 17A of the Act 143 and the rules 

and regulations promulgated 

thereunder. 

It is therefore ordered, pursuant to 

Section 19(b)(2) of the Act 144 that 

proposed rule change SR–NSCC–2020– 

003, be, and hereby is, approved.145

For the Commission, by the Division of 

Trading and Markets, pursuant to delegated 

authority.146

J. Matthew DeLesDernier, 

Assistant Secretary. 

[FR Doc. 2020–26401 Filed 11–30–20; 8:45 am] 

BILLING CODE 8011–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–90504; File No. SR–CBOE– 

2020–111] 

Self-Regulatory Organizations; Cboe 

Exchange, Inc.; Notice of Filing and 

Immediate Effectiveness of a Proposed 

Rule Change Relating To Amend Its 

Fees Schedule 

November 24, 2020. 

Pursuant to Section 19(b)(1) of the 

Securities Exchange Act of 1934 (the 

‘‘Act’’),1 and Rule 19b–4 thereunder,2

notice is hereby given that on November 

16, 2020, Cboe Exchange, Inc. (the 

‘‘Exchange’’ or ‘‘Cboe Options’’) filed 

with the Securities and Exchange 

Commission (the ‘‘Commission’’) the 

proposed rule change as described in 

Items I, II, and III below, which Items 

have been prepared by the Exchange. 

The Commission is publishing this 

notice to solicit comments on the 

proposed rule change from interested 

persons. 

I. Self-Regulatory Organization’s 

Statement of the Terms of Substance of 

the Proposed Rule Change 

Cboe Exchange, Inc. (the ‘‘Exchange’’ 

or ‘‘Cboe Options’’) proposes to amend 

its fees schedule. The text of the 

proposed rule change is provided in 

Exhibit 5. 

The text of the proposed rule change 

is also available on the Exchange’s 

website (http://www.cboe.com/ 

AboutCBOE/CBOELegalRegulatory

Home.aspx), at the Exchange’s Office of 

the Secretary, and at the Commission’s 

Public Reference Room. 


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