[Federal Register Volume 88, Number 188 (Friday, September 29, 2023)]
[Notices]
[Pages 67394-67397]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-21338]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-98494; File No. SR-FICC-2023-011]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Order Approving Proposed Rule Change, as Modified by Amendment No. 1, 
To Adopt a Portfolio Differential Charge as an Additional Component to 
the Government Securities Division Required Fund Deposit

September 25, 2023.

I. Introduction

    On August 3, 2023, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-FICC-2023-011 pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder.\2\ On August 16, 2023, FICC filed Amendment No. 1 to the 
proposed rule change, to make clarifications to the proposed rule 
change.\3\ The proposed rule change, as modified by Amendment No. 1, is 
hereinafter referred to as the ``Proposed Rule Change.'' The Proposed 
Rule Change was published for comment in the Federal Register on August 
23, 2023.\4\ The Commission has received no comments on the Proposed 
Rule Change. For the reasons discussed below, the Commission is 
approving the Proposed Rule Change.\5\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 made clarifications and corrections to the 
description of the proposed rule change and Exhibit 3a of the filing 
(Summary of Impact Study) to incorporate a longer impact analysis. 
As originally filed, the time-period of the impact analysis was 
November 2021 to October 2022. As amended by Amendment No. 1, the 
time-period of the impact analysis is November 2021 to March 2023. 
These clarifications and corrections have been incorporated, as 
appropriate, into the proposed rule change. FICC has requested 
confidential treatment of Exhibit 3a, pursuant to 17 CFR 240.24b-2.
    \4\ See Securities Exchange Act Release No. 98160 (Aug. 17, 
2023), 88 FR 57485 (Aug. 23, 2023) (File No. SR-FICC-2023-011) 
(``Notice of Filing'').
    \5\ Capitalized terms not defined herein are defined in the GSD 
Rulebook (``Rules''), available at https://www.dtcc.com/~/media/
Files/Downloads/legal/rules/ficc_gov_rules.pdf.
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II. Background

    FICC is a central counterparty (``CCP''), which means it interposes 
itself as the buyer to every seller and seller to every buyer for the 
financial transactions it clears. FICC's Government Securities Division 
(``GSD'') \6\ provides trade comparison, netting, risk management, 
settlement, and CCP services for the U.S. Government securities market. 
As such, FICC is exposed to the risk that one or more of its members 
may fail to make a payment or to deliver securities.
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    \6\ FICC operates two divisions: GSD and the Mortgage-Backed 
Securities Division (``MBSD''). GSD provides CCP services for the 
U.S. Government securities market; MBSD provides CCP services for 
the U.S. mortgage-backed securities market. GSD and MBSD maintain 
separate sets of rules, margin models, and clearing funds. The 
Proposed Rule Change relates solely to GSD.
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    A key tool that FICC uses to manage its credit exposures to its 
members is the daily collection of the Required Fund Deposit (i.e., 
margin) from each member. A member's margin is designed to mitigate 
potential losses associated with liquidation of the member's portfolio 
in the event of that member's default. The aggregated amount of all 
members' margin constitutes the Clearing Fund, which FICC would be able 
to access should a defaulted member's own margin be insufficient to 
satisfy losses to FICC caused by the liquidation of that member's 
portfolio. Each member's margin consists of a number of

[[Page 67395]]

components, each of which is calculated to address specific risks faced 
by FICC arising out of its members' trading activity. Each member's 
margin includes a value-at-risk (``VaR'') charge (``VaR Charge'') 
designed to capture the potential market price risk \7\ associated with 
the securities in a member's portfolio. The VaR Charge is typically the 
largest component of a member's margin requirement.
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    \7\ Market price risk refers to the risk that volatility in the 
market causes the price of a security to change between the 
execution of a trade and settlement of that trade. This risk is 
sometimes also referred to as volatility risk.
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    The VaR Charge uses a sensitivity-based VaR methodology and is 
based on the potential price volatility of unsettled positions in a 
member's portfolio. It is designed to project the potential losses that 
could occur in connection with the liquidation of a defaulting member's 
portfolio, assuming the portfolio would take three days to liquidate in 
normal market conditions and uses three inputs: (1) confidence level, 
(2) a time horizon and (3) historical market volatility. The projected 
liquidation gains or losses are used to determine the amount of the VaR 
Charge for each portfolio, which is calculated to capture the market 
price risk associated with each portfolio at a 99 percent confidence 
level.
    FICC calculates and collects a start-of-day VaR component, which is 
designed to address the risk presented by a member's start-of-day 
positions. FICC also calculates and collects an intraday VaR component, 
which reflects the changes in a member's positions and risk profile due 
to the submission of new trades and completed settlement activity from 
the start-of-day to noon. Additionally, FICC re-calculates the amount 
of the intraday VaR Charge applicable to each member portfolio, based 
on the open positions therein, to determine whether FICC will collect 
an additional margin amount (the ``Intraday Supplemental Fund Deposit'' 
or ``ISFD''). FICC calculates the ISFD by evaluating certain criteria 
with respect to a member's intraday VaR Charge and backtesting 
results.\8\ FICC may assess the ISFD in the event that a member's risk 
exposure breaches certain criteria.\9\
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    \8\ The first criterion, the ``Dollar Threshold,'' evaluates 
whether a member's intraday VaR Charge equals or exceeds a set 
threshold dollar amount when compared to the VaR Charge that was 
included in the most recent margin collection. The second criterion, 
the ``Percentage Threshold,'' evaluates whether the intraday VaR 
Charge equals or exceeds a percentage increase of the VaR Charge 
that was included in the most recent margin collection. The third 
criterion, the ``Coverage Target,'' evaluates whether a member's 
backtesting results are below the 99 percent confidence level. 
Securities Exchange Act Release No. 83362 (June 1, 2018), 83 FR 
26514 (June 7, 2018) (File No. SR-FICC-2018-001); Securities 
Exchange Act Release No. 83223 (May 11, 2018), 83 FR 23020 (May 17, 
2018) (File No. SR-FICC-2018-801).
    \9\ FICC assesses an ISFD if a member's risk exposure breaches 
all three of the Dollar Threshold, Percentage Threshold, and 
Coverage Target. FICC also assesses an ISFD if, under certain market 
conditions, a member's intraday VaR Charge breaches both the Dollar 
Threshold and the Percentage Threshold. Id.
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    FICC states that it regularly assesses market and liquidity risks 
as such risks relate to its margin methodologies to evaluate whether 
margin levels are commensurate with the particular risk attributes of 
each relevant product, portfolio, and market.\10\ For example, FICC 
employs daily backtesting \11\ to determine the adequacy of each 
member's margin. FICC compares each member's margin with the simulated 
liquidation gains/losses, using the actual positions in the member's 
portfolio(s) and the actual historical security returns. A backtesting 
deficiency occurs when a member's margin would not have been adequate 
to cover the projected liquidation losses estimated from the member's 
settlement activity based on the backtesting results. Backtesting 
deficiencies highlight exposure that could subject FICC to potential 
losses in the event of a member default. FICC states that it 
investigates the cause(s) of any backtesting deficiencies to determine 
whether there is an identifiable cause of repeat backtesting 
deficiencies and/or whether multiple members may experience backtesting 
deficiencies for the same underlying reason.\12\
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    \10\ See Notice of Filing, supra note 4, at 57485.
    \11\ Backtesting 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).
    \12\ See id. at 57486.
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    FICC states that based on its regular review of the effectiveness 
of its margin methodology, FICC has identified backtesting deficiencies 
attributable to intraday margin fluctuations in certain member 
portfolios as those members execute trades throughout the day.\13\ 
Specifically, since FICC generally novates and guarantees trades upon 
comparison,\14\ a member's trading activity may result in coverage gaps 
due to large un-margined intraday portfolio fluctuations that remain 
unmitigated from the time of novation until the next scheduled margin 
collection.\15\ FICC designed the Proposed Rule Change to mitigate such 
exposure.
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    \13\ See id. at 57487.
    \14\ Trade comparison consists of the reporting, validating, and 
in some cases, matching by FICC of the long and short sides of a 
securities trade to ensure that the details of such trade are in 
agreement between the parties. See GSD Rule 5, supra note 5.
    \15\ See Notice of Filing, supra note 4, at 57486.
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III. Description of the Proposed Rule Change

    FICC proposes to add a new margin component, the Portfolio 
Differential Charge (``PD Charge''), to its methodology for calculating 
members' margin. FICC designed the PD Charge to help mitigate the risks 
posed to FICC by the variability of clearing activity submitted by 
members to GSD throughout the day, by measuring the historical period-
over-period increases in the VaR Charge of a member over a given time-
period.\16\ FICC would calculate the PD Charge twice a day, and if 
applicable, add the PD Charge to the calculation of the member's 
margin.
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    \16\ See id. The proposed PD Charge is different from the ISFD 
because the PD Charge is meant to capture the risks presented by the 
unpredictability of a member's historical trading activity, as 
measured, in part, by the variability in a member's VaR Charge over 
the look-back period; by contrast, the ISFD is meant to capture the 
intraday volatility risks presented by the existing net unsettled 
positions in a member's portfolio. See id.
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    Specifically, in determining the PD Charge, FICC would take into 
account the historical period-over-period increases between the (1) 
start-of-day and intraday VaR components, and (2) intraday and end-of-
day VaR components, respectively, of a member's margin over a look-back 
period of no less than 100 days, with a decay factor of no greater than 
1.\17\ FICC would calculate the PD Charge to equal the exponentially 
weighted moving average of such changes to the member's VaR Charge 
during the look-back period, times a multiplier that is no less than 
one and no greater than three, as determined by FICC from time to time 
based on backtesting results.\18\ The use of this type of average means 
that FICC would use an exponentially weighted

[[Page 67396]]

array of VaR Charges, the result of which is to emphasize more recent 
observations in determining the PD Charge (that is, it places more 
weight and significance on more recent data points).
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    \17\ Upon implementation of the Proposed Rule Change, FICC would 
use a 100-day look-back period in conjunction with a decay factor of 
0.97, which FICC believes would provide a sufficient amount of time 
to reflect the current market conditions. As market conditions 
shift, FICC may modify the look-back period and/or the decay factor 
from time to time, subject to FICC's model governance process and 
announced by FICC via an Important Notice posted on its website. See 
id. at note 14.
    \18\ FICC states that the uncertainty of the market condition 
and/or changes in members' business models may lead to changes in 
member activity patterns that would require a multiplier greater 
than 1 be invoked from time to time. See id. at note 15. FICC would 
determine whether to modify the multiplier based on the backtesting 
results to evaluate the effectiveness of PD Charge as a mitigant of 
the position change risk and may change the multiplier from time to 
time to maintain the effectiveness of the PD Charge in generating 
sufficient backtesting coverage. Changes to the multiplier would be 
subject to FICC's model governance process and be announced by FICC 
via an Important Notice posted to its website.
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    FICC believes the PD Charge would address the period-over-period 
changes to members' VaR Charges, and thereby help mitigate the risks 
posed to FICC by un-margined period-over-period fluctuations to member 
portfolios resulting from trades that FICC novates and guarantees 
during the coverage gap between margin collections.\19\ In support, 
FICC cites an impact study it conducted that covers the period from 
November 2021 to March 2023 (the ``Impact Study'').\20\ The Impact 
Study shows, among other things, that if the PD Charge had been in 
place from April 2022 through March 2023, the number of backtesting 
deficiencies would have been reduced by 77 (from 498 to 421, or 
approximately 15 percent) and the backtesting coverage for 44 members 
(approximately 34 percent of the GSD membership) would have improved, 
with 14 members who were below 99 percent coverage brought back to 
above 99 percent.\21\
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    \19\ See id. at 57486.
    \20\ As part of the Proposed Rule Change, FICC filed Exhibit 
3a--Summary of Impact Analysis (i.e., the Impact Study), comparing, 
on a member by member basis, the actual margin collections during 
the period of the Impact Study to the hypothetical margin 
collections FICC would have collected had the PD Charge been in 
place during that period. The Impact Study shows that the rolling 
12-month Clearing Fund requirement backtesting coverage ratio (from 
April 2022 through March 2023) would have improved from 98.37 
percent to 98.62 percent. The Impact Study also shows what the 
average daily PD Charge would be on a per member basis. Pursuant to 
17 CFR 240.24b-2, FICC requested confidential treatment of Exhibit 
3b. For further discussion of the Impact Study, see the Notice of 
Filing. See id. at 57487.
    \21\ See id.
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IV. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \22\ directs the Commission to 
approve a proposed rule change of a self-regulatory 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 FICC. In particular, the 
Commission finds that the Proposed Rule Change is consistent with 
Section 17A(b)(3)(F) \23\ of the Act and Rules 17Ad-22(e)(4)(i), 
(e)(6)(i), and (e)(6)(iii) thereunder.\24\
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    \22\ 15 U.S.C. 78s(b)(2)(C).
    \23\ 15 U.S.C. 78q-1(b)(3)(F).
    \24\ 17 CFR 240.17Ad-22(e)(4)(i), (e)(6)(i), and (e)(6)(iii).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act \25\ requires that the rules of a 
clearing agency, such as FICC, be designed to, among other things, 
promote the prompt and accurate clearance and settlement of securities 
transactions and assure the safeguarding of securities and funds which 
are in the custody or control of the clearing agency or for which it is 
responsible.\26\ The Commission believes that the Proposed Rule Change 
is consistent with Section 17A(b)(3)(F) of the Act for the reasons 
stated below.
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    \25\ 15 U.S.C. 78q-1(b)(3)(F).
    \26\ Id.
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    As described above in Section III, FICC proposes to add the PD 
Charge to the margin requirements that FICC may collect. As discussed 
in more detail in Section IV.B infra, the Commission believes adding 
the PD Charge to FICC's margin methodology would help ensure that FICC 
collects sufficient margin to cover its credit exposure associated with 
the variability of clearing activity submitted by members to GSD 
throughout the day by measuring the historical period-over-period 
increases in the VaR Charges of members over the look-back period. By 
helping FICC to collect sufficient margin, the Proposed Rule Change 
would better ensure that, in the event of a member default, FICC's 
operation of its critical clearance and settlement services would not 
be disrupted because of insufficient financial resources. Accordingly, 
the Commission finds that the Proposed Rule Change should help FICC to 
continue providing prompt and accurate clearance and settlement of 
securities transactions, consistent with Section 17A(b)(3)(F) of the 
Act.\27\
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    \27\ 15 U.S.C. 78q-1(b)(3)(F).
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    Moreover, as described above in Section II, FICC would access the 
mutualized Clearing Fund should a defaulted member's own margin be 
insufficient to satisfy losses to FICC caused by the liquidation of 
that member's portfolio. Because FICC's proposal to adopt the PD Charge 
should help ensure that FICC has collected sufficient margin from 
members, the Proposed Rule Change should also help minimize the 
likelihood that FICC would have to access the Clearing Fund, thereby 
limiting non-defaulting members' exposure to mutualized losses. The 
Commission believes that by helping to limit the exposure of FICC's 
non-defaulting members to mutualized losses, the Proposed Rule Change 
would help FICC assure the safeguarding of securities and funds which 
are in its custody or control, consistent with Section 17A(b)(3)(F) of 
the Act.\28\
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    \28\ Id.
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B. Consistency With Rule 17Ad-22(e)(4)(i) Under the Act

    Rule 17Ad-22(e)(4)(i) under the Act requires that each covered 
clearing agency, such as FICC, 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.\29\ The Commission believes that the 
Proposed Rule Change is consistent with Rule 17Ad-22(e)(4)(i) under the 
Act for the reasons stated below.\30\
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    \29\ 17 CFR 240.17Ad-22(e)(4)(i).
    \30\ Id.
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    The Commission agrees that FICC's proposal to add the PD Charge to 
its margin methodology would enable FICC to better manage its credit 
exposures to members by maintaining sufficient resources to cover those 
credit exposures fully with a high degree of confidence. Specifically, 
the proposed PD Charge would allow FICC to collect additional margin on 
an intraday basis to help FICC effectively mitigate the risks 
attributable to intraday margin fluctuations in certain member 
portfolios as those members execute trades throughout the day between 
margin collections. As discussed above in Section II, since FICC 
generally novates and guarantees trades upon comparison, a member's 
trading activity may result in coverage gaps due to large un-margined 
intraday portfolio fluctuations that remain unmitigated from the time 
of novation until the next scheduled margin collection. The PD Charge 
would help FICC mitigate such exposure.
    The Commission has reviewed and analyzed the materials filed by 
FICC, including FICC's Impact Study and backtesting results submitted 
confidentially,\31\ which show that had the PD Charge been in place 
from April 2022 through March 2023, it would have reduced number of 
backtesting deficiencies and thereby better enabled FICC to collect 
margin sufficient to meet its coverage requirements. Accordingly,

[[Page 67397]]

for the reasons discussed above, the Commission finds that the Proposed 
Rule Change is reasonably designed to better enable FICC to effectively 
identify, measure, monitor, and manage its credit exposure to members, 
and those arising from its payment, clearing, and settlement processes, 
including by maintaining sufficient financial resources to cover its 
credit exposure to each member fully with a high degree of confidence 
consistent with Rule 17Ad-22(e)(4)(i).\32\
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    \31\ See supra note 20.
    \32\ 17 CFR 240.17Ad-22(e)(4)(i).
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C. Consistency With Rule 17Ad-22(e)(6)(i) Under the Act

    Rule 17Ad-22(e)(6)(i) under the Act requires that each covered 
clearing agency that provides central counterparty services, such as 
FICC, 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.\33\ The Commission believes that the proposal is consistent 
with Rule 17Ad-22(e)(6)(i) under the Act for the reason stated below.
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    \33\ 17 CFR 240.17Ad-22(e)(6)(i).
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    The Commission agrees that FICC's proposal to add the PD Charge to 
its margin methodology would enable FICC to more effectively address 
the risks posed to FICC by un-margined period-over-period fluctuations 
to member portfolios resulting from trades that FICC novates and 
guarantees during the coverage gap between margin collections. In its 
filing materials, FICC provided information regarding the impacts of 
the proposed PD Charge on its margin collection.\34\ Specifically, the 
Impact Study shows that if the PD Charge had been in place from April 
2022 through March 2023, the number of backtesting deficiencies would 
have been reduced by 77 (from 498 to 421, or approximately 15 percent) 
and the backtesting coverage for 44 members (approximately 34 percent 
of the GSD membership) would have improved, with 14 members who were 
below 99 percent coverage brought back to above 99 percent.\35\ The 
Commission has reviewed and analyzed FICC's analysis and agrees that 
adding the PD Charge to FICC's margin methodology would enable FICC to 
more effectively mitigate the risks attributable to intraday margin 
fluctuations arising out of member trading activity between margin 
collections. As a result, implementing the Proposed Rule Change would 
better enable FICC to collect margin amounts at levels commensurate 
with FICC's intraday credit exposures to its members.
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    \34\ See supra note 20.
    \35\ See id.
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    Accordingly, the Commission finds the Proposed Rule Change is 
consistent with Rule 17Ad-22(e)(6)(i) under the Act because it is 
designed to assist FICC in maintaining a risk-based margin system that 
considers, and produces margin levels commensurate with, the risks of 
portfolios that experience significant volatility on an intraday 
basis.\36\
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    \36\ 17 CFR 240.17Ad-22(e)(6)(i).
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D. Consistency With Rule 17Ad-22(e)(6)(iii) Under the Act

    Rule17Ad-22(e)(6)(iii) under the Act requires that each covered 
clearing agency, such as FICC, 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, 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.\37\ The Commission believes that the proposal is 
consistent with Rule 17Ad-22(e)(6)(iii) under the Act for the reason 
stated below.
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    \37\ 17 CFR 240.17Ad-22(e)(6)(iii).
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    As stated above in Section II, FICC's proposal to add the PD Charge 
is designed to address FICC's exposure to its members attributable to 
trading activity that takes place in the interval between margin 
collections. Specifically, since FICC generally novates and guarantees 
trades upon comparison, a member's trading activity may result in 
coverage gaps due to large un-margined intraday portfolio fluctuations 
that remain unmitigated between margin collections.\38\ As discussed 
above in Section IV.C, based on the Commission's review of the filing 
materials, the Commission agrees that that FICC's proposal to add the 
PD Charge to its margin methodology should enable FICC to more 
effectively address the risks posed to FICC by un-margined period-over-
period fluctuations to member portfolios resulting from trades that 
FICC novates and guarantees during the coverage gap between margin 
collections.
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    \38\ See Notice of Filing, supra note 4, at 57486.
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    Accordingly, the Commission finds the Proposed Rule Change is 
consistent with Rule 17Ad-22(e)(6)(iii) under the Act because it is 
designed to better enable FICC to cover its credit exposures to its 
members by establishing a risk-based margin system that specifically 
calculates margin sufficient to cover its potential future exposure to 
members in the interval between the last margin collection and the 
close out of positions following a member default.\39\
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    \39\ 17 CFR 240.17Ad-22(e)(6)(iii).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
Proposed Rule Change, as modified by Amendment No. 1, is consistent 
with the requirements of the Act and in particular with the 
requirements of Section 17A of the Act \40\ and the rules and 
regulations promulgated thereunder.
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    \40\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\41\ that proposed rule change SR-FICC-2023-011, be, and hereby is, 
approved.\42\
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    \41\ 15 U.S.C. 78s(b)(2).
    \42\ In approving the Proposed Rule Change, the Commission 
considered its impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\43\
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    \43\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-21338 Filed 9-28-23; 8:45 am]
BILLING CODE 8011-01-P