[Federal Register Volume 62, Number 146 (Wednesday, July 30, 1997)]
[Notices]
[Pages 40877-40879]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-20052]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38871; File No. SR-GSCC-97-03]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Notice of Filing of a Proposed Rule Change Relating to 
Eligibility of Forward-Starting Repos for Netting and Guaranteed 
Settlement Prior to Their Scheduled Start Date

July 24, 1997.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on May 8, 1997, the 
Government Securities Clearing Corporation (``GSCC'') filed with the 
Securities and Exchange Commission (``Commission'') and on June 13, 
1997, amended the proposed rule change (File No. SR-GSCC-97-03) as 
described in Items I, II, and III below, which items have been prepared 
primarily by GSCC. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Purpose of the proposed rule change is to make transactions in 
forward-starting repurchase agreements (``repos'') eligible for netting 
and guaranteed settlement before they reach their scheduled start date.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, GSCC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. GSCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of such 
statements.\2\
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    \2\ The Commission has modified the text of the summaries 
prepared by GSCC.
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A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    Presently, forward-starting repos are not eligible for netting and 
guaranteed settlement until they reach their scheduled settlement 
date.\3\ GSCC proposes amendments to several of its rules to make these 
transactions eligible for these services before they reach their 
scheduled start date.
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    \3\ Forward-starting repo transactions are repo transactions 
which have start legs settling one or more business days in the 
future.
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1. Background
    Since November 1995, GSCC has provided netting services for repo 
transactions. Each business day, all eligible repo transactions are 
netted with regular cash activity and Treasury auction purchases in the 
same CUSIP to establish a single net position in the security for each 
netting member participating in the repo netting process. For netting 
purposes, the settlements associated with repo close legs and reverse 
start legs are treated as long positions. The settlements associated 
with repo start legs and reverse close legs are treated as short 
positions. The difference between a participant's total short activity 
and its total long activity within a CUSIP is the participant's net 
position in the CUSIP.
    After GSCC nets repo transactions, it interposes itself between the 
submitting participants for transaction settlement purposes as it does 
for cash transactions. In doing so, GSCC assumes contra party 
responsibility and guarantees settlement of all repos that enter its 
netting system. GSCC's guarantee for netted repose includes 
guaranteeing the return of repo collateral to repo participants, the 
return of principal (i.e., repo start amount) to reverse participants, 
and the payment of repo interest to the full term of the repo to 
reverse participants.
    Because forward-starting repos currently are not eligible for 
netting or guaranteed settlement until they reach their scheduled start 
date, they are not subject to clearing fund or forward margin 
requirements until that time. This results in two problems. One is a 
general management concern for GSCC arising from the possibility that a 
netting member that has entered into a forward-starting repo will 
become insolvent on the morning of the scheduled start date for the 
repo, after GSCC has netted, novated, and guaranteed the settlement of 
the repo but before the member has satisfied its funds-only settlement 
obligation (i.e., clearing fund or forward margin requirements) with 
GSCC for that day. If this occurs, GSCC may have an uncovered interest 
rate exposure that has built up over a period of time and consequently 
is of a significant size.\4\ The other concern is that members that 
enter into forward-starting repos do not have the benefit of GSCC's 
netting and guaranteed settlement services for those transactions until 
the start of the transaction.
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    \4\ If a member defaults after GSCC has guaranteed the trade, 
GSCC will be responsible to the counterparty for the difference 
between the contract repo rate and the current repo rate.
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2. Comparison of Forward-Starting Repos
    The principal impediment to making forward-starting repos eligible 
for netting and guaranteed settlement immediately after their execution 
is an inability to compare certain types of forward-starting repos. 
Forward-starting repos may be said to be of two types: (1) ``Specific 
collateral'' for which the underlying CUSIP is known from the date of 
execution of the repo and (2) ``general collateral'' for which the 
specific security and par amount that will be transferred from the repo 
participant to the reverse participant on the start date are not known 
at the time of execution. Because the underlying CUSIP is not known, 
general collateral repo transactions cannot be compared under GSCC's 
current matching requirements for data submissions.
    To rectify this problem, GSCC will allow repo participants 
submitting to GSCC data on general collateral repo transactions to use 
one of the seventeen generic CUSIP numbers established by the CUSIP 
service bureau for identifying collateral. These CUSIP numbers identify 
the type of Government security (e.g., bill, bond, or note) and 
indicate the remaining length to maturity for the issue. In addition, 
the par amount of the underlying collateral will not be required to 
match. This will allow GSCC to make general collateral forward-starting 
repos eligible for netting upon their submission to GSCC.
    In conjunction with this, GSCC will impose upon the parties to a 
general collateral forward-starting repo the obligation to inform GSCC 
when the specific CUSIPs and associated par values that will be used 
for settlement purposes are determined. The notification must be made 
to GSCC no later than by the close of business on the business day 
prior to the date on which the repo is scheduled to start.
    The notification must be made in the same manner as that in which 
members inform GSCC of their intention to substitute collateral.\5\ 
First, they must submit an ``intent to substitute'' notification 
providing specific collateral details to GSCC using an on-line function 
(i.e., a screen input facility)

[[Page 40878]]

provided by GSCC. GSCC will then modify existing trade data in its 
system by canceling the ``old'' generic CUSIP data and by creating 
replacement data based on the specific CUSIP.
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    \5\ See Section 4 for a description of substitution of 
collateral.
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    If one of the members that has submitted the data on the repo is a 
broker, GSCC will accept the ``intent to substitute'' notification 
solely from the broker without the need for a matching notification 
from the dealer counterparty. If neither of the members that submitted 
the data on the repo are brokers, GSCC will accept the ``intent to 
substitute'' notification from the member in the short or delivering 
position without the need for a matching notification from the dealer 
counterparty; however, GSCC will attempt to verify manually with the 
other member the accuracy of the details of the notification.
3. Forward Margin and Clearing Fund Requirements
    A second impediment to making forward-starting repos eligible for 
netting was an internal system constraint that has been resolved. GSCC 
now has developed the system's capability to calculate and collect 
clearing fund and forward margin on forward-starting repos from the 
time of their submission to GSCC.
    Until a forward-starting repo actually starts, the forward margin 
and clearing fund requirements apply to it will differ from those 
applied at all other repos. With regard to forward margin, because a 
forward-starting repo that has not yet started presents only interest 
rate exposure and not exposure to movements in the value of the 
underlying collateral, only an interest rate mark-to-market will be 
applied.\6\ This interest rate mark component will be calculated by 
multiplying the principal value of the repo first by a factor equal to 
the absolute difference between the system and contract repo rates and 
then by a fraction where the numerator is the number of calendar days 
from the scheduled start date of the repo until the scheduled close 
date for the repo and the denominator is 360. The interest rate mark 
will differ from the financing mark applied to repos that have already 
started in that, because the exposure presented to GSCC is a pure rate 
risk exposure, it can be a debit to either the short side or the long 
side.\7\
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    \6\ As a part of the morning funds-only settlement process, GSCC 
collects and passes through a daily basis a mark-to-market amount 
(``forward margin'') equivalent to its ongoing exposure on each 
forward net settlement position. This payment requirement reflects 
the daily mark-to-market obligation associated with a member's 
ongoing forward net settlement position in each security with a 
distinct CUSIP from the time of comparison and novation of the 
trades that underlie such position. Thus, for repos, the market 
value is subtracted from the repo's contract value (i.e., the amount 
of money that was exchanged for the collateral), and a debit or 
credit collateral mark is established depending upon the result of 
the calculation and whether or not the participant is on the reverse 
or repo side of the transaction.
    The forward margin calculation for repos differs from that for 
cash market trades in that there is additional financing mark 
component. The financing mark component reflects the fact that, if 
GSCC replaced the reverse side or the repo by buying securities and 
putting them out on repo, a financing cost would be incurred. The 
financing mark is debited to the reverse side and credited to the 
repo side.
    \7\ For repos for which the underlying collateral has already 
been exchanged, each day GSCC guarantees to the reverse repo party 
the interest payment on the principal amount. However, until the 
repos begins, GSCC only guarantees the difference between the agreed 
upon repo rate and the rate the party could receive in the open 
market.
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    With regard to clearing fund, again because there is no exposure to 
movements in the value of the underlying collateral for a forward-
starting repo that has not yet started, only the funds adjustment 
component of clearing fund would be affected until the scheduled start 
date.\8\ Therefore, the clearing fund requirement for a forward-
starting repo during its forward-starting period will be computed by 
taking the average of the twenty largest funds-only settlement amounts 
occurring in the most recent seventy-five business days. Only the 
interest rate mark, described above, would be included in these funds-
only settlement amounts for any forward-starting repos entered into by 
the member.
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    \8\ There are three components to the regular clearing fund 
deposit requirement, with the sum of the three being a members 
overall requirement:
    (A) Funds Adjustment (FAD) Component: This is based on each 
member's average funds-only settlement amount. The relevant variable 
in this calculation is the size of the settlement amount; it does 
not matter whether the funds are to be collected from the member or 
paid to the member.
    (B) Receive/Deliver Settlement Component: This component is 
based on the size and nature of net settlement positions. The margin 
collected on net settlement positions is determined by applying 
margin factors that are designed to estimate security price 
movements. The factors are expressed as percentages and are 
determined by historical daily price volatility. Multiplying 
security settlement values by their corresponding margin factors is 
a proxy for the estimated amount of loss to which GSCC is 
potentially exposed from price changes.
    (C) Repo Volatility Component: This component reflects the 
interest rate exposure incurred by GSCC in guaranteeing the payment 
to the funds lender in a repo transaction of the full amount of 
interest due on the transaction. The repo volatility amount, which 
corresponds to the volatility of repo rates, is used to provide GSCC 
with protection from the portion of that fluctuation in value that 
represents interest exposure. A repo volatility factor essentially 
represents an estimate of the amount that repo market rates might 
change during the liquidation period for the repo transaction.
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4. Right to Substitute Collateral
    Currently, repo participants are able to submit details of their 
rights of substitution to GSCC. This proposal will amend GSCC's rules 
to clarify that a right of substitution continues after GSCC novates 
the trade. The proposal also will add Section 4 to Rule 18 to clarify 
the method of substituting collateral. Should a repo participant want 
to implement a substitution, either it or its broker must submit an 
``intent to substitute'' notification to GSCC using GSCC's on line 
collateral substitution function. The ``intent to substitute'' 
notification must contain information regarding the ``old'' collateral 
so that GSCC may begin preparing for the substitution. Additional 
details regarding the replacement collateral may be provided in the 
same notification or in a subsequent notification when known.
    Upon receiving the ``intent to substitute'' notification, GSCC will 
prepare to process the substitution by identifying the repo and 
collateral being replaced. The proposal will clarify that as it 
currently does today with other substitute GSCC will not review the 
appropriateness of the substitute collateral. Once all required details 
have been submitted, GSCC will modify its database to reflect the 
substitution. For money fill substitutions, the par amount and/or CUSIP 
may change, and for par fill substitutions, the principal, CUSIP, and/
or end money may change.
    All movements associated with the substitution will be made through 
GSCC, and substitutions will be reported to participants as ``cancel 
and correct'' transactions. The reverse dealer will deliver the ``old'' 
collateral to GSCC, and GSCC will redeliver that collateral to the repo 
dealer. These deliveries will be done versus the ``old'' collateral 
principal amount.
    Conversely, the repo dealer will deliver the replacement collateral 
to GSCC, and GSCC will redeliver that collateral to the reverse dealer. 
For par fill substitutions, these deliveries will be done versus the 
replacement or ``new'' collateral principal amount. For money fill 
substitutions, the principal amount will not change so both deliveries 
will be done at the same amount.
    Regardless of the type of substitution, GSCC will maintain accrued 
interest information throughout the life of the repo across multiple 
collateral substitutions as required. GSCC also will reverse any 
previous mark-to-market and clearing fund monies calculated for the 
collateral being replaced. These amounts will be

[[Page 40879]]

recalculated using the security information for the replacement 
collateral.
5. Substitution of Maturing Collateral
    Finally, GSCC is making eligible for its netting system repos with 
underlying collateral that matures on or prior to the scheduled close 
date by eliminating from the list of requirements for netting-
eligibility the requirement that the maturity date of the underlying 
securities be on or later than the scheduled settlement date of the 
close leg. The proposal will add Section 6 to Rule 18 to require that 
if a repo participant has transferred securities as underlying 
collateral that mature prior to the settlement date of the close leg, 
that participant must substitute equivalent securities with a later 
maturity date prior to the business day before the maturity date.
    The proposed rule change is consistent with the requirements of 
Section 17A of the Act \9\ and the rules and regulations thereunder 
because it will authorize GSCC to make forward-starting repos eligible 
for netting in a prudent fashion once they are compared by GSCC. This 
will allow members to enjoy the benefit of guaranteed settlement of 
their forward-starting repos as soon as possible.
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    \9\ 15 U.S.C. 78q-1.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    GSCC does not believe that the proposed rule change would impose a 
burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    Written comments relating to the proposed rule change have not yet 
been solicited or received. Members will be notified of the rule change 
filing and comments will be solicited by an important notice. GSCC will 
notify the Commission of any written comments received by GSCC.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within thirty-five days of the date of publication of this notice 
in the Federal Register or within such longer period (i) as the 
Commission may designate up to ninety days of such date if it finds 
such longer period to be appropriate and publishes its reasons for so 
finding or (ii) as to which GSCC consents, the Commission will:
    (a) By order approve such proposed rule change; or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. Sec. 552, will be available for inspection and copying in 
the Commission's Public Reference Section, 450 Fifth Street, N.W., 
Washington, D.C. 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of GSCC. All 
submissions should refer to the file number SR-GSCC-97-03 and should be 
submitted by August 20, 1997.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a) (12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 97-20052 Filed 7-29-97; 8:45 am]
BILLING CODE 8610-01-M