Federal Register / Vol. 62, No. 146 / Wednesday, July 30, 1997 / Notices 40877

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

2The Commission has modified the text of the

summaries prepared by GSCC.

3Forward-starting repo transactions are repo

transactions which have start legs settling one or

more business days in the future.

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.

5See Section 4 for a description of substitution

of collateral.

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.

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

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.

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.

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 forwardstarting 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)
40878 Federal Register / Vol. 62, No. 146 / Wednesday, July 30, 1997 / Notices

6As 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.

7For 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.

8There 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.

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.

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

With regard to clearing fund, again

because there is no exposure to

movements in the value of the

underlying collateral for a forwardstarting 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 forwardstarting 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.

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-tomarket and clearing fund monies

calculated for the collateral being

replaced. These amounts will be
Federal Register / Vol. 62, No. 146 / Wednesday, July 30, 1997 / Notices 40879

9 15 U.S.C. 78q–1. 10 17 CFR 200.30–3(a) (12).

1See Letter from Robert E. Aber, Vice President

and General Counsel, The Nasdaq Stock Market,

Inc., to Katherine England, Assistant Director,

Office of Market Supervision, Division of Market

Regulation, Commission, dated July 17, 1997. The

amendment would extend the 50 stock pilot from

December 31, 1997, to March 27, 1998, and expand

it to 150 stocks. This amendment corrects a

technical deficiency in an earlier amendment to

expand and extend the 50 stock pilot in a similar

fashion that was not published for notice and

comment. See Letter from Robert E. Aber, Vice

President and General Counsel, The Nasdaq Stock

Market, Inc., to Katherine England, Assistant

Director, Office of Market Supervision, Division of

Market Regulation, Commission, dated July 10,

1997.

2The initial approval of the 50 stock pilot

program was announced in Securities Exchange Act

Release No. 38156 (January 10, 1997), 62 FR 2415

(January 16, 1997). The approval of the extension

was announced in Securities Exchange Act Release

No. 38152 (April 15, 1997), 62 FR 19373 (April 21,

1997). On July 18, 1997, the Commission approved

a proposed rule change that extended—but did not

expand—the 50 stock pilot from July 18, 1997, to

December 31, 1997. Securities Exchange Act

Release No. 38851 (July 18, 1997), 62 FR 39565

(July 23, 1997) (File No. SR–NASD–97–49).

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 nettingeligibility 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 forwardstarting 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.

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. § 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

Jonathan G. Katz,

Secretary.

[FR Doc. 97–20052 Filed 7–29–97; 8:45 am]

BILLING CODE 8610–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–38872; File No. SR–NASD–

97–26]

Self-Regulatory Organizations; Notice

of Amendment to Proposed Rule

Change by the National Association of

Securities Dealers, Inc. Relating to an

Expansion of the Pilot for the NASD’s

Rule Permitting Market Makers to

Display Their Actual Quotation Size

July 24, 1997.

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

Securities Exchange Act of 1934

(‘‘Exchange Act’’), 15 U.S.C. 78s(b)91),

notice is hereby given that on July 17,

1997, the National Association of

Securities Dealers, Inc. (‘‘NASD’’ or

‘‘Association’’) filed with the Securities

and Exchange Commission

(‘‘Commission’’ or ‘‘SEC’’) an

amendment 1 to the proposed rule

change described below. The proposal

would allow market makers to quote

their actual size by reducing the

minimum quotation size requirement

for market makers in certain securities

listed on The Nasdaq Stock Market

(‘‘Nasdaq’’) to one normal unit of

trading (‘‘Actual Size Rule’’). The Actual

Size Rule presently applies to a group

of 50 Nasdaq securities on a pilot basis.2

The NASD has proposed to extend this

pilot program to March 27, 1998, and to

add an additional 100 stocks to the pilot

program. The Commission has already

received comments from many

individual investors and other market

participants on the ongoing pilot. The

Commission is publishing this notice to

solicit comments on the amended

proposed rule change from interested

persons.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

The NASD proposes to amend NASD

Rule (a)(1)(C) to allow market makers to

quote their actual size by reducing the

minimum quotation size requirement

for market makers in certain securities

listed on Nasdaq to one normal unit of

trading. The text of the proposed rule

change is as follows. (Additions are

italicized; deletions are bracketed.)

* * * * *

NASD Rule 4613 Character of

Quotations

(a) Two-Sided Quotations

(1) No change.

(A)–(B) No change.