[Federal Register Volume 66, Number 99 (Tuesday, May 22, 2001)]
[Notices]
[Pages 28207-28209]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-12824]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44301; File No. SR-GSCC-00-13]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Order Approving a Proposed Rule Change Relating to 
Establishment of a Cross-Margining Agreement With the Chicago 
Mercantile Exchange and a Clarification of the Government Securities 
Clearing Corporation's Cross-Margining Rules

May 11, 2001.
    On October 13, 2000, the Government Securities Clearing Corporation 
(``GSCC'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change (File No. SR-GSCC-00-13) 
pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'').\1\ Notice of the proposal was published in the Federal 
Register on January 23, 2001.\2\ No comment letters were received. For 
the reasons discussed below, the Commission is approving the proposed 
rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 43849 (January 17, 
2001), 66 FR 7522.
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I. Description

    On August 19, 1999, the Commission approved GSCC's proposed rule 
change to establish a cross-margining program with other clearing 
organizations and to begin its program with the New York Clearing 
Corporation (``NYCC'').\3\ GSCC is now establishing a cross-margining 
arrangement with the Chicago Mercantile Exchange (``CME'') similar to 
the one GSCC already has in place with NYCC. With the GSCC-CME cross-
margining arrangement, GSCC will implement its ``hub-and-spoke'' method 
of cross-margining, which was introduced in the rule filing 
establishing the GSCC-NYCC cross-margining arrangement and which 
applies when more than one clearing organization is involved in cross-
margining with GSCC.
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    \3\ Securities Exchange Act Release No. 41766 (August 19, 1999), 
64 FR 46737 (August 26, 1999) [File No. SR-GSCC-98-)4]. The rule 
changes necessary for GSCC to engage in cross-margining were made in 
the NYCC cross-margining rule filing.
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(i) GSCC's Cross-Margining Program

    GSCC believes that the most efficient and appropriate approach for 
establishing cross-margining links for fixed-income and other interest 
rate products is to do so on a multilateral basis with GSCC as the 
``hub.'' Each clearing organization that participates in a cross-
margining arrangement with GSCC (hereinafter a ``Participating CO'') 
will enter into a separate cross-margining agreement between itself and 
GSCC, as NYCC did and now CME will do. Each of the agreements will have 
similar terms,\4\ and no preference will be given by GSCC to one 
Participating CO over another.
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    \4\ It is anticipated that in the interest of conformity NYCC 
and GSCC will execute a new cross-margining agreement that is 
substantially the same as the draft agreement with the CME.
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    Cross-margining is available to any GSCC netting member (with the 
exception of inter-dealer broker netting members) that is, or that has 
an affiliate that is, a member of a Participating CO. Any such member 
(or pair of affiliated members) may elect to have its margin 
requirements at both clearing organizations calculated based upon the 
net risk of its cash and repo positions at GSCC and its offsetting and 
correlated positions in related contracts carried at the Participating 
CO. Cross-margining is intended to lower the cross-margining 
participant's (or pair of affiliated members') overall margin 
requirement.
    The GSCC member (and its affiliate, if applicable) signs an 
agreement under which it (or they) agrees to be bound by the cross-
margining agreement between GSCC and the Participating CO and which 
allows GSCC or the Participating CO to apply the member's (or its 
affiliate's) margin collateral to satisfy any obligation of GSCC to the 
Participating CO (or vice versa) that results from a default of the 
member (or its affiliate).
    Margining based on the net combined risk of correlated positions is 
based on an arrangement under which GSCC and each Participating CO 
agree to accept the correlated positions in lieu of supporting 
collateral. Under this arrangement, each clearing organizations holds 
and manages its own positions and collateral and independently 
determines the amount of margin that it will make available for cross-
margining (referred to as the ``residual margin amount'').
    GSCC computes the amount by which the cross-margining participant's 
margin requirement can be reduced at each clearing organization (i.e., 
the ``cross-margin reduction'') by comparing the participant's 
positions and the related margin requirements at GSCC against those at 
each Participating CO.\5\ GSCC offsets each cross-margining 
participant's residual margin amount (based on related position) at 
GSCC against the offsetting residual margin amounts of the participant 
(or its affiliate) at each Participating CO. If the residual margin 
that GSCC has available for a participant is greater than the combined 
residual margin submitted by the Participating COs, GSCC will allocate 
a portion of its residual margin equal to the combined residual margin 
at the Participating COs. If the combined residual margin submitted by 
the Participating COs is greater than the residual margin that GSCC has 
available for that participant, GSCC will first allocate its residual 
margin to the Participating CO with the most highly correlated 
position.\6\ If the positions are equally correlated, GSCC will 
allocate pro rata based upon the residual margin amount available at 
each Participating CO. GSCC and each Participating CO may then reduce 
the amount of collateral they collect to reflect the offsets between 
the cross-margining participant's positions at GSCC and its (or its 
affiliate's) position at the Participating CO.\7\ In the event of the 
default and liquidation of a cross-margining participant, the loss 
sharing between GSCC and each of the Participating COs will be based 
upon the foregoing allocations and the cross-margin reduction.
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    \5\ NYCC uses GSCC's margin rates to determine margin reduction. 
CME, which utilizes its own rates, and GSCC will compare margin 
reduction rates and will use the lower of the two in determining 
margin reduction.
    \6\ GSCC has computed and tested disallowance factors that will 
be applicable to each potential pair of positions being offset. 
``Disallowance factor'' means the specified percentage in the cross-
margining agreement between GSCC and CME that is applied to reduce 
the residual margin amount used to calculate the margin offset.
    \7\ GSCC and each Participating CO unilaterally have the right 
to not reduce its participant's margin requirement by the cross-
margin reduction or to reduce it by less than the cross-margin 
reduction. However, the clearing organizations may not reduce a 
participant's margin requirement by more than the cross-margin 
reduction.
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    GSCC will guarantee the cross-margining participant's (or its 
affiliate's) performance to each Participating CO

[[Page 28208]]

up to a specified maximum amount which relates back to the cross-margin 
reduction. There will always be a specified maximum amount that one 
clearing organization could be required to pay another clearing 
organization. Each Participating CO will provide the same guaranty up 
to the same specified maximum amount to GSCC.
    GSCC proposed one additional rule change, to Rule 22, Section 4, in 
this present rule filing in order to further clarify that before GSCC 
credits an insolvent member for any profit realized on the liquidation 
of the member's final net settlement positions, GSCC will fulfill its 
obligations with respect to that member under the cross-margining 
agreement.

(ii) Information Specific to the Current Agreement between GSCC and CME

    (a) Participation in the cross-margining program: Any netting 
member of GSCC other than an inter-dealer broker netting member will be 
eligible to participate. Any clearing member of CME will be eligible to 
participate.\8\
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    \8\ The draft GSCC-CME agreement requires ownership of 50 
percent or more of the common stock of an entity to indicate control 
of the entity for purposes of the definition of ``affiliate.''
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    (b) Products subject to cross-margining: The products that will be 
eligible for the GSCC-CME cross-margining arrangement will be (1) the 
Treasury bills, notes, and bonds that are cleared by GSCC and (2) 
Eurodollar futures contracts with ranges in maturity from 3 months to 
10 years and options on such futures contracts cleared by CME.\9\ GSCC 
offset classes will be offset against CME offset classes based on 
correlation studies and the appropriate disallowance factors will be 
applied. All eligible positions maintained by a cross-margining 
participant in its account at GSCC and in its (or its affiliate's) 
proprietary account at CME will be eligible for cross-margining.\10\
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    \9\ Under the GSCC-NYCC cross-margining arrangement are Treasury 
bills, notes, and bonds cleared by GSCC and Treasury futures cleared 
by NYCC.
    \10\ At least initially, the GSCC-CME cross-margining 
arrangement will be applicable on the futures side only to positions 
in a proprietary account of a cross-margining participant (or its 
affiliate) at the CME. The arrangement will not apply to positions 
in a customer account at CME that would be subject to segregation 
requirements under the CEA. This is also the case with respect to 
the GSCC-NYCC cross-margining arrangement.
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    (c) Margin Rates: GSCC and CME currently use different margin rates 
to establish margin requirements for their respective products. 
Residual margin amounts in the GSCC-CME cross-margining arrangement 
will always be computed based on the lower of the applicable margin 
rates. This methodology results in a potentially lesser benefit to the 
participant but ensures a more conservative result for both GSCC and 
CME (i.e., more collateral held at the clearing organizations).
    (d) Daily Procedures: On each business day, it is expected that CME 
will inform GSCC of the residual margin amounts it is making available 
for cross-margining by approximately 10 p.m. New York time. GSCC will 
inform CME by approximately 12 a.m. New York time how much of these 
residual margin amounts it will use. Reductions as computed will be 
reflected in GSCC's daily clearing fund calculation.

(iii) Benefits of Cross-Margining

    GSCC believes that its cross-margining program enhances the safety 
and soundness of the settlement process for the government securities 
marketplace by: (1) Providing clearing organizations with more data 
concerning members' intermarket positions (which is especially valuable 
during stressed market conditions) to enable the clearing organizations 
to more accurately make decisions regarding the true risk of such 
positions to the clearing organization; (2) allowing for enhanced 
sharing of collateral resources; and (3) encouraging coordinated 
liquidation processes for a joint participant, or a participant and its 
affiliate, in the event of an insolvency. GSCC further believes that 
cross-margining benefits participating clearing members by providing 
members with the opportunity to more efficiently use their collateral. 
More important from a regulatory perspective, however, is that cross-
margining programs have long been recognized as enhancing the safety 
and soundness of the clearing system itself. Studies of the October 
1987 market break gave support to the concept to the concept of cross-
margining. For example, The Report of the President's Task Force on 
Market Mechanisms (January 1988) noted that the absence of a cross-
margining system for futures and securities options markets contributed 
to payment strains in October 19878. The Interim Report of the 
President's Working Group on Financial Markets (May 1988) also 
recommended that the SEC and CFTC facilitate cross-margining programs 
among clearing organizations. As a result, the first cross-margining 
arrangement between clearing organizations was implemented in 1988.\11\
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    \11\ Securities Exchange Act Release No. 26153 (October 3, 
1988), 53 FR 39567 (October 7, 1988) [File No. SR-OCC-86-17] (order 
approving cross-margining program between The Options Clearing 
Corporations and the Intermarket Clearing Corporation).
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II. Discussion

    Under section 19(b) of the Act, the Commission is directed to 
approve a proposed rule change of a clearing agency if not finds that 
the proposed rule change is consistent with the Act and the rules and 
regulations thereunder.\12\ In section 17A(a)(2)(A)(ii) of the Act, 
Congress directs the Commission to use its authority under the Act to 
facilitate the establishment of linked or coordinated facilities for 
clearance and settlement of transactions in securities, securities 
options, contracts of sale for further delivery and options thereon, 
and commodity options.\13\ Section 17A(b)(3)(F) of the Act requires 
that the rules of a clearing agency be designed to assure the 
safeguarding of securities and funds which are in the custody or 
control of the clearing agency for which it is responsible.\14\ The 
Commission believes that the approval of GSCC's proposed rule change is 
consistent with these sections.
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    \12\ 15 U.S.C. 78s(b).
    \13\ 15 U.S.C. 78q-1(a)(2)(A)(ii).
    \14\ 15 U.S.C. 78q-1(b)(3)(F).
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    First, the Commission's approval of GSCC's proposed rule change to 
establish a cross-margining arrangement with the CME and to implement 
its hub and spoke approach to cross-margining with the CME and NYCC is 
in line with the Congressional directive to the Commission to 
facilitate linked and coordinated facilities for the clearance and 
settlement of securities and futures. Second, approval of GSCC's 
proposal should result in increased and better information sharing 
between GSCC and Participating COs regarding the portfolios and 
financial conditions of participating joint and affiliated members. As 
a result, GSCC and participating COs will be in a better position to 
monitor and assess the potential risks of participating joint or 
affiliated members and will be in a better position to handle the 
potential losses presented by the insolvent of any joint or affiliated 
member. Therefore, GSCC's proposal should help GSCC better safeguard 
the securities and funds in its possession or control or for which it 
is responsible.

[[Page 28209]]

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act and in 
particular with the requirements of section 17A of the Act and the 
rules and regulations thereunder.
    It is Therefore Ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-GSCC-00-13) be and hereby is 
approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 01-12824 Filed 5-21-01; 8:45 am]
BILLING CODE 8010-01-M