[Federal Register Volume 87, Number 106 (Thursday, June 2, 2022)]
[Notices]
[Pages 33528-33535]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-11839]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-94998; File No. SR-NSCC-2022-801]


Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of No Objection To Advance Notice To Introduce 
Central Clearing for Securities Financing Transaction Clearing Service

May 27, 2022.

I. Introduction

    On March 28, 2022, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') advance notice SR-NSCC-2022-801 (``Advance Notice''), 
pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act entitled the Payment, 
Clearing, and Settlement Supervision

[[Page 33529]]

Act of 2010 (``Clearing Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) 
under the Securities Exchange Act of 1934 (``Exchange Act'').\2\ The 
Advance Notice was published for comment in the Federal Register on 
April 19, 2022.\3\ The Commission has received comments regarding the 
proposal.\4\ This publication serves as notice of no objection to the 
Advance Notice.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ Securities Exchange Act Release No. 94695 (April 12, 2022), 
87 FR 23328 (April 19, 2022) (SR-NSCC-2022-801) (``Notice of 
Filing''). NSCC also filed related proposed rule change with the 
Commission pursuant to Section 19(b)(1) of the Act and Rule 19b-4 
thereunder, seeking approval of proposed changes to their rules 
necessary to implement the Advance Notice. 15 U.S.C. 78s(b)(1) and 
17 CFR 240.19b-4, respectively. The proposed rule change was 
published in the Federal Register on April 19, 2022. Securities 
Exchange Act Release No. 94694 (April 12, 2022), 87 FR 23372 (April 
19, 2022) (SR-NSCC-2022-003).
    \4\ Comments are available at https://www.sec.gov/comments/sr-nscc-2022-801/srnscc2022801.htm.
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II. Description of the Proposed Rule Change

A. Overview of Proposal

    NSCC proposes to expand its central counterparty (``CCP'') services 
to include securities financing transactions (``SFTs''), also referred 
to generally as securities lending.\5\ SFTs are transactions in which a 
securities lender loans securities to a securities borrower, for a fee. 
The borrowers typically use the borrowed securities to cover short 
sales or fails to deliver that may result from either short or long 
sales.\6\ A lender typically lends securities to generate income 
through the fees that it charges.
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    \5\ The Options Clearing Corporation (``OCC'') operates a stock 
loan program as a CCP. NSCC's new service is similar to OCC's 
service with one key difference: unlike OCC's service, which only 
covers transactions between OCC's direct members (i.e., broker to 
broker), NSCC's new service would allow indirect participation by 
buy-side clients. See Section II.B.(2).
    \6\ A short sale is any sale of securities that a seller does 
not own or has borrowed. See 17 CFR 242.200(a).
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    As a CCP, NSCC would interpose itself between the securities lender 
and borrower and become the counterparty to each entity. NSCC would 
then be obligated to complete the transaction, that is, to return 
loaned securities to the lender and collateral to the borrower, even if 
a lender or borrower in an SFT fails to satisfy its obligations, 
thereby assuming the risk of each entity's failure to perform to each 
other.
    Specifically, NSCC would novate and guarantee SFTs that involve 
eligible securities, meaning equity securities (including ETFs) cleared 
at NSCC with a particular per share price, initially set at $5 or 
greater. The service would be limited to overnight SFTs (i.e., with a 
one business day term), with the ability for the parties to extend an 
expiring SFT into a new transaction.
    The SFT service would be available to existing NSCC members.\7\ In 
addition, NSCC would create two new membership categories that would be 
able to submit SFTs for central clearing: Sponsoring Members that would 
sponsor institutional clients into NSCC and act as a principal to SFTs 
with their clients, and Agent Clearing Members that submit SFTs on 
behalf of institutional customers strictly as an agent. These two new 
types of membership would allow the proposed service to meet the 
existing market practices for SFTs, where different types of entities 
employ different trading strategies and relationships to accommodate 
their regulatory and other requirements.
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    \7\ Capitalized terms not defined herein are defined in the NSCC 
Rules & Procedures (``Rules''), available at http://www.dtcc.com/~/
media/Files/Downloads/legal/rules/nscc_rules.pdf.
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    Consistent with its risk management for all other transactions in 
equity securities, NSCC would collect margin from the lender and 
borrower for novated SFTs to address the credit risk arising from such 
transactions. NSCC would also identify potential liquidity exposures if 
an SFT member were to default and address that potential need in its 
risk management.
    According to NSCC, the proposed SFT clearing service would provide 
several benefits for market participants, including increased balance 
sheet netting benefits, capital efficiency opportunities, and 
mitigation of fire sale risk.\8\ With respect to balance sheet netting 
benefits and capital efficiency opportunities, NSCC states that the SFT 
clearing service may allow participants to net down payables and 
receivables related to the SFTs on their balance sheets because such 
payables and receivables have one counterparty, NSCC. In turn, NSCC 
states that because of the capital requirements arising under Basel III 
rules that favor a netted balance sheet,\9\ market participants may 
reduce the amount of capital they are required to hold under the 
applicable leverage requirements.\10\
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    \8\ See Notice of Filing, supra note 3, at 23329-30.
    \9\ See 12 CFR 217.10(c)(4)(ii)(E)-(F).
    \10\ The Basel III capital and leverage requirements, as 
implemented by the U.S. banking regulators, mandate banks and 
depository institutions to hold certain amounts of capital. See 
generally, e.g., 12 CFR part 3; 12 CFR part 217; 12 CFR part 252, 
subpart Q; 12 CFR part 324.
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    In addition, NSCC believes that the proposal would reduce the 
potential for market disruption from fire sales for a number of 
reasons.\11\ First, NSCC believes that it would be able to better 
manage default scenarios by conducting a centralized and orderly 
liquidation of the defaulter's SFT positions.\12\ NSCC represents that 
a centralized and orderly liquidation would result in substantially 
less price depreciation and market disruption compared to the multiple 
independent non-defaulting parties racing against one another to 
liquidate the positions. Second, NSCC would be able to liquidate the 
defaulter's net positions instead of gross positions, meaning that a 
position that needs to be liquidated would be smaller in size and a 
market disruption can be minimized. Third, by guaranteeing SFTs through 
central clearing, NSCC believes that it would be able to provide 
confidence to market participants in a stressed market scenario, 
thereby lessening any inclination to rush to unwind transactions.\13\
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    \11\ See Notice of Filing, supra note 3, at 23329.
    \12\ Id.
    \13\ See Notice of Filing, supra note 3, at 23329-30.
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B. Securities Financing Transaction Clearing Service

    NSCC proposes to introduce central clearing for SFTs by 
establishing rules governing (1) key aspects of the SFTs; (2) SFT 
participant categories; and (3) SFT risk management, as elaborated 
below.
(1) Key Aspects of the SFTs
    Overnight SFTs. The proposed SFT clearing service would apply to 
transactions with a one business day term (i.e., overnight SFTs) in 
eligible equity securities. NSCC represents that the proposal applies 
to overnight SFTs, as opposed to open SFTs, to offer balance sheet 
netting and capital efficiency opportunities, which require a scheduled 
settlement date.\14\ However, a lender and a borrower would have an 
option to extend an expiring SFT by rolling it, or a portion thereof, 
into a new, linked SFT. Accordingly, an expiring SFT would be eligible 
for renewal every day.
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    \14\ See Notice of Filing, supra note 3, at 23330-31.
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    Operational Issues. SFTs would be required to be submitted to NSCC 
on a locked-in basis and matched between the lender and the 
borrower.\15\ NSCC would receive underlying SFT securities from a 
lender, send them to a borrower,

[[Page 33530]]

receive cash collateral equal to no less than 100% of the market value 
of the securities from the borrower, and send it to the lender.\16\
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    \15\ Specifically, the transaction data for an SFT must be 
submitted by an entity that the parties have selected, which could 
be either a member or a third-party vendor. The SFT members would 
select which approved submitter to use, and NSCC would have to 
approve any entity serving as an approved submitter.
    \16\ To address regulatory and investment guideline requirements 
applicable to certain institutional firms (e.g., Section 17(f) of 
the Investment Company Act of 1940 and Rule 17f-2 thereunder), a 
participant would be permitted to transfer an additional cash 
haircut above 100% (e.g., 102%) to such institutional firms as part 
of this initial settlement of the SFT.
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    When an SFT settles, in general, NSCC would essentially reverse the 
transaction of the prior day by receiving the underlying SFT securities 
from the borrower and returning them to the lender, and receiving the 
cash collateral from the lender and returning it to the borrower. NSCC 
would also pass through daily interest,\17\ as applicable. If the 
parties decide to extend into a linked SFT, instead of transferring the 
underlying securities and collateral, NSCC would transfer the daily 
interest and calculate and pass through a mark-to-market payment on the 
underlying securities, effectively putting the parties in a position of 
closing the settling SFT and starting a new SFT.
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    \17\ NSCC refers to this daily interest as a ``Rate Payment.''
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    Eligible Equity Securities. As an initial matter, NSCC would 
provide the proposed SFT service for securities that are eligible to be 
processed through NSCC's Continuous Net Settlement (``CNS'') 
System,\18\ and have a per share price of $5 or more.\19\ If the price 
of the underlying securities of a novated SFT falls below the threshold 
price established by NSCC, that SFT would continue to be novated to 
NSCC, but the margin required for such SFT would be 100% of the market 
value of such underlying securities until the per share price of the 
underlying securities equals or exceeds the threshold price.
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    \18\ NSCC processes clearance and settlement of equity 
securities using the CNS System. Securities are CNS-eligible if they 
are eligible for book-entry transfer on the books of DTC, not 
subject to certain transfer restrictions, and not subject to certain 
corporate actions. NSCC, Disclosure Framework for Covered Clearing 
Agencies and Financial Market Infrastructures (December 2021), 
https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/NSCC_Disclosure_Framework.pdf. (``NSCC Disclosure'').
    NSCC would maintain a list of the securities that may underlie 
an SFT that NSCC will accept. Such list would not be a rule but a 
separate document maintained by NSCC and available to members, 
consistent with NSCC's practice for equity securities. See Notice of 
Filing, supra note 3, at 23331; Rule 3 (Lists to be Maintained) of 
the Rules, supra note 8.
    \19\ Notice of Filing, supra note 3, at 23331. NSCC selected $5 
as the per share price minimum for underlying equity securities 
because $5 is a common share price minimum adopted in brokerage 
margin eligibility schedules. NSCC may modify the eligible equity 
securities' minimum share price and would announce any such change 
via notice to its members. See id.
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    Recall, Buy-In, and Accelerated Settlement. Consistent with the 
existing bilateral market, NSCC proposes to introduce recall, buy-in, 
and accelerated settlement features in its proposed SFT clearing 
service. Under the proposal, a lender would have a right to recall an 
existing SFT and stop the SFT from being extended.
    Once a lender issues a recall notice, a borrower would be required 
to satisfy its final settlement obligations by the recall date, which 
would be the second business day following NSCC's receipt of such 
notice. If the borrower fails to satisfy its final settlement 
obligations by the recall date, the lender could go to the market to 
conduct a buy-in in a commercially reasonable manner,\20\ that is, to 
purchase some or all of securities equivalent to the underlying 
securities that are the subject to the SFT and charge the borrower for 
the cost of this purchase or to elect to be deemed to have purchased 
such securities.\21\ Similar to a lender's recall right, a borrower 
would have a right to accelerate the scheduled final settlement of an 
SFT that has been novated to NSCC. NSCC states that this right is 
required to ensure that certain borrowers would be able to satisfy 
their regulatory requirements.\22\
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    \20\ After a buy-in, the lender would give written notice to 
NSCC of its costs to purchase the relevant SFT securities or the 
buy-in costs. NSCC would then transfer the costs from the borrower 
to the lender, and the SFT would be closed.
    \21\ NSCC states that the requirement that a party exercising 
buy-in rights do so in a ``commercially reasonable manner'' is the 
current industry standard, as reflected in the Master Securities 
Loan Agreement published by Securities Industry and Financial 
Markets Association. See Notice of Filing, supra note 3, at 23332-
33; Section 13.1 of the Master Securities Loan Agreement published 
by Securities Industry and Financial Markets Association.
    \22\ Specifically, NSCC states that borrowers may have the need 
to accelerate settlement of securities lending transactions if they 
lose a ``permitted purpose'' for such loans under Regulation T. See 
12 CFR 220.1-220.12.
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(2) SFT Participant Categories
    The proposed SFT clearing service would be available for SFTs 
entered into between two current NSCC members. In addition, NSCC 
proposes new categories of membership that are designed to accommodate 
current bilateral SFT arrangements.\23\
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    \23\ See Notice of Filing, supra note 3, at 23330.
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    First, the Sponsoring Member/Sponsored Member categories would 
accommodate principal-style trades, in which a Sponsoring Member acting 
as principal for its own account completes a Sponsored Member's trades 
using its own inventory. Typically, in these types of arrangements, a 
Sponsoring Member can earn a profit from the bid-ask spread differences 
between its Sponsored Member trades and any offsetting trades.
    Second, the Agent Clearing Member category would accommodate 
transactions by firms who typically conduct trades on an agent basis 
for their institutional clients. An Agent Clearing Member would arrange 
a transaction on behalf of an institutional client and charge fees for 
the services (rather than taking spreads).\24\ Such client firms may, 
as part of their business models and agreed-upon investment guidelines, 
only permit agented transactions, making the Agent Clearing Member a 
better fit.
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    \24\ See Notice of Filing, supra note 3, at 23337.
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    According to NSCC, the costs of clearing that may be passed through 
to the institutional clients, whether as Sponsored Members or as 
clients to the Agent Clearing Members (``Customers''), by its 
intermediary would be largely equivalent.\25\ However, one key 
difference between Sponsored Members and Customers would be that 
Sponsored Members would have a contractual relationship with NSCC while 
the Agent Clearing Member's Customers would not. NSCC states that, from 
the perspective of an institutional firm client, whether to become a 
Sponsored Member or Customer to an Agent Clearing Member may be 
determined based on who the client's current clearing intermediaries 
are and the nature of the client's commercial arrangement with its 
intermediaries.\26\ NSCC states that giving a choice to institutions to 
become a Sponsored Member or Customer should facilitate additional 
central clearing of SFTs.\27\
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    \25\ See Notice of Filing, supra note 3, at 23338.
    \26\ See id.
    \27\ See Notice of Filing, supra note 3, at 23330.
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    Sponsoring Members. All NSCC members would be eligible to apply to 
become Sponsoring Members, so long as they meet the specified 
requirements.\28\ For operational and administrative purposes, NSCC 
would interact solely with the Sponsoring Member as the agent of its 
Sponsored Members, and the

[[Page 33531]]

Sponsoring Member would be responsible for posting the required margin 
on Sponsored Member transactions and for covering any default loss 
allocated to Sponsored Members.\29\
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    \28\ If a member is a registered broker-dealer, then such member 
would only be eligible to apply to become a Sponsoring Member if it 
satisfies certain financial requirements. In addition, NSCC may 
require that a person be a member for a time period deemed necessary 
by NSCC before that person may be considered to become a Sponsoring 
Member, for example, for a new member that has yet to demonstrate a 
track record of financial responsibility and operational capability. 
Moreover, after becoming a Sponsoring Member, it would be obligated 
to notify NSCC if it is no longer compliant with the relevant 
standards and qualifications. NSCC would have a right to review the 
financial responsibility and operational capability of Sponsoring 
Members.
    \29\ NSCC aggregates all members' margin together with certain 
other deposits required under NSCC's Rules as its clearing fund. 
NSCC would be able to access the clearing fund should a defaulted 
member's own margin be insufficient to satisfy losses to NSCC caused 
by the liquidation of that member's portfolio. See Rule 4 (Clearing 
Fund) and Procedure XV (Clearing Fund Formula and Other Matters) of 
the Rules, supra note 8.
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    Sponsoring Members would unconditionally guarantee to NSCC the 
payment and performance of their Sponsored Members' obligations under 
the Sponsored Member transactions submitted by the Sponsoring Member 
for novation. Although Sponsored Members are principally liable to NSCC 
for their own settlement obligations under such transactions in 
accordance with the proposal, the Sponsoring Member would be required 
to satisfy those settlement obligations on behalf of a Sponsored Member 
if the Sponsored Member defaults and fails to perform its settlement 
obligations. Moreover, Sponsoring Members would be subject to an 
activity limit based on the perceived volatility of its portfolio as 
compared to its capital.\30\
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    \30\ Specifically, if the sum of the margin charges applied by 
NSCC to capture the risks related to market price movement 
applicable to its Sponsored Member sub-accounts and its other 
accounts at NSCC exceeds its required net assets or equity capital, 
the Sponsoring Member would not be permitted to submit new Sponsored 
Member transactions, unless otherwise determined by NSCC.
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    Sponsored Members. Sponsored Members would be required to be either 
a qualified institutional buyer \31\ or a legal entity that satisfies 
the financial requirements necessary to be a qualified institutional 
buyer. Sponsored Members would enter into an agreement with NSCC 
whereby Sponsored Members would agree to terms and conditions NSCC 
identifies as necessary in order to protect NSCC and its members. 
Sponsored Members would not be full-service NSCC members, but instead 
would be limited members which rely on the Sponsoring Members to access 
NSCC's services.
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    \31\ The term qualified institutional buyer is defined by Rule 
144A under the Securities Act of 1933, as amended. See 17 CFR 
230.144A.
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    A Sponsored Member would only be eligible to submit transactions in 
which its respective Sponsoring Member is the counterparty (i.e., 
``done with'' transactions). However, a Sponsored Member can be 
sponsored by more than one Sponsoring Member, should it wish to 
continue to transact with different entities.
    Agent Clearing Members. Agent Clearing Members would serve as agent 
and credit intermediary for its institutional clients. Agent-style 
trading is the manner in which such agent lenders are typically 
approved to transact in securities lending transactions on behalf of 
their Customers. All NSCC members would be eligible to apply to become 
Agent Clearing Members in NSCC, so long as they meet the specified 
requirements.
    In addition, Agent Clearing Members would be subject to similar 
responsibilities as Sponsoring Members. Specifically, an Agent Clearing 
Member would be responsible for posting to NSCC the required margin for 
its Customers' activity and covering any default loss allocable to its 
Customers. Agent Clearing Member transactions would be subject to the 
same activity limit applicable to Sponsored Member transactions.
    An Agent Clearing Member would be fully liable for all obligations 
of its Customers under the Agent Clearing Member transactions that it 
submitted to NSCC as the member.\32\ Unlike Sponsored Members, 
Customers would not have any direct relationship with NSCC and would 
not need to apply to become a member or enter into an agreement with 
NSCC. Moreover, the Agent Clearing Members would be able to submit 
transactions with a counterparty other than the Agent Clearing Member, 
resulting in transactions ``done away'' from the Agent Clearing Member.
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    \32\ Like a Sponsoring Member, an Agent Clearing Member would be 
obligated to notify NSCC if it is no longer in compliance with the 
relevant standards and qualifications. NSCC would have a right to 
review Agent Clearing Members' financial and operational capability.
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(3) Risk Management
    Under the proposal, NSCC would centrally manage risks associated 
with SFTs in a manner consistent with other transactions in equity 
securities that NSCC clears.
    Calculation of Margin. NSCC would require all SFT members to 
provide margin with respect to their SFT activity, subject to a 
$250,000 minimum amount. NSCC is proposing to calculate an SFT member's 
required margin by applying the methodology used to determine margin 
for transactions in equity securities. Specifically, the determination 
would include certain risk-based margin components \33\ that are 
currently applicable to NSCC's equity securities transactions.
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    \33\ Specifically, it would include the volatility charge, mark-
to-market charge, special charge, margin required differential 
component charge, coverage component charge, and margin liquidity 
adjustment (``MLA'') charge set forth in NSCC's Rules, as well as 
charges for non-returned SFTs, which is similar to the charges that 
NSCC for CNS fails under its Rules. A further description of these 
charges is available in Procedure XV of NSCC's Rules and in the NSCC 
Disclosure. For the volatility charge, NSCC would consider the 
potential future exposure of a given portfolio based on historical 
price movements and the margin floor, and it would also determine 
margin to address the risk due to a high concentration level in a 
single stock (``gap risk''). For the MLA charge, NSCC would consider 
the risk when a member's portfolio contains large net unsettled 
positions in a particular group of securities with a similar risk 
profile or in a particular asset type, which could pose particular 
liquidation risk in the event of a default.
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    NSCC would determine an SFT member's required margin independently 
of the member's other positions, including its equity securities 
transaction positions outside of the SFTs. NSCC would not net a 
member's SFT positions with its other positions to determine margin, 
except for the margin liquidity adjustment charge component. Because 
NSCC would aggregate all members' margins together as its clearing fund 
\34\ regardless of whether they are for SFTs or CNS transactions, an 
SFT or CNS member default may impact NSCC's clearing fund as a whole. 
In other words, a default by an SFT member may impact non-SFT members 
and vice versa.
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    \34\ See supra note 31.
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    NSCC would require that a certain portion of its margin be a 
combination of cash and eligible securities, i.e., the specific 
Treasury securities that NSCC accepts as collateral. NSCC would also 
have the discretion to require an SFT member to post its margin in a 
higher proportion of cash than would otherwise be required, based on 
the current market conditions and the SFT member's financial and 
operational capabilities.
    For transactions submitted by Sponsoring Members or Agent Clearing 
Members, NSCC would require that the Sponsoring Members and Agent 
Clearing Members establish an account or accounts for the margin 
collected on behalf of Sponsored Members and Customers, respectively. 
This account would be separate from the Sponsoring Member or Agent 
Clearing Member's proprietary account. NSCC would determine the 
required margin for transactions for each Sponsored Member and Customer 
on a gross basis, that is, separately without netting. The margin 
obligated for a Sponsoring Member or Agent Clearing Member would be the 
sum of the individual margin amounts determined for each Sponsored 
Member and Customer to ensure that the total margin amount represents 
the sum of each individual institutional client's activity.

[[Page 33532]]

    Default Management. NSCC's proposed rules would specify the 
procedures that it would use to centrally manage the default of that 
member,\35\ including liquidating the underlying securities and meeting 
the final settlement obligations. If there is an SFT member default, 
NSCC would continue paying to and receiving from a non-defaulting SFT 
member the difference in market value of the underlying securities with 
respect to the novated SFTs until final settlement. By continuing to 
process the difference in market value, NSCC would maintain the non-
defaulting SFT member in largely the same position as if the defaulting 
SFT member has not defaulted.
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    \35\ NSCC would be able to take actions listed above when NSCC 
``ceases to act'' for an SFT member. The factors NSCC would consider 
in making the decision to cease to act include the member's 
suspension from any regulatory organization, failure to make a 
payment to NSCC, or other financial issues. See Rules 46 
(Restrictions on Access to Service) and 18 (Procedures for When the 
Corporation Ceases to Act) of the Rules, supra note 8.
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    In addition, in the event an SFT member defaults, NSCC would have 
all the rights and obligations of the defaulting party, whether it was 
the lender or borrower in relation to such default-related SFTs. For 
example, if a borrower defaults, NSCC would assume all the rights of a 
lender and the defaulting borrower, and be able to issue a recall 
notice and conduct a buy-in in a commercially reasonable manner.\36\ On 
the other hand, if a lender defaults, NSCC would be able to deliver a 
recall notice to a borrower to stop the final settlement date of a 
default-related SFT from being further delayed.
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    \36\ The proposal would specify that in the case of a default-
related SFT, the commercial reasonableness of a buy-in shall be 
determined by NSCC based on whether such buy-in would create a 
disorderly market in the relevant SFT security, consistent with the 
applicable market standard. See supra note 23.
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    To the extent that an SFT default generates a loss larger than the 
resources that the defaulter has provided to NSCC, i.e., its margin and 
the proceeds from its liquidated portfolio, NSCC's loss allocation rule 
would apply to all members including Sponsoring Members and Agent 
Clearing Members.\37\
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    \37\ Specifically, under NSCC's loss allocation rule, NSCC would 
use its own capital (referred to as the ``Corporate Contribution'') 
and then allocate losses to members pro rata via rounds of cash 
calls. See Rule 4 (Clearing Fund) of the Rules, supra note 8.
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    Liquidity Risk. The proposal also describes how NSCC manages 
potential liquidity exposures arising from clearing SFT transactions. 
Currently, NSCC is required to hold sufficient liquidity resources to 
cover the largest settlement obligation stemming from the cleared CNS 
positions, assuming a member default. Under the proposal, NSCC's 
liquidity exposures would also include settlement obligation arising 
from SFT positions. Specifically, the liquidity obligations relating to 
SFT would include the daily market to market of the underlying 
securities as well as any final cash settlement obligation owed by the 
defaulting member.
    To account for a potentially higher liquidity need as a result of 
the SFT expansion, NSCC is planning to utilize its current suite of 
qualifying liquidity resources, including the supplemental liquidity 
deposit. NSCC may collect supplemental liquidity deposits from members 
whose default would pose the largest liquidity exposure to NSCC.\38\ 
Accordingly, such deposits may be used to address any heightened 
liquidity exposures stemming from clearing SFTs because the deposits, 
by design, act to cover the difference between a member's peak 
liquidity need and NSCC's liquidity resources.
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    \38\ See Rule 4A (Supplemental Liquidity Deposits) of the Rules, 
supra note 8.
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III. Discussion and Notice of no Objection

    Although the Clearing Supervision Act does not specify a standard 
of review for an Advance Notice, the stated purpose of the Clearing 
Supervision Act is instructive: To mitigate systemic risk in the 
financial system and promote financial stability by, among other 
things, promoting uniform risk management standards for SIFMUs and 
strengthening the liquidity of SIFMUs.\39\ Section 805(a)(2) of the 
Clearing Supervision Act authorizes the Commission to prescribe 
regulations containing risk management standards for the payment, 
clearing, and settlement activities of designated clearing entities 
engaged in designated activities for which the Commission is the 
supervisory agency.\40\ Section 805(b) of the Clearing Supervision Act 
provides the following objectives and principles for the Commission's 
risk management standards prescribed under Section 805(a): \41\
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    \39\ See 12 U.S.C. 5461(b).
    \40\ 12 U.S.C. 5464(a)(2).
    \41\ 12 U.S.C. 5464(b).
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    <bullet> To promote robust risk management;
    <bullet> to promote safety and soundness;
    <bullet> to reduce systemic risks; and
    <bullet> to support the stability of the broader financial system.
    Section 805(c) provides, in addition, that the Commission's risk 
management standards may address such areas as risk management and 
default policies and procedures, among other areas.\42\
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    \42\ 12 U.S.C. 5464(c).
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    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act and Section 17A of the 
Exchange Act.\43\ These rules require, among other things, each covered 
clearing agency to establish, implement, maintain, and enforce written 
policies and procedures that are reasonably designed to meet certain 
minimum requirements for its operations and risk management practices 
on an ongoing basis.\44\ As such, it is appropriate for the Commission 
to review advance notices against the Clearing Agency Rules and the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Clearing Supervision Act.\45\ As 
discussed below, the Commission believes the proposal in the Advance 
Notice is consistent with the objectives and principles described in 
Section 805(b) of the Clearing Supervision Act,\46\ and in the Clearing 
Agency Rules, in particular Rules 17Ad-22(e)(6), (e)(7), (e)(18), 
(e)(19), and (e)(21).\47\
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    \43\ 17 CFR 240.17Ad-22. NSCC is a ``covered clearing agency'' 
as defined in Rule 17Ad-22(a)(5).
    \44\ 17 CFR 240.17Ad-22.
    \45\ The issues raised by the commenters that are outside the 
scope of this Advance Notice are generally not addressed here 
because they are not relevant to the Commission's decision. The 
standard of review for the proposal is whether the proposal is 
consistent with the objectives and principles of Section 805(b) of 
the Clearing Supervision Act and Rule 17Ad-22(e) under the Exchange 
Act.
    \46\ 12 U.S.C. 5464(b).
    \47\ 17 CFR 240.17Ad-22(e)(6), (e)(7), (e)(18), (e)(19), and 
(e)(21).
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A. Consistency With Section 805(b) of the Clearing Supervision Act

(1) Reducing Systemic Risks and Supporting the Stability of the Broader 
Financial System
    The Commission believes that NSCC's proposal to introduce the 
central clearing of SFTs is consistent with the objectives of reducing 
systemic risk and supporting the stability of the broader financial 
system.
    As described above in Section II.A., through central clearing, NSCC 
would be able to reduce each SFT member's counterparty credit risk by 
becoming a counterparty to all SFTs. Central clearing would also help 
reduce risk because unlike bilateral transactions involving multiple 
counterparties, a market participant would be able to transact with one 
counterparty, subject to uniform and transparent risk management 
practices and centralized default management, minimizing the

[[Page 33533]]

risk of potential fire sales. In addition, central clearing would 
provide netting efficiencies by allowing SFT members to offset cash 
payables and receivables, which in turn, would allow SFT members to 
reduce their required collateral amount and create capital 
efficiencies.
    For these reasons, the Commission believes that the proposal should 
help decrease the operational, credit, and liquidity risk of SFTs 
relative to those made outside of central clearing through risk 
management, novation, trade guarantee, and netting. Accordingly, the 
Commission believes that, through the new SFT clearing service, the 
proposal would help reduce systemic risks and support the stability of 
the broader financial system, consistent with Section 805(b) of the 
Act.\48\
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    \48\ 12 U.S.C. 5464(b).
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(2) Promoting Robust Risk Management and Safety and Soundness
    The Commission believes that NSCC's proposal is consistent with the 
objectives of promoting robust risk management and promoting safety and 
soundness at NSCC.
    As described in Section II.B.(3), NSCC proposes to manage the risks 
associated with the new SFT central clearing service in a manner 
consistent with its risk management of other equity securities 
transactions and provide a centralized method to manage any defaults. 
First, NSCC would manage its credit risk with respect to SFTs by 
requiring minimum margin deposits and applying specific aspects of its 
margin methodology to determine the appropriate margin to cover the 
risks posed by the SFTs, as well as by applying an additive margin 
component designed to address any high concentration risk posed by 
cleared SFTs. When calculating margin, NSCC would not net SFT members' 
SFT positions with other CNS position, and NSCC also would not net 
across Sponsored Member accounts or Customer accounts, thereby 
collecting greater amounts of margin and improving overall resilience 
of NSCC. NSCC also would specify that a certain portion of margin be in 
cash and eligible Treasury clearing fund securities to protect against 
market risk of the collateral. Further, as described in Section 
II.B.(2), NSCC would apply activity limits to ensure that SFT members' 
financial resources are sufficient to meet their margin requirements.
    Second, as described in Section II.B.(3), NSCC would include an SFT 
member's potential liquidity exposures as part of NSCC's potential 
liquidity need. This means that, if a member's SFT activity were to 
drive NSCC's potential liquidity need, that member would have to 
provide supplemental liquidity under NSCC's existing rules, to ensure 
that NSCC would maintain adequate resources to satisfy liquidity needs 
arising from its SFT settlement obligations.
    Third, the proposal would provide a procedure to address SFT member 
defaults to allow NSCC to take timely action to contain losses and 
continue to meet its obligations. Specifically, NSCC would have a right 
to close out a defaulting member's positions, assume the rights of the 
non-defaulting party in relation to such default-related SFTs, and 
apply its loss allocation procedure if the defaulting member's 
resources are insufficient to cover a loss. The loss allocation 
procedure would provide an orderly application of funds to absorb any 
loss.\49\ Taken together, these procedures should minimize the 
likelihood that losses arising out of an SFT member default would 
exceed NSCC's prefunded resources and threaten the safety and soundness 
of NSCC's ongoing operations.
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    \49\ See supra note 39.
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    For the foregoing reasons, the Commission believes that the 
proposal would promote robust risk management and safety and soundness 
at NSCC,\50\ consistent with Section 805(b) of the Act.\51\
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    \50\ A large number of commenters expressed concerns that the 
proposal is designed to exclusively benefit large institutions by 
obscuring and facilitating negligent risky behavior, and the 
proposal would hamper a fair and transparent market. See, e.g., 
Letters from Zachary Williams and from Rob Sanders, dated April 19, 
2022. The commenters' concerns generally rely on the premise that 
SFTs are designed to promote short sales and potentially naked short 
sales that such commenters believe should be illegal. See, e.g., 
Letters from Adam and from Bennett Zhang, dated April 19, 2022. Any 
SFTs that would be cleared as part of the proposed service are 
transactions that occur bilaterally today, and the proposal does not 
impact Commission rules applicable to short sales. Because this 
Advance Notice is not addressing short sales, and is designed to 
reduce risks associated with bilateral SFTs, the Commission believes 
that the commenters' concerns related to short sales are outside the 
scope of the Advance Notice and the Proposed Rule Change.
    \51\ 12 U.S.C. 5464(b).
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B. Consistency with Rule 17Ad-22(e)(6)(i)

    Rule 17Ad-22(e)(6)(i) under the Exchange Act requires that NSCC 
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.\52\
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    \52\ 17 CFR 240.17Ad-22(e)(6)(i).
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    As described above in Section II.B.(3)(i), NSCC proposes to 
establish margin requirements to cover its credit exposures to the SFT 
members. First, NSCC proposes to collect margin from SFT members, 
including the application of both a minimum margin amount and of NSCC's 
existing margin system that contains multiple component charges 
designed to cover various types of risk and meet applicable regulatory 
requirements.\53\ Second, NSCC would apply more conservative approaches 
to the calculation of SFT, as compared to NSCC's existing margin 
system. For example, unlike the current calculation of the volatility 
of a member's net unsettled positions, NSCC would apply a more 
stringent method to address risks associated with issuer-specific 
events affecting the price of the concentrated security within the SFT 
portfolio, and risk associated with liquidating a defaulted SFT 
member's portfolio with a large position by asset class, relative to 
market-wide liquidity.\54\ Further, NSCC would not net SFTs against 
other equity transactions at NSCC when determining margin requirements, 
to ensure that margins associated with SFTs would not be reduced by 
other equity transactions outside of the SFTs. Separately, it would 
collect margin on a gross basis for different Sponsored Members or 
different Customers, thereby accounting and collecting margin for each 
individual Sponsored Member and Customer.
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    \53\ See supra note 35.
    \54\ See id.
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    Because NSCC applies its risk-based margin methodology, tailored to 
address SFTs, the Commission believes that the proposal is reasonably 
designed to cover NSCC's credit exposures from SFT members and 
consistent with Rules 17Ad-22(e)(6)(i).

C. Consistency With Rule 17Ad-22(e)(7)

    Rule 17Ad-22(e)(7)(i) under the Exchange Act requires that NSCC 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to effectively measure, monitor, and 
manage the liquidity risk that arises in or is borne by the covered 
clearing agency, including measuring, monitoring, and managing its 
settlement and funding flows on an ongoing and timely basis, and its 
use of intraday liquidity by, at a minimum maintaining sufficient 
liquid resources at the minimum in all

[[Page 33534]]

relevant currencies to effect same-day and, where appropriate, intraday 
and multiday settlement of payment obligations with a high degree of 
confidence under a wide range of foreseeable stress scenarios that 
includes, but is not limited to, the default of the participant family 
that would generate the largest aggregate payment obligation for the 
covered clearing agency in extreme but plausible market conditions.\55\
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    \55\ 17 CFR 240.17Ad-22(e)(7)(i).
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    As described above in Section II.B.(3)(ii), when calculating its 
liquidity need, in addition to liquidity exposures relating to other 
equity positions, NSCC would include all the differences in market 
value of the underlying securities owed by a defaulting SFT member in 
the event an SFT member defaults, as well as all novated open SFT 
transactions of a defaulting SFT. This determination of the liquidity 
need is designed to ensure that NSCC would cover any liquidity need 
associated with its final settlement obligations to non-defaulting SFT 
members and members. NSCC currently relies on various liquidity 
resources, all of which would be available in the event of a liquidity 
shortfall relating to SFTs. The Commission believes that NSCC's 
existing liquidity risk management framework, including NSCC's ability 
to collect supplemental liquidity if a member's activity, including its 
SFT activity, increases NSCC's liquidity need,\56\ would be sufficient 
to ensure that NSCC would continue to meet its regulatory obligations.
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    \56\ NSCC is required to have policies and procedures reasonably 
designed to monitor and manage its liquidity risk by maintaining 
sufficient liquid resources at the minimum to effect settlement of 
payment obligations with a high degree of confidence under a wide 
range of foreseeable stress scenarios that includes, but is not 
limited to, the default of the participant family that would 
generate the largest aggregate payment obligation for the covered 
clearing agency in extreme but plausible market conditions, and by 
determining that amount and regularly testing the sufficiency of its 
liquidity resources. 17 CFR 240.17Ad-22(e)(7)(i) and (vi). Pursuant 
to this regulatory requirement, NSCC's Liquidity Risk Management 
Framework outlines NSCC's liquidity resources and liquidity risk 
management practices. See Securities Exchange Act Release No. 82377 
(December 21, 2017), 82 FR 61617 (December 28, 2017). One such 
liquidity resource is NSCC's supplemental liquidity deposit, which 
is designed to withstand NSCC's fluctuating peak liquidity needs and 
source adequate liquidity at all times. To do so, NSCC allocates a 
funding obligation to those members driving peak liquidity needs 
that surpass NSCC's available liquidity resources through SLDs. See 
Securities Exchange Act Release No. 71000 (December 5, 2013), 78 FR 
75400 (December 11, 2013).
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    The Commission believes that NSCC's proposal to manage its 
potential liquidity exposures associated with SFTs by using its 
established liquidity resources is reasonably designed to manage the 
liquidity risk that may arise in the SFT central clearing service, and 
consistent with Rule 17Ad-22(e)(7)(i).\57\
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    \57\ 17 CFR 240.17Ad-22(e)(7)(i).
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D. Consistency With Rule 17Ad-22(e)(18)

    Rule 17Ad-22(e)(18) under the Exchange Act requires that NSCC 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to establish objective, risk-based, and 
publicly disclosed criteria for participation, which permit fair and 
open access by direct and, where relevant, indirect participants and 
other financial market utilities, require participants to have 
sufficient financial resources and robust operational capacity to meet 
obligations arising from participation in the clearing agency, and 
monitor compliance with participation requirements on an ongoing 
basis.\58\
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    \58\ 17 CFR 240.17Ad-22(e)(18).
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    First, the Commission believes that the proposal is reasonably 
designed to establish objective, risk-based, and publicly-disclosed 
criteria for SFT members. As described above, all members would be 
eligible to apply to become Sponsoring Members or Agent Clearing 
Members subject to such criteria, similar to how NSCC currently 
provides membership criteria for its members. For example, if a 
Sponsoring or Agent Clearing Member applicant is a registered broker-
dealer, it would be subject to particular financial resource 
requirements, as specified in the proposed rule. Only a qualified 
institutional buyer or a legal entity that satisfies the financial 
requirements necessary to be a qualified institutional buyer would be 
eligible to be a Sponsored Member. In addition, an applicant must 
provide adequate assurances for its financial responsibility and 
operational capability.
    Second, the proposal is reasonably designed to allow direct and 
indirect participants to access the new SFT central clearing service by 
establishing new membership categories to allow for such access by 
particular types of market participants. For example, a participant who 
cannot or does not want to meet the requirements to become either a 
member, a Sponsoring Member, or an Agent Clearing Member can 
participate as a Sponsored Member or as a Customer, the latter of which 
does not have a direct relationship with NSCC.
    Third, the proposal is reasonably designed to allow NSCC to monitor 
compliance with participation requirements on an ongoing basis. The 
proposal would require an SFT member to notify NSCC if it is no longer 
in compliance with applicable requirements to be an SFT member, and 
allow NSCC to inspect SFT members' financial resources and operational 
capability on an ongoing basis.
    For the foregoing reasons, the Commission believes that the 
proposal is consistent with Rule 17Ad-22(e)(18).\59\
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    \59\ Id.
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E. Consistency With Rule 17Ad-22(e)(19)

    Rule 17Ad-22(e)(19) under the Exchange Act requires a covered 
clearing agency to establish, implement, maintain, and enforce written 
policies and procedures reasonably designed to identify, monitor, and 
manage the material risks to the covered clearing agency arising from 
arrangements in which firms that are indirect participants in the 
covered clearing agency rely on the services provided by direct 
participants to access the covered clearing agency's payment, clearing, 
or settlement facilities.\60\
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    \60\ 17 CFR 240.17Ad-22(e)(19).
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    The proposal allows Sponsoring Members to submit Sponsored Members' 
transactions to NSCC, and Agent Clearing Members to submit its 
Customers' transactions to NSCC. In both cases, Sponsoring Members and 
Agent Clearing Members would be ultimately responsible to NSCC for 
Sponsored Members' and Customers' transactions and liable to satisfy 
all settlement obligations. Both Sponsoring Members and Agent Clearing 
Members serve as the processing agent for all the Sponsored Member and 
Customer transactions responsible for posting margin and satisfying any 
losses arising from the client transactions. Sponsoring Members and 
Customers do not have any direct mechanism to submit their own margin 
or settle transactions directly with NSCC. Moreover, even though 
Sponsored Members would be principally liable for their own settlement 
obligations, Sponsoring Members' guaranty requires Sponsoring Members 
to satisfy settlement obligations on behalf of its Sponsored Members.
    By calculating and collecting margins for Sponsored Members' and 
Customers' transactions and providing certainty that Sponsoring Members 
and Agent Clearing Members would be responsible for their Sponsored 
Members' and Customers' transactions, the Commission believes that the 
proposal

[[Page 33535]]

is consistent with Rule 17Ad-22(e)(19).\61\
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    \61\ Id.
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F. Consistency With Rule 17Ad-22(e)(21)

    Rule 17Ad-22(e)(21) under the Exchange Act requires a covered 
clearing agency to establish, implement, maintain, and enforce written 
policies and procedures reasonably designed to be efficient and 
effective in meeting the requirements of its participants and the 
markets it serves, including the clearing agency's clearing and 
settlement arrangements and the scope of products cleared or 
settled.\62\
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    \62\ 17 CFR 240.17Ad-22(e)(21).
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    As described above in Section II.B.(1) and (2), the proposal is 
designed to reflect the current structure of the bilateral securities 
lending market, ensuring that relevant features and market participants 
subject to differing regulatory requirements and existing contractual 
relationships can be accommodated as part of the service provided by 
NSCC. For example, the proposal would allow for central clearing of 
SFTs with a one business day term, in order to provide a scheduled 
settlement date so that the transaction may be eligible for balance 
sheet netting benefit as explained in Section II.(B)(1). Second, the 
proposal would allow accelerated settlement so that certain market 
participants are able to quickly unwind their SFTs to satisfy 
applicable regulatory requirements. Third, the proposed membership 
categories would accommodate principal and agency trading to allow 
different types of market participants to enter into the new SFT 
central clearing service, consistent with their business models and 
applicable regulatory requirements.
    Accordingly, the Commission believes that the proposal is 
reasonably designed to be efficient and effective in meeting the 
requirements of its participants and the market it serves, and 
consistent with Rule 17Ad-22(e)(21).\63\
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    \63\ Id.
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VI. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act, that the Commission does not object to 
Advance Notice (SR-NSCC-2022-801) and that NSCC is authorized to 
implement the proposal as of the date of this notice or the date of an 
order by the Commission approving proposed rule change SR-NSCC-2022-
003, whichever is later.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2022-11839 Filed 6-1-22; 8:45 am]
BILLING CODE P