[Federal Register Volume 86, Number 114 (Wednesday, June 16, 2021)]
[Notices]
[Pages 32079-32085]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-12598]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-92145; File No. SR-FICC-2020-804]


Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of No Objection To Advance Notice To Modify the Calculation of 
the MBSD VaR Floor To Incorporate a Minimum Margin Amount

June 10, 2021.
    On November 27, 2020, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
advance notice SR-FICC-2020-804 (``Advance Notice'') pursuant to 
Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act, entitled Payment, Clearing and Settlement 
Supervision Act of 2010 (``Clearing Supervision Act''),\1\ and Rule 
19b-4(n)(1)(i) \2\ under the Securities Exchange Act of 1934 
(``Exchange Act'').\3\ In the Advance Notice, FICC proposes to add a 
minimum margin amount calculation to its margin methodology to enhance 
FICC's margin collections as needed in response to periods of extreme 
market volatility, as described more fully below. The Advance Notice 
was published for public comment in the Federal Register on January 6, 
2021.\4\ Upon publication of the Notice of Filing, the Commission 
extended the review period of the Advance Notice for an additional 60 
days because the Commission determined that the Advance Notice raised 
novel and complex issues.\5\ On March 12, 2021, the Commission, by the 
Division of Trading and Markets, pursuant to delegated authority,\6\ 
requested additional information from FICC pursuant to Section 
806(e)(1)(D) of the Act.\7\ The request for information tolled the 
Commission's period of review of the Advance Notice until 60 days from 
the date of the Commission's receipt of the information requested from 
FICC, absent an additional information request.\8\
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ 15 U.S.C. 78a et seq.
    \4\ Securities Exchange Act Release No. 90834 (December 31, 
2020), 86 FR 584 (January 6, 2021) (File No. SR-FICC-2020-804) 
(``Notice of Filing''). FICC also filed a related proposed rule 
change with the Commission pursuant to Section 19(b)(1) of the 
Exchange Act and Rule 19b-4 thereunder. 15 U.S.C. 78s(b)(1) and 17 
CFR 240.19b-4, respectively. FICC seeks approval of the proposed 
changes to its rules necessary to implement the Advance Notice (the 
``Proposed Rule Change''). The Proposed Rule Change was published in 
the Federal Register on December 10, 2020. Securities Exchange Act 
Release No. 90568 (December 4, 2020), 85 FR 79541 (December 10, 
2020) (SR-FICC-2020-017). On December 30, 2020, the Commission 
published a notice designating a longer period of time for 
Commission action and a longer period for public comment on the 
Proposed Rule Change. Securities Exchange Act Release No. 90794 
(December 23, 2020), 85 FR 86591 (December 30, 2020) (SR-FICC-2020-
017). On February 16, 2021, the Commission published an order 
instituting proceedings to determine whether to approve or 
disapprove the Proposed Rule Change. Securities Exchange Act Release 
No. 91092 (February 9, 2021), 86 FR 91092 (February 16, 2021) (SR-
FICC-2020-017).
    \5\ Pursuant to Section 806(e)(1)(H) of the Act, the Commission 
may extend the review period of an advance notice for an additional 
60 days, if the changes proposed in the advance notice raise novel 
or complex issues, subject to the Commission providing the FMU with 
prompt written notice of the extension. 12 U.S.C. 5465(e)(1)(H); see 
also Notice of Filing, supra note 4 at 590 (explaining the 
Commission's rationale for determining that the proposed changes in 
the Advance Notice raised novel and complex issues because (1) the 
proposed changes to FICC's margin model are a direct response by 
FICC to address the unique circumstances that occurred during the 
pandemic-related market volatility in March and April 2020, and (2) 
the proposed changes potentially could impact the mortgage market).
    \6\ 17 CFR 200.30-3(a)(93).
    \7\ 12 U.S.C. 5465(e)(1)(D).
    \8\ See 12 U.S.C. 5465(e)(1)(E)(ii) and (G)(ii); see Memorandum 
from the Office of Clearance and Settlement, Division of Trading and 
Markets, titled ``Commission's Request for Additional Information,'' 
available at https://www.sec.gov/comments/sr-ficc-2020-804/srficc2020804-8490035-229981.pdf.
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    The Commission has received comments on the changes proposed in the 
Advance Notice.\9\ In addition, the

[[Page 32080]]

Commission received a letter from FICC responding to the comments.\10\ 
This publication serves as notice of no objection to the Advance 
Notice.
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    \9\ Comments on the Advance Notice are available at https://www.sec.gov/comments/sr-ficc-2020-804/srficc2020804.htm. Comments on 
the Proposed Rule Change are available at https://www.sec.gov/comments/sr-ficc-2020-017/srficc2020017.htm. Because the proposals 
contained in the Advance Notice and the Proposed Rule Change are the 
same, all comments received on the proposal were considered 
regardless of whether the comments were submitted with respect to 
the Advance Notice or the Proposed Rule Change.
    \10\ See Letter from Timothy J. Cuddihy, Managing Director of 
Depository Trust & Clearing Corporation Financial Risk Management, 
(March 5, 2021) (``FICC Letter'').
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I. The Advance Notice

A. Background

    FICC, through MBSD, serves as a central counterparty (``CCP'') and 
provider of clearance and settlement services for the mortgage-backed 
securities (``MBS'') markets. A key tool that FICC uses to manage its 
respective credit exposures to its members is the daily collection of 
margin from each member. The aggregated amount of all members' margin 
constitutes the Clearing Fund, which FICC would access should a 
defaulted member's own margin be insufficient to satisfy losses to FICC 
caused by the liquidation of that member's portfolio.
    Each member's margin consists of a number of applicable components, 
including a value-at-risk (``VaR'') charge (``VaR Charge'') designed to 
capture the potential market price risk associated with the securities 
in a member's portfolio. The VaR Charge is typically the largest 
component of a member's margin requirement. The VaR Charge is designed 
to provide an estimate of FICC's projected liquidation losses with 
respect to a defaulted member's portfolio at a 99 percent confidence 
level.
    To determine each member's daily VaR Charge, FICC generally uses a 
model-based calculation designed to quantify the risks related to the 
volatility of market prices associated with the securities in a 
member's portfolio.\11\ As an alternative to this calculation, FICC 
also uses a haircut-based calculation to determine the ``VaR Floor,'' 
which replaces the model-based calculation to become a member's VaR 
Charge in the event that the VaR Floor is greater than the amount 
determined by the model-based calculation.\12\ Thus, the VaR Floor 
currently operates as a minimum VaR Charge.
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    \11\ The model-based calculation, often referred to as the 
sensitivity VaR model, relies on historical risk factor time series 
data and security-level risk sensitivity data. Specifically, for 
TBAs, the model calculation incorporates the following risk factors: 
(1) Key rate, which measures the sensitivity of a price change to 
changes in interest rates; (2) convexity, which measures the degree 
of curvature in the price/yield relationship of key interest rates; 
(3) spread, which is the yield spread added to a benchmark yield 
curve to discount a TBA's cash flows to match its market price; (4) 
volatility, which reflects the implied volatility observed from the 
swaption market to estimate fluctuations in interest rates; (5) 
mortgage basis, which captures the basis risk between the prevailing 
mortgage rate and a blended Treasury rate; and (6) time risk factor, 
which accounts for the time value change (or carry adjustment) over 
an assumed liquidation period. See Securities Exchange Act Release 
No. 79491 (December 7, 2016), 81 FR 90001, 90003-04 (December 13, 
2016) (File No. SR-FICC-2016-007).
    \12\ FICC uses the VaR Floor to mitigate the risk that the 
model-based calculation does not result in margin amounts that 
accurately reflect FICC's applicable credit exposure, which may 
occur in certain member portfolios containing long and short 
positions in different asset classes that share a high degree of 
historical price correlation.
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    During the period of extreme market volatility in March and April 
2020, FICC's current model-based calculation and the VaR Floor haircut-
based calculation generated VaR Charge amounts that were not sufficient 
to mitigate FICC's credit exposure to its members' portfolios at a 99 
percent confidence level. Specifically, during the period of extreme 
market volatility, FICC observed that its margin collections yielded 
backtesting deficiencies beyond FICC's risk tolerance.\13\ FICC states 
that these deficiencies arose from a particular aspect of its margin 
methodology with respect to MBS (particularly, higher coupon TBAs 
\14\), i.e., that current prices may reflect higher mortgage prepayment 
risk than FICC's margin methodology currently takes into account during 
periods of extreme market volatility. In the Advance Notice, FICC 
proposes to revise the margin methodology in its Rules \15\ and its 
quantitative risk model \16\ to better address the risks posed by 
member portfolios holding TBAs during such volatile market conditions.
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    \13\ Backtesting is an ex-post comparison of actual outcomes 
(i.e., the actual margin collected) with expected outcomes derived 
from the use of margin models. See 17 CFR 240.17Ad-22(a)(1). FICC 
conducts daily backtesting to determine the adequacy of its margin 
assessments. MBSD's monthly backtesting coverage ratio with respect 
to margin amounts was 86.6 percent in March 2020 and 94.2 percent in 
April 2020. See Notice of Filing, supra note 4 at 585.
    \14\ The vast majority of agency MBS trading occurs in a forward 
market, on a ``to-be-announced'' or ``TBA'' basis. In a TBA trade, 
the seller agrees on a sale price, but does not specify which 
particular securities will be delivered to the buyer on settlement 
day. Instead, only a few basic characteristics of the securities are 
agreed upon, such as the MBS program, maturity, coupon rate, and the 
face value of the bonds to be delivered.
    \15\ The MBSD Clearing Rules are available at https://www.dtcc.com/legal/rules-and-procedures.aspx.
    \16\ As part of the Advance Notice, FICC filed Exhibit 5B--
Proposed Changes to the Methodology and Model Operations Document 
MBSD Quantitative Risk Model (``QRM Methodology''). Pursuant to 17 
CFR 240.24b-2, FICC requested confidential treatment of Exhibit 5B.
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B. Minimum Margin Amount

    FICC proposes to introduce a new minimum margin amount into its 
margin methodology. Under the proposal, FICC would revise the existing 
definition of the VaR Floor to mean the greater of (1) the current 
haircut-based calculation, as described above, and (2) the proposed 
minimum margin amount, which would use a dynamic haircut method based 
on observed TBA price moves. Application of the minimum margin amount 
would increase FICC's margin collection during periods of extreme 
market volatility, particularly when TBA price changes would otherwise 
significantly exceed those projected by either the model-based 
calculation or the current VaR Floor calculation.
    Specifically, the minimum margin amount would serve as a minimum 
VaR Charge for net unsettled positions, calculated using the historical 
market price changes of certain benchmark TBA securities.\17\ FICC 
proposes to calculate the minimum margin amount per member 
portfolio.\18\ The proposal

[[Page 32081]]

would allow offsetting between short and long positions within TBA 
securities programs since the TBAs aggregated in each program exhibit 
similar risk profiles and can be netted together to calculate the 
minimum margin amount to cover the observed market price changes for 
each portfolio.
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    \17\ FICC would consider the MBSD portfolio as consisting of 
four programs: Federal National Mortgage Association (``Fannie 
Mae'') and Federal Home Loan Mortgage Corporation (``Freddie Mac'') 
conventional 30-year mortgage-backed securities (``CONV30''), 
Government National Mortgage Association (``Ginnie Mae'') 30-year 
mortgage-backed securities (``GNMA30''), Fannie Mae and Freddie Mac 
conventional 15-year mortgage-backed securities (``CONV15''), and 
Ginnie Mae 15-year mortgage-backed securities (``GNMA15''). Each 
program would, in turn, have a default benchmark TBA security.
     FICC would map 10-year and 20-year TBAs to the corresponding 
15-year TBA security benchmark. As of August 31, 2020, 20-year TBAs 
account for less than 0.5%, and 10-year TBAs account for less than 
0.1%, of the positions in MBSD clearing portfolios. FICC states that 
these TBAs were not selected as separate TBA security benchmarks due 
to the limited trading volumes in the market. See Notice of Filing, 
supra note 4 at 586.
    \18\ The specific calculation would involve the following: FICC 
would first calculate risk factors using historical market prices of 
the benchmark TBA securities. FICC would then calculate each 
member's portfolio exposure on a net position across all products 
and for each securitization program (i.e., CONV30, GNMA30, CONV15 
and GNMA15). Finally, FICC would multiply a ``base risk factor'' by 
the absolute value of the member's net position across all products, 
plus the sum of each risk factor spread to the base risk factor 
multiplied by the absolute value of its corresponding position, to 
determine the minimum margin amount.
    To determine the base risk factor, FICC would calculate an 
``outright risk factor'' for GNMA30 and CONV30, which constitute the 
majority of the TBA market and of positions in MBSD portfolios. For 
each member's portfolio, FICC would assign the base risk factor 
based on whether GNMA30 or CONV30 constitutes the larger absolute 
net market value in the portfolio. If GNMA30 constitutes the larger 
absolute net market value in the portfolio, the base risk factor 
would be equal to the outright risk factor for GNMA30. If CONV30 
constitutes the larger absolute net market value in the portfolio, 
the base risk factor would be equal to the outright risk factor for 
CONV30.
    For a detailed example of the minimum margin amount calculation, 
see Notice of Filing, supra note 4 at 586-87.
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    The proposal would allow a lookback period for those historical 
market price moves and parameters of between one and three years, and 
FICC would set the initial lookback period for the minimum margin 
amount calculation at two years.\19\ FICC states that the minimum 
margin amount would improve the responsiveness of its margin 
methodology during periods of market volatility because it would have a 
shorter lookback period than the model-based calculation, which 
reflects a ten-year lookback period.\20\
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    \19\ FICC would be permitted to adjust the lookback period 
within the range in accordance with FICC's model risk management 
practices and governance procedures set forth in the Clearing Agency 
Model Risk Management Framework. See Securities Exchange Act Release 
No. 81485 (August 25, 2017), 82 FR 41433 (August 31, 2017) (SR-DTC-
2017-008; SR-FICC-2017-014; SR-NSCC-2017-008); Securities Exchange 
Act Release No. 84458 (October 19, 2018), 83 FR 53925 (October 25, 
2018) (SR-DTC-2018-009; SR-FICC-2018-010; SR-NSCC-2018-009); 
Securities Exchange Act Release No. 88911 (May 20, 2020), 85 FR 
31828 (May 27, 2020) (SR-DTC-2020-008; SR-FICC-2020-004; SR-NSCC-
2020-008).
    \20\ Notice of Filing, supra note 4 at 586; FICC Letter at 5.
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II. Discussion and Commission Findings

    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.\21\
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    \21\ See 12 U.S.C. 5461(b).
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    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.\22\ 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): \23\
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    \22\ 12 U.S.C. 5464(a)(2).
    \23\ 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 others areas.\24\
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    \24\ 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 (the ``Clearing Agency Rules'').\25\ The Clearing Agency 
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.\26\ 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. As 
discussed below, the Commission believes the proposals in the Advance 
Notice are consistent with the objectives and principles described in 
Section 805(b) of the Clearing Supervision Act \27\ and in the Clearing 
Agency Rules, in particular Rule 17Ad-22(e)(4)(i) and (e)(6)(i) and 
(v).\28\
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    \25\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No. 
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11). 
See also Securities Exchange Act Release No. 78961 (September 28, 
2016), 81 FR 70786 (October 13, 2016) (S7-03-14) (``Covered Clearing 
Agency Standards''). FICC is a ``covered clearing agency'' as 
defined in Rule 17Ad-22(a)(5).
    \26\ Id.
    \27\ 12 U.S.C. 5464(b).
    \28\ 17 CFR 240.17Ad-22(e)(4)(i) and (e)(6)(i).
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A. Consistency With Section 805(b) of the Clearing Supervision Act

    The Commission believes that the Advance Notice is consistent with 
the stated objectives and principles of Section 805(b) of the Clearing 
Supervision Act.\29\ Specifically, the Commission believes that the 
changes proposed in the Advance Notice are consistent with promoting 
robust risk management, promoting safety and soundness, reducing 
systemic risks, and supporting the broader financial system.\30\
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    \29\ 12 U.S.C. 5464(b).
    \30\ Several of the issues raised by the commenters are directed 
at the Proposed Rule Change and will be addressed in that context. 
These comments generally relate to the proposal's impact on 
competition and its consistency with the Exchange Act. See Letter 
from James Tabacchi, Chairman, Independent Dealer and Trade 
Association, Mike Fratantoni, Chief Economist/Senior Vice President, 
Mortgage Bankers Association (January 26, 2021) (``IDTA/MBA Letter 
I'') at 2-6; Letter from Christopher A. Iacovella, Chief Executive 
Officer, American Securities Association (January 28, 2021) (``ASA 
Letter'') at 1-2; Letter from Christopher Killian, Managing 
Director, Securities Industry and Financial Markets Association 
(January 29, 2021) (``SIFMA Letter I'') at 2-4 (commenting on impact 
on competition and the application of Section 17A(b)(3)(F) of the 
Exchange Act). The Commission's evaluation of the Advance Notice is 
conducted under the Clearing Supervision Act and, as noted above, 
generally considers whether the proposal would promote robust risk 
management, promote safety and soundness, reduce systemic risks, and 
support the broader financial system.
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1. Promoting Robust Risk Management and Safety and Soundness
    The Commission believes that adopting the proposed minimum margin 
amount would be consistent with the promotion of robust risk management 
and safety and soundness at FICC. FICC proposes to add the minimum 
margin amount calculation to its margin methodology to better ensure 
that FICC collects sufficient margin amounts during periods of extreme 
market volatility to cover the costs that FICC might incur upon 
liquidating a defaulted member's portfolio.
    Specifically, FICC designed the minimum margin amount calculation 
to better manage the risk of incurring costs associated with increased 
volatility in a defaulted member's portfolio that contains a large 
position in TBAs. As described above, during the period of extreme 
market volatility in March and April 2020, FICC's margin methodology 
generated margin amounts that were not sufficient to mitigate FICC's 
credit exposure to its members' portfolios at a 99 percent confidence 
level. The minimum margin amount would collect additional margin in 
such circumstances, i.e., when the market price volatility implied by 
both the current VaR Charge calculation and the current VaR Floor 
calculation is lower than the market price volatility from 
corresponding price changes of the proposed TBA securities benchmarks 
observed during the proposed lookback period.
    The Commission believes that FICC's implementation of the minimum 
margin amount would result in margin levels that better reflect the 
risks and particular attributes of member portfolios holding positions 
in TBAs,

[[Page 32082]]

including in times of increased market price volatility such as what 
occurred in March and April 2020. Accordingly, the Commission believes 
that the proposal is consistent with promoting robust risk management 
because the minimum margin amount would enable FICC to better manage 
the relevant risks.
    Further, the Commission has reviewed and analyzed FICC's analyses 
regarding how the proposal would improve FICC's backtesting coverage, 
which demonstrate that the proposal would result in less credit 
exposure for FICC to its members. By helping to ensure that FICC 
collects margin amounts sufficient to manage the risk associated with 
its members' portfolios holding large TBA positions during periods of 
extreme market volatility, the proposed minimum margin amount would 
help limit FICC's exposure in a member default scenario. The proposal 
would generally provide FICC with additional resources to manage 
potential losses arising out of a member default. Such an increase in 
FICC's available financial resources would decrease the likelihood that 
losses arising out of a member default would exceed FICC's prefunded 
resources and threaten the safety and soundness of FICC's ongoing 
operations. Accordingly, the Commission believes that the proposal is 
also consistent with promoting safety and soundness at FICC.
2. Reducing Systemic Risks and Supporting the Stability of the Broader 
Financial System
    The Commission believes that the proposed minimum margin amount is 
consistent with reducing systemic risks and supporting the stability of 
the broader financial system. As discussed above, FICC would access its 
Clearing Fund should a defaulted member's own margin be insufficient to 
satisfy losses caused by the liquidation of the member's portfolio. 
FICC proposes to add the minimum margin amount calculation to its 
margin methodology to collect additional margin from members to cover 
such costs, and thereby better manage the potential costs of 
liquidating a defaulted member's portfolio. This could reduce the 
possibility that FICC would need to mutualize among the non-defaulting 
members a loss arising out of the close-out process. Reducing the 
potential for loss mutualization could, in turn, reduce the potential 
resultant effects on non-defaulting members, their customers, and the 
broader market arising out of a member default. Accordingly, the 
Commission believes that adoption of the proposed minimum margin amount 
by FICC is consistent with the reduction of systemic risk and 
supporting the stability of the broader financial system.
    One commenter argues that the proposed minimum margin amount is not 
necessary because despite FICC's March-April 2020 backtesting 
deficiencies, there were no failures that caused broader systemic 
problems.\31\ Another commenter argues that the proposed minimum margin 
amount is not necessary because mid-sized broker/dealers do not present 
significant risks to the broader financial system.\32\ The Commission 
disagrees with these comments, as they do not take into account FICC's 
regulatory requirements with respect to maintaining sufficient 
financial resources. As discussed more fully below, the standard under 
Rule 17Ad-22(e)(4) is not merely for FICC to maintain sufficient 
financial resources to avoid failures or systemic issues, but to cover 
its credit exposure to each participant fully with a high degree of 
confidence.\33\ During periods of extreme market volatility, FICC has 
demonstrated that adding the minimum margin amount to its margin 
methodology would better enable FICC to manage its credit exposures to 
members by assessing appropriate margin charges. The Commission has 
reviewed and analyzed FICC's backtesting data, and agrees that the data 
demonstrate that the minimum margin amount would result in better 
backtesting coverage and, therefore, less credit exposure of FICC to 
its members. Accordingly, the Commission believes that the proposed 
minimum margin amount would enable FICC to better manage its credit 
risks resulting from periods of extreme market volatility. Morevoer, as 
discussed here, the proposal should help FICC to contain the effects of 
a member default from spreading to other members and more broadly to 
other market participants, consistent with the objectives of reducing 
systemic risks and supporting the stability of the broader financial 
system.
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    \31\ See SIFMA Letter I at 2.
    \32\ See IDTA/MBA Letter I at 3.
    \33\ 17 CFR 240.17Ad-22(e)(4)(i).
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    For the reasons stated above, the Commission believes the changes 
proposed in the Advance Notice are consistent with Section 805(b) of 
the Clearing Supervision Act.\34\
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    \34\ 12 U.S.C. 5464(b).
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B. Consistency With Rule 17Ad-22(e)(4)(i)

    Rule 17Ad-22(e)(4)(i) requires that FICC establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to effectively identify, measure, monitor, and manage its 
credit exposures to participants and those arising from its payment, 
clearing, and settlement processes, including by maintaining sufficient 
financial resources to cover its credit exposure to each participant 
fully with a high degree of confidence.\35\
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    \35\ 17 CFR 240.17Ad-22(e)(4)(i).
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    Several commenters question whether FICC has adequately 
demonstrated that the proposal in the Advance Notice is consistent with 
Rule 17Ad-22(e)(4)(i) under the Act, arguing that there are more 
effective methods that FICC could use to mitigate the relevant risks. 
Three commenters argue that the model-based calculation is well-suited 
to address FICC's credit risk in volatile market conditions, and 
instead of adding the minimum margin amount to its margin methodology, 
FICC should enhance this calculation to address periods of extreme 
market volatility such as occurred in March and April 2020.\36\
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    \36\ See IDTA/MBA Letter I at 4-5; ASA Letter at 1; SIFMA Letter 
I at 2-3; SIFMA Letter II at 1-2.
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    In response to these comments, FICC explains that enhancing the 
model-based calculation would not be an effective approach towards 
mitigating the risk resulting from periods of extreme market 
volatility. Although the model-based calculation takes into account 
risk factors typical to TBAs, the extreme market volatility of March 
and April 2020 was caused by other factors (e.g., changes in the 
Federal Reserve purchase program) affecting the TBA markets, yet such 
factors are not accounted for in the model-based calculation.\37\ To 
further demonstrate why the minimum margin amount is necessary, FICC 
relies upon the results of recent backtesting analyses demonstrating 
that its existing VaR Charge calculations did not respond effectively 
to the March and April 2020 levels of market volatility and economic 
uncertainty such that FICC's margin collections during that period did 
not meet its 99 percent confidence level.\38\
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    \37\ See FICC Letter at 2-3.
    \38\ See FICC Letter at 3.
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    The Commission believes that the proposal in the Advance Notice is 
consistent with Rule 17Ad-22(e)(4)(i) under the Exchange Act.\39\ As 
described above, FICC's current VaR Charge calculations resulted in 
margin amounts that were not sufficient to mitigate FICC's credit 
exposure to its members' portfolios at FICC's targeted confidence level 
during periods of extreme market volatility, particularly when TBA 
price changes significantly exceeded those implied by the VaR model 
risk factors.

[[Page 32083]]

Adding the minimum margin amount calculation to its margin methodology 
should better enable FICC to collect margin amounts that are sufficient 
to mitigate FICC's credit exposure to its members' portfolios.
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    \39\ 17 CFR 240.17Ad-22(e)(4)(i).
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    In reaching this conclusion, the Commission thoroughly reviewed and 
analyzed the (1) Advance Notice, including the supporting exhibits that 
provided confidential information on the calculation of the proposed 
minimum margin amount, impact analyses (including detailed information 
regarding the impact of the proposed change on the portfolio of each 
FICC member over various time periods), and backtesting coverage 
results, (2) comments received, and (3) the Comission's own 
understanding of the performance of the current margin methodology, 
with which the Commission has experience from its general supervision 
of FICC, compared to the proposed margin methodology.\40\ Specifically, 
as discussed above, the Commission has considered the results of FICC's 
backtesting coverage analyses, which indicate that the current margin 
methodology results in backtesting coverage that does not meet FICC's 
targeted confidence level. The analyses also indicate that the minimum 
margin amount would result in improved backtesting coverage towards 
meeting FICC's targeted coverage level. FICC's backtesting data shows 
that if the minimum margin amount had been in place, overall margin 
backtesting coverage (based on 12-month trailing backtesting) would 
have increased from approximately 99.3% to 99.6% through January 31, 
2020 and approximately 97.3% to 98.5% through June 30, 2020.\41\ 
Therefore, the proposal would provide FICC with a more precise margin 
calculation, thereby enabling FICC to manage its credit exposures to 
members by maintaining sufficient financial resources to cover such 
exposures fully with a high degree of confidence.
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    \40\ In addition, because the proposals contained in the Advance 
Notice and the Proposed Rule Change are the same, all information 
submitted by FICC was considered regardless of whether the 
information submitted with respect to the Advance Notice or the 
Proposed Rule Change. See supra note 9.
    \41\ See Notice of Filing, supra note 4 at 588.
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    In response to the comments regarding enhancing the model-based 
calculation instead of adding the minimum margin amount, the Commission 
believes that FICC's model-based calculation takes into account risk 
factors that are typical TBA attributes, whereas the extreme market 
volatility of March and April 2020 was caused by other external factors 
that are less subject to modeling. Thus, the commenters' preferred 
approach is not a viable alternative that would allow for consideration 
of such factors.\42\
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    \42\ This Commission also notes that Section 19(b)(2)(C) of the 
Act directs the Commission to approve a proposed rule change of a 
self-regulatory organization if the change is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to such organization. 15 U.S.C. 78s(b)(2)(C). Therefore, 
the Commission is required to approve the proposal unless the 
existence of alternatives identified by commenters renders the 
proposal inconsistent with the Act. The Commission does not believe 
this threshold has been met.
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    Accordingly, for the reasons discussed above, the Commission 
believes that the proposed minimum margin amount is reasonably designed 
to enable FICC to effectively identify, measure, monitor, and manage 
its credit exposure to members, consistent with Rule 17Ad-
22(e)(4)(i).\43\
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    \43\ 17 CFR 240.17Ad-22(e)(4)(i).
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C. Consistency With Rules 17Ad-22(e)(6)(i) and (iii)

    Rules 17Ad-22(e)(6)(i) and (iii) require that FICC establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to cover its credit exposures to its participants 
by establishing a risk-based margin system that, at a minimum, 
considers, and produces margin levels commensurate with, the risks and 
particular attributes of each relevant product, portfolio, and market, 
and calculates margin sufficient to cover its potential future exposure 
to participants.\44\
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    \44\ 17 CFR 240.17Ad-22(e)(6)(i) and (iii).
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    One commenter suggests that the minimum margin amount would be 
inefficient and ineffective at collecting margin amounts commensurate 
with the risks presented by the securities in member portfolios.\45\ 
Several commenters argue that the proposed minimum margin amount 
calculation would produce sudden and persistent spikes in margin 
requirements.\46\ One commenter argues that the minimum margin amount 
would effectively replace FICC's existing model-based calculation with 
one likely to produce procyclical results by increasing margin 
requirements at times of increased market volatility.\47\ One commenter 
suggests the March-April 2020 market volatility was so unique that FICC 
need not adjust its margin methodology to account for a future similar 
event.\48\
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    \45\ See id.
    \46\ See IDTA/MBA Letter I at 5; ASA Letter at 2; SIFMA Letter I 
at 3-4.
    \47\ See IDTA/MBA Letter I at 5.
    \48\ See SIFMA Letter I at 3.
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    In addition, one commenter argues that the proposed minimum margin 
amount is inconsistent with Rule 17Ad-22(e)(6)(i) because the minimum 
margin amount calculation is not reasonably designed to mitigate future 
risk due to its reliance on historical price movements that will not 
generate margin requirements that equate to future protections against 
market volatility.\49\ Two commenters argue that the proposed minimum 
margin amount calculation is not reasonably designed to mitigate future 
risks because the calculation relies on historical price movements, 
which will not necessarily generate margin amounts that will protect 
against future periods of market volatility.\50\ One commenter argues 
that the MMA is not necessary despite the March and April 2020 
backtesting deficiencies because there were no failures or other events 
that caused systemic issues.\51\
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    \49\ See IDTA/MBA Letter I at 4.
    \50\ See IDTA/MBA Letter I at 5; SIFMA Letter I at 2.
    \51\ See SIFMA Letter I at 2.
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    Several commenters speculate that since the minimum margin amount 
is typically larger than the model-based calculation, the minimum 
margin amount will likely become the predominant calculation for 
determining a member's VaR Charge.\52\ One commenter argues that 
instead of the minimum margin amount, FICC should consider adding 
concentration charges to its margin methodology to address the relevant 
risks.\53\
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    \52\ See IDTA/MBA Letter I at 4-5; ASA Letter at 1; SIFMA Letter 
I at 2-3.
    \53\ See IDTA/MBA Letter I at 5.
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    In response, FICC states that any increased margin requirements 
resulting from the proposed minimum margin amount during periods of 
extreme market volatility would appropriately reflect the relevant 
risks presented to FICC by member portfolios holding large TBA 
positions.\54\ FICC also states that the minimum margin amount's 
reliance on observed price volatility with a shorter lookback period 
will provide margin that responds quicker during market volatility to 
limit FICC's exposures.\55\ FICC also notes that the margin increases 
that the minimum margin amount would have imposed following the March-
April 2020 market volatility would not have persisted at such high 
levels indefinitely.\56\
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    \54\ See FICC Letter at 5-6.
    \55\ See id.
    \56\ See id.
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    In addition, regarding whether the minimum margin amount will 
likely become the predominant calculation for determining a member's 
VaR Charge,

[[Page 32084]]

FICC states that as the period of extreme market volatility stabilized 
and the model-based calculation recalibrated to current market 
conditions, the average daily VaR Charge increase decreased from $2.2 
billion (i.e., 42%) to $838 million (i.e., 7%) during the fourth 
quarter of 2020.\57\ Regarding concentration charges, FICC states that 
concentration charges and the minimum margin amount address separate 
and distinct types of risk.\58\ Whereas the minimum margin amount is 
designed to cover the risk of market price volatility, concentration 
charges (e.g., FICC's recently approved Margin Liquidity Adjustment 
Charge \59\) are designed to mitigate the risk to FICC of incurring 
additional market impact cost from liquidating a directionally 
concentrated portfolio.\60\
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    \57\ See FICC Letter at 5.
    \58\ See FICC Letter at 7-8.
    \59\ See Securities Exchange Act Release No. 90182 (October 14, 
2020), 85 FR 66630 (October 20, 2020) (SR-FICC-2020-009).
    \60\ See FICC Letter at 7-8.
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    The Commission believes that the proposal is consistent with Rule 
17Ad-22(e)(6)(i). Implementing the proposed minimum margin amount would 
result in margin requirements that reflect the risks such holdings 
present to FICC better than FICC's current margin methodology. In 
reaching this conclusion and considering the comments above, the 
Commission thoroughly reviewed and analyzed the (1) Advance Notice, 
including the supporting exhibits that provided confidential 
information on the calculation of the proposed minimum margin amount, 
impact analyses, and backtesting coverage results, (2) comments 
received, and (3) the Commission's own understanding of the performance 
of the current margin methodology, with which the Commission has 
experience from its general supervision of FICC, compared to the 
proposed margin methodology. Based on its review and analysis of these 
materials, including the effect that the minimum margin amount would 
have on FICC's backtesting coverage, the Commission believes that the 
proposed minimum margin amount is designed to consider, and collect 
margin commensurate with, the market risk presented by member 
portfolios holding TBA positions, specifically during periods of market 
volatility such as what occurred in March and April 2020. For the same 
reasons, the Commission disagrees with the comments suggesting that the 
minimum margin amount calculation is not designed to effectively and 
efficiently collect margin sufficient to mitigate the risks presented 
by the securities.
    In response to comments regarding the sudden and persistent 
increases in margin that could arise from the minimum margin amount, 
the Commission acknowledges that, for some member portfolios in certain 
market conditions, application of the minimum margin amount calculation 
would result in an increase in the member's margin requirement based on 
the potential exposures arising from the TBA positions. The Commission 
notes that, by design, the minimum margin amount should respond more 
quickly to heightened market volatility because of its use of 
historical price data over a relatively short lookback period, as 
opposed to the model-based calculation which relies on risk factors and 
uses a longer lookback period.
    The Commission also observes, however, based on its review and 
analysis of FICC's confidential data and analyses, that the increase in 
margin requirements generated by the minimum margin amount as compared 
to the other calculations would generally only apply during periods of 
high market volatility and for a time period thereafter.\61\ The 
frequency with which the minimum margin amount would constitute a 
majority of members' margin requirements decreases as markets become 
less volatile, and therefore, is not expected to persist 
indefinitely.\62\ The Commission believes that including the minimum 
margin amount as a potential method of determining a member's margin 
requirement is appropriate, in light of the potential exposures that 
could arise in a time of heightened market volatility and the need for 
FICC to cover those exposures. Therefore, the Commission believes that 
the proposal would provide FICC with a margin calculation better 
designed to enable FICC to cover its credit exposures to its members by 
enhancing FICC's risk-based margin system to produce margin levels 
commensurate with, the risks and particular attributes of TBAs during 
periods of extreme market volatility.
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    \61\ FICC provided this data as part of its response to the 
Commission's Request for Additional Information in connection with 
the Advance Notice. Pursuant to 17 CFR 240.24b-2, FICC requested 
confidential treatment of its RFI response. See also FICC Letter at 
5.
    \62\ See FICC Letter at 5.
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    In response to the comments regarding the potential procyclical 
nature of the minimum margin amount calculation and whether it is 
appropriate for the margin methodology to take into account such 
extreme market events, the Commission notes that as a general matter, 
margin floors generally operate to reduce procyclicality by preventing 
margin levels from falling too low. Moreover, despite the commenters' 
procyclicality concerns, the Commission understands that the purpose of 
the minimum margin amount is to ensure that FICC collects sufficient 
margin in times of heightened market volatility, which means that FICC 
would, by design, collect additional margin at such times if the 
minimum margin amount applies. The Commission believes that, because 
heightened market volatility may lead to increased credit exposure for 
FICC, it is reasonable for FICC's margin methodology to collect 
additional margin at such times and to be responsive to market activity 
of this nature.
    In response to the comment that the proposed minimum margin amount 
is not necessary because the March and April 2020 market volatility did 
not cause the failure of FICC members or otherwise cause broader 
systemic problems, the Commission disagrees. Similar to the 
Commission's analysis above in Section II.B., the relevant standard is 
not merely for FICC to maintain sufficient financial resources to avoid 
failures or systemic issues, but for FICC to cover its credit exposures 
to members with a risk-based margin system that produces margin levels 
commensurate with, the risks and particular attributes of each relevant 
product, portfolio, and market.\63\ During periods of extreme market 
volatility, FICC has demonstrated that adding the minimum margin amount 
to its margin methodology would better enable FICC to manage its credit 
exposures to members by producing margin charges commensurate with the 
applicable risks. The Commission has reviewed and analyzed FICC's 
backtesting data, and agrees that the data demonstrate that the minimum 
margin amount would result in better backtesting coverage and, 
therefore, less credit exposure of FICC to its members. Accordingly, 
the Commission believes that the proposed minimum margin amount would 
enable FICC to better manage its credit risks resulting from periods of 
extreme market volatility.
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    \63\ 17 CFR 240.17Ad-22(e)(6)(i).
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    In response to the comments regarding the minimum margin amount 
calculation's reliance on historical price movements, the Commission 
does not agree that Rules 17Ad-22(e)(6)(i) and (iii) preclude FICC from 
implementing a margin methodology that relies, at least in part, on 
historical price movements or that FICC's margin methodology must

[[Page 32085]]

generate margin requirements that ``equate to future protections 
against market volatility.'' FICC's credit exposures are reasonably 
measured both by events that have actually happened as well as events 
that could potentially occur in the future. For this reason, a risk-
based margin system is necessary for FICC to cover its potential future 
exposure to members.\64\ Potential future exposure is, in turn, defined 
as the maximum exposure estimated to occur at a future point in time 
with an established single-tailed confidence level of at least 99 
percent with respect to the estimated distribution of future 
exposure.\65\ Thus, to be consistent with its regulatory requirements, 
FICC must consider potential future exposure, which includes, among 
other things, losses associated with the liquidation of a defaulted 
member's portfolio.
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    \64\ See 17 CFR 240.17Ad-22(e)(6)(iii) (requiring a covered 
clearing agency to establish, implement, maintain and enforce 
written policies and procedures reasonably designed to cover its 
credit exposures to its participants by establishing a risk-based 
margin system that, at a minimum, calculates margin sufficient to 
cover its potential future exposure to participants in the interval 
between the last margin collection and the close out of positions 
following a participant default).
    \65\ 17 CFR 240.17Ad-22(a)(13).
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    In response to the comments regarding enhancing the model-based 
calculation instead of adding the minimum margin amount, the Commission 
believes that, as FICC stated in its response, the inputs to FICC's 
model-based calculation include risk factors that are typical TBA 
attributes, whereas the extreme market volatility of March and April 
2020, which affected the TBA markets, was caused by other external 
factors that are less subject to modeling. Accordingly, the Commission 
believes that FICC would more effectively cover its exposure during 
such periods by including the minimum margin amount as an alternative 
margin component based the price volatility in each member's portfolio 
using observable TBA benchmark prices, using a relatively short 
lookback period.\66\
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    \66\ See FICC Letter at 3.
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    In response to the comments regarding whether the minimum margin 
amount will likely become the predominant calculation for determining a 
member's VaR Charge, the Commission disagrees. For example, the average 
daily VaR Charge increase from February 3, 2020 through June 30, 2020 
would have been approximately $2.2 billion or 42%, but as the model-
based calculation took into account the current market conditions, the 
average daily increase during Q4 of 2020 would have been approximately 
$838 million or 7%.\67\
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    \67\ See FICC Letter at 5. The Commission's conclusion is also 
based upon information that FICC submitted confidentially regarding 
member-level impact of the proposal from February through December 
2020.
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    Finally, in response to the comments regarding concentration 
charges, the Division states that there is a distinction between 
concentration charges and the VaR Charge in that they are generally 
designed to mitigate different risks. Whereas the VaR Charge is 
designed to cover the risk of market price volatility, concentration 
charges are typically designed to mitigate the risk of incurring 
additional market impact cost from liquidating a directionally 
concentrated portfolio.\68\
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    \68\ See Securities Exchange Act Release No. 34-90182 (October 
14, 2020), 85 FR 66630 (October 20, 2020).
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    Accordingly, the Commission believes that adding the minimum margin 
amount to FICC's margin methodology would be consistent with Rules 
17Ad-22(e)(6)(i) and (iii) because this new margin calculation should 
better enable FICC to establish a risk-based margin system that 
considers and produces relevant margin levels commensurate with the 
risks (including potential future exposure) associated with liquidating 
member portfolios in a default scenario, including volatility in the 
TBA market.\69\
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    \69\ 17 CFR 240.17Ad-22(e)(6)(i) and (iii).
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III. 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-FICC-2020-804) and that FICC is authorized to 
implement the proposed change as of the date of this notice or the date 
of an order by the Commission approving proposed rule change SR-FICC-
2020-017, whichever is later.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021-12598 Filed 6-15-21; 8:45 am]
BILLING CODE 8011-01-P