Document ID: SEC-2016-2095-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: National Securities Clearing Corp.
Posted Date: 2016-11-30T05:00Z

[Federal Register Volume 81, Number 230 (Wednesday, November 30, 2016)]
[Notices]
[Pages 86348-86355]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-28771]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79391; File No. SR-NSCC-2016-803]

Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing of Advance Notice To Accelerate Its Trade 
Guaranty, Add New Clearing Fund Components, Enhance Its Intraday Risk 
Management, Provide for Loss Allocation of ``Off-the-Market 
Transactions,'' and Make Other Changes

November 23, 2016.
    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 Act of 2010 (``Clearing 
Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the Securities 
Exchange Act of 1934 (``Act''),\2\ notice is hereby given that on 
October 25, 2016, National Securities Clearing Corporation (``NSCC'' or 
the ``Corporation'') filed with the Securities and Exchange Commission 
(``Commission'') the advance notice SR-NSCC-2016-803 (``Advance 
Notice'') as described in Items I, II and III below, which Items have 
been prepared primarily by the clearing agency.\3\ The Commission is 
publishing this notice to solicit comments on the Advance Notice from 
interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ On October 25, 2016, NSCC filed this Advance Notice as a 
proposed rule change (SR-NSCC-2016-005) with the Commission pursuant 
to Section 19(b)(1) of the Act, 15 U.S.C. 78s(b)(1) and Rule 19b-4, 
17 CFR 240.19b-4. A copy of the proposed rule change is available at 
http://www.dtcc.com/legal/sec-rule-filings.aspx.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    This Advance Notice consists of amendments to NSCC's Rules & 
Procedures (``Rules'') \4\ in order to (i) accelerate NSCC's trade 
guaranty from midnight of one day after trade date (``T+1'') to the 
point of trade comparison and validation for bilateral submissions or 
to the point of trade validation for locked-in submissions, (ii) add 
three new components to the Clearing Fund formula and eliminate the 
current Specified Activity charge from the Clearing Fund formula, (iii) 
amend Procedure II to remove language that permits NSCC to delay 
processing and reporting for certain index receipt transactions, (iv) 
enhance NSCC's current intraday mark-to-market margin process and 
clarify the circumstances and criteria for its intraday risk management 
monitoring and intraday collections of mark-to-market margin, (v) 
introduce a new loss allocation provision for any trades that fall 
within the proposed definition of ``Off-the-Market Transactions'' and 
(vi) make a technical change to Procedure XV to remove the reference to 
ID Net Subscribers, as described below.
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    \4\ Capitalized terms not defined herein are defined in the 
Rules, available at http://dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

    In its filing with the Commission, the clearing agency included 
statements concerning the purpose of and basis for the Advance Notice 
and discussed any comments it received on the Advance Notice. The text 
of these statements may be examined at the places specified in Item IV 
below. The clearing agency has prepared summaries, set forth in 
sections A and B below, of the most significant aspects of such 
statements.

(A) Clearing Agency's Statement on Comments on the Advance Notice 
Received From Members, Participants, or Others

    NSCC has not received any written comments relating to this 
proposed rule change. NSCC will notify the Commission of any written 
comments it receives.

(B) Advance Notice Filed Pursuant to Section 806(e) of the Payment, 
Clearing and Settlement Supervision Act

Description of Change
(i) Accelerate the NSCC Trade Guaranty
    Pursuant to Addendum K of the Rules, NSCC currently guarantees the 
completion of trades that are cleared and settled through NSCC's 
Continuous Net Settlement (``CNS'') \5\ system (``CNS trades'') and 
through its Balance Order Accounting Operation \6\ (``Balance Order 
trades'') that have reached the later of midnight of T+1 or midnight of 
the day they are reported to Members.\7\ NSCC proposes to amend its 
Rules in order to guarantee the completion of CNS trades and Balance 
Order trades upon comparison and validation for bilateral submissions 
to NSCC or upon validation for locked-in submissions to NSCC. 
Validation refers to the process whereby NSCC validates a locked-in 
trade, or compares and validates a bilateral trade, to confirm such 
trade has sufficient and correct information for clearance and 
settlement processing. For purposes of this description in the proposed 
rule change, the process of comparing and validating bilateral 
submissions and the process for validating locked-in submissions are 
collectively referred to as ``trade validation.''
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    \5\ CNS and its operation are described in Rule 11 and Procedure 
VII.
    \6\ The Balance Order Accounting Operation is described in Rule 
5 and Procedure V. NSCC does not become a counterparty to Balance 
Order trades, but it does provide a trade guaranty to the receive 
and deliver parties that remains effective through close of business 
on the originally scheduled settlement date.
    \7\ Today, shortened process trades, such as same-day and next-
day settling trades, are already guaranteed upon comparison or trade 
recording processing.
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    NSCC has previously shortened the time at which its trade guaranty 
applied to trades in response to processing developments and risk 
management considerations and to follow industry settlement cycles.\8\ 
Since implementation of the current trade guaranty policy, the 
marketplace has experienced significant change. The proposed 
accelerated trade guaranty and related proposed changes described 
herein would benefit the industry by mitigating counterparty risk and 
enhancing counterparties' ability to assess that risk by having NSCC 
become the central counterparty to CNS trades and by applying the trade 
guaranty to Balance Order trades at an earlier point in the settlement 
cycle.
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    \8\ See Securities Exchange Act Release Nos. 44648 (August 2, 
2001), 66 FR 42245 (August 10, 2001) (SR-NSCC-2001-11); 35442 (March 
3, 1995), 60 FR 13197 (March 10, 1995) (SR-NSCC-95-02); 35807 (June 
5, 1995), 60 FR 31177 (June 13, 1995) (SR-NSCC-95-03); and 27192 
(August 29, 1989), 54 FR 37010 (approving SR-NSCC-87-04, SR-MCC-87-
03, and SR-SCCP-87-03 until December 31, 1990).
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    The transfer of counterparty credit risk from Members to NSCC at an 
earlier point in the settlement cycle facilitates a shortened holding 
period of bilateral credit risk for counterparties by transferring the 
obligation onto NSCC, which is better equipped to manage that 
counterparty credit risk, including potential systemic impact, compared 
to the counterparties themselves.

[[Page 86349]]

    In order to implement this proposed change, NSCC would amend 
Addendum K of its Rules \9\ to provide that CNS trades and Balance 
Order trades would be guaranteed by NSCC at the point of trade 
validation.\10\
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    \9\ Supra note 4.
    \10\ The proposed accelerated trade guaranty would not apply to 
items not currently guaranteed today.
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    NSCC also proposes to clarify in Addendum K \11\ that the guaranty 
of obligations arising out of the exercise or assignment of options 
that are settled at NSCC is not governed by Addendum K \12\ but by a 
separate arrangement between NSCC and The Options Clearing Corporation, 
as referred to in Procedure III of the Rules.\13\
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    \11\ Supra note 4.
    \12\ Id.
    \13\ Id.
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(ii) Proposed Enhancements to NSCC's Clearing Fund Formula
    In conjunction with accelerating the trade guaranty, NSCC would 
enhance its Clearing Fund formula to address the risks posed by the 
expanded trade guaranty. Specifically, NSCC proposes to amend Procedure 
XV \14\ (Clearing Fund Formula and Other Matters) to include three new 
components: The Margin Requirement Differential (``MRD''), the Coverage 
Component and the Intraday Backtesting Charge.
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    \14\ Id.
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    NSCC also proposes to add to Procedure XV \15\ a description of the 
enhanced intraday mark-to-market component of the Clearing Fund formula 
that clarifies the circumstances and criteria for the assessment of an 
intraday mark-to-market call. In addition, NSCC proposes to delete the 
Specified Activity charge, a component of the Clearing Fund formula 
that mitigates shortened cycle risk (that is, the risk of the trade 
guaranty attaching prior to collection of daily Clearing Fund). This 
charge would no longer be necessary because the MRD would mitigate 
those same risks.
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    \15\ Id.
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    A more detailed description of the foregoing changes follows:
A. The Required Deposit and the Accelerated Trade Guaranty
    NSCC collects Required Deposits from all Members as margin to 
protect NSCC against losses in the event of a Member's default. The 
objective of the Required Deposit is to mitigate potential losses to 
NSCC associated with liquidation of the Member's portfolio if NSCC 
ceases to act for a Member (hereinafter referred to as a ``default''). 
NSCC determines Required Deposit amounts using a risk-based margin 
methodology that is intended to capture market price risk. The 
methodology uses historical market moves to project or forecast the 
potential gains or losses on the liquidation of a defaulting Member's 
portfolio, assuming that a portfolio would take three days to liquidate 
or hedge in normal market conditions. The projected liquidation gains 
or losses are used to determine the Member's Required Deposit, which is 
calculated to cover projected liquidation losses to be at or above a 99 
percent confidence level (the ``Coverage Target''). The aggregate of 
all Members' Required Deposits constitutes NSCC's Clearing Fund, which 
NSCC would be able to access if a defaulting Member's own Required 
Deposit is insufficient to satisfy losses to NSCC caused by the 
liquidation of the Member's portfolio.
    NSCC calculates and collects Required Deposits from Members daily. 
Each Member's daily Required Deposit is calculated based on the end-of-
day positions from the prior day and is generally collected by 10:00 
a.m. ET. NSCC's current trade guaranty does not generally attach to 
trades until midnight of T+1, after Required Deposits reflecting these 
trades have been collected. Therefore, Members' Required Deposits are 
generally sufficient to cover projected liquidation losses for 
guaranteed trades. However, under the accelerated trade guaranty 
proposal, NSCC's trade guaranty would attach to current-day trades 
immediately upon trade validation, before Required Deposits reflecting 
these trades have been collected (which NSCC refers to herein as the 
``coverage gap'').\16\ Therefore, Members' Required Deposits may not be 
sufficient to cover the projected liquidation losses of trades 
guaranteed by NSCC upon trade validation, and NSCC, absent the proposed 
Clearing Fund formula enhancements, could incur a loss associated with 
those trades if it ceases to act for a Member.
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    \16\ The coverage gap is the period between the time that NSCC 
would guarantee a trade and the time that NSCC would collect 
additional margin to cover such trade.
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B. Addition of the MRD to the Clearing Fund Formula
    The MRD is designed to help mitigate the risks posed to the 
Corporation by day-over-day fluctuations in a Member's portfolio by 
forecasting future changes in a Member's portfolio based on a 
historical look-back at each Member's portfolio over a given time 
period. A Member's portfolio may fluctuate significantly from one 
trading day to the next as the Member executes trades throughout the 
day. Currently, daily fluctuations in a Member's portfolio resulting 
from such trades do not pose any additional or different risk to NSCC 
because those trades are not guaranteed by NSCC until a Required 
Deposit reflecting such trades is collected by NSCC. However, under the 
accelerated trade guaranty proposal, trades would be guaranteed by NSCC 
upon trade validation and therefore may result in large un-margined 
intraday portfolio fluctuations during the coverage gap. The MRD would 
increase Members' Required Deposits by an amount calculated to cover 
forecasted fluctuations in Members' portfolios, based upon historical 
activity.
    The MRD would be calculated and charged on a daily basis as a part 
of each Member's Required Deposit and consists of two components: The 
``MRD VaR'' and the ``MRD MTM.'' The MRD VaR looks at historical day-
over-day positive changes in the start of day (``SOD'') volatility 
component of a Member's Required Deposit \17\ (``Volatility Charge'') 
over a 100-day look-back period and would be calculated to equal the 
exponentially weighted moving average (``EWMA'') of such changes to the 
Member's Volatility Charge during the look-back period. The MRD MTM 
looks at historical day-over-day increases to the SOD mark-to-market 
component of a Member's Required Deposit \18\ over a 100-day look-back 
period and would be calculated to equal the EWMA of such changes to the 
Member's SOD mark-to-market component during the look-back period. The 
MRD is calculated to equal the sum of MRD VaR and MRD MTM times a 
multiplier calibrated based on backtesting results. NSCC has determined 
that a 100-day look-back period would provide it with a sufficient time 
series to reflect current market conditions.
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    \17\ The volatility component of the Clearing Fund formula for 
CNS trades and Balance Order trades is described in Procedure XV, 
Sections I.(A)(1)(a) and I.(A)(2)(a), respectively.
    \18\ The SOD mark-to-market component of the Clearing Fund 
formula for CNS trades consists of Regular Mark-to-Market and ID Net 
Mark-to-Market, which are described in Procedure XV, Sections 
I.(A)(1)(b) and I.(A)(1)(c), respectively. The SOD mark-to-market 
component of the Clearing Fund formula for Balance Order trades is 
described in Procedure XV, Section I.(A)(2)(b).
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    By addressing the day-over-day changes to each Member's SOD 
Volatility Charge and SOD mark-to-market component, the MRD would help 
mitigate the risks posed to the Corporation by un-margined day-over-day 
fluctuations to a Member's portfolio resulting from intraday trading 
activity

[[Page 86350]]

that would be guaranteed during the coverage gap.
C. Addition of the Coverage Component to the Clearing Fund Formula
    The ``Coverage Component'' is designed to mitigate the risks 
associated with a Member's Required Deposit being insufficient to cover 
projected liquidation losses to the Coverage Target by adjusting a 
Member's Required Deposit towards the Coverage Target. The Corporation 
would face increased exposure to a Member's un-margined portfolio as a 
result of the proposed accelerated trade guaranty and would have an 
increased need to have each Member's Required Deposit meet the Coverage 
Target. The Coverage Component would supplement the MRD by preemptively 
increasing a Member's Required Deposit in an amount calculated to 
forecast potential deficiencies in the margin coverage of a Member's 
guaranteed portfolio. The preemptive nature of the Coverage Component 
differentiates it from the Regular Backtesting Charge and the Intraday 
Backtesting Charge, both of which are reactive measures to increase the 
Member's Required Deposit to above the Coverage Target.
    The Coverage Component would be calculated and charged on a daily 
basis as a part of each Member's Required Deposit. To calculate the 
Coverage Component, NSCC would compare the simulated liquidation profit 
and loss of a Member's portfolio, using the actual positions in the 
Member's portfolio and the actual historical returns on the security 
positions in the portfolio, against the sum of each of the following 
components of the Clearing Fund formula: The Volatility Charge, the 
MRD, the Illiquid Charge and the Market Maker domination charge 
(collectively, the ``Market Risk Components''), to determine if there 
were any deficiencies between the amounts collected by these components 
and the simulated profit and loss of the Member's portfolio that would 
have been realized had it been liquidated during a 100-day look-back 
period. NSCC would then determine a daily ``peak deficiency'' amount 
for each Member equal to the maximum deficiency over a rolling 10 
business day period for the preceding 100 days. The Coverage Component 
would be calculated to equal the EWMA of the peak deficiencies over the 
100-day look-back period.
    In working to bring each Member's Required Deposit towards the 
Coverage Target by preemptively collecting an amount designed to cover 
projected liquidation profit and loss of a Member's portfolio, 
including the trades guaranteed during the coverage gap, NSCC would 
further mitigate the risks posed to it by the proposed accelerated 
trade guaranty.
D. Addition of the Intraday Backtesting Charge to the Clearing Fund 
Formula
    NSCC employs daily backtesting to determine the adequacy of each 
Member's Required Deposit. NSCC compares the Required Deposit \19\ for 
each Member with the simulated liquidation profit and loss using the 
actual positions in the Member's portfolio and the actual historical 
returns on the security positions in the portfolio. NSCC investigates 
the cause(s) of any backtesting deficiencies. As a part of this 
investigation, NSCC pays particular attention to Members with 
backtesting deficiencies that bring the results for that Member below 
the Coverage Target to determine if there is an identifiable cause of 
repeat backtesting deficiencies. NSCC also evaluates whether multiple 
Members experience backtesting deficiencies for the same underlying 
reason. Upon implementation of the accelerated trade guaranty, NSCC 
would employ a similar backtesting process on an intraday basis to 
determine the adequacy of each Member's Required Deposit. However, 
instead of backtesting a Member's Required Deposit against the Member's 
SOD portfolio, NSCC would use portfolios from two intraday time 
slices.\20\
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    \19\ For backtesting comparisons, NSCC uses the Required Deposit 
amount without regard to the actual collateral posted by the Member.
    \20\ Intraday time slices are subject to change based upon 
market conditions and would include the positions from SOD plus any 
additional positions up to that time.
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1. Calculation of the Intraday Backtesting Charge
    The objective of the Intraday Backtesting Charge is to increase 
Required Deposits for Members that are likely to experience intraday 
backtesting deficiencies on the basis described above by an amount 
sufficient to maintain such Member's intraday backtesting coverage 
above the Coverage Target. Members that maintain consistent end of day 
positions but have a high level of intraday trading activity pose risk 
to NSCC if they were to default intraday.
    Because the intraday trading activity and size of the intraday 
backtesting deficiencies vary among impacted Members, NSCC must assess 
an Intraday Backtesting Charge that is specific to each impacted 
Member. To do so, NSCC examines each impacted Member's historical 
intraday backtesting deficiencies observed over the prior 12-month 
period to identify the five largest intraday backtesting deficiencies 
that have occurred during that time. The presumptive Intraday 
Backtesting Charge amount would equal that Member's fifth largest 
historical intraday backtesting deficiency, subject to adjustment as 
further described below. NSCC believes that applying an additional 
margin charge equal to the fifth largest historical intraday 
backtesting deficiency to a Member's Required Deposit would have 
brought the Member's historically observed intraday backtesting 
coverage above the Coverage Target.\21\
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    \21\ Intraday backtesting would include 500 observations per 
year (twice per day over 250 observation days). Each occurrence of a 
backtesting deficiency would reduce a Member's overall backtesting 
coverage by 0.2 percent (1 exception/500 observations). Accordingly, 
an Intraday Backtesting Charge equal to the fifth largest 
backtesting deficiency would have brought backtesting coverage up to 
99.2 percent.
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    The Intraday Backtesting Charge would only be applicable to those 
Members whose overall 12-month trailing intraday backtesting coverage 
falls below the Coverage Target.
    Although the fifth largest historical backtesting deficiency for a 
Member would be used as the Intraday Backtesting Charge in most cases, 
NSCC would retain discretion to adjust the charge amount based on other 
circumstances that might be relevant for assessing whether an impacted 
Member is likely to experience future backtesting deficiencies and the 
estimated size of such deficiencies. Examples of relevant circumstances 
that could be considered by NSCC in calculating the final, applicable 
Intraday Backtesting Charge amount include material differences among 
the Member's five largest intraday backtesting deficiencies observed 
over the prior 12-month period, variability in the net settlement 
activity after the collection of the Member's Required Deposit and 
observed market price volatility in excess of the Member's historical 
Volatility Charge. Based on NSCC's assessment of the impact of these 
circumstances on the likelihood, and estimated size, of future intraday 
backtesting deficiencies for a Member, NSCC may, in its discretion, 
adjust the Intraday Backtesting Charge for such Member in an amount 
that NSCC determines to be more appropriate for maintaining such 
Member's intraday backtesting results above the Coverage Target.
    The resulting Intraday Backtesting Charge would be added to the 
Required

[[Page 86351]]

Deposit for such Member and would be imposed on a daily basis for a 
one-month period.
    In order to differentiate the Backtesting Charge assessed on the 
start of the day portfolio from the Backtesting Charge assessed on an 
intraday basis, NSCC would amend the Rules by adding a defined term 
``Regular Backtesting Charge'' to Procedure XV, Section I.(B)(3).\22\
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    \22\ Supra note 4.
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2. Communication With Members and Imposition of the Intraday 
Backtesting Charge
    If NSCC determines that an Intraday Backtesting Charge should apply 
to a Member who was not assessed an Intraday Backtesting Charge during 
the immediately preceding month or that the Intraday Backtesting Charge 
applied to a Member during the previous month should be increased, NSCC 
would notify the Member on or around the 25th calendar day of the month 
prior to the assessment of the Intraday Backtesting Charge or prior to 
the increase to the Intraday Backtesting Charge, as applicable, if not 
earlier.
    NSCC would impose the Intraday Backtesting Charge as an additional 
charge applied to each impacted Member's Required Deposit on a daily 
basis for a one-month period and would review each applied Intraday 
Backtesting Charge each month. If an impacted Member's trailing 12-
month intraday backtesting coverage exceeds the Coverage Target 
(without taking into account historically imposed Intraday Backtesting 
Charges), the Intraday Backtesting Charge would be removed.
E. Removal of the Specified Activity Charge From the Clearing Fund 
Formula
    Currently, NSCC collects a Specified Activity charge, which is 
designed to cover the risk posed to NSCC by transactions that settle on 
a shortened cycle.\23\ Such transactions pose an increased risk to NSCC 
because these trades settle on a shortened settlement cycle and may be 
guaranteed by NSCC prior to the collection of margin on them. The 
Specified Activity charge currently mitigates this risk by increasing 
the Required Deposit for a Member in relation to the number of 
Specified Activity trades submitted by the Member to NSCC over a 100-
day look-back period. However, the risk posed to NSCC by Specified 
Activity would no longer be unique to such trade activity--the proposed 
accelerated trade guaranty would result in a similar risk to NSCC. The 
addition of the MRD and Coverage Components to the Clearing Fund 
formula would mitigate the risks posed by trades guaranteed by NSCC 
prior to the collection of margin on those trades. As a result, NSCC 
proposes to eliminate the Specified Activity charge because imposing a 
separate Specified Activity charge would no longer be necessary once 
the MRD and Coverage Components are added to the Clearing Fund formula.
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    \23\ Examples of these trades can include next day settling 
trades, same day settling trades, cash trades or sellers' options.
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F. Enhanced Intraday Mark-to-Market Margining
    NSCC proposes to enhance its current intraday margining to further 
mitigate the intraday coverage gap risk that may be introduced to the 
Corporation as a result of the proposed accelerated trade guaranty. By 
way of background, NSCC currently collects a SOD mark-to-market margin, 
which is designed to mitigate the risk arising out of the value change 
between the contract/settlement value of a Member's open positions and 
the current market value, as part of its Clearing Fund formula. A 
Member's SOD mark-to-market margin is calculated and collected as part 
of a Member's daily Required Deposit based on the Member's prior end-
of-day positions. The SOD mark-to-market component of the daily 
Required Deposit is calculated to cover a Member's exposure due to 
market moves and/or trading and settlement activity by bringing the 
portfolio of open positions up to the current market value. However, 
because the SOD mark-to-market component is calculated only once daily 
using the prior end-of-day positions and prices, it will not cover a 
Member's exposure arising out of any intraday changes to position and 
market value in a Member's portfolio. Accordingly, NSCC currently 
collects intraday mark-to-market margin from Members to cover 
additional risk exposure arising out of intraday position and market 
value changes to the Member's portfolio if the additional risks are 
sufficiently large to warrant the collection of an intraday margin.
    NSCC has determined that it is not necessary to collect intraday 
margin from every Member that experiences an intraday mark-to-market 
change because the Volatility Charge already collected as part of 
Members' daily Required Deposits is calculated to cover projected 
changes in the contract/settlement value of a Member's portfolio and 
likely cover intraday changes to a Member's portfolio. However, in 
certain instances, Members may have intraday mark-to-market changes 
that are significant enough that NSCC is exposed to an increased risk 
of loss as a result of such Member's intraday activities. In 
particular, NSCC measures each Member's intraday mark-to-market 
exposure against the Volatility Charge. NSCC collects an intraday mark-
to-market amount from any Member that has an intraday mark-to-market 
exposure that meets or exceeds a threshold percentage as compared to 
the Member's Volatility Charge. NSCC believes that such Members pose an 
increased risk of loss to the Corporation because the coverage provided 
by the Volatility Charge, which is designed to cover estimated losses 
to a portfolio over a specified time period, would be exhausted by an 
intraday mark-to-market exposure so large that the Member's Required 
Deposit would potentially be unable to absorb further intraday losses 
to the Member's portfolio.
    In order to further mitigate the risk posed to NSCC by the proposed 
accelerated trade guaranty, NSCC is proposing to enhance its collection 
of intraday mark-to-market margin. NSCC would impose the intraday mark-
to-market margin amount at a lower threshold. Currently, NSCC makes an 
intraday mark-to-market margin call if a Member's intraday mark-to-
market exposure meets or exceeds 100 percent of such Member's 
Volatility Charge; however, such threshold may be reduced by NSCC 
during volatile market conditions. With this proposal, NSCC would make 
an intraday margin call if a Member's intraday mark-to-market exposure 
meets or exceeds 80 percent of such Member's Volatility Charge, where 
such threshold may still be reduced by NSCC during volatile market 
conditions. This proposed change would serve to collect intraday margin 
earlier and more proactively preserve the coverage provided by a 
Member's Volatility Charge and Required Deposit.
    In addition, NSCC would monitor intraday changes to Member's mark-
to-market exposure at regular intervals to further mitigate the risk 
posed to NSCC by the accelerated trade guaranty. By doing so, NSCC 
would be able to make intraday margin calls more frequently to those 
Members whose intraday mark-to-market exposures exceed the Volatility 
Charge threshold. Enhancing the collection of the intraday mark-to-
market amount so that it occurs earlier and more frequently would allow 
NSCC to reduce the amount of uncovered risk during the coverage gap and 
would therefore further mitigate the risk posed to the Corporation by 
the accelerated trade guaranty.
    NSCC proposes to amend Procedure XV to include a description of the

[[Page 86352]]

enhanced intraday mark-to-market margin charge that clarifies the 
circumstances and criteria for the assessment of an intraday mark-to-
market call. This would ensure that Members are aware that the 
Corporation regularly monitors and considers intraday mark-to-market as 
part of its regular Clearing Fund formula.
G. Adjustments to the Calculation of the Excess Capital Premium 
Component
    The Excess Capital Premium \24\ is designed to address spikes in a 
Member's Required Deposit based upon any one day of activity. It is not 
designed to provide additional Required Deposits over an extended 
period of time. Currently, the Excess Capital Premium for a Member is 
calculated based upon the Member's Clearing Fund Required Deposit and 
the Member's excess net capital. With the addition of the MRD and the 
Coverage Component, NSCC proposes to exclude these charges from the 
calculation of the Excess Capital Premium. The MRD and the Coverage 
Component all utilize a historical look-back period, which accounts for 
the risk of such activity well after the relevant trades have settled. 
Risks related to such trades would be reflected in increased amounts 
assessed for these components over the subsequent time periods. If 
these components are included in the calculation of the Excess Capital 
Premium, especially during periods following an increase in activity, 
then the increased MRD and Coverage Component could lead to more 
frequent Excess Capital Premium charges over an extended period of 
time. This is not the intended purpose of the Excess Capital Premium 
and could place an unnecessary burden on Members.
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    \24\ The Excess Capital Premium is a charge imposed on a Member 
when the Member's Required Deposit exceeds its excess net capital, 
as described in Procedure XV.
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(iii) Proposed Changes to Procedure II (Trade Comparison and Recording 
Service)
    Next day settling index receipts may be guaranteed prior to the 
collection of margin reflecting such trades and thus carry a very 
similar risk as Specified Activity trades described above. More 
specifically, because these trades are settled on the day after they 
are received and validated by NSCC, NSCC currently attaches its 
guaranty to them at the time of validation, prior to the collection of 
a Required Deposit that reflects such trades. Unlike the risk from 
Specified Activity trades, which is mitigated by the Specified Activity 
charge, the risk for next day settling index receipts is currently 
mitigated by permitting NSCC to delay the processing and reporting of 
these trades if a Member's Required Deposit is not paid on time. 
However, like the risk associated with Specified Activity, under the 
proposed rule change, this risk would generally be mitigated by the 
addition of the MRD and the Coverage Component. Therefore, NSCC 
proposes to amend Procedure II \25\ (Trade Comparison and Recording 
Service) to remove the language that permits NSCC to delay the 
processing and reporting of next day settling index receipts until the 
applicable margin on these transactions is paid.
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    \25\ Supra note 4.
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(iv) Loss Allocation Provision for Off-the-Market Transactions
    NSCC proposes to introduce a new loss allocation provision for any 
trades that fall within the proposed definition of ``Off-the-Market 
Transactions'' in order to limit NSCC's exposure to certain trades that 
have a price that differs significantly from the prevailing market 
price for the underlying security at the time the trade is executed. 
This provision would apply in the event that NSCC ceases to act for a 
Member that engaged in Off-the-Market Transactions and only to the 
extent that NSCC incurs a net loss in the liquidation of such 
Transactions.\26\
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    \26\ A net loss on liquidation of the Off-the-Market Transaction 
means that the loss on liquidation of the Member's portfolio exceeds 
the collected Required Deposit of the Member and such loss is 
attributed to the Off-the-Market Transaction. Such loss would be 
allocated directly and entirely to the Member that submitted the 
Off-the-Market Transaction, or on whose behalf the Off-the-Market 
Transaction was submitted, to NSCC; however, no allocation would be 
made if such Member has satisfied all applicable intraday mark-to-
market margin charges assessed by NSCC with respect to the Off-the-
Market Transaction.
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    NSCC would define ``Off-the-Market Transactions'' as either a 
single transaction or a series of transactions settled within the same 
cycle with greater than $1 million in gross proceeds and either higher 
or lower than the most recently observed market price by a percentage 
amount based on market conditions and factors that impact trading 
behavior of the underlying security, including volatility, liquidity 
and other characteristics of such security.
    The proposed rule change would establish the loss allocation for 
Off-the-Market Transactions. NSCC would allocate any losses to NSCC 
resulting from the liquidation of any guaranteed, open Off-the-Market 
Transaction of a defaulted Member directly and entirely to the 
surviving counterparty to that transaction. Losses would be allocated 
to counterparties in proportion to their specific Off-the-Market 
Transaction gain and would be allocated only to the extent of NSCC's 
loss; however, no allocation shall be made if the defaulted Member has 
satisfied all requisite intraday mark-to-market margin assessed by NSCC 
with respect to the Off-the-Market Transaction.\27\
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    \27\ A Member's Off-the-Market Transaction that has been marked 
to market is, by definition, no longer an Off-the-Market Transaction 
when the mark-to-market component of the Member's Required Deposit 
is satisfied.
---------------------------------------------------------------------------

    This proposed change would allow NSCC to mitigate the risk of loss 
associated with guaranteeing these Off-the-Market Transactions. The 
proposal recognizes that applying the accelerated trade guaranty to 
transactions whose price significantly differs from the most recently 
observed market price could inappropriately increase the loss that NSCC 
may incur if a Member that has engaged in Off-the-Market Transactions 
defaults and its open, guaranteed positions are liquidated. Members not 
involved in Off-the-Market Transactions, or not involved in Off-the-
Market Transactions that result in losses to NSCC, would not be 
included in this process. This exclusion would apply only to losses 
that are attributable to Off-the-Market Transactions and would not 
exclude Members from other obligations that may result from any loss or 
liabilities incurred by NSCC from a Member default.
    In order to implement this proposed change, NSCC would amend Rule 4 
\28\ (Clearing Fund) to provide that, if a loss or liability of NSCC is 
determined by NSCC to arise in connection with the liquidation of any 
Off-the-Market Transactions, such loss or liability would be allocated 
directly to the surviving counterparty to the Off-the-Market 
Transaction that submitted the transaction to NSCC for clearing. NSCC 
would also amend Rule 1 \29\ (Definitions and Descriptions) to include 
a definition of Off-the-Market Transactions.
---------------------------------------------------------------------------

    \28\ Supra note 4.
    \29\ Id.
---------------------------------------------------------------------------

(v) Technical Proposed Rule Change
    NSCC is proposing a change to Procedure XV \30\ to clarify the 
calculation of the Regular Mark-to-Market component for CNS 
transactions. NSCC's historical and current policy for the calculation 
of any mark-to-market component of the Clearing Fund calculation for 
CNS trades and Balance Order trades is that where a credit is derived 
from a Member's mark-to-

[[Page 86353]]

market calculation, the value of the calculation is adjusted to zero. 
When NSCC implemented the ID Net service,\31\ a provision was added to 
Procedure XV \32\ that explicitly stated this policy as it relates to 
CNS transactions of subscribers to the ID Net service. This change 
inadvertently created an implication that the calculation of Regular 
Mark-to-Market credit for Members who were not ID Net Subscribers would 
not be set to zero. NSCC is proposing to revise the applicable 
provision to remove the reference to ID Net Subscribers.
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    \30\ Id.
    \31\ NSCC's ID Net service is defined further in Rule 65. Rules, 
supra note 4. See Securities Exchange Act Release No. 57901 (June 2, 
2008), 73 FR 32373 (June 6, 2008) (SR-NSCC-2007-14).
    \32\ Supra note 4.
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Expected Effect on Risks to the Clearing Agency, Its Participants and 
the Market
    The proposed rule changes would mitigate Member's counterparty 
risks and would enhance Members' ability to assess that risk by having 
NSCC become the central counterparty to CNS trades and by applying the 
trade guaranty to Balance Order trades at an earlier point in the 
settlement cycle.
    Although the transfer of counterparty credit risk from Members to 
NSCC at an earlier point in the settlement cycle facilitates a 
shortened holding period of bilateral credit risk for the Members, it 
does increase risk to NSCC. However, as discussed below, NSCC believes 
that it is better equipped to manage that counterparty credit risk, 
including potential systemic impact, compared to the counterparties 
themselves.
Management of Identified Risks
    The proposal is designed to mitigate counterparty risk while still 
protecting NSCC and its membership.
    The proposed rule changes to (i) add the new components to the 
Clearing Fund formula and (ii) enhance the intraday mark-to-market 
margin process would allow NSCC to appropriately collect additional 
margin to mitigate the exposure presented to NSCC by the accelerated 
trade guaranty. The proposal to introduce a new loss allocation 
provision for Off-the-Market Transactions would help NSCC to limit its 
exposure to Off-the-Market Transactions.
    Specifically, the proposal to add the MRD, the Coverage Component 
and the Intraday Backtesting Charge to the Clearing Fund formula and to 
collect intraday mark-to-market margin at a lower threshold would 
mitigate the exposure presented to NSCC by the accelerated trade 
guaranty and permit NSCC to enhance its margin requirements to better 
limit its credit exposures to participants under normal market 
conditions.
    In addition, NSCC's proposal to expand its current intraday margin 
collection to include (a) the collection of intraday mark-to-market 
margin at a lower threshold and (b) the collection of the Intraday 
Backtesting Charge would further enhance its intraday monitoring and 
its ability to measure credit exposures at least once a day.
    Similarly, the proposed rule changes to introduce a new loss 
allocation provision for any trades that fall within the proposed 
definition of Off-the-Market Transactions would help NSCC to limit its 
exposure to certain trades that have a price that differs significantly 
from the most recently observed market price for the underlying 
security. Therefore, the reduction of NSCC's exposure to Off-the-Market 
Transactions would assist NSCC in responding to a Member default and 
would minimize potential losses to NSCC and its non-defaulting Members.
    NSCC has also taken actions outside of the proposals described in 
this filing to strengthen its liquidity resources and to enable it to 
cover its total liquidity needs, including any liquidity needs that 
would arise from the accelerated trade guaranty. NSCC calculates its 
liquidity need by assuming the failure of the Member (including the 
simultaneous default of the Member's affiliated family) that has the 
largest net settlement debit in extreme but plausible market 
conditions.\33\ Although the proposal would increase the number of days 
for which NSCC would be required, under its Rules, to guarantee 
settlement to include T and T+1 trades, the Rules currently provide 
that it may, although it is not legally obligated to, optionally 
guarantee these trades. Given NSCC's role in promoting safety, 
soundness and stability in the U.S. equities markets, NSCC currently 
includes these trades in its daily liquidity need analyses to account 
for the circumstances where this optional guaranty would be called 
upon. NSCC has never actually experienced a liquidity shortfall in the 
close out of a defaulted Member.
---------------------------------------------------------------------------

    \33\ Every day NSCC measures the liquidity obligations of each 
of NSCC's Members by taking the sum of their purchase obligations on 
that day from CNS and for the following three settlement days, and 
then, taking into account certain adjustments, assumptions and 
offsets, NSCC identifies the largest Member liquidity need on each 
day and, determines if the available liquidity resources are 
adequate to cover that largest liquidity need or if there is a 
projected liquidity shortfall.
---------------------------------------------------------------------------

    NSCC measures the potential liquidity impact of the accelerated 
trade guaranty on a daily basis. NSCC has enhanced its liquidity 
resources through the implementation of NSCC's supplemental liquidity 
deposit (``SLD'') requirements.\34\ NSCC's SLD requirements were 
designed to require Members with historically elevated options activity 
to provide supplemental liquidity deposits in advance of and in 
anticipation of options expiry periods, as well as to accept voluntary 
pre-funded supplemental liquidity deposits from other Members who 
anticipate elevated liquidity needs during these periods. As such, the 
SLD requirements provide NSCC with the needed liquidity resources to 
address any liquidity shortfalls that may be experienced under the 
accelerated trade guaranty settlement cycle. Furthermore, NSCC has 
established a liquidity program to raise prefunded liquidity through 
the issuance and private placement of short-term, unsecured notes 
(``Prefunded Liquidity Program''), which may consist of a combination 
of commercial paper notes and extendible notes.\35\ Proceeds from the 
Prefunded Liquidity Program further supplement NSCC's existing default 
liquidity risk management resources.
---------------------------------------------------------------------------

    \34\ Securities Exchange Act Release No. 70999 (December 5, 
2013), 78 FR 75413 (December 11, 2013) (SR-NSCC-2013-02).
    \35\ Securities Exchange Act Release No. 75730 (August 19, 
2015), 80 FR 51638 (August 25, 2015) (SR-NSCC-2015-802).
---------------------------------------------------------------------------

Consistency With the Clearing Supervision Act
    The objectives and principles of the Clearing Supervision Act are 
to promote robust risk management, promote safety and soundness, reduce 
systemic risks, and support the stability of the broader financial 
system.\36\
---------------------------------------------------------------------------

    \36\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

    The proposal to accelerate the time that NSCC's trade guaranty 
attaches to trades submitted to it for clearing has been designed to 
promote robust risk management, promote safety and soundness, reduce 
systemic risks and support the stability of the broader financial 
system in furtherance of the Clearing Supervision Act.
    Specifically, NSCC would provide a trade guaranty to CNS trades and 
Balance Order trades at an earlier point in the settlement cycle. The 
proposed rule changes would mitigate counterparty risk and would 
enhance NSCC Members' ability to assess that risk by having NSCC become 
the central counterparty to CNS trades and by applying the trade 
guaranty to Balance Order trades at an earlier point in the settlement 
cycle. The transfer of

[[Page 86354]]

counterparty credit risk from Members to NSCC at an earlier point in 
the settlement cycle facilitates a shortened holding period of 
bilateral credit risk for the counterparties by transferring the 
obligation onto NSCC, which is better equipped to manage that 
counterparty credit risk, including potential systemic impact, compared 
to the counterparties themselves. Therefore, NSCC believes the proposal 
to accelerate the trade guaranty would promote robust risk management, 
promote safety and soundness, reduce systemic risks and support the 
stability of the broader financial system, consistent with the 
objectives and principles of Section 805(b) of the Clearing Supervision 
Act cited above.
    The proposed rule changes to enhance the Clearing Fund formula and 
to introduce a new loss allocation provision for Off-the-Market 
Transactions have been designed to promote robust risk management and 
promote safety and soundness in furtherance of the Clearing Supervision 
Act. In conjunction with the enhanced trade processing in the form of 
the accelerated trade guaranty, the proposed additional Clearing Fund 
components and enhancements to NSCC's current intraday mark-to-market 
margin process would allow NSCC to appropriately manage its risk by 
collecting additional margin to mitigate the exposure presented to NSCC 
by the accelerated trade guaranty. Additionally, the proposal to 
introduce a new loss allocation provision for any trades that fall 
within a proposed definition of ``Off-the-Market Transactions'' would 
help NSCC to limit its exposure to certain trades that have a price 
that differs significantly from the most recently observed market price 
for the underlying security. Together, the collection of additional 
margin and the reduction of NSCC's exposures to ``Off-the-Market 
Transactions'' would assist NSCC in responding to a Member default and 
would minimize potential losses to NSCC and its non-defaulting Members. 
Therefore, NSCC believes the proposed enhancements to the Clearing Fund 
formula and the introduction of an Off-the-Market Transaction 
allocation process would also promote robust risk management and 
promote safety and soundness, consistent with objectives and principles 
of Section 805(b) of the Clearing Supervision Act, cited above.
    NSCC believes that the proposal is also consistent with Rules 17Ad-
22(b)(1) and (b)(2), promulgated under the Act. Rule 17Ad-22(b)(1) 
requires NSCC to establish, implement, maintain and enforce written 
policies and procedures reasonably designed to measure its credit 
exposures to its participants at least once a day and limit its 
exposures to potential losses from defaults by its participants under 
normal market conditions so that the operations of NSCC would not be 
disrupted and non-defaulting participants would not be exposed to 
losses that they cannot anticipate or control.\37\ NSCC's proposal to 
expand its current intraday margin collection to include (a) the 
collection of intraday mark-to-market margin at a lower threshold and 
(b) the collection of the Intraday Backtesting Charge would further 
enhance its intraday monitoring and its ability to measure credit 
exposures at least once a day. The proposal to enhance the amount of 
margin collected from each Member would help NSCC to limit its exposure 
to potential losses from defaults by its participants under normal 
market conditions and reduce risk of loss mutualization to the NSCC 
membership. Similarly, the proposal to introduce a new loss allocation 
provision for Off-the-Market Transactions would also help NSCC to limit 
its exposure to potential losses from defaults by its participants 
under normal market conditions. Therefore, NSCC believes the proposals 
are consistent with the requirements of Rule 17Ad-22(b)(1), promulgated 
under the Act, cited above.
---------------------------------------------------------------------------

    \37\ 17 CFR 240.17Ad-22(b)(1).
---------------------------------------------------------------------------

    Rule 17Ad-22(b)(2) requires NSCC to establish, implement, maintain 
and enforce written policies and procedures reasonably designed to 
``use margin requirements to limit its credit exposures to participants 
under normal market conditions and use risk-based models and parameters 
to set margin requirements.'' \38\ The proposal to add the MRD, the 
Coverage Component and the Intraday Backtesting Charge to the Clearing 
Fund formula and to collect intraday mark-to-market margin at a lower 
threshold in order to mitigate the exposure presented to NSCC by the 
accelerated trade guaranty would enable NSCC to enhance its margin 
requirements to better limit its credit exposures to participants under 
normal market conditions. Therefore, NSCC believes the proposed changes 
are consistent with the requirements of Rule 17Ad-22(b)(2), promulgated 
under the Act, cited above.
---------------------------------------------------------------------------

    \38\ 17 CFR 240.17Ad-22(b)(2).
---------------------------------------------------------------------------

    The proposed changes to NSCC's Clearing Fund formula and the 
intraday margin process are also designed to be consistent with Rules 
17Ad-22(e)(4) and (e)(6) of the Act, which were recently adopted by the 
Commission.\39\ Rule 17Ad-22(e)(4) will require NSCC to 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 exposures arising 
from its payment, clearing, and settlement processes.\40\ NSCC's 
proposal to expand its current intraday margin collection to include 
(a) the collection of intraday mark-to-market margin at a lower 
threshold and (b) the collection of the Intraday Backtesting Charge 
would enhance its ability to identify, measure, monitor and manage its 
credit exposures to participants. The proposal to enhance the amount of 
margin NSCC collected from each Member and to introduce a new loss 
allocation provision for Off-the-Market Transactions would further help 
NSCC to manage its credit exposures to participants and those exposures 
arising from its payment, clearing, and settlement processes. 
Therefore, NSCC believes these proposals are consistent with the 
requirements of Rule 17Ad-22(e)(4), promulgated under the Act, cited 
above.
---------------------------------------------------------------------------

    \39\ The Commission adopted amendments to Rule 17Ad-22, 
including the addition of new section 17Ad-22(e), on September 28, 
2016. See Securities Exchange Act Release No. 78961 (September 28, 
2016), 81 FR 70786 (October 13, 2016) (S7-03-14). The amendments to 
Rule 17Ad-22 become effective on December 12, 2016. Id. NSCC is a 
``covered clearing agency'' as defined in Rule 17Ad-22(a)(5) and 
must comply with new section (e) of Rule 17Ad-22 by April 11, 2017. 
Id.
    \40\ See Securities Exchange Act Release No. 78961 (September 
28, 2016), 81 FR 70786 (October 13, 2016) (S7-03-14).
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(6) will require NSCC 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 is monitored by management 
on an ongoing basis and regularly reviewed, tested, and verified.\41\ 
The proposal to add the MRD, the Coverage Component and the Intraday 
Backtesting Charge to the Clearing Fund formula and to collect intraday 
mark-to-market margin at a lower threshold would help NSCC to cover its 
credit exposures to its participants by establishing a risk-based 
margin system that is monitored by management on an ongoing basis and 
regularly reviewed, tested, and verified. Therefore, NSCC believes this 
proposal is consistent with the requirements of Rule 17Ad-22(e)(6), 
promulgated under the Act, cited above.
---------------------------------------------------------------------------

    \41\ Id.

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[[Page 86355]]

Implementation Timeframe
    Pending Commission approval, Members would be advised of the 
implementation date of this proposal through issuance of an NSCC 
Important Notice. NSCC expects to run the proposed changes in a test 
environment for a parallel period of at least three months prior to 
implementation. Details and dates regarding such test period would be 
communicated to Members through an NSCC Important Notice.

III. Date of Effectiveness of the Advance Notice, and Timing for 
Commission Action

    The proposed change may be implemented if the Commission does not 
object to the proposed change within 60 days of the later of (i) the 
date that the proposed change was filed with the Commission or (ii) the 
date that any additional information requested by the Commission is 
received. The clearing agency shall not implement the proposed change 
if the Commission has any objection to the proposed change.
    The Commission may extend the period for review by an additional 60 
days if the proposed change raises novel or complex issues, subject to 
the Commission providing the clearing agency with prompt written notice 
of the extension. A proposed change may be implemented in less than 60 
days from the date the advance notice is filed, or the date further 
information requested by the Commission is received, if the Commission 
notifies the clearing agency in writing that it does not object to the 
proposed change and authorizes the clearing agency to implement the 
proposed change on an earlier date, subject to any conditions imposed 
by the Commission.
    The clearing agency shall post notice on its Web site of proposed 
changes that are implemented.
    The proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the Advance 
Notice is consistent with the Clearing Supervision Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-NSCC-2016-803 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549.

All submissions should refer to File Number SR-NSCC-2016-803. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the Advance Notice that are filed 
with the Commission, and all written communications relating to the 
Advance Notice between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for Web site viewing and printing in 
the Commission's Public Reference Room, 100 F Street NE., Washington, 
DC 20549 on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of the filing also will be available for inspection 
and copying at the principal office of NSCC and on DTCC's Web site 
(http://dtcc.com/legal/sec-rule-filings.aspx). All comments received 
will be posted without change; the Commission does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-NSCC-2016-803 and should be submitted on 
or before December 15, 2016.

    By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2016-28771 Filed 11-29-16; 8:45 am]
 BILLING CODE 8011-01-P