Document ID: SEC-2020-1414-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: National Securities Clearing Corp.
Posted Date: 2020-09-04T04:00Z

[Federal Register Volume 85, Number 173 (Friday, September 4, 2020)]
[Notices]
[Pages 55332-55337]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-19656]

[[Page 55332]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-89719; File No. SR-NSCC-2020-804]

Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing of Advance Notice, as Modified by 
Amendment No. 1, To Introduce the Margin Liquidity Adjustment Charge 
and Include a Bid-Ask Risk Charge in the VaR Charge

September 1, 2020.
    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 July 
30, 2020, National Securities Clearing Corporation (``NSCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
advance notice SR-NSCC-2020-804. On August 13, 2020, NSCC filed 
Amendment No. 1 to the advance notice, to make clarifications and 
corrections to the advance notice.\3\ The advance notice, as modified 
by Amendment No. 1 (hereinafter, the ``Advance Notice''), is described 
in Items I, II and III below, which Items have been prepared by the 
clearing agency.\4\ 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\ Amendment No. 1 made clarifications and corrections to the 
description of the advance notice and Exhibits 3 and 5 of the 
filing, and these clarifications and corrections have been 
incorporated, as appropriate, into the description of the advance 
notice in Item I below.
    \4\ On July 30, 2020, NSCC filed this Advance Notice as a 
proposed rule change (SR-NSCC-2020-016) with the Commission pursuant 
to Section 19(b)(1) of the Act, 15 U.S.C. 78s(b)(1), and Rule 19b-4 
thereunder, 17 CFR 240.19b-4. On August 13, 2020, NSCC filed 
Amendment No. 1 to the proposed rule change to make similar 
clarifications and corrections to the proposed rule change. A copy 
of the proposed rule change, as modified by Amendment No. 1, 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 modifications to NSCC's Rules & 
Procedures (``Rules'') to (1) introduce a new component of the Clearing 
Fund, the Margin Liquidity Adjustment (``MLA'') charge, and (2) enhance 
the calculation of the volatility component of the Clearing Fund 
formula that utilizes a parametric Value-at-Risk (``VaR'') model 
(defined for purposes of this filing as the ``VaR Charge,'' and 
described in more detail in Item II(B)(i) below) by including a bid-ask 
spread risk charge, as described in greater detail below.\5\
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    \5\ 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 or solicited any written comments relating to 
this proposal. NSCC will notify the Commission of any written comments 
received by NSCC.

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

Description of Proposed Change
    NSCC is proposing to enhance its Clearing Fund methodology by (1) 
introducing a new component, the MLA charge, which would be calculated 
to address the risk presented to NSCC when a Member's portfolio 
contains large Net Unsettled Positions \6\ in a particular group of 
securities with a similar risk profile or in a particular asset type 
(referred to as ``asset groups''), and (2) enhancing the calculation of 
the VaR Charge by including a bid-ask spread risk charge, as described 
in more detail below.\7\
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    \6\ ``Net Unsettled Positions'' and ``Net Balance Order 
Unsettled Positions'' refer to net positions that have not yet 
passed their settlement date or did not settle on their settlement 
date, and are referred to collectively in this filing as Net 
Unsettled Positions. See Procedure XV (Clearing Fund Formula and 
Other Matters) of the Rules, id.
    \7\ The results of a study of the potential impact of adopting 
the proposed changes have been provided to the Commission.
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(i) Overview of the Required Fund Deposit and NSCC's Clearing Fund
    As part of its market risk management strategy, NSCC manages its 
credit exposure to Members by determining the appropriate Required Fund 
Deposits to the Clearing Fund and monitoring its sufficiency, as 
provided for in the Rules.\8\ The Required Fund Deposit serves as each 
Member's margin.
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    \8\ See Rule 4 (Clearing Fund) and Procedure XV (Clearing Fund 
Formula and Other Matters), supra note 4. NSCC's market risk 
management strategy is designed to comply with Rule 17Ad-22(e)(4) 
under the Act, where these risks are referred to as ``credit 
risks.'' 17 CFR 240.17Ad-22(e)(4).
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    The objective of a Member's Required Fund Deposit is to mitigate 
potential losses to NSCC associated with liquidating a Member's 
portfolio in the event NSCC ceases to act for that Member (hereinafter 
referred to as a ``default'').\9\ The aggregate of all Members' 
Required Fund Deposits constitutes the Clearing Fund of NSCC. NSCC 
would access its Clearing Fund should a defaulting Member's own 
Required Fund Deposit be insufficient to satisfy losses to NSCC caused 
by the liquidation of that Member's portfolio.
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    \9\ The Rules identify when NSCC may cease to act for a Member 
and the types of actions NSCC may take. For example, NSCC may 
suspend a firm's membership with NSCC or prohibit or limit a 
Member's access to NSCC's services in the event that Member defaults 
on a financial or other obligation to NSCC. See Rule 46 
(Restrictions on Access to Services) of the Rules, supra note 4.
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    Pursuant to the Rules, each Member's Required Fund Deposit amount 
consists of a number of applicable components, each of which is 
calculated to address specific risks faced by NSCC, as identified 
within Procedure XV of the Rules.\10\ The volatility component of each 
Member's Required Fund Deposit is designed to measure market price 
volatility and is calculated for Members' Net Unsettled Positions. The 
volatility component is designed to capture the market price risk 
associated with each Member's portfolio at a 99th percentile level of 
confidence. The VaR Charge is the volatility component applicable to 
most Net Unsettled Positions,\11\ and usually comprises the largest 
portion of a Member's Required Fund Deposit. Procedure XV of the Rules 
currently provides that the VaR Charge shall be calculated in 
accordance with a generally accepted portfolio volatility margin model 
utilizing assumptions based on historical data as NSCC deems reasonable 
and a volatility range that NSCC deems appropriate.\12\
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    \10\ Supra note 4.
    \11\ As described in Procedure XV, Section I(A)(1)(a)(ii), (iii) 
and (iv), and Section I(A)(2)(a)(ii), (iii) and (iv) of the Rules, 
Net Unsettled Positions in certain securities are excluded from the 
VaR Charge and instead charged a volatility component that is 
calculated by multiplying the absolute value of those Net Unsettled 
Positions by a percentage. Supra note 4.
    \12\ Procedure XV, Section I(A)(1)(a)(i) and Section 
I(A)(2)(a)(i) of the Rules, supra note 4.

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    NSCC regularly assesses market and liquidity risks as such risks 
relate to its margining methodologies to evaluate whether margin levels 
are commensurate with the particular risk attributes of each relevant 
product, portfolio, and market. The proposed changes to include the MLA 
charge to its Clearing Fund methodology and to enhance the VaR Charge 
by including a bid-ask spread risk charge, as described below, are the 
result of NSCC's regular review of the effectiveness of its margining 
methodology.
(ii) Overview of Liquidation Transaction Costs and Proposed Changes
    Each of the proposed changes addresses a similar, but separate, 
risk that NSCC faces increased transaction costs when it liquidates the 
Net Unsettled Positions of a defaulted Member due to the unique 
characteristics of that Member's portfolio. The transaction costs to 
NSCC to liquidate a defaulted Member's portfolio include both market 
impact costs and fixed costs. Market impact costs are the costs due to 
the marketability of a security, and generally increase when a 
portfolio contains large Net Unsettled Positions in a particular group 
of securities with a similar risk profile or in a particular asset 
type, as described more below. Fixed costs are the costs that generally 
do not fluctuate and may be caused by the bid-ask spread of a 
particular security. The bid-ask spread of a security accounts for the 
difference between the observed market price that a buyer is willing to 
pay for that security and the observed market price that a seller is 
willing to sell that security.
    The transaction cost to liquidate a defaulted Member's portfolio is 
currently captured by the measurement of market risk through the 
calculation of the applicable volatility charge.\13\ The proposed 
changes would supplement and enhance the current measurement of this 
market risk to address situations where the characteristics of the 
defaulted Member's portfolio could cause these costs to be higher than 
the amount collected for the applicable volatility charge.
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    \13\ The calculation of the VaR Charge and the haircut-based 
volatility charge are described in Sections I.(A)(1)(a) and 
I.(A)(2)(a) of Procedure XV of the Rules. Supra note 4. The 
methodologies for these calculations and how they are designed to 
address risks faced by NSCC have been described in recent proposed 
rule change and advance notice filings. See Securities Exchange Act 
Release Nos. 82780 (February 26, 2018), 82 FR 9035 (March 2, 2018) 
(File No. SR-NSCC-2017-808); 82781 (February 26, 2018), 82 FR 9042 
(March 2, 2018) (File No. SR-NSCC-2017-020).
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    First, as described in more detail below, the MLA charge is 
designed to address the market impact costs of liquidating a defaulted 
Member's portfolio that may increase when that portfolio includes large 
Net Unsettled Positions in a particular group of securities with a 
similar risk profile or in a particular asset type. These positions may 
be more difficult to liquidate because a large number of securities 
with similar risk profiles could reduce the marketability of those 
large Net Unsettled Positions, increasing the market impact costs to 
NSCC. As described below, the MLA charge would supplement the 
applicable volatility charge.
    Second, as described in more detail below, the bid-ask spread risk 
charge would address the risk that the transaction costs of liquidating 
a defaulted Member's Net Unsettled Positions may increase due to the 
fixed costs related to the bid-ask spread. As described below, this 
proposed change would be incorporated into, and, thereby, enhance the 
current measure of transaction costs through, the VaR Charge.
(iii) Proposed Margin Liquidity Adjustment Charge
    In order to address the risks of an increased market impact cost 
presented by portfolios that contain large Net Unsettled Positions in 
the same asset group, NSCC is proposing to introduce a new component to 
the Clearing Fund formula, the MLA charge.
    As noted above, a Member portfolio with large Net Unsettled 
Positions in a particular group of securities with a similar risk 
profile or in a particular asset type may be more difficult to 
liquidate in the market in the event the Member defaults because a 
concentration in that group of securities or in an asset type could 
reduce the marketability of those large Net Unsettled Positions. 
Therefore, such portfolios create a risk that NSCC may face increased 
market impact cost to liquidate that portfolio in the assumed margin 
period of risk of three business days at market prices.
    The proposed MLA charge would be calculated to address this 
increased market impact cost by assessing sufficient margin to mitigate 
this risk. As described below, the proposed MLA charge would be 
calculated for different asset groups, and subgroups for the equities 
asset group. Essentially, the calculation is designed to compare the 
total market value of a Net Unsettled Position in a particular asset 
group or subgroup, which NSCC would be required to liquidate in the 
event of a Member default, to the available trading volume of that 
asset group or equities subgroup in the market.\14\ If the market value 
of the Net Unsettled Position is large, as compared to the available 
trading volume of that asset group or subgroup, then there is an 
increased risk that NSCC would face additional market impact costs in 
liquidating that position in the event of a Member default. Therefore, 
the proposed calculation would provide NSCC with a measurement of the 
possible increased market impact cost that NSCC could face when it 
liquidates a large Net Unsettled Position in a particular asset group 
or subgroup.
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    \14\ NSCC would determine average daily trading volume by 
reviewing data that is made publicly available by the Securities 
Industry and Financial Markets Association (``SIFMA''), at https://www.sifma.org/resources/archive/research/statistics.
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    Rather than calculate the market impact cost for each CUSIP, NSCC's 
MLA charge would estimate market impact cost at the portfolio-level 
using aggregated volume data. For example, as described in greater 
detail below, the calculation of market impact cost would include a 
measurement of the gross market value of the portfolio. Given the vast 
number of CUSIPs processed by NSCC, this approach is simpler and is 
expected to result in more predicable calculations of the MLA charge.
    To calculate the MLA charge, NSCC would categorize securities into 
separate asset groups, which have similar risk profiles--(1) equities 
\15\ (excluding equities defined as Illiquid Securities pursuant to the 
Rules \16\), (2) Illiquid Securities, (3) unit investment trusts, or 
UITs, (4) municipal bonds (including municipal bond exchange-traded 
products, or ``ETPs''), and (5) corporate bonds (including corporate 
bond ETPs). NSCC would then further segment the equities asset group 
into the following subgroups: (i) Micro-capitalization equities, (ii) 
small capitalization equities, (iii) medium capitalization equities, 
(iv) large capitalization equities, (v) treasury ETPs, and (vi) all 
other ETPs.\17\
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    \15\ NSCC would exclude long positions in Family-Issued 
Securities, as defined in Rule 1 (Definitions) of the Rules, from 
the MLA charge. NSCC believes the margin charge applicable to long 
Net Unsettled Positions in Family-Issued Securities pursuant to 
Sections I.(A)(1)(a)(iv) and (2)(a)(iv) of Procedure XV of the Rules 
provides adequate mitigation of the risks presented by those Net 
Unsettled Positions, such that an MLA charge would not be triggered. 
Supra note 4.
    \16\ See Rule 1 (Definitions), supra note 4.
    \17\ Initially, the market capitalization categorizations would 
be: (i) Micro-capitalization equities would be less than $300 
million, (ii) small capitalization equities would be equal to or 
greater than $300 million and less than $2 billion, (iii) medium 
capitalization equities would be equal to or greater than $2 billion 
and less than $10 billion, and (iv) large capitalization equities 
would be equal to or greater than $10 billion. In determining the 
range of these market capitalization categorizations, NSCC would 
consult publications issued by sources it deems appropriate. NSCC 
would review these categories annually and any changes that NSCC 
deems appropriate would be subject to NSCC's model risk management 
governance procedures set forth in the Clearing Agency Model Risk 
Management Framework (``Model Risk Management Framework''). See 
Securities Exchange Act Release Nos. 81485 (August 25, 2017), 82 FR 
41433 (August 31, 2017) (File No. SR-NSCC-2017-008); 84458 (October 
19, 2018), 83 FR 53925 (October 25, 2018) (File No. SR-NSCC-2018-
009); 88911 (May 20, 2020), 85 FR 31828 (May 27, 2020) (File No. SR-
NSCC-2020-008).

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[[Page 55334]]

    NSCC would first calculate a measurement of market impact cost for 
each asset group and equities subgroup for which a Member has Net 
Unsettled Positions in its portfolio. As described above, the 
calculation of an MLA charge is designed to measure the potential 
additional market impact cost to NSCC of closing out a large Net 
Unsettled Position in that particular asset group or equities subgroup.
Market Impact Cost Calculation for Market Capitalization Subgroups of 
Equities Asset Group
    The market impact cost for each Net Unsettled Position in a market 
capitalization subgroup of the equities asset group would be calculated 
by multiplying four components: (1) An impact cost coefficient that is 
a multiple of the one-day market volatility of that subgroup and is 
designed to measure impact costs, (2) the gross market value of the Net 
Unsettled Position in that subgroup, (3) the square root of the gross 
market value of the Net Unsettled Position in that subgroup in the 
portfolio divided by an assumed percentage of the average daily trading 
volume of that subgroup, and (4) a measurement of the concentration of 
the Net Unsettled Position in that subgroup in the portfolio (as 
described in greater detail below).\18\
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    \18\ See supra note 13.
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    NSCC also represents that its measurement of the concentration of 
the Net Unsettled Position in the portfolio would include aggregating 
the relative weight of each CUSIP in that Net Unsettled Position 
relative to the weight of that CUSIP in the subgroup, such that a 
portfolio with fewer positions in a subgroup would have a higher 
measure of concentration for that subgroup.\19\
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    \19\ The relative weight would be calculated by dividing the 
absolute market value of a single CUSIP in the Member's portfolio by 
the total absolute market value of that portfolio.
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Market Impact Cost Calculation for the Other Asset Groups and Equities 
Subgroups
    The market impact cost for Net Unsettled Positions in the municipal 
bond, corporate bond, Illiquid Securities and UIT asset groups and for 
Net Unsettled Positions in the treasury ETP and other ETP subgroups of 
the equities asset group would be calculated by multiplying three 
components: (1) An impact cost coefficient that is a multiple of the 
one-day market volatility of that asset group or subgroup, (2) the 
gross market value of the Net Unsettled Position in that asset group or 
subgroup, and (3) the square root of the gross market value of the Net 
Unsettled Position in that asset group or subgroup in the portfolio 
divided by an assumed percentage of the average daily trading volume of 
that subgroup.\20\
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    \20\ See supra note 13.
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Total MLA Charge Calculation for Each Portfolio
    For each asset group or subgroup, NSCC would compare the calculated 
market impact cost to a portion of the volatility charge that is 
allocated to Net Unsettled Positions in that asset group or subgroup 
(as determined by Sections I.(A)(1)(a) and I.(A)(2)(a) of Procedure XV 
of the Rules).\21\ If the ratio of the calculated market impact cost to 
the applicable 1-day volatility charge is greater than a threshold, an 
MLA charge would be applied to that asset group or subgroup.\22\ If the 
ratio of these two amounts is equal to or less than this threshold, an 
MLA charge would not be applied to that asset group or subgroup. The 
threshold would be based on an estimate of the market impact cost that 
is incorporated into the calculation of the applicable 1-day volatility 
charge, such that an MLA charge would apply only when the calculated 
market impact cost exceeds this threshold.
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    \21\ Supra note 4. NSCC's margining methodology uses a three-day 
assumed period of risk. For purposes of this calculation, NSCC would 
use a portion of the applicable volatility charge that is based on 
one-day assumed period of risk and calculated by applying a simple 
square-root of time scaling, referred to in this proposed rule 
change as ``1-day volatility charge.'' Any changes that NSCC deems 
appropriate to this assumed period of risk would be subject to 
NSCC's model risk management governance procedures set forth in the 
Model Risk Management Framework. See supra note 16.
    \22\ Initially, the threshold would be 0.4, because, currently, 
approximately 40 percent of the 1-day volatility charge addresses 
market impact costs. NSCC would review this threshold from time to 
time and any changes that NSCC deems appropriate would be subject to 
NSCC's model risk management governance procedures set forth in the 
Model Risk Management Framework. See id.
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    When applicable, an MLA charge for each asset group or subgroup 
would be calculated as a proportion of the product of (1) the amount by 
which the ratio of the calculated market impact cost to the applicable 
1-day volatility charge exceeds the threshold, and (2) the 1-day 
volatility charge allocated to that asset group or subgroup.
    For each Member portfolio, NSCC would add the MLA charges for Net 
Unsettled Positions in each of the subgroups of the equities asset 
group to determine an MLA charge for the Net Unsettled Positions in the 
equities asset group. NSCC would then add the MLA charge for Net 
Unsettled Positions in the equities asset group with each of the MLA 
charges for Net Unsettled Positions in the other asset groups to 
determine a total MLA charge for a Member.
    The ratio of the calculated market impact cost to the 1-day 
volatility charge would also determine if NSCC would apply a downward 
adjustment, based on a scaling factor, to the total MLA charge, and the 
size of any adjustment. For Net Unsettled Positions that have a higher 
ratio of calculated market impact cost to the 1-day volatility charge, 
NSCC would apply a larger adjustment to the MLA charge by assuming that 
it would liquidate that position on a different timeframe than the 
assumed margin period of risk of three business days. For example, NSCC 
may be able to mitigate potential losses associated with liquidating a 
Member's portfolio by liquidating a Net Unsettled Position with a 
larger volatility charge over a longer timeframe. Therefore, when 
applicable, NSCC would apply a multiplier to the calculated MLA charge. 
When the ratio of calculated market impact cost to the 1-day volatility 
charge is lower, the multiplier would be one, and no adjustment would 
be applied; as the ratio gets higher the multiplier decreases and the 
MLA charge is adjusted downward.
    The final MLA charge would be calculated daily and, when the charge 
is applicable, as described above, would be included as a component of 
Members' Required Fund Deposit.
Proposed Changes to NSCC Rules
    The proposal described above would be implemented into Procedure XV 
of the NSCC Rules. Specifically, the proposed changes to Procedure XV 
would describe the calculation of the MLA charge in a new subsection 
(i) of Section I(A)(1) and a new subsection (g) of Section I(A)(2).
    These new subsections would first identify each of the asset groups 
and subgroups. The proposed new subsections would then separately 
describe the two calculations of market

[[Page 55335]]

impact cost for these asset groups and subgroups by identifying the 
components of these calculations. The new subsections would state that 
NSCC would compare the calculated market impact cost to a portion of 
that Member's volatility charge, to determine if an MLA charge would be 
applied to an asset group or subgroup. The new subsections would then 
state that NSCC would add each of the applicable MLA charges calculated 
for each asset group together. Finally, the new subsections would state 
that NSCC may apply a downward adjusting scaling factor to result in a 
final MLA charge.
    NSCC would also amend Section I(B)(2) of Procedure VX, which 
describes the Excess Capital Premium charge, to add the MLA charge to 
the list of Clearing Fund components that are excluded from the 
calculation of the Excess Capital Premium charge.\23\ The Excess 
Capital Premium is imposed on a Member when the Member's Required Fund 
Deposit exceeds its excess net capital. NSCC believes that including 
the MLA charge in the calculation of the Excess Capital Premium could 
lead to more frequent and unnecessary Excess Capital Premium charges. 
This is not the intended purpose of the Excess Capital Premium charge 
and could place an unnecessary burden on Members.
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    \23\ See Section I.(B)(2) of Procedure XV of the Rules. Supra 
note 4.
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(iv) Proposed Bid-Ask Spread Risk Charge
    NSCC has identified potential risk that its margining methodologies 
do not account for the transaction costs related to bid-ask spread in 
the market that could be incurred when liquidating a portfolio. Bid-ask 
spreads account for the difference between the observed market price 
that a buyer is willing to pay for a security and the observed market 
price that a seller is willing to sell that security. Therefore, NSCC 
is proposing to include a bid-ask spread risk charge in the VaR Charge 
to address this risk.
    In order to calculate this charge, NSCC would segment Member's 
portfolios into four bid-ask spread risk classes: (i) Large and medium 
capitalization equities, (ii) small capitalization equities, (iii) 
micro capitalization equities, and (iv) ETPs.\24\
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    \24\ See supra note 16.
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    Each risk class would be assigned a specific bid-ask spread haircut 
rate in the form of a basis point charge that would be applied to the 
gross market value in that particular risk class. The applicable bid-
ask spread risk charge would be the product of the gross market value 
in a particular risk class in the Member's portfolio and the applicable 
basis point charge. The bid-ask spread risk charge would be calculated 
at the portfolio level, such that NSCC would aggregate the bid-ask 
spread risk charges of the applicable risk classes for the Member's 
portfolio.
    NSCC proposes to review the haircut rates annually based on either 
the analysis of liquidation transaction costs related to the bid-ask 
spread that is conducted in connection with its annual simulation of a 
Member default or market data that is sourced from a third-party data 
vendor. Based on the analyses from recent years' simulation exercises, 
NSCC does not anticipate that these haircut rates would change 
significantly year over year. NSCC may also adjust the haircut rates 
following its annual model validation review, to the extent the results 
of that review indicate the current haircut rates are not adequate to 
address the risk presented by transaction costs from a bid-ask 
spread.\25\
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    \25\ All proposed changes to the haircuts would be subject to 
NSCC's model risk management governance procedures set forth in the 
Model Risk Management Framework. See id.
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    The proposed initial haircuts are based on the analysis from the 
most recent annual default simulation and market data sourced from a 
third-party data vendor, and are listed in the table below:

------------------------------------------------------------------------
                                                               Haircut
                           Class                                (bps)
------------------------------------------------------------------------
Large and Medium Capitalization Equities...................          5.0
Small Capitalization Equities..............................         12.3
Micro Capitalization Equities..............................         23.1
ETPs.......................................................          1.5
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Proposed Changes to NSCC Rules
    The proposal described above would be implemented into Procedure XV 
of the NSCC Rules. Specifically, NSCC would amend subsection (a)(i)(I) 
of Sections I(A)(1) and I(A)(2) of Procedure XV by stating that the 
calculations of the estimations of volatility described in these 
Sections shall include an additional bid-ask spread risk charge 
measured by multiplying the gross market value of each Net Unsettled 
Position by a basis point charge. The proposed change to this 
subsection would also state that the basis point charge would be based 
on four risk classes and would identify those risk classes.
(v) Implementation Timeframe
    NSCC would implement the proposed changes no later than 10 Business 
Days after the later of the no objection to the Advance Notice and 
approval of the related proposed rule change \26\ by the Commission. 
NSCC would announce the effective date of the proposed changes by 
Important Notice posted to its website.
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    \26\ Supra note 3.
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Anticipated Effect on and Management of Risk
    NSCC believes that the proposed changes to enhance the margining 
methodology as described above would enable NSCC to better limit its 
risk exposures to Members arising out of their Net Unsettled Positions.
    As stated above, the proposed MLA charge is designed to help limit 
NSCC's exposures to the risks presented by a Member portfolio that 
contains large Net Unsettled Positions in securities of the same asset 
group, and would enhance NSCC's ability to address risks related to 
liquidating such positions in the event of a Member default. The 
proposed MLA charge would allow NSCC to collect sufficient financial 
resources to cover its exposure that it may face increased market 
impact costs in liquidating Net Unsettled Positions that is not 
captured by the applicable volatility charge.
    The proposal to enhance the VaR Charge by including a bid-ask 
spread risk charge is also designed to help limit NSCC's exposures to 
the risks related to increased transaction costs due to the bid-ask 
spread in the market that could be incurred when liquidating a 
portfolio. Therefore, this proposed change would also help address 
NSCC's risks related to its ability to liquidate such positions in the 
event of a Member default.
    By providing NSCC with a more effective measurement of its 
exposures, the proposed changes would also mitigate risk for Members 
because lowering the risk profile for NSCC would in turn lower the risk 
exposure that Members may have with respect to NSCC in its role as a 
central counterparty.
Consistency With Clearing Supervision Act
    NSCC believes that the proposals are consistent with the Clearing 
Supervision Act, specifically with the risk management objectives and 
principles of Section 802(b), and with certain of the risk management 
standards adopted by the Commission pursuant to Section 805(a)(2), for 
the reasons described below.\27\
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    \27\ 12 U.S.C. 5464(a)(2) and (b)(1).

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[[Page 55336]]

(i) Consistency With Section 805(b) of the Clearing Supervision Act
    Although the Clearing Supervision Act does not specify a standard 
of review for an advance notice, its stated purpose is instructive: To 
mitigate systemic risk in the financial system and promote financial 
stability by, among other things, promoting uniform risk management 
standards for systemically important financial market utilities and 
strengthening the liquidity of systemically important financial market 
utilities.\28\
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    \28\ 12 U.S.C. 5464(b)(1).
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    NSCC believes the proposals are consistent with the objectives and 
principles of these risk management standards as described in Section 
805(b) of the Clearing Supervision Act and in the Covered Clearing 
Agency Standards.
    First, the proposal would include the MLA charge as an additional 
component to the Clearing Fund. As described above, this new margin 
charge is designed to address the market impact costs of liquidating a 
defaulted Member's portfolio that may increase when that portfolio 
includes large Net Unsettled Positions in a particular group of 
securities with a similar risk profile or in a particular asset type. 
These positions may be more difficult to liquidate in the market 
because a concentrating in that group of securities or in an asset type 
could reduce the marketability of those large Net Unsettled Positions, 
increasing the market impact costs to NSCC. The proposed MLA charge 
would allow NSCC to collect sufficient financial resources to cover its 
exposure that it may face increased market impact costs in liquidating 
Net Unsettled Positions that is not captured by the applicable 
volatility charge.
    Second, the proposed bid-ask spread risk charge is designed to help 
limit NSCC's exposures to the risks related to increased transaction 
costs due to the bid-ask spread in the market that could be incurred 
when liquidating a portfolio. As stated above, this proposal would also 
help address NSCC's risks related to its ability to liquidate such 
positions in the event of a Member default.
    Therefore, because the proposals are designed to enable NSCC to 
better limit its exposure to Members in the event of a Member default, 
NSCC believes they are consistent with promoting robust risk 
management. The proposals would also strengthen the liquidity of NSCC 
by requiring deposits to the Clearing Fund that are calculated to 
address the potential risks NSCC may face, which is one of NSCC's 
default liquidity resources.
    As a result, NSCC believes the proposals would be consistent with 
the objectives and principles of Section 805(b) of the Clearing 
Supervision Act, which specify the promotion of robust risk management, 
promotion of safety and soundness, reduction of systemic risks and 
support of the stability of the broader financial system by, among 
other things, strengthening the liquidity of systemically important 
financial market utilities, such as NSCC.
(ii) Consistency With Rule 17Ad-22(e)(4)(i) and (6)(i) Under the Act
    Section 805(a)(2) of the Clearing Supervision Act authorizes the 
Commission to prescribe risk management standards for the payment, 
clearing and settlement activities of designated clearing entities, 
like NSCC, and financial institutions engaged in designated activities 
for which the Commission is the supervisory agency or the appropriate 
financial regulator.\29\ The Commission has accordingly adopted risk 
management standards under Section 805(a)(2) of the Clearing 
Supervision Act \30\ and Section 17A of the Act (``Covered Clearing 
Agency Standards'').\31\ The Covered Clearing Agency Standards require 
covered clearing agencies to establish, implement, maintain, and 
enforce written policies and procedures that are reasonably designed to 
meet certain minimum requirements for their operations and risk 
management practices on an ongoing basis.\32\
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    \29\ 12 U.S.C. 5464(a)(2).
    \30\ Id.
    \31\ 17 CFR 240.17Ad-22(e).
    \32\ Id.
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    NSCC believes that the proposed changes are consistent with Rules 
17Ad-22(e)(4)(i) and (e)(6)(i) of the Covered Clearing Agency Standards 
\33\ for the reasons described below.
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    \33\ 17 CFR 240.17Ad-22(e)(4)(i), (e)(6)(i).
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    Rule 17Ad-22(e)(4)(i) under the Act requires, in part, that NSCC 
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.\34\
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    \34\ 17 CFR 240.17Ad-22(e)(4)(i).
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    As described above, NSCC believes that both of the proposed changes 
would enable it to better identify, measure, monitor, and, through the 
collection of Members' Required Fund Deposits, manage its credit 
exposures to Members by maintaining sufficient resources to cover those 
credit exposures fully with a high degree of confidence.
    Specifically, NSCC believes that the proposed MLA charge would 
effectively mitigate the risks related to large Net Unsettled Positions 
of securities in the same asset group within a portfolio and would 
address the potential increased risks NSCC may face related to its 
ability to liquidate such positions in the event of a Member default.
    Therefore, NSCC believes that the proposal would enhance NSCC's 
ability to effectively identify, measure and monitor its credit 
exposures and would enhance its ability to maintain sufficient 
financial resources to cover its credit exposure to each participant 
fully with a high degree of confidence. As such, NSCC believes the 
proposed changes are consistent with Rule 17Ad-22(e)(4)(i) under the 
Act.\35\
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    \35\ Id.
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    Additionally, NSCC believes that the proposed bid-ask spread risk 
charge would enhance NSCC's ability to identify, measure, monitor and 
manage its credit exposures to Members and those exposures arising from 
its payment, clearing, and settlement processes because the proposed 
changes would better ensure that NSCC maintains sufficient financial 
resources to cover its credit exposure to each Member with a high 
degree of confidence. NSCC believes that the proposed change would 
enable NSCC to more effectively identify, measure, monitor and manage 
its exposures to risks related to market price, and enable it to better 
limit its exposure to potential losses from Member defaults by 
providing a more effective measure of the risks related to market 
price. As described above, due to the bid-ask spread in the market, 
there is an observable transaction cost to liquidate a portfolio. The 
proposed bid-ask spread risk charge is designed to manage the risk 
related to this transaction cost in the event a Member's portfolio is 
liquidated. As such, NSCC believes that the proposed change would 
better address the potential risks that NSCC may face that are related 
to its ability liquidate a Member's Net Unsettled Positions in the 
event of that firm's default, and thereby enhance NSCC's ability to 
effectively identify, measure and monitor its credit exposures and 
would enhance its ability to maintain sufficient financial resources to 
cover its credit exposure to each participant fully

[[Page 55337]]

with a high degree of confidence. In this way, NSCC believes this 
proposed change is also consistent with Rule 17Ad-22(e)(4)(i) under the 
Act.\36\
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    \36\ Id.
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    Rule 17Ad-22(e)(6)(i) under the Act requires, in part, that NSCC 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, considers, and produces margin levels commensurate with, the 
risks and particular attributes of each relevant product, portfolio, 
and market.\37\
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    \37\ 17 CFR 240.17Ad-22(e)(6)(i).
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    The Required Fund Deposits are made up of risk-based components (as 
margin) that are calculated and assessed daily to limit NSCC's credit 
exposures to Members, including the VaR Charge. NSCC's proposed change 
to introduce an MLA charge is designed to more effectively address the 
risks presented by large Net Unsettled Positions in the same asset 
group. NSCC believes the addition of the MLA charge would enable NSCC 
to assess a more appropriate level of margin that accounts for these 
risks. This proposed change is designed to assist NSCC in maintaining a 
risk-based margin system that considers, and produces margin levels 
commensurate with, the risks and particular attributes of portfolios 
that contain large Net Unsettled Positions in the same asset group and 
may be more difficult to liquidate in the event of a Member default. 
Therefore, NSCC believes the proposed change is consistent with Rule 
17Ad-22(e)(6)(i) under the Act.\38\
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    \38\ Id.
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    Furthermore, NSCC believes that including the bid-ask spread risk 
charge within the calculation of the final VaR Charge would provide 
NSCC with a better assessment of its risks related to market price. 
This proposed change would enable NSCC to assess a more appropriate 
level of margin that accounts for this risk at the portfolio level. As 
such, each Member portfolio would be subject to a risk-based margining 
system that, at minimum, considers, and produces margin levels 
commensurate with, the risks and particular attributes of each relevant 
product, portfolio, and market, consistent with Rule 17Ad-22(e)(6)(i) 
under the Act.\39\
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    \39\ Id.
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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 website 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-2020-804 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-2020-804. 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 website (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 website 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 website 
(http://dtcc.com/legal/sec-rule-filings.aspx). All comments received 
will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-NSCC-2020-804 and should be submitted on 
or before September 21, 2020.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-19656 Filed 9-3-20; 8:45 am]
BILLING CODE 8011-01-P