Document ID: SEC-2017-0601-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: National Securities Clearing Corp.
Posted Date: 2017-04-13T04:00Z

[Federal Register Volume 82, Number 70 (Thursday, April 13, 2017)]
[Notices]
[Pages 17921-17927]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-07453]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-80396; File No. SR-NSCC-2017-801]

Self-Regulatory Organizations; National Securities Clearing 
Corporation; Notice of Filing of Advance Notice To Enhance the Credit 
Risk Rating Matrix and Make Other Changes

April 7, 2017.
    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 March 
22, 2017, National Securities Clearing Corporation (``NSCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
advance notice SR-NSCC-2017-801 (``Advance Notice'') as described in 
Items I, II and III below, which Items have been prepared by NSCC.\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 March 22, 2017, NSCC filed this Advance Notice as a 
proposed rule change (SR-NSCC-2017-002) 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 proposed modifications to NSCC's 
Rules and Procedures (``Rules'').\4\ The proposed rule change would 
amend the Rules in order to (i) enhance the matrix (hereinafter 
referred to as the ``Credit Risk Rating Matrix'' or ``CRRM'') \5\ 
developed by NSCC to evaluate the risks posed by certain Members 
(``CRRM-Rated Members'') to NSCC and its Members from providing 
services to these CRRM-Rated Members and (ii) make other amendments to 
the Rules to provide more transparency and clarity regarding NSCC's 
current ongoing membership monitoring process.
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    \4\ Capitalized terms not defined herein are defined in the 
Rules, available at http://www.dtcc.com/~/media/Files/Downloads/
legal/rules/nscc_rules.pdf.
    \5\ The proposed rule changes with respect to the enhancement of 
the CRRM are reflected in the inclusion of (i) qualitative factors 
and examples thereof in the proposed new definition for ``Credit 
Risk Rating Matrix'' in Rule 1 and (ii) Members that are foreign 
banks or trust companies that have audited financial data that is 
publicly available in Section 4(b)(i) of Rule 2B.
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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

    Written comments relating to this proposal have not been solicited 
or received. NSCC will notify the Commission of any written comments 
received by NSCC.

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

Nature of the Proposed Change
    The proposed rule change would, among other things, enhance the 
CRRM to enable it to rate Members that are foreign banks or trust 
companies and have audited financial data that is publicly available. 
It would also enhance the CRRM by allowing it to take into account 
qualitative factors when generating credit ratings for Members. In 
addition, it would enhance the CRRM by shifting it from a relative 
scoring approach to an absolute scoring approach.
    This rule filing also contains proposed rule changes that are not 
related to the proposed CRRM enhancements but that provide specificity, 
clarity and additional transparency to the Rules related to NSCC's 
current ongoing membership monitoring process.
(i) Background
    NSCC occupies an important role in the securities settlement system 
by interposing itself as a central counterparty between Members that 
are counterparties to transactions accepted for clearing by NSCC, 
thereby reducing the risk faced by Members. NSCC uses the CRRM, the 
Watch List (as defined below) and the enhanced surveillance to manage 
and monitor default risks of Members on an ongoing basis, as discussed 
below. The level and frequency of such monitoring for a Member is 
determined by the Member's risk of default as assessed by NSCC. Members 
that are deemed by NSCC to pose a heightened risk to NSCC and its 
Members are subject to closer and more frequent monitoring.
Existing Credit Risk Rating Matrix
    In 2005, the Commission approved a proposed rule change filed by 
NSCC (``Initial Filing'') \6\ to establish new criteria for placing 
certain Members on a list for closer monitoring (``Watch List'').
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    \6\ See Securities Exchange Act Release No. 51362 (March 11, 
2005), 70 FR 13562 (March 21, 2005) (SR-NSCC-2003-11).
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    NSCC proposed in the Initial Filing that all U.S. broker-dealers 
and U.S. banks that were Members would be assigned a rating generated 
by entering financial data of those Members into an internal risk 
assessment matrix, i.e., the CRRM. However, the text of the current 
Rule 2B, Section 4, does not specify which Members are CRRM-Rated 
Members and whether non-CRRM-Rated

[[Page 17922]]

Members may be included on the Watch List.
    Currently, Members that are U.S. broker-dealers and U.S. banks are 
assessed against the CRRM and assigned a credit rating based on certain 
quantitative factors.\7\ Unfavorably-rated Members are placed on the 
Watch List. In addition, NSCC credit risk staff may downgrade a 
particular Member's credit rating based on various qualitative factors. 
An example of such qualitative factors might be that the Member in 
question received a qualified audit opinion on its annual audit. NSCC 
believes that, in order to protect NSCC and its other Members, it is 
important that credit risk staff maintain the discretion to downgrade a 
Member's credit rating on the CRRM and thus subject the Member to 
closer monitoring.
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    \7\ Quantitative factors considered by NSCC include (a) for 
broker dealers, size (i.e., total excess net capital), capital, 
leverage, liquidity, and profitability and (b) for banks, size, 
capital, asset quality, earnings, and liquidity.
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    The current CRRM is comprised of two credit rating models--one for 
the U.S. broker-dealers and one for the U.S. banks--and generates 
credit ratings for the relevant Members based on a 7-point rating 
system, with ``1'' being the strongest credit rating and ``7'' being 
the weakest credit rating.
    Over time, the current CRRM has not kept pace with NSCC's evolving 
membership base and heightened expectations from regulators and 
stakeholders for robustness of financial models. Specifically, the 
current CRRM only generates credit ratings for those Members that are 
U.S. banks or U.S. broker-dealers that file standard reports with their 
regulators. Although these types of Members currently represent the 
vast majority (approximately 95%) of Members at NSCC,\8\ foreign banks 
and trust companies are expected to be a growing category of NSCC's 
membership base in the future, and the proposed enhancements to the 
CRRM would enable it to assign credit ratings to these entities. 
Foreign banks and trust companies are typically large global financial 
institutions that have complex businesses and conduct a high volume of 
activities. Although foreign banks and trust companies are not 
currently rated by the CRRM, they are monitored by NSCC's credit risk 
staff using financial criteria deemed relevant by NSCC and can be 
placed on the Watch List if they experience a financial change that 
presents risk to NSCC. Given the potential increase in the number of 
Members that are foreign banks or trust companies in the coming years, 
there is a need to formalize NSCC's credit risk evaluation process of 
these Members by assigning credit ratings to them in order to better 
facilitate the comparability of credit risks among Members.\9\
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    \8\ As of March 16, 2017, there are 155 Members. Of the 155 
Members, 11 (or 7%) are U.S. banks, 136 (or 88%) are U.S. broker-
dealers and one (or 1%) is a foreign bank or trust company.
    \9\ CRRM is applied across NSCC and its affiliated clearing 
agencies, Fixed Income Clearing Corporation (``FICC'') and The 
Depository Trust Company (``DTC''). Specifically, in order to run 
the CRRM, credit risk staff uses the financial data of the 
applicable NSCC Members in addition to data of applicable members 
and participants of FICC and DTC, respectively. In this way, each 
applicable NSCC Member is rated against other applicable members and 
participants of FICC and DTC, respectively.
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    In addition, the current CRRM assigns each Member that is a U.S. 
bank or U.S. broker-dealer and that files standard reports with its 
regulator(s) a credit rating based on inputting certain quantitative 
data relative to the applicable Member into the CRRM. Accordingly, a 
Member's credit rating is currently based solely upon quantitative 
factors. It is only after the CRRM has generated a credit rating with 
respect to a particular Member that such Member's credit rating may be 
downgraded manually by credit risk staff, after taking into 
consideration relevant qualitative factors. The inability of the 
current CRRM to take into account qualitative factors requires frequent 
and manual overrides by credit risk staff, which may result in 
inconsistent and/or incomplete credit ratings for Members.
    Furthermore, the current CRRM uses a relative scoring approach and 
relies on peer grouping of Members to calculate the credit rating of a 
Member. This approach is not ideal because a Member's credit rating can 
be affected by changes in its peer group even if the Member's financial 
condition is unchanged.
Proposed Credit Risk Rating Matrix Enhancements
    To improve the coverage and the effectiveness of the current CRRM, 
NSCC is proposing three enhancements. The first proposed enhancement 
would expand the scope of CRRM coverage by enabling the CRRM to 
generate credit ratings for Members that are foreign banks or trust 
companies and that have audited financial data that is publicly 
available. The second proposed enhancement would incorporate 
qualitative factors into the CRRM and therefore is expected to reduce 
the need and the frequency of manual overrides of Member credit 
ratings. The third enhancement would replace the relative scoring 
approach currently used by CRRM with a statistical approach to estimate 
the absolute probability of default of each Member.
A. Enable the CRRM to Generate Credit Ratings for Foreign Bank or Trust 
Company Members
    The current CRRM is comprised of two credit rating models--one for 
the U.S. broker-dealers and one for the U.S. banks. NSCC is proposing 
to enhance the CRRM by adding an additional credit rating model for the 
foreign banks and trust companies. The additional model would expand 
the membership classes to which the CRRM would apply to include Members 
that are foreign banks or trust companies and that have audited 
financial data that is publicly available. The CRRM credit rating of a 
Member that is a foreign bank or trust company would be based on 
quantitative factors, including size, capital, leverage, liquidity, 
profitability and growth, and qualitative factors, including market 
position and sustainability, information reporting and compliance, 
management quality, capital management and business/product diversity. 
By enabling the CRRM to generate credit ratings for these Members, the 
enhanced CRRM would provide more comprehensive credit risk coverage of 
NSCC's membership base.
    With the proposed enhancement to the CRRM as described above, 
applicable foreign bank or trust company Members would be included in 
the CRRM process and be evaluated more effectively and efficiently 
because financial data with respect to these foreign bank or trust 
company Members could be extracted from data sources in an automated 
form.\10\
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    \10\ Currently, these Members are monitored by NSCC credit risk 
staff that review similar criteria as those reviewed for CRRM-Rated 
Members, but such review occurs outside of the CRRM process.
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    After the proposed enhancement, CRRM would be able to generate 
credit ratings on an ongoing basis for all Members that are U.S. banks, 
U.S. brokers-dealers and foreign banks and trust companies, which 
together represent approximately 96% of the NSCC Members.\11\
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    \11\ As of March 16, 2017, there are 7 Members that would not be 
rated by the enhanced CRRM, as proposed, because they are central 
securities depositories, securities exchanges and U.S. trust 
companies that do not file Call Reports (as defined below).
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B. Incorporate Qualitative Factors Into the CRRM
    In addition, as proposed, the enhanced CRRM would blend qualitative 
factors with quantitative factors to produce a credit rating for each 
applicable Member in relation to

[[Page 17923]]

the Member's credit risk. For U.S. and foreign banks and trust 
companies, the enhanced CRRM would use a 70/30 weighted split between 
quantitative and qualitative factors to generate credit ratings. For 
U.S. broker-dealers, the weight split between quantitative and 
qualitative factors would be 60/40. These weight splits are chosen by 
NSCC based on the industry best practice as well as research and 
sensitivity analysis conducted by NSCC. NSCC would review and adjust 
the weight splits as well as the quantitative and qualitative factors, 
as needed, based on recalibration of the CRRM to be conducted by NSCC 
approximately every three to five years.
    Although there are advantages to measuring credit risk 
quantitatively, quantitative evaluation models alone are incapable of 
fully capturing all credit risks. Certain qualitative factors may 
indicate that a Member is or will soon be undergoing financial 
distress, which may in turn signal a higher default exposure to NSCC 
and its other Members. As such, a key enhancement being proposed to the 
CRRM is the incorporation of relevant qualitative factors into each of 
the three credit rating models mentioned above. By including 
qualitative factors in the three credit rating models, the enhanced 
CRRM would capture risks that would otherwise not be accounted for with 
quantitative factors alone.\12\ Adding qualitative factors to the CRRM 
would not only enable it to generate more consistent and comprehensive 
credit ratings for applicable Members, but it would also help reduce 
the need and frequency of manual credit rating overrides by the credit 
risk staff because overrides would likely only be required under more 
limited circumstances.\13\
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    \12\ The initial set of qualitative factors that would be 
incorporated into the CRRM includes (a) for U.S. broker dealers, 
market position and sustainability, management quality, capital 
management, liquidity management, geographic diversification, 
business/product diversity and access to funding, (b) for U.S. 
banks, environment, compliance/litigation, management quality, 
liquidity management and parental demands and (c) for foreign banks 
and trust companies, market position and sustainability, information 
reporting and compliance, management quality, capital management and 
business/product diversity.
    \13\ Once a Member is assigned a credit rating, if circumstances 
warrant, credit risk staff would still have the ability to override 
the CRRM-issued credit rating by manually downgrading such rating as 
they do today. To ensure a conservative approach, the CRRM-issued 
credit ratings cannot be manually upgraded.
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C. Shifting From Relative Scoring to Absolute Scoring
    As proposed, the enhanced CRRM would use an absolute scoring 
approach and rank each Member based on its individual probability of 
default rather than the relative scoring approach that is currently in 
use. This proposed change is designed to have a Member's CRRM-generated 
credit rating reflect an absolute measure of the Member's default risk 
and eliminate any potential distortion of a Member's credit rating from 
the Member's peer group that may occur under the relative scoring 
approach used in the existing CRRM.
D. Watch List and Enhanced Surveillance
    In addition to the Watch List, NSCC also maintains an enhanced 
surveillance list (referenced herein and in the proposed rule text as 
``enhanced surveillance'') for membership monitoring. The enhanced 
surveillance list is generally used when Members are undergoing drastic 
and unexpected changes in their financial conditions or operation 
capabilities and thus are deemed by NSCC to be of the highest risk 
level and/or warrant additional scrutiny due to NSCC's ongoing concerns 
about these Members. Accordingly, Members that are subject to enhanced 
surveillance are reported to NSCC's management committees and are also 
regularly reviewed by a cross-functional team comprised of senior 
management of NSCC. More often than not, Members that are subject to 
enhanced surveillance are also on the Watch List. The group of Members 
that is subject to enhanced surveillance is generally much smaller than 
the group on the Watch List. The enhanced surveillance list is an 
internal tool for NSCC that triggers increased monitoring of a Member 
above the monitoring that occurs when a Member is on the Watch List.
    A Member could be placed on the Watch List either based on its 
credit rating of 5, 6 or 7, which can either be generated by the CRRM 
or from a manual downgrade, or when NSCC deems such placement as 
necessary to protect NSCC and its Members. In contrast, a Member would 
be subject to enhanced surveillance only when close monitoring of the 
Member is deemed necessary to protect NSCC and its Members.
    The Watch List and enhanced surveillance tools are not mutually 
exclusive; they may complement each other under certain circumstances. 
A key distinction between the Watch List and enhanced surveillance is 
that being placed on the Watch List may result in Required Deposit \14\ 
related consequences under the Rules, whereas enhanced surveillance 
does not.\15\ For example, a Member that is in a precarious situation 
could be placed on the Watch List and be subject to enhanced 
surveillance; however, because the Watch List status could increase a 
Member's Required Deposit, when NSCC has preliminary concerns about a 
Member, to avoid potential increase to a Member's Required Deposit, 
NSCC may opt not to place the Member on the Watch List until it is 
certain that such concerns would not be alleviated in the short-term. 
Instead, in such a situation, NSCC might first subject the Member to 
enhanced surveillance in order to closely monitor the Member's 
situation without affecting the Member's Required Deposit. If the 
Member's situation improves, then it will no longer be subject to 
enhanced surveillance. If the situation of the Member worsens, the 
Member may then be placed on the Watch List as deemed necessary by 
NSCC.
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    \14\ See Rule 4 (Section 1). The ``Required Deposit'' is the 
amount that each Member is required to deposit in NSCC's Clearing 
Fund. Rules, supra note 4.
    \15\ NSCC expects to provide additional clarity to Members 
regarding the Watch List and its impact on Required Deposit in a 
subsequent proposed rule change to be filed with the Commission in 
2017.
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(ii) Detailed Description of the Proposed Rule Changes Related to the 
Proposed CRRM Enhancements
    In connection with the proposed enhancements to the CRRM, NSCC 
proposes to amend the Rules to (1) incorporate qualitative factors into 
CRRM and (2) add Members that are foreign banks or trust companies to 
the categories of Members that would be assigned credit ratings by NSCC 
using the CRRM.
A. Proposed Changes to Rule 1 (Definitions and Descriptions)
    NSCC is proposing to include qualitative factors, such as 
management quality, market position/environment, and capital and 
liquidity risk management in the proposed new definition for ``Credit 
Risk Rating Matrix'' in Rule 1 because, as proposed, the enhanced CRRM 
would blend both qualitative factors and quantitative factors to 
produce a credit rating for each applicable Member.
B. Proposed Changes to Section 4(b)(i) of Rule 2B (Ongoing Membership 
Requirements and Monitoring)
    NSCC is proposing to expand the membership types to which the CRRM 
would apply to include Members that are foreign banks or trust 
companies and that have audited financial data that is

[[Page 17924]]

publicly available by amending Section 4 of Rule 2B.
    The enhanced CRRM would assign credit ratings for each Member that 
is a foreign bank or trust company based on its publicly available 
audited financial data. The credit rating would be based on an 18-point 
scale, which is then mapped to the 7-point rating system currently in 
use today, with ``1'' being the strongest credit rating and ``7'' being 
the weakest credit rating.
(iii) Other Proposed Rule Changes
    This rule filing also contains proposed rule changes that are 
unrelated to the proposed enhancement of the CRRM. These proposed rule 
changes would provide specificity, clarity and additional transparency 
to the Rules with respect to NSCC's current ongoing membership 
monitoring process, as described below.
A. Proposed Changes to Rule 1 (Definitions and Descriptions)
    NSCC is proposing to amend Rule 1 to add definitions for the CRRM 
and the Watch List.
    The proposed definition of the CRRM would provide that the term 
``Credit Risk Rating Matrix'' means a matrix of credit ratings of 
Members as specified in Section 4 of Rule 2B. The definition would 
state that the CRRM is developed by NSCC to evaluate the credit risk 
such Members pose to NSCC and its Members and is based on factors 
determined to be relevant by NSCC from time to time, which factors are 
designed to collectively reflect the financial and operational 
condition of a Member. The proposed definition would state that, in 
addition to the proposed qualitative factors described above, these 
factors include quantitative factors, such as capital, assets, earnings 
and liquidity.
    The proposed definition of the Watch List would provide that the 
term ``Watch List'' means, at any time and from time to time, the list 
of Members whose credit ratings derived from the CRRM are 5, 6 or 7, as 
well as Members and Limited Members that, based on NSCC's consideration 
of relevant factors, including those set forth in Section 4(d) of Rule 
2B (described below), are deemed by NSCC to pose a heightened risk to 
NSCC and its Members.
B. Proposed Changes to Rule 2B (Ongoing Membership Requirements and 
Monitoring)
Section 2B of Rule 2B
    NSCC is proposing to amend Section 2B of Rule 2B to state that NSCC 
may review the financial responsibility and operational capability of 
each Member and may otherwise require additional reporting from the 
Member regarding its financial or operational condition that may (1) 
include information regarding the businesses and operations of the 
Member and its risk management practices with respect to NSCC's 
services utilized by the Member for another Person and (2) result in 
the Member being placed on the Watch List and/or being subject to 
enhanced surveillance as determined by NSCC.
    Members are direct participants of NSCC. However, there are firms 
that rely on the services provided by Members in order to have their 
activity cleared and settled through NSCC's facilities (the ``indirect 
participants''). These indirect participants pose certain risks to NSCC 
that need to be identified and monitored as part of NSCC's ongoing 
member due diligence process. In order for NSCC to understand (1) the 
material dependencies between Members and the indirect participants 
that rely on the Members for the clearance and settlement of the 
indirect participants' transactions, (2) significant Member-indirect 
participant relationships and (3) the various risk controls and 
mitigants that these Members employ to manage their risks with respect 
to such relationships, NSCC may request information from Members 
regarding the Members' businesses and operations as well as their risk 
management practices with respect to services of NSCC utilized by the 
Members for indirect participants. The information provided by Members 
would then be taken into consideration by NSCC when determining whether 
a Member may need to be placed on the Watch List, be subject to 
enhanced surveillance or both.
Section 4 of NSCC Rule 2B
    NSCC is proposing to amend Section 4 of Rule 2B in order to (1) 
specify the membership types that are currently subject to NSCC's 
ongoing monitoring and review, (2) clarify which U.S. broker-dealers 
and U.S. banks will be assigned a credit rating by NSCC in accordance 
with the CRRM, (3) provide that NSCC may manually downgrade a CRRM-
Rated Member's credit rating in certain instances, (4) provide that 
NSCC may place non-CRRM-Rated Members and certain Limited Members on 
the Watch List and/or subject them to enhanced surveillance, if 
necessary, (5) describe some of the factors that could be taken into 
consideration by NSCC when downgrading a Member's or Limited Member's 
credit rating, placing a Member or Limited Member on the Watch List 
and/or subjecting a Member or Limited Member to enhanced surveillance, 
(6) allow NSCC to collect additional deposits to the Clearing Fund and 
to retain deposits in excess of the Required Deposit from Members or 
Limited Members that are on the Watch List and (7) provide for enhanced 
monitoring of Members or Limited Members that are on the Watch List 
and/or are subject to enhanced surveillance.
    In connection with the forgoing, NSCC proposes to delete the 
current first paragraph in Section 4 of NSCC Rule 2B and add the 
following:
    1. Section 4(a), specifying that NSCC currently monitors and 
reviews all Members and certain Limited Members on an ongoing and 
periodic basis, which may include monitoring news and market 
developments relating to these Members and Limited Members and 
conducting reviews of financial reports and other public information of 
these Members and Limited Members.
    2. Section 4(b)(i), clarifying that (1) Members that are (A) U.S. 
banks or trust companies that file the Consolidated Report of Condition 
and Income (``Call Report'') or (B) U.S. broker-dealers that file the 
Financial and Operational Combined Uniform Single Report (``FOCUS 
Report'') or the equivalent with their regulators, would be assigned a 
credit rating by NSCC in accordance with the CRRM and (2) each CRRM-
Rated Member's credit rating would be reassessed upon receipt of 
additional information from the Member.
    3. Section 4(b)(ii), providing that, because the factors used as 
part of the CRRM may not identify all risks that a Member may pose to 
NSCC, NSCC may, in addition to other actions permitted by the Rules, 
downgrade the Member's credit rating derived from the CRRM if NSCC 
believes the CRRM-generated rating is insufficiently conservative or if 
it deems such downgrade as necessary to protect NSCC and its Members. 
Depending on the credit rating of the Member, a downgrade may result in 
the Member being placed on the Watch List and/or being subject to 
enhanced surveillance based on relevant factors.
    4. Section 4(c), specifying that, other than CRRM-Rated Members, 
NSCC may place Members and Limited Members that are monitored and 
reviewed by NSCC on the Watch List and/or subject them to enhanced 
surveillance even though they are not being assigned credit ratings by 
NSCC in accordance with the CRRM.
    5. Section 4(d), describing some of the factors that could be taken 
into consideration by NSCC when downgrading a Member's credit rating, 
placing a Member or Limited Member on the Watch List and/or subjecting 
a

[[Page 17925]]

Member or Limited Member to enhanced surveillance. These factors 
include but are not limited to (i) news reports and/or regulatory 
observations that raise reasonable concerns relating to the Member or 
Limited Member, (ii) reasonable concerns around the Member's or Limited 
Member's liquidity arrangements, (iii) material changes to the Member's 
or Limited Member's organizational structure, (iv) reasonable concerns 
of NSCC about the Member's or Limited Member's financial stability due 
to particular facts and circumstances, such as material litigation or 
other legal and/or regulatory risks, (v) failure of the Member or 
Limited Member to demonstrate satisfactory financial condition or 
operational capability or if NSCC has a reasonable concern regarding 
the Member's or Limited Member's ability to maintain applicable 
membership standards and (vi) failure of the Member or Limited Member 
to provide information required by NSCC to assess risk exposures posed 
by the Member's or Limited Member's activity.
    6. Section 4(e), allowing NSCC to (1) require a Member or Limited 
Member that has been placed on the Watch List to make and maintain 
additional deposits to the Clearing Fund and (2) withhold any deposit 
in excess of the Required Deposit of a Member or Limited Member that 
has been placed on the Watch List as provided in Section 9 of Rule 4.
    7. Section 4(f), providing that NSCC would, in addition to other 
actions permitted by the Rules, conduct a more thorough monitoring of 
the financial condition and/or operational capability of, and require 
more frequent financial disclosures from, not only those Members and 
Limited Members that are placed on the Watch List but also Members and 
Limited Members subject to enhanced surveillance, including examples of 
how the monitoring could be conducted and the types of disclosures that 
may be required. In addition, Members and Limited Members that are 
subject to enhanced surveillance would be reported to NSCC's management 
committees and regularly reviewed by a cross-functional team comprised 
of senior management of NSCC.
    In addition to the proposed changes described above, NSCC is 
proposing to make technical corrections to the second paragraph of 
Section 4 of Rule 2B to (1) renumber the paragraph as Section 4(g), (2) 
update an internal cross reference and (3) clarify that the references 
in the paragraph to Members under surveillance are referring to Members 
on the Watch List.
C. Proposed Changes to Rule 4 (Clearing Fund)
    NSCC is proposing to amend Section 9 of Rule 4 to clarify that NSCC 
may, in its discretion, withhold all or part of any excess Clearing 
Fund deposit of Members that are on the Watch List.
D. Proposed Changes to Procedure XV (Clearing Fund Formula and Other 
Matters)
    NSCC is proposing to amend Section I(B)(1) of Procedure XV to 
clarify that Members or Limited Members that are placed on the Watch 
List would be required to make additional Clearing Fund deposits, as 
determined by NSCC.
    In addition, NSCC is proposing to make the following technical 
corrections to Section I(B)(1) of Procedure XV, (i) renumber the final 
three paragraphs as Section I(B)(2) and title the new subsection 
``Family Issued Securities'' to reflect the different subject matter of 
the new subsection, (ii) capitalize references to the Credit Risk 
Rating Matrix to reflect the proposed addition of the defined term to 
Rule 1 and (iii) make other grammatical corrections to the new Section 
I(B)(2).
    Finally, NSCC is proposing to amend Section II(C) of Procedure XV 
to clarify that, although NSCC would not request additional Clearing 
Fund deposits from Members unless they exceed a predetermined 
threshold, such floor would not apply to Members or Limited Members 
that are on the Watch List.
E. Additional Proposed Changes to Rule 1 (Definitions and Descriptions) 
and Procedure XV (Clearing Fund Formula and Other Matters)
    NSCC is proposing to amend the definition of ``Illiquid Position'' 
in Rule 1 as well as Procedure XV Sections I(A)(1) and I(A)(2), each as 
proposed in connection with a separate proposed rule change filed with 
the Commission but not yet approved.\16\ Specifically, the proposed 
amendments would replace and conform references to ``credit risk 
matrix'' with ``Credit Risk Rating Matrix'' in the proposed definition 
of ``Illiquid Position'' in Rule 1 as well as Procedure XV Sections 
I(A)(1) and I(A)(2).
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    \16\ See Securities Exchange Act Release No. 80260 (March 16, 
2017), 82 FR 14781 (March 22, 2017) (SR-NSCC-2017-001).
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Implementation Timeframe
    Pending Commission approval, NSCC expects to implement this 
proposal promptly. Members would be advised of the implementation date 
of this proposal through issuance of a NSCC Important Notice.
Expected Effect on Risks to the Clearing Agency, Its Participants and 
the Market
    The proposed rule changes would mitigate counterparty credit risk 
for NSCC by allowing NSCC to more accurately monitor the 
creditworthiness and risk profile of its Members. The enhanced CRRM 
would provide a more robust credit rating methodology by incorporating 
qualitative factors and adopting an absolute scoring approach. Both of 
these enhancements would improve NSCC's ability to monitor the credit 
risk of its Members and are expected to lessen the frequency of manual 
overrides. The enhanced CRRM would also expand the coverage of NSCC's 
membership by providing credit ratings for Members that are foreign 
banks or trust companies, which are not covered under the existing 
CRRM.
    By mitigating counterparty credit risk for NSCC as described above, 
the enhanced CRRM 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.
Management of Identified Risks
    The proposed rule changes are designed to mitigate counterparty 
credit risk for NSCC and to provide greater clarity and transparency to 
Members regarding the counterparty credit risk management approach used 
by NSCC.
    The enhanced CRRM would improve NSCC's ability to monitor the 
probability of default for Members that are rated by the CRRM and is 
expected to lessen the need and the frequency of manual downgrades due 
to the anticipated improvement in the accuracy of the credit ratings 
generated by the enhanced CRRM.
    NSCC employs a risk-based approach to conducting monitoring and 
review of its Members by using the CRRM to identify higher risk 
Members. Once identified, NSCC would place these Members on the Watch 
List, which would result in more frequent review by NSCC of these 
Members than the other Members. For Members that are placed on the 
Watch List, NSCC would conduct more thorough monitoring of these 
Members' financial condition and/or operational capability, which could 
include, for example, on-site visits or additional due diligence 
information requests.
    Members that have been placed on the Watch List may also be 
required to maintain a higher deposit to the Clearing Fund, which would 
help offset potential risks to NSCC and its Members arising from 
activity submitted by these Members.

[[Page 17926]]

    The enhanced CRRM would also expand the coverage of NSCC's 
membership by providing credit ratings for foreign banks and trust 
companies, which are not currently rated under the existing CRRM. The 
addition of these entities would allow NSCC to employ its risk-based 
approach to identify those higher risk Members for additional 
monitoring with more efficiency (by reducing the need for manual 
overrides) and effectiveness (by generating a more comprehensive and 
accurate credit rating after taking into account both quantitative and 
qualitative factors and adopting the absolute scoring approach).
    Thus, the enhanced CRRM would help NSCC to identify those Members 
that could present credit risk to NSCC, which then would allow NSCC to 
better manage the potential risks from these Members.
Consistency With the Clearing Supervision Act
    The proposed enhancements to the CRRM as described in detail above 
would be consistent with Section 805(b) of Clearing Supervision 
Act.\17\ The objectives and principles of Section 805(b) of the 
Clearing Supervision Act include, among other things, the promotion of 
robust risk management.\18\
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    \17\ 12 U.S.C. 5464(b).
    \18\ Id.
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    By enhancing the CRRM to enable it to assign credit ratings to 
Members that are foreign banks or trust companies and that have audited 
financial data that is publicly available, the proposed rule change 
would expand the CRRM's applicability to a wider group of Members, 
which would improve NSCC's membership monitoring process and promote 
robust risk management, consistent with the objectives and principles 
of Section 805(b) of the Clearing Supervision Act cited above.
    Similarly, by enhancing the CRRM to enable it to incorporate 
qualitative factors when assigning a Member's credit rating, the 
proposed change would enable NSCC to take into account relevant 
qualitative factors in an automated and more effective manner when 
monitoring the credit risks presented by the Members, which would 
improve NSCC's membership monitoring process overall and promote robust 
risk management, consistent with the objectives and principles of 
Section 805(b) of the Clearing Supervision Act cited above.
    Likewise, by enhancing the CRRM to shift from a relative scoring 
approach to an absolute scoring approach when assigning a Member's 
credit rating, the proposed rule change would enable NSCC to generate 
credit ratings for Members that are more reflective of the Members' 
default risk, which would improve NSCC's membership monitoring process 
and promote robust risk management, consistent with the objectives and 
principles of Section 805(b) of the Clearing Supervision Act cited 
above.
    The proposed enhancements to the CRRM are consistent with Rule 
17Ad-22(e)(3)(i) under the Act, which was recently adopted by the 
Commission.\19\ Rule 17Ad-22(e)(3)(i) will require NSCC to establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to maintain a sound risk management framework for 
comprehensively managing risks that arise in or are born by NSCC, which 
includes * * * systems designed to identify, measure, monitor and 
manage the range of risks that arise in or are borne by NSCC.\20\ The 
proposed enhancements to the CRRM have been designed to assist NSCC in 
identifying, measuring, monitoring and managing the credit risks to 
NSCC posed by its Members. The proposed enhancements to the CRRM 
accomplish this by (i) expanding the CRRM's applicability to a wider 
group of Members to include Members that are foreign banks or trust 
companies, (ii) enabling the CRRM to take into account relevant 
qualitative factors in an automated and more effective manner when 
monitoring the credit risks presented by Members and (iii) enabling the 
CRRM to generate credit ratings for Members that are more reflective of 
the Members' default risk by shifting to an absolute scoring approach, 
all of which would improve NSCC's membership monitoring process 
overall. Therefore, NSCC believes the proposed enhancements to the CRRM 
would assist NSCC in identifying, measuring, monitoring and managing 
risks that arise in or are born by NSCC, consistent with the 
requirements of Rule 17Ad-22(e)(3)(i).
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    \19\ 17 CFR 240.17Ad-22(e)(3)(i). The Commission adopted 
amendments to Rule 17Ad-22, including the addition of new subsection 
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). FICC is a ``covered clearing agency'' as defined 
by the new Rule 17Ad-22(a)(5) and must comply with new subsection 
(e) of Rule 17Ad-22 by April 11, 2017. Id.
    \20\ Id.
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    The proposed rule change to Section 2B of Rule 2B with respect to 
the scope of information that may be requested by NSCC from its Members 
has been designed to be consistent with Rule 17Ad-22(e)(19) under the 
Act, which was recently adopted by the Commission.\21\ Rule 17Ad-
22(e)(19) will require NSCC to establish, implement, maintain and 
enforce written policies and procedures reasonably designed to 
identify, monitor, and manage the material risk to NSCC arising from 
arrangements in which firms that are indirect participants in NSCC rely 
on the services provided by Members to access NSCC's payment, clearing, 
or settlement facilities.\22\ By expressly reflecting in the Rules what 
is already NSCC's current practice associated with its request for 
additional reporting of a Member's financial or operational conditions 
to state that such request may include information regarding the 
businesses and operations of the Member, as well as its risk management 
practices with respect to services of NSCC utilized by the Member for 
another Person, this proposed rule change would help enable NSCC to 
have rule provisions that are reasonably designed to identify, monitor 
and manage the material risks to NSCC arising from tiered participation 
arrangements consistent with Rule 17Ad-22(e)(19).
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    \21\ 17 CFR 240.17Ad-22(e)(19). Id.
    \22\ Id.
---------------------------------------------------------------------------

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.

[[Page 17927]]

    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-2017-801 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-2017-801. 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-2017-801 and should be submitted on 
or before April 28, 2017.

    By the Commission.
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-07453 Filed 4-12-17; 8:45 am]
 BILLING CODE 8011-01-P