Document ID: SEC-2013-0971-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Fixed Income Clearing Corp.
Posted Date: 2013-05-23T04:00Z

[Federal Register Volume 78, Number 100 (Thursday, May 23, 2013)]
[Notices]
[Pages 30948-30951]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-12266]

[[Page 30948]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-69602; File No. SR-FICC-2013-802]

Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Advance Notice To Include Options on Interest Rate 
Futures Contracts With Maturities Not Longer Than Two Years in the One-
Pot Cross-Margining Program Between the Government Securities Division 
and New York Portfolio Clearing, LLC

May 17, 2013.
    Pursuant to Section 806(e)(1) of the Payment, Clearing, and 
Settlement Supervision Act of 2010 (``Clearing Supervision Act'') \1\ 
and Rule 19b-4(n)(1)(i) \2\ of the Securities Exchange Act of 1934 
(``Exchange Act''),\3\ notice is hereby given that, on April 15, 2013, 
the Fixed Income Clearing Corporation (``FICC'') filed with the 
Securities and Exchange Commission (``Commission'') the advance notice 
described in Items I and II below, which Items have been prepared 
primarily by FICC. 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\ 15 U.S.C. 78q-1.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance 
Notice

    This advance notice concerns proposed rule changes that would allow 
FICC to include options on interest rate futures contracts with 
maturities not longer than two years in the one-pot cross-margining 
program between FICC's Government Securities Division (``GSD'') and New 
York Portfolio Clearing, LLC (``NYPC'').\4\
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    \4\ NYPC is jointly owned by NYSE Euronext and The Depository 
Trust & Clearing Corporation (``DTCC'').
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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, FICC 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. FICC has prepared summaries, set forth in sections (A), (B), and 
(C) below, of the most significant aspects of these statements.\5\
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    \5\ The Commission has modified the text of the summaries 
prepared by FICC.
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(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Advance Notice

    (i) The purpose of the advance notice is to include options on 
interest rate futures contracts with maturities not longer than two 
years in the one-pot cross-margining program between the GSD and NYPC.
Background on NYPC and the FICC-NYPC One-Pot Cross-Margining Program
    NYPC is registered with the Commodity Futures Trading Commission 
(``CFTC'') as a derivatives clearing organization (``DCO'') pursuant to 
Section 5b of the Commodity Exchange Act and Part 39 of the CFTC 
regulations. NYPC launched operations on March 21, 2011, and currently 
clears U.S. dollar-denominated interest rate futures contracts. It 
plans to add options on interest rate futures to its suite of products.
    Pursuant to FICC Rule Filing 2010-09,\6\ FICC offers ``single pot'' 
cross margining of certain positions cleared at NYPC and the GSD. This 
arrangement is reflected in a cross-margining agreement (``FICC-NYPC 
Cross-Margining Agreement'') between FICC and NYPC, which is a part of 
the GSD's rules. Specifically, certain GSD members are permitted to 
combine their positions at GSD with their positions at NYPC, or with 
the positions of certain permitted affiliates that are cleared at NYPC, 
within a single margin portfolio. Joint GSD-NYPC members or GSD members 
and their permitted affiliates who wish to participate in the one-pot 
program must execute the requisite cross-margining participant 
agreements, which are exhibits to the FICC-NYPC Cross-Margining 
Agreement.\7\
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    \6\ The Commission approved this rule filing on February 28, 
2011. See Securities Exchange Act Release No. 63986 (Feb. 28, 2011); 
76 FR 12144 (Mar. 4, 2011) (SR-FICC-2010-09).
    \7\ GSD members and NYPC members are also permitted to cross 
margin in the single pot the activity of their market professional 
customers. See Securities Exchange Act Release No. 66989 (May 15, 
2012); 77 FR 30032 (May 21, 2012) (SR-FICC-2012-03).
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    As noted in FICC Rule Filing 2010-09, FICC is responsible for 
performing the margin calculations in its capacity as the 
``Administrator'' under the terms of the FICC-NYPC Cross-Margining 
Agreement. Specifically, FICC determines the combined FICC Clearing 
Fund and NYPC Original Margin \8\ requirement for each cross-margining 
participant. The FICC-NYPC one-pot margin requirement for each 
participant is then allocated between FICC and NYPC in proportion to 
each clearing organization's respective ``stand-alone'' margin 
requirements--in other words, an amount reflecting the ratio of what 
each clearing organization would have required from that member if it 
were not participating in the cross-margining program. The FICC-NYPC 
Cross-Margining Agreement refers to this as the ``Constituent Margin 
Ratio.''
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    \8\ Original Margin is NYPC's equivalent of the GSD's Clearing 
Fund.
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    The FICC-NYPC Cross-Margining Agreement provides that either FICC 
or NYPC may, at any time, require additional margin to be deposited by 
a participant (above what is calculated under the FICC-NYPC Cross-
Margining Agreement) based upon the financial condition of the 
participant, unusual market conditions or other special circumstances. 
The standards that FICC proposed in Rule Filing 2010-09 to use for 
these purposes are the standards contained within the GSD's rules 
currently, so that notwithstanding the calculation of a participant's 
Clearing Fund requirement pursuant to the FICC-NYPC Cross-Margining 
Agreement, FICC still retains the rights contained within the GSD's 
rules to require an additional Clearing Fund deposit under the 
circumstances specified in the GSD's rules. For example, the GSD's 
rules currently provide that, if a Dealer Netting Member \9\ falls 
below its minimum financial requirement, it shall be required to make 
an additional Clearing Fund deposit equal to the greater of (i) $1 
million or (ii) 25 percent of its Required Fund Deposit.\10\
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    \9\ The GSD's rules define the term ``Dealer Netting Member'' as 
``a Registered Government Securities Dealer that is admitted to 
membership in the Netting System pursuant to these Rules, and whose 
membership in the Netting System has not been terminated. . . .'' 
GSD Rulebook, Rule 2A, Section 2.
    \10\ The GSD's rules define the term ``Required Fund Deposit'' 
as ``the amount a Netting Member is required to deposit to the 
Clearing Fund.'' GSD Rulebook, Rule 1.
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    In the event of the insolvency or default of a member that 
participates in the one-pot cross-margining arrangement, the positions 
in such member's FICC-NYPC one-pot portfolio (including, when 
applicable, the positions of its permitted margin affiliate at NYPC) 
will be liquidated by FICC and NYPC as a single portfolio, and the 
liquidation proceeds will be applied to the defaulting member's 
obligations to FICC and NYPC in accordance with the provisions of the 
FICC-NYPC Cross-Margining Agreement. The FICC-NYPC Cross-Margining 
Agreement provides for the sharing of losses by FICC and NYPC in the 
event that the one-pot portfolio

[[Page 30949]]

margin deposits of a defaulting participant are not sufficient to cover 
the losses resulting from the liquidation of that participant's trades 
and positions, which is covered in detail in FICC Rule Filing 2010-09, 
and is reflected in the terms of the FICC-NYPC Cross-Margining 
Agreement.
    According to FICC, the addition of options on interest rate futures 
to the one-pot cross-margining arrangement does not require any changes 
to the terms of the FICC-NYPC Cross-Margining Agreement. FICC would 
continue to act as the Administrator for purposes of margin 
calculations if the proposed rule changes were approved. The loss-
sharing provisions in the FICC-NYPC Cross-Margining Agreement that 
would apply in the event of a participant's default would remain 
unchanged under this proposal, as well.
Proposal To Include Options on Interest Rate Futures in the One-Pot 
Cross-Margining Arrangement
    FICC proposes to add options on interest rate futures contracts 
with maturities not longer than two years to the one-pot cross-
margining arrangement. NYPC will act as the DCO for such products.
    FICC observes that options on interest rate futures are a well-
established, standardized product traded and cleared by futures 
exchanges \11\ around the globe, including the Chicago Mercantile 
Exchange (``CME'').\12\ FICC states that the key risks associated with 
adding options on interest rate futures to the one-pot cross-margining 
arrangement relate to the ability of FICC and NYPC to properly model, 
test and monitor the risks that options on interest rate futures 
present to the clearing organizations. Consistent with FICC's 
quantitative policy for new initiatives, any new models or enhancements 
are subject to external review before they are utilized. FICC avers 
that the options proposal has followed this protocol, and that a team 
of external reviewers has tested the models and validated their 
methodology.
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    \11\ Exchanges that list options on interest rate futures 
include the following: (i) CME (US); (ii) CBOT (a subsidiary of 
CME); (iii) BM&F (Brazil); (iv) NYSE LIFFE (UK); (v) Eurex 
(Germany); (vi) ASX (Australia); (vii) Montreal Exchange (Canada); 
(viii) SGX (Singapore); and (ix) TFX (Japan).
    \12\ Options on interest rate futures are currently included in 
the ``two-pot'' cross-margining arrangement between FICC and the 
CME. The cross-margining agreement between FICC and the CME is 
incorporated in the GSD's Rules and may be found on the DTCC Web 
site, www.dtcc.com.
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    FICC asserts that, in the case of options on interest rate futures 
that are physically deliverable, the addition of options on interest 
rate futures to the one-pot cross-margining arrangement will not alter 
the manner in which physical deliveries occur. According to FICC, upon 
exercise or assignment of an option, the resulting futures position 
will be treated as a traded futures contract, with the same delivery 
obligations if the resulting futures position is not closed out prior 
to delivery. In general, delivery of U.S. Treasury futures can be 
submitted to FICC by NYPC on a locked-in basis and processed in 
accordance with FICC's rules (when such futures are submitted to FICC, 
they are no longer futures contracts but rather are in the form of buy-
sells eligible for processing at the GSD).
    FICC asserts that it will submit a separate rule filing to the 
Commission seeking approval for the inclusion in the single pot of 
longer-dated interest rate options products. FICC contends that it will 
also conduct appropriate testing and analysis of any future changes to 
the options model and, consistent with FICC's quantitative policy for 
new initiatives, submit the model for external review.
Risk Considerations Regarding the Proposal To Include Options on 
Interest Rate Futures in the One-Pot Cross-Margining Arrangement
    FICC states that its methodology for managing the risks associated 
with options on interest rate futures that will be included in the one-
pot cross-margining arrangement has three pillars: (i) Value-at-Risk 
(``VaR'') with historical simulation, (ii) the Barone-Adesi & Whaley 
(``BAW'') approximation, and (iii) the Stochastic Alpha, Beta, Rho 
(``SABR'') volatility model.
    According to FICC, the historical-simulation-based VaR model 
proposed for options on interest rate futures to be included in the 
one-pot cross-margining arrangement is the same model utilized in the 
current one-pot cross-margining arrangement between NYPC and the GSD, 
which is described in FICC Rule Filing 2010-09. FICC contends that the 
backbone of this VaR model--namely, the three-day/one-day liquidation 
period assumption for cash and derivatives positions, respectively; the 
99th percentile confidence level; the one-year look-back period and the 
use of a linear interpolation/front-weighting mechanism to arrive at 
the 99th percentile threshold from simulated profits and losses--will 
remain the same when options on interest rate futures are added to 
FICC-NYPC one-pot portfolios.
    FICC asserts that the BAW approximation is the pricing function 
that FICC and NYPC will use to estimate the value of options on 
interest rate futures within the Black-Scholes-Merton framework. FICC 
also contends that the SABR volatility model will be used to estimate 
volatility curves for various options series.
    As noted above, a three-day liquidation period is assumed for cash 
positions cleared by FICC, whereas a one-day liquidation period is 
assumed for futures positions cleared by NYPC. FICC states that options 
on interest rate futures in the one-pot cross-margining arrangement 
will also be subject to a one-day liquidation requirement because 
options and futures share a similar liquidity profile. FICC contends 
that this is also consistent with CFTC requirements. FICC further 
observes that each cross-margining participant's FICC-NYPC one-pot 
margin requirement is currently subject to a daily back test, and that 
a ``coverage component'' is applied and charged to the participant in 
the event the daily back test reflects insufficient coverage. FICC 
states that options on interest rate futures in the one-pot cross-
margining arrangement will be subject to this daily testing.
    FICC asserts that the one-pot FICC-NYPC VaR model will account for 
the non-linear risk posed by the addition of options on interest rate 
futures to the one-pot cross-margining arrangement by performing full 
revaluation of such options using BAW and SABR. As options on interest 
rate futures can exhibit magnified exposure in extreme market 
conditions, FICC is proposing to employ the additional tools described 
below:
1. Minimum Margin Charge for Portfolios That Include Options
    Similar to the practice FICC's Mortgage-Backed Securities Division 
uses to address potential mark-to-market offset of margin requirements, 
FICC and NYPC are proposing to apply a floor margin charge of five 
basis points of the gross market value of positions in options on 
interest rate futures to the unadjusted Required Fund Deposit of GSD 
Netting Members with one-pot portfolios that include options on 
interest rate futures. Therefore, for GSD Netting Members with one-pot 
portfolios that include options on interest rate futures, their minimum 
Required Fund Deposit will be the greater of: (i) The current minimum 
Required Fund Deposit as prescribed in GSD Rule 4, Section 2; or (ii) 
the proposed floor margin charge.
2. Short Option Minimum Charge
    To address the risk associated with short positions in deep out-of-
the-

[[Page 30950]]

money (``OTM'') options, FICC and NYPC propose to introduce a short 
option minimum (``SOM'') for options on interest rate futures in the 
one-pot cross-margining arrangement. The SOM will apply only to options 
on interest rate futures with a settlement price of ``cabinet.'' \13\ 
FICC notes that these options demonstrate minimum price volatility in 
normal market conditions, but may potentially become volatile when 
market conditions change dramatically. In light of the losses that such 
options may cause, FICC proposes to apply an SOM charge to any short 
position in these options.
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    \13\ The minimum price increment for futures or options on 
futures is normally referred to as a ``tick.'' For options on 
futures whose value is less than one tick, trading and settlement in 
the options are allowed at a price that is less than a tick. This 
latter price is known as ``cabinet.''
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3. Out-of-the-Money Options Surcharge
    FICC and NYPC also propose to impose a surcharge on all OTM options 
positions in the one-pot cross-margining arrangement in order to 
address any potential biases in the BAW options pricing model. The 
amount of the surcharge will be determined by the moneyness of the 
options position.
4. Options Stress Testing
    In addition to the regular stress testing practices utilized by 
FICC and NYPC, FICC proposes to conduct monthly hypothetical implied 
volatility stress tests of FICC-NYPC one-pot portfolios, including 
options on interest rate futures, in order to analyze specifically the 
non-linear tail risks associated with options products.
Proposed Rule Changes
    FICC's proposal to add options on interest rate futures to the one-
pot cross-margining arrangement requires that Rule 4, Section 2 of 
GSD's rulebook be changed to include a reference to the proposed 
minimum margin charge discussed above. Technical clarifications to 
certain GSD Rules would also be required in order to make it clear that 
options on interest rate futures will be included in the arrangement. 
Specifically, FICC is proposing to make technical clarifications to the 
following: (i) The definitions of ``CFTC-Recognized Clearing 
Organization'' and ``Eligible Positions'' set forth in Rule 1; (ii) 
Section 5a of GSD Rule 13, and (iii) subsection (b) of GSD Rule 29. As 
noted above, no changes are required to be made to the FICC-NYPC Cross-
Margining Agreement itself.
    (ii) FICC believes the proposed rule changes described above are 
consistent with the purposes and requirements of Section 17A of the 
Exchange Act \14\ and the rules and regulations promulgated thereunder. 
FICC contends that these proposed changes may increase the available 
offsets among positions held at FICC and NYPC, which, in turn, may 
allow a more efficient use of member collateral and promote additional 
efficiencies in the marketplace. FICC therefore believes the proposed 
rule changes would support the prompt and accurate clearance and 
settlement of securities transactions.\15\ FICC further believes that, 
as it will implement the proposed rule changes using the enhanced risk-
management measures discussed above, the proposed rule changes will 
also be consistent with the Exchange Act because they will help to 
assure the safeguarding of the securities and funds in FICC's custody 
and control.\16\
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    \14\ 15 U.S.C. 78q-1.
    \15\ 15 U.S.C. 78q-1(b)(3)(F) (requiring that a clearing 
agency's rules be designed to ``promote the prompt and accurate 
clearance and settlement of securities transactions. . . .'').
    \16\ 15 U.S.C. 78q-1(b)(3)(A) (requiring a clearing agency to 
have the capacity to ``safeguard securities and funds in its custody 
or control or for which it is responsible. . .'').
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(B) Clearing Agency's Statement on Burden on Competition

    FICC does not believe that the proposed rule changes described 
above will have any negative impact, or impose any burden, on 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Exchange Act.

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

    Written comments relating to the advance notice have not yet been 
solicited or received. FICC will notify the Commission of any written 
comments received by FICC.

(D) Anticipated Effect on and Management of Risk

    FICC is filing these proposed rule changes as an advance notice 
pursuant to Section 806(e)(2) of Clearing Supervision Act because it 
believes the proposed changes could be deemed to affect materially the 
nature or level of risks presented by FICC. FICC believes that the 
proposed rule changes will not impair its ability to manage these 
risks. As described in Section (A) above, FICC has enhanced its risk-
management framework to account for the added risks posed by including 
options on interest rate futures with a maturity of less than two years 
in the one-pot cross-margining arrangement. This framework has three 
pillars: (i) VaR with historical simulation, (ii) BAW approximation, 
and (iii) the SABR volatility model. Options on interest rate futures 
in the one-pot cross-margining arrangement will also be subject to a 
one-day liquidation requirement, as these products' liquidity profile 
is similar to that of futures, and because this is consistent with CFTC 
requirements. In addition, each cross-margining participant's FICC-NYPC 
one-pot margin requirement is currently subject to a daily back test, 
and a ``coverage component'' is applied and charged to the participant 
in the event the daily back test reflects insufficient coverage. 
Options on interest rate futures in the one-pot cross-margining 
arrangement will be subject to this daily testing.
    The one-pot FICC-NYPC VaR model will account for the non-linear 
risk posed by the addition of options on interest rate futures to the 
one-pot cross-margining arrangement by performing full revaluation of 
such options using the BAW and SABR methodologies. Because options on 
interest rate futures may exhibit magnified exposure in extreme market 
conditions, FICC is proposing to employ the following additional tools, 
as described above: (1) A minimum margin charge for portfolios 
including options, (2) an SOM charge, (3) an OTM options surcharge, and 
(4) options stress testing.

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

    A clearing agency may implement a proposed change pursuant to 
Section 806(e)(1)(G) of the Clearing Supervision Act \17\ if the 
Commission does not object to the proposed change within 60 days of the 
later of: (i) The date the advance notice was filed with the 
Commission; or (ii) the date the Commission receives any further 
information it requests in order to facilitate its review of the 
notice. The clearing agency shall not implement the proposed change if 
the Commission has any objection to the proposed change.
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    \17\ 12 U.S.C. 5465(e)(1)(G).
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    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 the 
Commission receives any further information it has

[[Page 30951]]

requested, 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 proposal shall not take effect until all regulatory actions 
required with respect to the proposal are completed.\18\ The clearing 
agency shall post notice on its Web site of proposed changes that are 
implemented.\19\
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    \18\ FICC also filed the proposals contained in this advance 
notice as a proposed rule change under Section 19(b)(1) of the Act 
and Rule 19b-4 thereunder, seeking Commission approval to permit it 
to change its rules to reflect the proposed changes in this advance 
notice. Securities Exchange Act Release No. 69470 (Apr. 29, 2013), 
78 FR 26093 (May 3, 2013) (File No. SR-FICC-2013-02). Pursuant to 
Section 19(b)(2) of the Exchange Act, within 45 days of the date of 
publication of the proposed rule change in the Federal Register or 
within such longer period up to 90 days (i) as the Commission may 
designate if it finds such longer period to be appropriate and 
publishes its reasons for so finding or (ii) as to which the self-
regulatory organization consents, the Commission will: (A) by order 
approve or disapprove such proposed rule change, or (B) institute 
proceedings to determine whether the proposed rule change should be 
disapproved. 15 U.S.C. 78s(b)(2)(A). The Commission will consider 
all public comments received on these proposed changes regardless of 
whether the comments are submitted in response to the proposed rule 
change (File No. SR-FICC-2013-02) or this advance notice (File No. 
SR-FICC-2013-802).
    \19\ See 17 CFR 240.19b-4(n)(4).
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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 No. SR-FICC-2013-802 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File No. SR-FICC-2013-802. 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 of submission. 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 such filings also will be available 
for inspection and printing at the principal office of FICC and on 
FICC's Web site at http://dtcc.com/downloads/legal/rule_filings/2013/ficc/AN_FICC_2013_802.pdf. 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 No. SR-FICC-2013-802 and should be submitted on or before June 13, 
2013.

    By the Commission.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-12266 Filed 5-22-13; 8:45 am]
BILLING CODE 8011-01-P