Document ID: SEC-2017-0749-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; ProposedRule Changes: National Securities Clearing Corp.
Posted Date: 2017-05-10T04:00Z

[Federal Register Volume 82, Number 89 (Wednesday, May 10, 2017)]
[Notices]
[Pages 21863-21866]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-09425]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-80597; File No. SR-NSCC-2017-001]

Self-Regulatory Organizations; National Securities Clearing 
Corporation; Order Approving Proposed Rule Change To Describe the 
Illiquid Charge That May Be Imposed on Members

May 4, 2017.
    On March 13, 2017, National Securities Clearing Corporation 
(``NSCC'') filed with the Securities and Exchange Commission 
(``Commission'') proposed rule change SR-NSCC-2017-001, pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ 
and Rule 19b-4 thereunder.\2\ The proposed rule change was published 
for comment in the Federal Register on March 22, 2017.\3\ The 
Commission did not receive any comment letters on the proposed rule 
change. For the reasons discussed below, the Commission is granting 
approval of the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 80260 (March 16, 
2017), 82 FR 14781 (March 22, 2017) (SR-NSCC-2017-001) (``Notice'').
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I. Description of the Proposed Rule Change

    NSCC proposes to amend its Rules & Procedures (``Rules'') \4\ in 
order to provide transparency to an existing margin charge (i.e., the 
``Illiquid Charge'') and to codify NSCC's current practices with 
respect to the assessment and collection of the Illiquid Charge, as 
described below.\5\ Separately, NSCC also proposes to amend Procedure 
XV of the Rules to define the ``Market Maker Domination Charge,'' also 
described below.
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    \4\ Available at http://www.dtcc.com/en/legal/rules-and-procedures.
    \5\ Specifically, NSCC proposes to amend Rule 1 (Definitions and 
Descriptions) to add certain defined terms associated with the 
Illiquid Charge, and amend Procedure XV (Clearing Fund Formula and 
Other Matters) to clarify the circumstances and manner in which NSCC 
calculates and imposes the Illiquid Charge.
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A. The Illiquid Charge

    NSCC states that it designed the Illiquid Charge to mitigate the 
market risk that NSCC faces when liquidating securities that lack 
marketability, based on insufficient access to a trading venue, and may 
have low and volatile share prices (``Illiquid Securities''),\6\ 
following a member default.\7\ In such a situation, the liquidation of 
Illiquid Securities could be difficult or delayed due to a lack of 
interest in the securities or limitations on the share price of the 
securities.\8\
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    \6\ More specifically, NSCC proposes to define Illiquid Security 
to mean a security, other than a family-issued security as defined 
in Procedure XV of the Rules, that either (i) is not traded on or 
subject to the rules of a national securities exchange registered 
under the Act, or (ii) is an OTC Bulletin Board or OTC Link issue.
    \7\ Notice, 82 FR at 14781.
    \8\ Id.
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    NSCC calculates an Illiquid Charge for each net unsettled position 
in an Illiquid Security (i.e., an ``Illiquid Position'') that exceeds 
applicable volume thresholds. Following is a description of (i) the 
volume thresholds that must be met in order for the Illiquid Charge to 
be applied, (ii) the methodology for calculating the Illiquid Charge, 
and (iii) the exceptions to and application of the Illiquid Charge.
1. Net Buy Illiquid Positions and Net Sell Illiquid Positions
    Depending on whether the Illiquid Positon is a net buy or a net 
sell position, NSCC applies different volume thresholds and calculation 
methods for establishing the Illiquid Charge. The purpose of this is to 
address the different risk profiles presented by such net buy and net 
sell positions.\9\
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    \9\ In the event of a Member default, NSCC would complete the 
liquidation of an Illiquid Position by buying or selling that 
position into the market. Notice, 82 FR at 14783. According to NSCC, 
the different risk profiles of net buy positions and net sell 
positions are based on, in part, the difference in the potential 
responsiveness of prices change to quantity that may occur when NSCC 
is liquidating a net buy position in an Illiquid Security, compared 
to when it is liquidating a net sell position in an Illiquid 
Security. Id.
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a. Net Buy Illiquid Positions
    The Illiquid Charge only applies to a member's net buy Illiquid 
Position if the position meets a specific volume threshold. For an NSCC 
member with a strong credit rating, the net buy Illiquid Position must 
meet a volume threshold of greater than 100 million shares.\10\ For

[[Page 21864]]

an NSCC member with a weak credit rating, the net buy Illiquid Positon 
must meet a volume threshold of greater than 10 million shares.\11\ If 
the volume threshold is met, the net buy position in the Illiquid 
Securities is considered an Illiquid Position and is subject to the 
Illiquid Charge.
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    \10\ Credit ratings are established through NSCC's credit risk 
rating matrix (``CRRM''). See Rule 2B, Section 4, supra note 4; see 
also Securities Exchange Act Release No. 80381 (April 5, 2017), 82 
FR 17475 (April 11, 2017) (SR-NSCC-2017-002) (NSCC proposed rule 
change to modify the CRRM formula). The CRRM applies a 7-point 
rating system, with ``1'' being the strongest rating and ``7'' being 
the weakest rating. Id. A CRRM credit rating of 1-4 would be a 
stronger credit rating, while a CRRM credit rating of 5-7 would be a 
weaker credit rating. Id.
    \11\ Members with a stronger CRRM rating would be assessed an 
Illiquid Charge on a net buy Illiquid Position at a higher volume 
threshold because NSCC believes these members pose a lower risk of 
default. Notice, 82 FR at 14783. Meanwhile, members with a weaker 
CRRM rating present a heightened credit risk to NSCC or have 
demonstrated a higher risk related to their ability to meet 
settlement. Id.
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    In addition, the Illiquid Charge only applies to net buy Illiquid 
Positions in Illiquid Securities that have a share price below $0.01. 
If a transaction in any security, including an Illiquid Security, with 
a share price below $0.01 is entered into NSCC's Continuous Net 
Settlement system or Balance Order Accounting Operation,\12\ NSCC 
rounds up the price of the security to $0.01. Therefore, when a member 
holds a buy position in a sub-penny security, NSCC records the 
position's value at a higher price than the actual per share price of 
the position. The difference may reduce the member's required fund 
deposit,\13\ particularly for a large quantity of buy positions in a 
sub-penny security.
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    \12\ NSCC processed guaranteed trades through the Continuous Net 
Settlement system if the underlying security is freely transferable. 
NSCC processed guaranteed trades through the Balance Order 
Accounting Operation when the underlying security is subject to a 
restriction such as Reg. S or Reg. 144A. See Rule 1, supra note 4.
    \13\ The required fund deposit is a mutualized deposit made by a 
member to NSCC to be used in the event of a member default. See Rule 
4, Section 1, supra note 4.
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    To address this risk, NSCC states that it calculates the Illiquid 
Charge for net buy Illiquid Positions by multiplying the aggregate 
quantity of shares in such positions by $0.01.\14\ NSCC assesses and 
collects the resulting amounts as the Illiquid Charge component of 
affected members' required fund deposit.\15\
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    \14\ Notice, 82 FR at 14783.
    \15\ Id.
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b. Net Sell Illiquid Positions
    The Illiquid Charge only applies to a member's net sell Illiquid 
Position if the position meets a specific volume threshold. To 
determine the volume threshold, NSCC first offsets the quantity of 
shares in the member's net sell Illiquid Position against the number of 
shares of the same Illiquid Security held by the member at The 
Depository Trust Company (``DTC inventory offset'').\16\ Next, NSCC 
determines the applicable volume threshold for the net sell Illiquid 
Position based on (i) the percentage of the average daily volume 
(``ADV'') \17\ of the underlying Illiquid Securities, (ii) the member's 
credit rating, and, in some cases, (iii) the member's excess net 
capital (``ENC''). More specifically, for an NSCC member with a strong 
credit rating (i.e., a CRRM rating of 1-4), the net sell Illiquid 
Position must meet a volume threshold of 1 million shares, when the net 
sell Illiquid Position is greater than or equal to 25 percent of the 
ADV. For an NSCC member with a weak credit rating (i.e., a CRRM rating 
of 5-7), the net sell Illiquid Position must meet a volume threshold of 
500,000 shares, when the net sell Illiquid Position is greater than or 
equal to 25 percent of the ADV and the member's ENC is greater than $10 
million. However, the net sell Illiquid Position need only meet a 
volume threshold of 100,000 shares, if an NSCC member has a weak credit 
rating (i.e., a CRRM rating of 5-7), and the net sell Illiquid Position 
is greater than or equal to 25 percent of the ADV, and the member's ENC 
is less than or equal to $10 million. A member may not meet the 
applicable volume thresholds after applying the DTC inventory offset, 
and, therefore, would not be subject to the Illiquid Charge.
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    \16\ DTC is a central depository where NSCC-traded securities 
are held. The DTC inventory offset does not apply to members with 
the weakest CRRM rating (i.e., a 7). See Rule 2B, Section 4, supra 
note 4; Notice, 82 FR at 14783.
    \17\ NSCC states that ``ADV'' is the average daily volume over 
the most recent twenty business days as determined by NSCC. Notice, 
82 FR at 14783.
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    If the applicable volume threshold is met, the net sell Illiquid 
Position is subject to the Illiquid Charge. To calculate the Illiquid 
Charge for net sell Illiquid Positions, NSCC considers the Current 
Market Price \18\ of the subject Illiquid Security and the quantity of 
shares in such position compared to the ADV of that Illiquid Security:
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    \18\ The term ``Current Market Price'' is defined in Rule 1 and 
is generally the most recent closing price of the security. Supra 
note 4.
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    (A) If the Illiquid Position has a Current Market Price equal to or 
less than $1.00, NSCC calculates the Illiquid Charge as the product of 
the aggregate quantity of shares in the Illiquid Position and either 
(i) the highest market price of the Illiquid Security during the 
preceding 20 trading days (``One Month High Price''),\19\ or (ii) the 
Current Market Price of the Illiquid Security multiplied by a factor 
between 2 and 10, depending on the market price.\20\
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    \19\ The ``One Month High Price'' means the highest of all NSCC 
observed market prices over the most recent 20 trading day period 
for purposes of the Illiquid Charge. Notice, 82 FR at 14783.
    \20\ Generally, the factor applied would be 10 where the market 
price is less than $0.10; the factor applied would be 5 where the 
market price is between $0.10 and $0.20; the factor applied would be 
2 where the market price is between $0.20 and $1.00. Where the 
market price is greater than $1.00, a $0.50 price increment is 
applied. Id.
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    (B) If the Illiquid Position has a Current Market Price that is 
greater than $1.00, NSCC calculates the Illiquid Charge as the product 
of the aggregate quantity of shares in the Illiquid Position and either 
(i) the One Month High Price, or (ii) the Current Market Price of the 
Illiquid Security rounded up to the next $0.50 increment.
    In determining whether to use the One Month High Price or the 
Current Market Price of the Illiquid Security to calculate the Illiquid 
Charge, NSCC compares the percentage of the ADV to the share quantity 
in the Illiquid Position. If the quantity of shares in the Illiquid 
Position is less than 100 percent of the ADV, but greater than or equal 
to 25 percent of the ADV, then the calculation uses the lesser of the 
One Month High Price or the Current Market Price of the Illiquid 
Securities (rounded up to the next $0.50 increment, if applicable). If 
the quantity of shares in the Illiquid Position is greater than or 
equal to 100 percent of the ADV, then the calculation uses the greater 
of the One Month High Price or the Current Market Price of the Illiquid 
Security (rounded up to the next $0.50 increment, if applicable).
    Furthermore, depending on the result of the calculation described 
above, the Illiquid Charge would remain subject to a minimum price per 
share, which would not be less than $0.01. Therefore, when calculating 
the Illiquid Charge, the One Month High Price or the Current Market 
Price of the Illiquid Security is substituted by the minimum price per 
share if the One Month High Price or the Current Market Price, as 
applicable, is below the minimum price per share.
2. Exceptions and Exclusions From the Illiquid Charge
    NSCC states that, in order to avoid duplicate margin charges, it 
does not apply the Illiquid Charge when a greater Market Maker 
Domination Charge (``MMDC'') charge is also applicable to the same 
Illiquid Positions.\21\ The MMDC applies to a position in a security 
that is greater than 40 percent of the overall unsettled long position 
in

[[Page 21865]]

that security, if such position is held by the Market Maker in that 
security.\22\
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    \21\ Notice, 82 FR at 14784.
    \22\ For purposes of calculating the MMDC, the overall unsettled 
long position is calculated as the sum of each member's net long 
position. Application and calculation of the MMDC is described in 
Procedure XV of the Rules, Sections I(A)(1)(d) and I(A)(2)(c). Supra 
note 4.
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    Similarly, NSCC proposes to exclude family-issued securities from 
the definition of ``Illiquid Security.'' \23\ NSCC believes that 
family-issued securities have a different risk profile than other 
illiquid securities that is better addressed through a separate margin 
charge.
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    \23\ NSCC defines family-issued securities as securities that 
were issued by either that member or by an affiliate of that member. 
Procedure XV, Section I(B)(1), supra note 4.
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B. The Market Maker Domination Charge Change

    Separate from the proposed changes related to the Illiquid Charge, 
NSCC would amend the Rules to define the term ``Market Maker Domination 
Charge'' in Procedure XV, Section I(A)(1)(d) of the Rules and use the 
defined term in Section I(A)(2)(c) of the Rules. NSCC believes that 
this change would improve clarity and create ease of reference in the 
Rules.\24\
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    \24\ Supra note 4.
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II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \25\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that such proposed rule change is consistent with the 
requirements of the Act and rules and regulations thereunder applicable 
to such organization. The Commission believes the proposal is 
consistent with Act, specifically Section 17A(b)(3)(F) of the Act and 
Rules 17Ad-22(e)(1), (e)(4)(i), and (e)(6)(v) \26\ under the Act, as 
discussed below.
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    \25\ 15 U.S.C. 78s(b)(2)(C).
    \26\ 15 U.S.C. 78q-1(b)(3)(F); 17 CFR 240.17Ad-22(e)(1); 17 CFR 
240.17Ad-22(e)(4)(i); 17 CFR 240.17Ad-22(e)(6).
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A. Consistency With Section 17A(b)(3)(F)

    Section 17A(b)(3)(F) of the Act, requires, in part, that NSCC's 
Rules be designed to assure the safeguarding of securities and funds 
that are within the custody or control of the clearing agency and to 
promote the prompt and accurate clearance and settlement of securities 
transactions.\27\ As described above, the Illiquid Charge could help 
protect NSCC from potential losses in the event that a member defaults. 
Specifically, the Illiquid Charge is calculated and collected to help 
mitigate the potential costs associated with NSCC's potential 
difficulties or delays in liquidating Illiquid Securities, due to the 
illiquid nature of such securities, following a member default. By 
enabling NSCC to better assess and collect required fund deposits in 
consideration of members' Illiquid Positions, the Commission believes 
that the proposed changes related to the Illiquid Charge would help 
promote the safeguarding of securities and funds that are within NSCC's 
custody or control, consistent with the requirements of Section 
17(b)(3)(F) of the Act.\28\
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    \27\ 15 U.S.C. 78q-1(b)(3)(F).
    \28\ Id.
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    The Commission also finds that the proposed rule change pertaining 
to the Market Maker Domination Charge is consistent with Section 
17A(b)(3)(F) of the Act.\29\ As described above, NSCC proposes to add 
to its Rules a definition of the Market Maker Domination Charge. This 
change could make the Rules more clear for members that rely on them, 
enabling members to more easily and promptly rely on the Rules, which 
helpssupport NSCC's prompt and accurate clearance and settlement of 
securities transactions made by members. Therefore, the Commission 
believes that the proposed rule change related to the Market Maker 
Domination Charge is consistent with Section 17A(b)(3)(F) of the 
Act.\30\
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    \29\ Id.
    \30\ Id.
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B. Consistency With Rule 17Ad-22(e)(1)

    Rule 17Ad-22(e)(1) under the Act requires, in part, a clearing 
agency to ``establish, implement, maintain and enforce written policies 
and procedures reasonably designed to . . . [p]rovide for a well-
founded, clear, transparent and enforceable legal basis for each aspect 
of its activities.'' \31\ As described above, NSCC proposes to define 
the term ``Market Maker Domination Charge'' Procedure XV, Section 
I(A)(1)(d) of the Rules.\32\ The Commission believes that this proposed 
change could make the Rules more clear and transparent for members that 
rely on them, consistent with Rule 17Ad-22(e)(1).
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    \31\ 17 CFR 240.17Ad-22(e)(1).
    \32\ Supra note 4.
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C. Consistency With Rule 17Ad-22(e)(4)(i)

    Rule 17Ad-22(e)(4)(i) under the Act requires a clearing agency to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to effectively identify, measure, 
monitor, and manage its credit exposures to members and those exposures 
arising from its payment, clearing, and settlement processes, including 
by maintaining sufficient financial resources to cover its credit 
exposure to each member fully with a high degree of confidence.\33\ As 
described above, the Illiquid Charge is calculated and imposed based on 
the amount and nature of Illiquid Securities in each member's 
portfolio, and in consideration of the members' credit rating. In doing 
so, the Illiquid Charge is designed to help obtain sufficient financial 
resources to help cover the credit exposures, with a high degree of 
confidence, presented by members that maintain Illiquid Positions. 
Therefore, the Commission believes that the proposed changes related to 
the Illiquid Charge are consistent with Rule 17Ad-22(e)(4)(i) under the 
Act.\34\
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    \33\ 17 CFR 240.17Ad-22(e)(4)(i).
    \34\ Id.
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D. Consistency With Rule 17Ad-22(e)(6)(v)

    Rule 17Ad-22(e)(6)(v) under the Act requires, in part, NSCC to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover its credit exposures to its 
members by establishing a risk-based margin system that, at a minimum, 
uses an appropriate method for measuring credit exposure that accounts 
for relevant product risk factors and portfolio effects across 
products.\35\ As described above, the Illiquid Charge is a component of 
the required fund deposits that NSCC calculates and collects using a 
risk-based margin methodology that is designed to help maintain the 
coverage of NSCC's credit exposures to its members at a confidence 
level of at least 99 percent. The Illiquid Charge is calculated to 
address the unique risk characteristics presented by Illiquid 
Securities, specifically their lack of marketability and their low and 
volatile share prices, and in consideration of the credit rating of the 
member holding the Illiquid Position. Therefore, the Commission 
believes that the proposed changes related to the Illiquid Charge are 
consistent with Rule 17Ad-22(e)(6)(v) under the Act.\36\
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    \35\ 17 CFR 240.17Ad-22(e)(6)(v).
    \36\ Id.
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III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act, in particular 
the requirements of

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Section 17A of the Act \37\ and the rules and regulations thereunder.
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    \37\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that proposed rule change SR-NSCC-2017-001 be, and hereby is, 
Approved.\38\
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    \38\ In approving the proposed rule change, the Commission 
considered the proposals' impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\39\
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    \39\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-09425 Filed 5-9-17; 8:45 am]
 BILLING CODE 8011-01-P