Document ID: SEC-2018-0867-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Fixed Income Clearing Corp.
Posted Date: 2018-06-07T04:00Z

[Federal Register Volume 83, Number 110 (Thursday, June 7, 2018)]
[Notices]
[Pages 26514-26530]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-12195]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83362; File No. SR-FICC-2018-001]

Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Amendment No. 1 and Order Granting Accelerated 
Approval of a Proposed Rule Change, as Modified by Amendment No. 1, To 
Implement Changes to the Required Fund Deposit Calculation in the 
Government Securities Division Rulebook

June 1, 2018.

I. Introduction

    The Fixed Income Clearing Corporation (``FICC'') filed with the 
U.S. Securities and Exchange Commission (``Commission'') on January 12, 
2018 proposed rule change SR-FICC-2018-001 (``Proposed Rule Change'') 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'') \1\ and Rule 19b-4 thereunder.\2\ The Proposed Rule 
Change was published for comment in the Federal Register on February 1, 
2018.\3\ The Commission received eight comments on the proposal.\4\ On 
March 14, 2018, the Commission issued an order instituting proceedings 
to determine whether to approve or disapprove the Proposed Rule 
Change.\5\ On April 25, 2018, FICC filed Amendment No. 1 to the 
Proposed Rule Change (``Amendment No. 1'').\6\ The Commission is 
publishing this notice to solicit comment on Amendment No. 1 from 
interested persons and to approve the Proposed Rule Change, as modified 
by Amendment No. 1, on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4. FICC also filed the Proposed Rule Change 
as advance notice SR-FICC-2018-801 (``Advance Notice'') pursuant to 
Section 806(e)(1) of the Payment, Clearing, and Settlement 
Supervision Act of 2010, 12 U.S.C. 5465(e)(1), and Rule 19b-
4(n)(1)(i) under the Exchange Act, 17 CFR 240.19b-4(n)(1)(i). Notice 
of Filing of the Advance Notice was published for comment in the 
Federal Register on March 2, 2018. Securities Exchange Act Release 
No. 82779 (February 26, 2018), 83 FR 9055 (March 2, 2018) (SR-FICC-
2018-801). The Commission extended the deadline for its review 
period of the Advance Notice for an additional 60 days on March 7, 
2018. Securities Exchange Act Release No. 82820 (March 7, 2018), 83 
FR 10761 (March 12, 2018) (SR-FICC-2018-801). On April 25, 2018, 
FICC filed Amendment No.1 to the Advance Notice. Available at 
https://www/sec/gov/comments/sr-ficc-2018-801/ficc2018801.htm. The 
Commission issued a notice of filing of Amendment No. 1 and notice 
of no objection to the Advance Notice, as modified by Amendment No. 
1, on May 11, 2018. Securities Exchange Act Release No. 83223 (May 
11, 2018), 83 FR 23020 (May 17, 2018).
    \3\ Securities Exchange Act Release No. 82588 (January 26, 
2018), 83 FR 4687 (February 1, 2018) (SR-FICC-2018-001).
    \4\ Letter from Robert E. Pooler, Chief Financial Officer, Ronin 
Capital LLC (``Ronin''), dated February 22, 2018, to Robert W. 
Errett, Deputy Secretary, Commission (``Ronin Letter I''); letter 
from Michael Santangelo, Chief Financial Officer, Amherst Pierpont 
Securities LLC (``Amherst''), dated February 22, 2018, to Brent J. 
Fields, Secretary, Commission (``Amherst Letter I''); letter from 
Timothy Cuddihy, Managing Director, FICC, dated March 19, 2018, to 
Robert W. Errett, Deputy Secretary, Commission (``FICC Letter I''); 
letter from James Tabacchi, Chairman, Independent Dealer and Trader 
Association (``IDTA''), dated March 29, 2018, to Eduardo A. Aleman, 
Assistant Secretary, Commission (``IDTA Letter''); letter from 
Michael Santangelo, Chief Financial Officer, Amherst Pierpont 
Securities LLC, dated April 4, 2018, to Brent J. Fields, Secretary, 
Commission (``Amherst Letter II''); letter from Levent Kahraman, 
Chief Executive Officer, KGS-Alpha Capital Markets (``KGS''), dated 
April 4, 2018, to Brent J. Fields, Secretary, Commission (``KGS 
Letter''); letter from Timothy Cuddihy, Managing Director, FICC, 
dated April 13, 2018, to Robert W. Errett, Deputy Secretary, 
Commission (``FICC Letter II''); and letter from Robert E. Pooler, 
Chief Financial Officer, Ronin, dated April 13, 2018, to Eduardo A. 
Aleman, Assistant Secretary, Commission (``Ronin Letter II''). Since 
the proposal contained in the Proposed Rule Change was also filed as 
an Advance Notice, supra note 2, the Commission is considering all 
public comments received on the proposal regardless of whether the 
comments were submitted to the Advance Notice or the Proposed Rule 
Change.
    \5\ See Securities Exchange Act Release No. 34-82876 (March 14, 
2018), 83 FR 12229 (March 20, 2018) (SR-FICC-2018-001). The order 
instituting proceedings re-opened the comment period and extended 
the Commission's period of review of the Proposed Rule Change. See 
id.
    \6\ Available at https://www.sec.gov/comments/sr-ficc-2018-001/ficc2018001.htm. FICC filed related amendments to the related 
Advance Notice. Supra note 2.
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II. Description of the Proposed Rule Change

    FICC proposes to change the FICC GSD Rulebook (``GSD Rules'') \7\ 
to adjust GSD's method of calculating GSD netting members' 
(``Members'') margin.\8\ Specifically, FICC proposes to (1) change 
GSD's method of calculating the Value-at-Risk (``VaR'') Charge 
component; (2) add a new component referred to as the ``Blackout Period 
Exposure Adjustment;'' (3) eliminate the existing Blackout Period 
Exposure Charge and the Coverage Charge components; (4) adjust the 
existing Backtesting Charge component to (i) include the backtesting 
deficiencies of certain GCF Repo Transaction \9\ counterparties during 
the Blackout Period, and (ii) give GSD the ability to assess the 
Backtesting Charge on an intraday basis for all Members; and (5) adjust 
the calculation for determining

[[Page 26515]]

the existing Excess Capital Premium for Broker Members, Inter-Dealer 
Broker Members, and Dealer Members.\10\ In addition, FICC proposes to 
provide transparency with respect to GSD's existing authority to 
calculate and assess Intraday Supplemental Fund Deposit amounts.\11\ 
The proposed QRM Methodology document would reflect the proposed VaR 
Charge calculation and the proposed Blackout Period Exposure Adjustment 
calculation.\12\
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    \7\ Available at http://www.dtcc.com/legal/rules-and-procedures.
    \8\ Notice, supra note 3, at 4688.
    \9\ GCF Repo Transactions refer to transactions made on FICC's 
GCF Repo Service that enable dealers to trade general collateral 
repos, based on rate, term, and underlying product, throughout the 
day, without requiring intra-day, trade-for-trade settlement on a 
Delivery-versus-Payment basis. Id.
    \10\ Notice, supra note 3, at 4689.
    \11\ Id. Pursuant to the GSD Rules, FICC has the existing 
authority and discretion to calculate an additional amount on an 
intraday basis in the form of an Intraday Supplemental Clearing Fund 
Deposit. See GSD Rules 1 and 4, supra note 7.
    \12\ Notice, supra note 3, at 4689.
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A. Changes to GSD's VaR Charge Component

    FICC states that the changes proposed in the Proposed Rule Change 
are designed to improve GSD's current VaR Charge so that it responds 
more effectively to market volatility.\13\ Specifically, FICC proposes 
to (1) replace GSD's current full revaluation approach with a 
sensitivity approach; \14\ (2) employ the existing Margin Proxy as an 
alternative (i.e., a back-up) VaR Charge calculation; \15\ (3) use an 
evenly-weighted 10-year look-back period, instead of the current front-
weighted one-year look-back period; (4) eliminate GSD's current 
augmented volatility adjustment multiplier; (5) utilize a haircut 
method for securities cleared by GSD that lack sufficient historical 
data; and (6) establish a VaR Floor calculation that would serve as a 
minimum VaR Charge for Members, as discussed below.\16\
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    \13\ Id. FICC proposes to change its calculation of GSD's VaR 
Charge because during the fourth quarter of 2016, FICC's current 
methodology for calculating the VaR Charge did not respond 
effectively to the market volatility that existed at that time. Id. 
As a result, the VaR Charge did not achieve backtesting coverage at 
a 99 percent confidence level and, therefore, yielded backtesting 
deficiencies beyond FICC's risk tolerance. Id.
    \14\ Notice, supra note 3, at 4690 GSD's proposed sensitivity 
approach is similar to the sensitivity approach that FICC's 
Mortgage-Backed Securities Division (``MBSD'') uses to calculate the 
VaR Charge for MBSD clearing members. See Securities Exchange Act 
Release No. 79868 (January 24, 2017) 82 FR 8780 (January 30, 2017) 
(SR-FICC-2016-007); Securities Exchange Act Release No. 79643 
(December 21, 2016), 81 FR 95669 (December 28, 2016) (SR-FICC-2016-
801).
    \15\ The Margin Proxy was implemented by FICC in 2017 to 
supplement the full revaluation approach to the VaR Charge 
calculation with a minimum VaR Charge calculation. Securities 
Exchange Act Release No. 80349 (March 30, 2017), 82 FR 16638 (April 
5, 2016) (SR-FICC-2017-001); see also Securities Exchange Act 
Release No. 80341 (March 30, 2017), 82 FR 16644 (April 5, 2016) (SR-
FICC-2017-801).
    \16\ Id.
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    For the proposed sensitivity approach to the VaR Charge, FICC would 
source sensitivity data and relevant historical risk factor time series 
data generated by an external vendor based on its econometric, risk, 
and pricing models.\17\ FICC would conduct independent data checks to 
verify the accuracy and consistency of the data feed received from the 
vendor.\18\ In the event that the external vendor is unable to provide 
the sourced data in a timely manner, FICC would employ its existing 
Margin Proxy as a back-up VaR Charge calculation.\19\
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    \17\ See Notice, supra note 3, at 4690. The following risk 
factors would be incorporated into GSD's proposed sensitivity 
approach: Key rate, convexity, implied inflation rate, agency 
spread, mortgage-backed securities spread, volatility, mortgage 
basis, and time risk factor. These risk factors are defined as 
follows:
     Key rate measures the sensitivity of a price change to 
changes in interest rates;
     convexity measures the degree of curvature in the 
price/yield relationship of key interest rates;
     implied inflation rate measures the difference between 
the yield on an ordinary bond and the yield on an inflation-indexed 
bond with the same maturity;
     agency spread is yield spread that is added to a 
benchmark yield curve to discount an Agency bond's cash flows to 
match its market price;
     mortgage-backed securities spread is the yield spread 
that is added to a benchmark yield curve to discount a to-be-
announced (``TBA'') security's cash flows to match its market price;
     volatility reflects the implied volatility observed 
from the swaption market to estimate fluctuations in interest rates;
     mortgage basis captures the basis risk between the 
prevailing mortgage rate and a blended Treasury rate; and
     time risk factor accounts for the time value change (or 
carry adjustment) over the assumed liquidation period. Id.
    The above-referenced risk factors are similar to the risk 
factors currently utilized in MBSD's sensitivity approach; however, 
GSD has included other risk factors that are specific to the U.S. 
Treasury securities, Agency securities and mortgage-backed 
securities cleared through GSD. Id. Concerning U.S. Treasury 
securities and Agency securities, FICC would select the following 
risk factors: Key rates, convexity, agency spread, implied inflation 
rates, volatility, and time. Id. For mortgage-backed securities, 
each security would be mapped to a corresponding TBA forward 
contract and FICC would use the risk exposure analytics for the TBA 
as an estimate for the mortgage-backed security's risk exposure 
analytics. Id. FICC would use the following risk factors to model a 
TBA security: Key rates, convexity, mortgage-backed securities 
spread, volatility, mortgage basis, and time. Id. To account for 
differences between mortgage-backed securities and their 
corresponding TBA, FICC would apply an additional basis risk 
adjustment. Id.
    \18\ Notice, supra note 3, at 4690.
    \19\ See Notice, supra note 3, at 4692. In the event that the 
data used for the sensitivity approach is unavailable for a period 
of more than five days, FICC proposes to revert back to the Margin 
Proxy as an alternative VaR Charge calculation. Id.
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    Additionally, FICC proposes to change the look-back period from a 
front-weighted one-year look-back to an evenly-weighted 10-year look-
back period that would include, to the extent applicable, an additional 
stressed period. FICC states that the proposed extended look-back 
period would help to ensure that the historical simulation contains a 
sufficient number of historical market conditions.\20\ In the event 
FICC observes that the 10-year look-back period does not contain a 
sufficient number of stressed market conditions, FICC would have the 
ability to include an additional period of historically observed 
stressed market conditions to a 10-year look-back period or adjust the 
length of look-back period.\21\
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    \20\ Notice, supra note 3, at 4691.
    \21\ Id.
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    FICC also proposes to look at the historical changes of specific 
risk factors during the look-back period in order to generate risk 
scenarios to arrive at the market value changes for a given 
portfolio.\22\ A statistical probability distribution would be formed 
from the portfolio's market value changes, and then the VaR Charge 
calculation would be calibrated to cover the projected liquidation 
losses at a 99 percent confidence level.\23\ The portfolio risk 
sensitivities and the historical risk factor time series data would 
then be used by FICC's risk model to calculate the VaR Charge for each 
Member.\24\
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    \22\ Notice, supra note 3, at 4690.
    \23\ Id.
    \24\ Id.
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    FICC also proposes to eliminate the augmented volatility adjustment 
multiplier. FICC states that the multiplier would not be necessary 
because the proposed sensitivity approach would have a longer look-back 
period and the ability to include an additional stressed market 
condition to account for periods of market volatility.\25\
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    \25\ Notice, supra note 3, at 4692.
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    According to FICC, in the event that a portfolio contains classes 
of securities that do not have sufficient volume and price information 
available, a historical simulation approach would not generate VaR 
Charge amounts that reflect the risk profile of such securities.\26\ 
Therefore, FICC proposes to calculate the VaR Charge for these 
securities by utilizing a haircut approach based on a market benchmark 
with a similar risk profile as the related security.\27\ The proposed 
haircut approach would be calculated separately for U.S. Treasury/
Agency securities and mortgage-backed securities.\28\
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    \26\ Notice, supra note 3, at 4693.
    \27\ Id.
    \28\ Id.
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    Finally, FICC proposes to adjust the existing calculation of the 
VaR Charge to include a VaR Floor, which would be the amount used as 
the VaR Charge when the sum of the amounts calculated

[[Page 26516]]

by the proposed sensitivity approach and haircut method is less than 
the proposed VaR Floor.\29\ The VaR Floor would be calculated as the 
sum of (1) a U.S. Treasury/Agency bond margin floor \30\ and (2) a 
mortgage-backed securities margin floor.\31\
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    \29\ Id.
    \30\ Id. The U.S. Treasury/Agency bond margin floor would be 
calculated by mapping each U.S. Treasury/Agency security to a tenor 
bucket, then multiplying the gross positions of each tenor bucket by 
its bond floor rate, and summing the results. Id. The bond floor 
rate of each tenor bucket would be a fraction (initially set at 10 
percent) of an index-based haircut rate for such tenor bucket. Id.
    \31\ Notice, supra note 3, at 4693. The mortgage-backed 
securities margin floor would be calculated by multiplying the gross 
market value of the total value of mortgage-backed securities in a 
Member's portfolio by a designated amount, referred to as the pool 
floor rate, (initially set at 0.05 percent). Id.
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B. Addition of the Blackout Period Exposure Adjustment Component

    FICC proposes to add a new component to GSD's margin calculation--
the Blackout Period Exposure Adjustment.\32\ FICC states that the 
Blackout Period Exposure Adjustment would be calculated to address 
risks that could result from overstated values of mortgage-backed 
securities that are pledged as collateral for GCF Repo Transactions 
\33\ during a Blackout Period.\34\ A Blackout Period is the period 
between the last business day of the prior month and the date during 
the current month upon which a government-sponsored entity that issues 
mortgage-backed securities publishes its updated Pool Factors.\35\ The 
proposed Blackout Period Exposure Adjustment would result in a charge 
that either increases a Member's VaR Charge or a credit that decreases 
the VaR Charge.\36\
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    \32\ Notice, supra note 3, at 4694. The proposed Blackout Period 
Exposure Adjustment would be calculated by (1) projecting an average 
pay-down rate of mortgage loan pools (based on historical pay down 
rates) for the government sponsored enterprises (Fannie Mae and 
Freddie Mac) and the Government National Mortgage Association 
(Ginnie Mae), respectively, then (2) multiplying the projected pay-
down rate by the net positions of mortgage-backed securities in the 
related program, and (3) summing the results from each program. Id.
    \33\ Id.
    \34\ Id.
    \35\ Id. Pool Factors are the percentage of the initial 
principal that remains outstanding on the mortgage loan pool 
underlying a mortgage-backed security, as published by the 
government-sponsored entity that is the issuer of such security. Id.
    \36\ Notice, supra note 3, at 4694.
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C. Elimination of the Blackout Period Exposure Charge and Coverage 
Charge Components

    FICC proposes to eliminate the existing Blackout Period Exposure 
Charge component from GSD's margin calculation.\37\ The Blackout Period 
Exposure Charge only applies to Members with GCF Repo Transactions that 
have two or more backtesting deficiencies during the Blackout Period 
and whose overall 12-month trailing backtesting coverage falls below 
the 99 percent coverage target.\38\ FICC would eliminate this charge 
because the proposed Blackout Period Exposure Adjustment would apply to 
all Members with GCF Repo Transactions collateralized with mortgage-
backed securities during the Blackout Period.\39\
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    \37\ Id.
    \38\ Id.
    \39\ Id.
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    FICC also proposes to eliminate the existing Coverage Charge 
component from GSD's margin calculation.\40\ FICC would eliminate the 
Coverage Charge because, as FICC states, the proposed sensitivity 
approach would provide overall better margin coverage, rendering the 
Coverage Charge unnecessary.\41\
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    \40\ Id.
    \41\ Notice, supra note 3, at 4695.
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D. Adjustment to the Backtesting Charge Component

    FICC proposes to amend GSD's existing Backtesting Charge component 
of its margin calculation to (1) include the backtesting deficiencies 
of certain Members during the Blackout Period and (2) give GSD the 
ability to assess the Backtesting Charge on an intraday basis.\42\
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    \42\ Id.
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    Currently, the Backtesting Charge does not apply to Members with 
mortgage-backed securities during the Blackout Period because such 
Members would be subject to a Blackout Period Exposure Charge.\43\ In 
coordination with its proposal to eliminate the Blackout Period 
Exposure Charge, FICC proposes to adjust the applicability of the 
Backtesting Charge.\44\ Specifically, FICC proposes to apply the 
Backtesting Charge to Members with backtesting deficiencies that also 
experience backtesting deficiencies that are attributed to the Member's 
GCF Repo Transactions collateralized with mortgage-backed securities 
during the Blackout Period within the prior 12-month rolling 
period.\45\
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    \43\ Id.
    \44\ Id.
    \45\ Id. Additionally, during the Blackout Period, the proposed 
Blackout Period Exposure Adjustment Charge, as described in Section 
I.C, above, would be applied to all applicable Members. Id.
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    FICC also proposes to adjust the Backtesting Charge to apply to 
Members that experience backtesting deficiencies during the trading day 
because of such Member's intraday trading activities.\46\ The Intraday 
Backtesting Charge would be assessed on Members with portfolios that 
experience at least three intraday backtesting deficiencies over the 
prior 12-month period and would generally equal a Member's third 
largest historical intraday backtesting deficiency.\47\
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    \46\ Id.
    \47\ Id.
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E. Adjustment to the Excess Capital Premium Charge

    FICC proposes to adjust GSD's calculation for determining the 
Excess Capital Premium. Currently, GSD assesses the Excess Capital 
Premium when a Member's VaR Charge exceeds the Member's Excess 
Capital.\48\ Only Members that are brokers or dealers are required to 
report Excess Net Capital figures to FICC while other Members report 
net capital or equity capital, based on the type of regulation to which 
the Member is subject.\49\ If a Member is not a broker or dealer, FICC 
uses the net capital or equity capital in order to calculate each 
Member's Excess Capital Premium.\50\ FICC proposes to move to a net 
capital measure for broker Members, inter-dealer broker Members, and 
dealer Members.\51\ FICC states that such a change would make the 
Excess Capital Premium for those Members more consistent with the 
equity capital measure that is used for other Members in the Excess 
Capital Premium calculation.\52\
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    \48\ Notice, supra note 3, at 4696. The term ``Excess Capital'' 
means Excess Net Capital, net assets, or equity capital as 
applicable, to a Member based on its type of regulation. GSD Rules, 
Rule 1, supra note 7.
    \49\ Id.
    \50\ Id.
    \51\ Id.
    \52\ Id.
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F. Additional Transparency Surrounding the Intraday Supplemental Fund 
Deposit

    Separate from the above changes to GSD's margin calculation, FICC 
proposes to provide transparency in the GSD Rules with respect to GSD's 
existing calculation of the Intraday Supplemental Fund Deposit.\53\ 
FICC proposes to provide more detail in the GSD rules surrounding both 
GSD's calculation of the Intraday Supplemental Fund Deposit charge and 
its determination of whether to assess the charge.\54\
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    \53\ Id.
    \54\ Id.
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    FICC calculates the Intraday Supplemental Fund Deposit by tracking 
three criteria for each Member.\55\ The first criterion, the ``Dollar 
Threshold,'' evaluates whether a Member's Intraday VaR Charge equals or 
exceeds a set

[[Page 26517]]

dollar amount when compared to the VaR Charge that was included in the 
most recent margin collection.\56\ The second criterion, the 
``Percentage Threshold,'' evaluates whether the Intraday VaR Charge 
equals or exceeds a percentage increase of the VaR Charge that was 
included in the most recent margin collection.\57\ The third criterion, 
the ``Coverage Target,'' evaluates whether a Member is experiencing 
backtesting results below a 99 percent confidence level.\58\ In the 
event that a Member's additional risk exposure breaches all three 
criteria, FICC assesses an Intraday Supplemental Fund Deposit.\59\ FICC 
also assesses an Intraday Supplemental Fund Deposit if, under certain 
market conditions, a Member's Intraday VaR Charge breaches both the 
Dollar Threshold and the Percentage Threshold.\60\
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    \55\ Id.
    \56\ Id.
    \57\ Notice, supra note 3, at 4697.
    \58\ Id.
    \59\ Id.
    \60\ Id.
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G. Description of the QRM Methodology

    The QRM Methodology document provides the methodology by which FICC 
would calculate the VaR Charge, with the proposed sensitivity approach, 
as well as other components of the Members' margin calculation.\61\ The 
QRM Methodology document specifies (i) the model inputs, parameters, 
assumptions and qualitative adjustments; (ii) the calculation used to 
generate margin amounts; (iii) additional calculations used for 
benchmarking and monitoring purposes; (iv) theoretical analysis; (v) 
the process by which the VaR methodology was developed as well as its 
application and limitations; (vi) internal business requirements 
associated with the implementation and ongoing monitoring of the VaR 
methodology; (vii) the model change management process and governance 
framework (which includes the escalation process for adding a stressed 
period to the VaR Charge calculation); (viii) the haircut methodology; 
(ix) the Blackout Period Exposure Adjustment calculations; (x) intraday 
margin calculation; and (xi) the Margin Proxy calculation.\62\
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    \61\ Notice, supra note 3, at 4698.
    \62\ Id.
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H. Description of Amendment No. 1

    In Amendment No. 1, FICC proposes three things. First, FICC 
proposes to stagger the implementation of the proposed Blackout Period 
Exposure Adjustment and the proposed removal of the Blackout Period 
Exposure Charge.\63\ Specifically, on a date that is approximately 
three weeks after the later of the Commission's order approving the 
Proposed Rule Change, as modified by Amendment No. 1, or its notice of 
no objection to the related Advance Notice, as modified by Amendment 
No. 1 (``Implementation Date''), FICC would charge Members only 50 
percent of any amount calculated under the proposed Blackout Period 
Exposure Adjustment, while, at the same time, decreasing by 50 percent 
any amount charge under the Blackout Period Exposure Charge.\64\ Then, 
no later than September 30, 2018, FICC would increase any amount 
charged under the Blackout Period Exposure Adjustment to 75 percent, 
while, at the same time, decreasing by 75 percent any amount charge 
under the Blackout Period Exposure Charge.\65\ Finally, no later than 
December 31, 2018, FICC would increase any amount charged under the 
Blackout Period Exposure Adjustment to 100 percent, while, at the same 
time, eliminating the Blackout Period Exposure Charge. FICC states that 
it is proposing this amendment to address concerns raised by several 
Members that the implementation of the proposed Blackout Period 
Exposure Adjustment would have a material impact on their liquidity 
planning and margin charge.\66\ FICC states that the staggered 
implementation would give Members the opportunity to assess and further 
prepare for the impact of the proposed Blackout Period Exposure 
Adjustment. FICC states the proposed VaR Charge calculation and the 
existing Blackout Period Exposure Charge would appropriately mitigate 
the potential mortgage-backed securities pay-down on a short-term 
basis, given FICC's assessment of mortgage-backed securities pay-down 
projections for this calendar year.\67\
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    \63\ Amendment No. 1, supra note 6.
    \64\ Id.
    \65\ Id.
    \66\ Id.
    \67\ Id.
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    Second, FICC proposes to amend the implementation date for the 
remainder of the proposed changes contained in the Proposed Rule 
Change.\68\ Specifically, FICC proposes that such remaining changes 
would become operative on the Implementation Date, as opposed to the 
originally proposed 45 business days after the later of the 
Commission's order approving the Proposed Rule Change, as modified by 
Amendment No. 1, or notice of no objection to the related Advance 
Notice, as modified by Amendment No. 1.\69\ FICC states that it is 
proposing this amendment because FICC is primarily concerned that the 
look-back period that is currently used in calculating the VaR Charge 
under the Margin Proxy may not calculate sufficient margin amounts to 
cover GSD's exposure to a defaulting Member.\70\
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    \68\ Id.
    \69\ Id.
    \70\ Id.
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    Third, FICC proposes to correct an incorrect description of the 
calculation of the Excess Capital Premium that appears once in the 
narrative to the Proposed Rule Change, as well as in the corresponding 
location in the Exhibit 1A to the Proposed Rule Change.\71\ 
Specifically, FICC proposes to change the term ``Required Fund 
Deposit'' to ``VaR Charge'' in the description at issue, as ``Required 
Fund Deposit'' was incorrectly used in that instance.\72\
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    \71\ Id.
    \72\ Id.
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III. Solicitation of Comments on Amendment No. 1

    Interested persons are invited to submit written data, views and 
arguments concerning whether Amendment No. 1 is consistent with the 
Exchange 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 [email protected]. Please include 
File Number SR-FICC-2018-001 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FICC-2018-001. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (http://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the Proposed Rule Change that are filed with 
the Commission, and all written communications relating to the Proposed 
Rule Change between the Commission and any person, other than those 
that may be withheld from the

[[Page 26518]]

public in accordance with the provisions of 5 U.S.C. 552, will be 
available for website viewing and printing in the Commission's Public 
Reference Room, 100 F Street NE, Washington, DC 20549, on official 
business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of 
the filing also will be available for inspection and copying at the 
principal office of FICC and on DTCC's website (http://dtcc.com/legal/sec-rule-filings.aspx). All comments received will be posted without 
change. Persons submitting comments are cautioned that we do not redact 
or edit personal identifying information from comment submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to File Number SR-FICC-2018-001 
and should be submitted on or before June 22, 2018.

IV. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Exchange Act \73\ directs the Commission 
to approve a proposed rule change of a self-regulatory organization if 
it finds that the proposed rule change is consistent with the 
requirements of the Exchange Act and the rules and regulations 
thereunder applicable to such organization. After carefully considering 
the Proposed Rule Change, as modified by Amendment No. 1, and all 
comments received, the Commission finds that the Proposed Rule Change, 
as modified by Amendment No. 1, is consistent with the Exchange Act and 
the rules and regulations thereunder applicable to FICC.\74\ In 
particular, as discussed below, the Commission finds that the Proposed 
Rule Change, as modified by Amendment No. 1, is consistent with 
Sections 17A(b)(3)(F) \75\ and (I) of the Exchange Act,\76\ as well as 
Rules 17Ad-22(e)(4)(i),\77\ (6)(i),\78\ (ii),\79\ (iv),\80\ (v),\81\ 
(vi)(B),\82\ and (23)(ii) under the Exchange Act.\83\
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    \73\ 15 U.S.C. 78s(b)(2)(C).
    \74\ In approving this Proposed Rule Change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f). The Commission 
addresses comments about economic effects of the Proposed Rule 
Change, including competitive effects, below.
    \75\ 15 U.S.C. 78q-1(b)(3)(F).
    \76\ 15 U.S.C. 78q-1(b)(3)(I).
    \77\ 17 CFR 240.17Ad-22(e)(4)(i).
    \78\ 17 CFR 240.17Ad-22(e)(6)(i).
    \79\ 17 CFR 240.17Ad-22(e)(6)(ii).
    \80\ 17 CFR 240.17Ad-22(e)(6)(iv).
    \81\ 17 CFR 240.17Ad-22(e)(6)(v).
    \82\ 17 CFR 240.17Ad-22(e)(6)(vi)(B).
    \83\ 17 CFR 240.17Ad-22(e)(23)(ii).
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A. Consistency With Section 17A(b)(3)(F) of the Exchange Act

    Section 17A(b)(3)(F) of the Exchange Act requires, in part, that 
the rules of a clearing agency be designed to, among other things, 
assure the safeguarding of securities and funds which are in the 
custody or control of the clearing agency or for which it is 
responsible.\84\
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    \84\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission believes that the changes proposed in the Proposed 
Rule Change, as modified by Amendment No. 1, are designed to assure the 
safeguarding of securities and funds which are in the custody or 
control of the clearing agency or for which it is responsible, 
consistent with Section 17A(b)(3)(F) of the Exchange Act.\85\ First, as 
described above, FICC currently calculates the VaR Charge component of 
each Member's margin using a VaR Charge calculation that relies on a 
full revaluation approach. FICC proposes to instead implement a 
sensitivity approach to its VaR Charge calculation, with, at minimum, 
an evenly-weighted 10-year look-back period. The proposed sensitivity 
approach would leverage an external vendor's expertise in supplying 
market risk attributes (i.e., sensitivity data) used to calculate the 
VaR Charge. Relying on such sensitivity data with a 10-year look-back 
period would help correct deficiencies in FICC's existing VaR Charge 
calculation, thus enabling FICC to better account for market risk in 
calculating the VaR Charge and better limit its credit exposure to 
Members.
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    \85\ Id.
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    Second, as described above, FICC proposes to implement the existing 
Margin Proxy as a back-up methodology to the proposed sensitivity 
approach to the VaR Charge calculation. This proposed change would help 
FICC to better limit its credit exposure to Members by continuing to 
calculate each Member's VaR Charge in the event that FICC experiences a 
data disruption with the vendor that supplies the sensitivity data.
    Third, as described above, FICC proposes to eliminate the augmented 
volatility adjustment multiplier from its current VaR Charge 
calculation. This proposed change would enable FICC to remove a 
component from the VaR Charge calculation that would no longer be 
needed on account of the proposed 10-year look-back period that has the 
option of an additional stress period.
    Fourth, as described above, FICC proposes to implement a haircut 
method for securities with inadequate historical pricing data and, 
thus, lack sufficient data to generate a historical simulation that 
adequately reflects the risk profile of such securities under the 
proposed sensitivity approach to FICC's VaR Charge calculation. 
Employing a haircut on such securities would help FICC limit its credit 
exposure to Members that transact in the securities by establishing a 
way to better capture their risk profile.
    Fifth, as described above, FICC proposes to implement a VaR Floor. 
The proposed VaR Floor would be triggered in the event that the 
proposed sensitivity VaR model calculates a VaR Charge that is too low 
because of offsets applied by the model from certain offsetting long 
and short positions. In other words, the VaR Floor would serve as a 
backstop to the proposed sensitivity approach to FICC's VaR Charge 
calculation, which would help ensure that FICC continues to limit its 
credit exposure to Members. Altogether, these proposed changes to the 
VaR Charge component of the margin calculation would enable FICC to 
view and respond more effectively to market volatility by attributing 
market price moves to various risk factors and more effectively 
limiting FICC's credit exposure to Members in market conditions that 
reflect a rapid decrease in market price volatility levels.
    In addition to these changes to the VaR Charge component of the 
margin calculation, FICC proposes to make a number of changes to other 
components of the margin calculation. Specifically, as described above, 
FICC proposes to (1) add the Blackout Period Exposure Adjustment 
component to FICC's margin calculation to help address risks that could 
result from overstated values of mortgage-backed securities that are 
pledged as collateral for GCF Repo Transactions during a Blackout 
Period; (2) make changes to the existing Backtesting Charge component 
to help ensure that the charge will apply to (i) all Members that 
experience backtesting deficiencies attributable to the Member's GCF 
Repo Transactions that are collateralized with mortgage-backed 
securities during the Blackout Period, and (ii) all Members that 
experience backtesting deficiencies during the trading day because of 
such Member's intraday trading activities; (3) provide more detail in 
the GSD Rules regarding FICC's calculation of the existing Intraday 
Supplemental Fund Deposit charge and its determination of whether to 
assess the charge; and (4) remove the Coverage Charge and Blackout 
Period Exposure Charge components because the risk these components 
addressed would be addressed by the other proposed changes to the 
margin calculation, specifically the proposed

[[Page 26519]]

sensitivity approach to FICC's VaR Charge calculation and the proposed 
Blackout Period Exposure Adjustment component, respectively.
    In Amendment No. 1, as described above, FICC proposes to (1) 
stagger the implementation of the proposed Blackout Period Exposure 
Adjustment and the proposed removal of the Blackout Period Exposure 
Charge in response to commenters; (2) accelerate the implementation 
date for the remainder of the proposed changes contained in the 
Proposed Rule Change, in order address concerns with the existing VaR 
Charge calculation sooner; and (3) correct an incorrect description of 
the calculation of the Excess Capital Premium in the originally filed 
materials.
    Taken together, the above mentioned proposed changes to the 
components of the margin calculation would enhance FICC's current 
method for calculating each Member's margin. This enhancement, in turn, 
would enable FICC to produce margin levels more commensurate with the 
risks associated with its Members' portfolios in a broader range of 
scenarios and market conditions, and, thus, more effectively cover its 
credit exposure to its Members. In addition, the Proposed Rule Change 
is designed to help FICC mitigate losses that Member default could 
cause to FICC and its non-defaulting Members.
    By better limiting FICC's credit exposure to Members, the proposed 
changes are designed to help ensure that, in the event of a Member 
default, FICC has collected sufficient margin from the defaulted Member 
to manage the default, so that non-defaulting Members would not be 
exposed to mutualized losses as a result of the default. By helping to 
limit non-defaulting Members' exposure to mutualized losses, the 
proposal is designed to help assure the safeguarding of securities and 
funds that are in FICC's custody or control. As such, the Proposed Rule 
Change, as modified by Amendment No. 1, is designed to help promote the 
safeguarding of securities and funds in FICC's custody and control. 
Therefore, the Commission believes that the Proposed Rule Change, as 
modified by Amendment No. 1, is consistent with Section 17A(b)(3)(F) of 
the Exchange Act.\86\
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    \86\ Id.
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B. Consistency With Section 17A(b)(3)(I) of the Exchange Act

    Section 17A(b)(3)(I) of the Exchange Act requires that the rules of 
a clearing agency do not impose any burden on competition not necessary 
or appropriate in furtherance of the purposes of the Exchange Act.\87\ 
As discussed above, FICC is proposing a number of changes to the way it 
calculates margin collected from Members--a key tool that FICC uses to 
mitigate potential losses to FICC associated with liquidating a 
Member's portfolio in the event of a Member default. FICC states that 
the proposed changes are designed to assure the safeguarding of 
securities and funds that are in the custody or control of FICC, 
consistent with Section 17A(b)(3)(F) of the Exchange Act,\88\ because 
the proposed changes would enable FICC to better limit its credit 
exposure to Members arising out of the activity in Members' 
portfolios.\89\ FICC states that the proposed changes would 
collectively work to help ensure that FICC calculates and collects 
adequate margin from its Members.\90\
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    \87\ 15 U.S.C. 78q-1(b)(3)(I).
    \88\ See 15 U.S.C. 78q-1(b)(3)(F).
    \89\ Notice, supra note 3, at 4698.
    \90\ Id.
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    However, several commenters stated that some, if not all, of the 
proposed changes would impose an undue burden on competition. 
Specifically, Ronin states that the proposed sensitivity VaR model 
requires more margin of its Members than is necessary, and thus, would 
unduly impose a competitive burden on Members that have higher costs of 
capital.\91\ Ronin further states that over-margining also unfairly 
exposes smaller Members to greater potential risk of loss should one of 
the largest Members' default.\92\ Ronin also states the proposed 
changes would make it less economic for non-bank Members to participate 
in centralized clearing.\93\
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    \91\ Ronin Letter at 5.
    \92\ Id.
    \93\ Id.
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    Similarly, IDTA states that that the proposed changes would 
disproportionately result in greater increases in margin for non-Bank 
Members on a percentage basis and consequently would impose an 
unnecessary burden on competition.\94\ Specifically, IDTA states the 
proposed changes would result in a material increase to some Members' 
margin due to the proposed change to the VaR Charge and also due to the 
compounding effect the new VaR Charge has on other components of the 
margin calculation.\95\ IDTA notes that FICC illustrates that the 
statistical impact of the Proposed Rule Change resulted in 40 percent 
of Members having a net reduction to margin and 31 percent of Members 
having between no change and a 10 percent increase in margin.\96\ IDTA 
states that the remaining 29 percent of Members therefore saw an 
increase of over 10 percent to the margin.\97\ IDTA adds that six 
members of the IDTA that submitted data saw, on average, an 85 percent 
increase under the proposed changes compared to the existing FICC 
margin calculation.\98\ IDTA states that this disproportionality places 
competitive and financial burdens on non-Bank Members that have a 
higher cost of funds and access to fewer pools of liquidity than those 
available to Bank Members.\99\ IDTA also states it is possible that 
these burdens could adversely affect the diversity of liquidity across 
fixed income markets during times when both market participants and 
regulators want this diversity.\100\
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    \94\ IDTA Letter at 14.
    \95\ IDTA Letter at 3.
    \96\ Id.
    \97\ Id.
    \98\ Id.
    \99\ IDTA Letter at 1.
    \100\ Id.
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    Two commenters state that not utilizing cross-margining in the GSD 
margin calculation creates a burden on competition.\101\ Specifically, 
Amherst states that the lack of cross-margining inflates the margin 
requirements and that the ``inflation, in turn, could distort the 
liquidity profile'' of Members.\102\ Additionally, KGS states that not 
having a cross-margining process for positions in GSD and MBSD will 
have a distortive effect on GSD's margining system, producing 
``burdensome double charges.'' \103\ KGS also states that the absence 
of cross-margining will impose a disproportionate and adverse impact on 
all GSD members other than ``the very largest banks and dealers'' and 
that the burdens on competition that would be imposed are 
significant.\104\ Finally, KGS states that absent cross-margining for 
common Members of GSD and MBSD, ``markets that are free and open to all 
competitors with the greatest spreading of risk'' cannot be achieved.'' 
\105\
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    \101\ See Amherst Letter II; KGS Letter.
    \102\ Amherst Letter II at 4.
    \103\ KGS Letter at 2.
    \104\ Id.
    \105\ Id.
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    Two commenters state that FICC's use of a 10-year look-back period 
and an additional stressed period in the VaR Charge calculation would 
impose a burden on competition.\106\ Ronin first notes that FICC 
acknowledges that the proposed changes might impose a competitive 
burden.\107\ Ronin then

[[Page 26520]]

states that the overall effect of this proposed rule change is to 
``treat every day as if the market was in the midst of a financial 
crisis'' and to require more margin from Members at all times.\108\ 
Ronin contends that this ``blunt approach'' of requiring more margin by 
utilizing ``statistical bias is discriminatory and imposes an undue 
competitive burden on firms with a higher cost of capital.'' \109\ 
Similarly, IDTA states that the 10-year look-back period and additional 
stressed period result in the unnecessary collection of margin, which 
creates harmful costs that disproportionately burden non-Bank Members 
as compared to larger Bank Members.\110\
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    \106\ See Ronin Letter; IDTA Letter.
    \107\ Ronin Letter at 5.
    \108\ Id.
    \109\ Id.
    \110\ IDTA Letter at 7, 11.
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    Two commenters state that the proposed Excess Capital Premium 
charge would impose a burden on competition.\111\ Specifically, Amherst 
states that broker-dealer Members would see a material impact from the 
adoption of the proposed sensitivity approach because it would 
significantly increase the numerator in the formula and, thereby, 
increase the likelihood of triggering the Excess Capital Premium 
charge.\112\ Similarly, IDTA states that the proposed use of Net 
Capital in the denominator in the Excess Capital Premium would result 
in a discriminatory change that arbitrarily penalizes Dealer Members as 
many Members who currently do not have an Excess Capital Premium charge 
would end up having the charge if the Proposed Rule Change is 
approved.\113\
---------------------------------------------------------------------------

    \111\ See Amherst Letter; IDTA Letter.
    \112\ Amherst Letter II at 4.
    \113\ IDTA Letter at 9.
---------------------------------------------------------------------------

    Amherst further states that the Excess Capital Premium calculation 
would impose an additional competitive burden on broker-dealer Members, 
as non broker-dealer Member's Excess Capital used in the measurement of 
any Excess Capital Premium may not be based on net worth after 
reductions for haircuts or other non-allowable asset deductions similar 
to broker-dealer Member requirements.\114\ Similarly, IDTA states that 
using Net Capital as the Excess Capital figure also would result in 
discrimination against Dealer Members as compared to Bank Members 
because Bank Members' Excess Capital is based on equity without any 
reduction for positions, while Dealer Members are required to use Net 
Capital, a measure of net worth after reductions for haircuts on 
positions.\115\
---------------------------------------------------------------------------

    \114\ Amherst Letter II at 4.
    \115\ IDTA Letter at 9.
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    One commenter states that the Blackout Period Exposure Adjustment 
would result in a burden on competition.\116\ Specifically, IDTA states 
that serious flaws exist in the current Blackout Period Exposure Charge 
and the proposed Blackout Period Exposure Adjustment would result in 
both an inaccurate measurement of risk and excessive margin charges 
that are harmful to Members, particularly non-Bank Members that have a 
relative higher cost of funds than other Members.\117\ IDTA states that 
the proposed Blackout Period Exposure Adjustment assumes 100 percent 
probability of a GCF Repo Service counterparty default across all 
Members. IDTA states that it does not believe a credit risk model would 
account for such a high probability of loss and suggests applying a 
credit risk weighting to the Blackout Period Exposure Adjustment.\118\
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    \116\ Id. at 12.
    \117\ Id.
    \118\ Id. at 13.
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    In response to commenters concerns, generally, FICC states that the 
proposed changes are necessary to ensure that its margin methodology 
would appropriately address the risks presented by Members' clearing 
portfolios.\119\ Specifically, in response to concerns regarding the 
proposed sensitivity approach, FICC states that the proposed 
sensitivity approach integrates observed risk factor changes over 
current and historical market conditions to more effectively respond to 
current market price moves that may not be adequately reflected in the 
current methodology for calculating the VaR Charge as supplemented by 
the Margin Proxy.\120\ With this in mind, FICC states that Ronin's 
assertion that the proposed sensitivity approach ``simply requires 
increased margin from Members'' is inaccurate.\121\ FICC notes it 
proposes to eliminate the augmented volatility adjustment multiplier 
and Coverage Component because these components would have the effect 
of unnecessarily increasing margin amounts.\122\ Additionally, FICC 
notes that its impact study reveals that the proposed methodology does 
not simply increase the margin requirements and the impacts vary based 
on Members' clearing portfolios and the market volatility that exists 
at that time.\123\ Statistically, FICC states that 71 percent of all 
Members will have a 10 percent or less increase in margin under the 
proposed changes and 40 percent of all Members will have no 
increase.\124\
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    \119\ FICC Letter I at 4.
    \120\ Id. at 3.
    \121\ Id.
    \122\ Id.
    \123\ Id.
    \124\ Id.
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    In response to Ronin and IDTA concerns, discussed above, that 
smaller, non-bank Members would see greater increases in margin as a 
result of the proposed changes, FICC states that the proposed 
sensitivity approach is based on a risk factor approach for securities 
in a Member's portfolio to calculate such Member's VaR Charge.\125\ 
FICC states that if Members have similar portfolios, the impact of the 
proposed VaR Charge calculation, together with the other proposed 
changes to the margin calculation, would be similar.\126\ FICC further 
states that the largest impact of the proposal is for those Members 
with mortgage-backed securities (``MBS'') concentrations.\127\ FICC 
acknowledges that while smaller Members with MBS concentrations would 
be impacted more, many of these Members have less diversified 
portfolios; thus, the effect of the margin calculation on conventional 
MBS would be more pronounced.\128\ FICC notes that the impact of the 
proposal would be determined by a Member's portfolio composition rather 
than a Member ``type,'' as a result, Members with lower MBS 
concentrations would experience smaller impacts from the proposal.\129\ 
Therefore, FICC believes that the proposal does not create a burden on 
any particular size or type of Member, such as non-bank Members, that 
does not result from the necessary and appropriate risk mitigation of 
the underlying securities in each Member's portfolio.\130\
---------------------------------------------------------------------------

    \125\ Id.
    \126\ Id.
    \127\ FICC Letter II at 5.
    \128\ Id. at 6.
    \129\ Id.
    \130\ Id.
---------------------------------------------------------------------------

    In response to the commenters concerns, discussed above, regarding 
the need for utilizing cross-margining in the GSD margin calculation, 
FICC notes that it operates under two divisions--GSD and MBSD--and each 
has its own rules and members.\131\ FICC states that as a registered 
clearing agency, it is subject to the requirements that are contained 
in the Exchange Act and in the Commission's regulations and rules 
thereunder.\132\ Further, FICC states it must ensure that the GSD Rules 
and the MBSD Rules, individually, are consistent with the Exchange 
Act.\133\ Therefore, FICC states that because it must comply with the 
Exchange Act for

[[Page 26521]]

GSD and MBSD separately, FICC disagrees with Amherst's statement that 
FICC's failure to implement a cross-margining arrangement would be 
inconsistent with the requirements of Rule 17Ad-22(e)(6) under the 
Exchange Act.\134\
---------------------------------------------------------------------------

    \131\ Id. at 12.
    \132\ Id.
    \133\ Id.
    \134\ Id.
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    Nevertheless, FICC agrees that data sharing and cross-margining 
arrangements would be beneficial to its membership.\135\ FICC notes it 
has and will continue to explore data sharing and cross-margining 
opportunities.\136\ FICC also states it will continue to develop a 
framework with the Chicago Mercantile Exchange (``CME'') that will 
enhance FICC's existing cross-margining arrangement with CME.\137\
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    \135\ Id.
    \136\ Id.
    \137\ Id.
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    In response to the commenters concerns, discussed above, suggesting 
FICC's proposed use of a 10-year look-back period and an additional 
stressed period in the VaR Charge calculation would be unnecessary and 
biased, FICC states that the proposed changes to extend the look-back 
period and add an additional stressed period would help to ensure that 
the historical simulation contains a sufficient number of historical 
market conditions (including but not limited to stressed market 
conditions) that are necessary to calculate margin amounts that achieve 
a 99 percent confidence level.\138\ FICC further states that because 
VaR models typically rely on historical data to estimate the 
probability distribution of potential market prices, FICC believes that 
a longer look-back period will typically produce more stable VaR 
estimates that adequately reflect extreme market moves.\139\ FICC notes 
that, as part of its model validation report, FICC performed a 
benchmark analysis of its calculation of the VaR Charge which included 
the 10-year look-back period and two alternative look-back periods--a 
five-year look-back period and a one-year look-back period.\140\ FICC 
notes that the model validation report compared the rolling one-year 
backtesting performance for the one-year, five-year, and 10-year look-
back periods using all Member portfolios for the period of January 1, 
2013 through April 28, 2017.\141\ FICC states that the 10-year look-
back period (which included a stress period) provides backtesting 
coverage above 99 percent while the five-year look-back period and the 
one-year look-back period do not.\142\ Therefore, FICC states that the 
proposed look-back period provides the appropriate margin coverage for 
GSD's exposures.\143\
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    \138\ FICC Letter I at 4.
    \139\ Id.
    \140\ FICC Letter II at 9.
    \141\ Id.
    \142\ Id.
    \143\ Id. at 10.
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    In response to the commenters concerns, discussed above, regarding 
the Excess Capital Premium, FICC states that for a majority of Members, 
the proposed VaR Charge calculation would be higher than the current 
VaR Charge calculation excluding the Margin Proxy and that the higher 
VaR Charge could result in a higher Excess Capital Premium for some 
Members.\144\ However, FICC believes that this increase is appropriate 
for the exposure that the Excess Capital Premium is designed to 
mitigate.\145\ FICC notes that even with the potential increase in the 
proposed VaR Charge, the majority of Members would not incur the Excess 
Capital Premium.\146\ Additionally, FICC believes that the proposed 
change to Net Capital for the Excess Capital Premium would reduce the 
impact to Members.\147\ Statistically, FICC states that, during a test 
period, the proposed change to utilize Net Capital would reduce the 
Excess Capital Premium from 188 to 159 instances.\148\ Further, FICC 
states that as a result of the proposed change to utilize Net Capital 
(instead of the existing practice of using the Excess Net Capital) in 
the Excess Capital Premium calculation, the Member with the largest 
number of instances would have had a 27 percent reduction in the number 
of instances of Excess Capital Premium and, on average, an 82 percent 
decrease in the dollar value of the charge on the days such Excess 
Capital Premium occurred.\149\ Also, FICC believes that the proposed 
change to the Excess Capital Premium would benefit a small set of 
Members and potentially lower the Excess Capital Premium for Members 
that exhibit fluctuations in their Excess Net Capital because the 
proposed change would be based on Net Capital that may be more 
predictable.\150\
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    \144\ Id. at 11.
    \145\ Id.
    \146\ Id.
    \147\ Id.
    \148\ Id.
    \149\ Id.
    \150\ Id.
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    In response to the commenters concerns, discussed above, regarding 
the Blackout Period Exposure Adjustment, FICC states that the proposed 
Blackout Period Exposure Adjustment is appropriate at the intraday 
collection cycle on the last business day of the month to mitigate 
exposure that begins on the first business day of the following 
month.\151\ FICC believes that Blackout Period Exposure Adjustment 
collections that occur after the MBS collateral pledge would not 
mitigate the risk that a Member defaults after the collateral is 
pledged but before such Member satisfies the next day's margin.\152\ 
FICC believes the proposed Blackout Period Exposure Adjustment is 
necessary because it would help to ensure that FICC maintains a 
sufficient margin that covers FICC's current and future exposure to 
changes in MBS collateral from pay-down exposure from its Members, at a 
99 percent confidence level.\153\ In response to IDTA's suggestion that 
a probability of default approach would be more appropriate, FICC 
states that such an approach would provide insufficient margin coverage 
to maintain a 99 percent confidence level.\154\
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    \151\ Id. at 12.
    \152\ Id. at 13.
    \153\ Id. at 14.
    \154\ Id. at 13.
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    As a general matter, the Commission acknowledges that a proposal to 
enhance FICC's VaR model, such as this proposal, could entail increased 
margin charges to some Members that would be borne by those Members and 
market participants more generally. The Commission understands that the 
impact of the cost of meeting an increased margin requirement would 
depend, in part, on each Member's specific business model and that some 
Members could satisfy the increase at a lower cost than others. As a 
result, the proposed changes contained in the Proposed Rule Change that 
would result in an increased margin charge could impose higher costs on 
some Members relative to others because of those Members' business 
choices. These higher relative burdens may weaken certain Members' 
competitive positions relative to other Members. However, as discussed 
below, the Commission believes that any competitive burden imposed by 
the proposed changes would not impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.\155\
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    \155\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

    As discussed above, during the fourth quarter of 2016, FICC's 
current methodology for calculating the VaR Charge did not respond 
effectively to the market volatility that existed at that time. As a 
result, the VaR Charge did not achieve backtesting coverage at a 99 
percent confidence level and, therefore, yielded backtesting 
deficiencies beyond FICC's risk tolerance. To address this

[[Page 26522]]

issue, FICC has proposed the changes discussed herein, which are 
designed to improve GSD's current VaR Charge calculation so that it 
responds more effectively to market volatility and helps FICC achieve 
backtesting coverage at a 99 percent confidence level. Although FICC 
had previously implemented the Margin Proxy to help address the 
issue,\156\ FICC is still concerned that the look-back period that is 
currently used in calculating the VaR Charge under the Margin Proxy may 
not calculate sufficient margin amounts to cover GSD's exposure to a 
defaulting Member.\157\ Therefore, the Commission believes that the 
Proposed Rule Change will help FICC better address this ongoing concern 
of maintaining sufficient financial resources to cover its credit 
exposure to each Member fully with a high degree of confidence. By 
helping FICC to better manage its credit exposure, the proposed changes 
would, in turn, help FICC better mitigate the potential losses to FICC 
and its Members associated with liquidating a Member's portfolio in the 
event of a Member default, in furtherance of FICC's obligations under 
Section 17A(b)(3)(F) of the Exchange Act to safeguard the securities 
and funds in FICC's custody or control, as discussed above.\158\
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    \156\ Supra note 14.
    \157\ See Amendment No. 1, supra note 6. Based on information 
learned from the Commission's general supervision of FICC, the 
Commission agrees that FICC should address this concern.
    \158\ As described further in Sections IV.A, C, D, and G.
---------------------------------------------------------------------------

    While the proposed changes contained in the Proposed Rule Change 
may raise the costs that certain Members incur to cover the risks 
associated with their portfolios, the Commission believes that these 
costs reflect the risks that these Members present to FICC, as the 
proposal is tailored to the different risk factors presented by each 
Member's portfolio, as described above. Specifically, the proposal to 
(1) move to a sensitivity approach to the VaR Charge calculation would 
enable the VaR Charge calculation to respond more effectively to market 
volatility by allowing FICC to attribute market price moves to various 
risk factors; (2) establish an evenly-weighted 10-year look-back 
period, with the option to add an additional stress period, would help 
FICC to ensure that the proposed sensitivity VaR Charge calculation 
contains a sufficient number of historical market conditions, to 
include stressed market conditions; (3) use the existing Margin Proxy 
as a back-up methodology system would help ensure FICC is able to 
calculate a VaR Charge for Members despite not being able to receive 
sensitivity data; (4) to implement a haircut method for securities with 
insufficient sensitivity data would help ensure that FICC is able to 
capture the risk profile of the securities; (5) establish the VaR Floor 
would help ensure that FICC assesses a VaR Charge where the proposed 
sensitivity calculation has produce too low of a VaR Charge; (6) 
establish the Blackout Period Exposure Adjustment component would 
enable FICC to address risks that could result from overstated values 
of mortgage-backed securities that are pledged as collateral for GCF 
Repo Transactions during a Blackout Period; (7) adjust the existing 
Backtesting Charge component would enable FICC to ensure that the 
charge applies to all Members, as appropriate, and to Members intraday 
trading activities that could pose a risk to FICC in the event that 
such Members default during the trading day; and (8) eliminate the 
Blackout Period Exposure Charge, Coverage Charge, and augmented 
volatility adjustment multiplier components would ensure that FICC did 
not maintain elements of the prior margin calculation that would 
unnecessarily increase Members' margin under the proposed margin 
calculation. Therefore, the Commission believes that each of the above 
proposed changes is tailored to the different risk factors presented by 
Members' portfolios. Tailoring the proposed changes to the different 
risk factors presented would, in turn, help FICC better mitigate the 
potential losses to FICC and its Members associated with liquidating a 
Member's portfolio in the event of a Member default. Specifically, such 
tailoring would help ensure that FICC collects adequate margin to 
offset the specific risks associated with each Member's portfolio, in 
furtherance of FICC's obligations under Section 17A(b)(3)(F) of the 
Exchange Act to safeguard the securities and funds in FICC's custody or 
control, as discussed above.\159\
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    \159\ As described further in Sections IV.A and C through G.
---------------------------------------------------------------------------

    In response to commenters' concerns, discussed above, that too much 
margin would be collected, after reviewing the data provided by FICC in 
Exhibit 3 to the Proposed Rule Change in conjunction with the 
Commission's supervisory observations, the Commission believes that the 
proposed changes would better enable FICC to collect margin 
commensurate with the different levels of risk that Members pose to 
FICC. Further, the Commission believes the amount of margin FICC would 
collect under the proposed changes would help FICC better manage its 
credit exposures to its Members and those exposures arising from its 
payment, clearing, and settlement processes. The Commission also 
believes, having reviewed Exhibit 3 to the Proposed Rule Change, that 
not all Members' margin requirements would increase as a result of the 
proposed changes and that the impact of the proposed changes vary based 
on Members' clearing portfolios and the market volatility that exists 
at that time. Further, the Commission believes that the proposed 
changes to the VaR Charge would not necessarily result in higher margin 
requirements in other components of the margin calculation where the 
VaR Charge is used in calculating the component. The Commission also 
notes that FICC proposes to eliminate the augmented volatility 
adjustment multiplier and Coverage Component because these components 
would have the effect of unnecessarily increasing margin amounts. 
Therefore, the Commission is not persuaded by IDTA's generalized 
statement that the proposed changes would have such a dramatic effect 
as to limit the diversity of liquidity in the U.S. markets, such as by 
causing Members to terminate their GSD membership. Rather, the 
Commission believes that the proposed changes promote a margin 
methodology that would appropriately address the risks presented by 
Members' clearing portfolios, enabling FICC to better mitigate losses 
that a Member default could cause to FICC and its non-defaulting 
Members.
    Commenters expressed concerns, discussed above, that smaller, non-
bank Members would be overly burdened by the proposed changes. After 
reviewing the data provided by FICC in Exhibit 3 to the Proposed Rule 
Change in conjunction with the Commission's supervisory observations, 
the Commission believes that the proposed sensitivity approach 
appropriately calculates a Member's VaR Charge based on risk factors 
presented by the securities held in a Member's portfolio and, thus, 
that the impact of the proposed changes would be determined by a 
Member's portfolio composition rather than a Member ``type.'' To the 
extent a Member's VaR Charge would increase under the proposed changes, 
it would be based on the securities held by the Member and FICC needing 
to collect margin to appropriately address that risk.
    In response to the commenters concerns, discussed above, regarding 
the need for utilizing cross-margining in

[[Page 26523]]

the GSD margin calculation, the Commission notes that the Proposed Rule 
Change does not propose to establish or change any cross-margining 
agreements, whether between GSD and MBSD or between GSD, MBSD, and 
another clearing agency. As such, cross-margining is not one of the 
proposed changes under the Commission's review. The Commission further 
notes that GSD and MBSD have different members (although a member of 
one could, and some do, apply and become a member of the other), offer 
different services, and clear different products. To the extent there 
is the potential to offset risk exposures present across the different 
products, those products are still cleared by different services. 
Accordingly, FICC maintains not only separate rulebooks for each 
division but also separate liquidity resources. Therefore, the 
Commission believes that the potential burden on Members that exists 
absent a proposed change in the Proposed Rule Change to establish 
cross-margining between GSD and MBSD, or to expanding cross-margining 
between GSD and another clearing agency, does not mean that the 
proposals are in and of themselves not necessary or not appropriate. 
Rather, the Commission believes that the proposed changes to GSD's 
margin calculation are tailored to the specific risks associated with 
the products and services offered by GSD and that the proposed GSD 
margin calculation is commensurate with the risks associated with 
portfolios held by Members in GSD.
    The Commission also notes that certain other actions by FICC may 
address some of the commenter concerns with respect to cross-margining. 
For instance, FICC states that it has and will continue to explore data 
sharing and cross-margining opportunities, and that FICC is in the 
process of completing a proposal that would enable a margin reduction 
for Members with MBS positions that offset between GSD and MBSD. FICC 
has also committed to continuing to develop a framework with CME that 
will enhance FICC's existing cross-margining arrangement with CME.
    In response to the commenters concerns, discussed above, regarding 
the 10-year look-back period and an additional stressed period in the 
VaR Charge calculation, the Commission believes that an evenly-weighted 
10-year look-back period, plus an additional stress period, as needed, 
would be an appropriate approach to help ensure that the proposed 
sensitivity VaR Charge calculation accounts for historical market 
observations of the securities cleared by GSD. Such a look-back period 
would help enable FICC to be in a better position to maintain 
backtesting coverage above 99 percent for GSD. As evidenced in FICC's 
second comment letter, a 10-year look-back period that includes a 
stress period would provide backtesting coverage above 99 percent, 
while a five-year look-back period and a one-year look-back period 
would not.\160\
---------------------------------------------------------------------------

    \160\ FICC Letter II at 9-10.
---------------------------------------------------------------------------

    In response to the commenters concerns, discussed above, regarding 
the Excess Capital Premium, the Commission notes that this proposed 
change would modify the denominator used in the calculation. 
Specifically, the denominator would become larger, as the proposal to 
use Net Capital (proposed denominator) is a larger amount than the 
current use of Excess Net Capital (current denominator).\161\ The 
effect, holding all else constant, would be to lower those Members' 
Excess Capital Premium.
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    \161\ See Form X-17A-5, line 3770, available at https://www.sec.gov/files/formx-17a-5_2.pdf.
---------------------------------------------------------------------------

    The Commission notes that under the Proposed Rule Change, FICC is 
not proposing to amend the numerator, as the numerator used for 
calculating the Excess Capital Premium would still be calculated using 
the VaR Charge calculation. Of course, if the numerator in the 
calculation (i.e., a Member's VaR Charge amount using the proposed 
sensitivity approach) were to increase as a result of the other 
proposed changes, then the Excess Capital Premium could increase. 
Further, the numerator will not necessarily increase for every Member. 
Data provided by FICC, which was filed with the Commission as Exhibit 3 
to the Proposed Rule Change, shows that the numerator used for 
calculating the Excess Capital Premium could increase or decrease 
depending on the risks associated with a Member's portfolio.
    In response to the commenters concerns, discussed above, regarding 
the calculation of the Blackout Period Exposure Adjustment, the 
Commission agrees with FICC. Specifically, the Commission agrees that 
(i) given the number of assumptions that one would need to make with 
respect to the various factors that influence MBS pay-down rates, the 
weighted-average approach would provide Members more transparency and 
certainty around the charge; and (ii) a credit-risk weighting would not 
likely produce a sufficient charge amount in the event of an actual 
Member default, as the approach would assume something less than a 100 
percent probability of default in calculating the charge. Furthermore, 
in response to commenters' concerns regarding the Blackout Period 
Exposure Adjustment collection cycle, the Commission notes the proposed 
cycle follows the same cycle currently used for the Blackout Period 
Exposure Charge, which FICC proposes to eliminate on account of the 
proposed Blackout Period Exposure Adjustment. For both the current and 
proposed cycle, the Commission understands, based on its experience and 
expertise, that FICC's application of the charge on the last business 
day of the month, as opposed to the first business day of the following 
month, is an appropriate way to ensure that FICC collects the funds 
before realizing the risk that the charge is intended to mitigate 
(i.e., a Member defaults during the Blackout Period). Similarly, FICC's 
extension of the charge through the end of the day on the Factor Date, 
as opposed to releasing the charge during FICC's standard intraday 
margin calculation on the Factor Date, also is an appropriate way to 
mitigate the risk exposure to FICC because, operationally, the MBS are 
not released and revalued with the update factors by the applicable 
clearing bank until after FICC has already completed the intraday 
margin calculation.
    Taken together, the Commission believes that the above discussed 
proposed changes to the components of the margin calculation would 
enhance FICC's current method for calculating each Member's margin. 
This enhancement would enable FICC to produce margin levels more 
commensurate with the risks associated with its Members' portfolios in 
a broader range of scenarios and market conditions, and, thus, more 
effectively cover its credit exposure to its Members.
    Therefore, for all of the above reasons, Commission believes that 
the Proposed Rule Change is consistent with Section 17A(b)(3)(I) of the 
Exchange Act, as the proposal would not impose a burden on competition 
not necessary or appropriate in furtherance of the purposes of the 
Exchange Act.

C. Consistency With Rule 17Ad-22(e)(4)(i) of the Exchange Act

    The Commission believes that the changes proposed in the Proposed 
Rule Change are consistent with Rule 17Ad-22(e)(4)(i) under the 
Exchange Act. Rule 17Ad-22(e)(4)(i) requires each covered clearing 
agency \162\ to establish,

[[Page 26524]]

implement, maintain and enforce written policies and procedures 
reasonably designed to effectively identify, measure, monitor, and 
manage its credit exposures to participants and those arising from its 
payment, clearing, and settlement processes, including by maintaining 
sufficient financial resources to cover its credit exposure to each 
participant fully with a high degree of confidence.\163\
---------------------------------------------------------------------------

    \162\ A ``covered clearing agency'' means, among other things, a 
clearing agency registered with the Commission under Section 17A of 
the Exchange Act (15 U.S.C. 78q-1 et seq.) that is designated 
systemically important by Financial Stability Oversight Council 
(``FSOC'') pursuant to the Clearing Supervision Act (12 U.S.C. 5461 
et seq.). See 17 CFR 240.17Ad-22(a)(5)-(6). Because FICC is a 
registered clearing agency with the Commission that has been 
designated systemically important by FSOC, FICC is a covered 
clearing agency.
    \163\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

    As described above, FICC proposes a number of changes to the way it 
addresses credit exposure to its Members through its margin 
calculation. Specifically, FICC proposes to (1) replace its existing 
full revaluation VaR Charge calculation with a sensitivity approach to 
the VaR Charge calculation that uses an evenly-weighted 10-year look-
back period; (2) utilize the existing Margin Proxy as a back-up VaR 
Charge calculation to the proposed sensitivity approach in the event 
that FICC experiences a data disruption with the third-party vendor; 
(3) implement a haircut method for securities that are ineligible for 
the sensitivity approach to FICC's VaR Charge calculation due to 
inadequate historical pricing data; (4) establish the VaR Floor; (5) 
establish the Blackout Period Exposure Adjustment component; (6) adjust 
the existing Backtesting Charge component; and (7) use Net Capital 
instead of Excess Capital when calculating the Excess Capital Premium, 
as applicable, for broker Members, inter-dealer broker Members, and 
dealer Members.
    Two commenters expressed concerns regarding the proposed change to 
the Excess Capital Premium.\164\ IDTA states that FICC needs to provide 
further clarification and justification for the Excess Capital Premium 
because the Excess Capital Premium under the proposed sensitivity 
approach to the VaR Charge calculation could result in additional 
margin for some Members ``without sufficient explanation in the 
proposed rule change.'' \165\ Additionally, IDTA states that the use of 
Net Capital in the denominator of the Excess Capital Premium will 
result in some additional Members being assessed the charge, 
specifically Dealer Members.\166\ IDTA states that Dealer Members 
should be able to use net worth, as compared to Net Capital, because a 
bank Member's capital figure is based on assets without any haircut for 
certain positions.\167\ In contrast, IDTA states that dealers must 
include haircuts on certain positions before calculating Net 
Capital.\168\ IDTA also states that FICC should allow dealer Members to 
calculate Net Capital for purposes of the Excess Capital Premium to not 
include a haircut on U.S. Government securities cleared at FICC.\169\ 
Finally, IDTA states that the Excess Capital Premium should instead be 
used to trigger a credit review for Members because, in conjunction 
with the other proposed changes, the Excess Capital Premium would not 
be a ``sound measure'' of a Member's credit risk.\170\ Similarly, 
Amherst notes that FICC should review further how it can allow dealer 
Members to be compared similarly to bank Members for Excess Capital 
Premium purposes to account for the haircut on assets that dealers must 
account for in their Net Capital calculation.\171\
---------------------------------------------------------------------------

    \164\ IDTA Letter; Amherst Letter II.
    \165\ IDTA Letter at 9.
    \166\ Id.
    \167\ Id. at 10.
    \168\ Id. at 10.
    \169\ Id. at 10.
    \170\ Id.
    \171\ Amherst Letter II at 4.
---------------------------------------------------------------------------

    In response, FICC states that the Excess Capital Premium is used to 
more effectively manage the risk posed by a Member whose activity 
causes it to have a margin requirement that is greater than its excess 
regulatory capital.\172\ FICC notes that for a majority of Members, the 
proposed sensitivity VaR Charge calculation would be higher than the 
current VaR Charge calculation, excluding the Margin Proxy, and that 
the higher VaR Charge could result in a higher Excess Capital 
Premium.\173\ Where there is an increase, FICC states that this 
increase is appropriate for the exposure that the Excess Capital 
Premium is designed to mitigate.\174\ However, FICC notes that even 
with the potential increase in the proposed VaR Charge, the majority of 
Members would not incur the Excess Capital Premium.\175\ Additionally, 
FICC states that the proposed change to Net Capital for the Excess 
Capital Premium would reduce the impact to Members.\176\ For example, 
for period of December 18, 2017 through April 2, 2018, FICC states that 
by using Net Capital instead of Excess Net Capital, the Member with the 
largest number of instances of the Excess Capital Premium would have 
had a 27 percent reduction in the number of instances and, on average, 
an 82 percent decrease in the dollar value of the charge on the days 
such Excess Capital Premium occurred.\177\
---------------------------------------------------------------------------

    \172\ FICC Letter II at 10,11; see Exchange Act Release No. 
54457 (September 15, 2006), 71 FR 55239 (September 21, 2006) (SR-
FICC-2006-03).
    \173\ FICC Letter II at 11.
    \174\ Id.
    \175\ Id.
    \176\ Id.
    \177\ Id.
---------------------------------------------------------------------------

    Additionally, two commenters noted that the proposed sensitivity 
approach to the VaR Charge calculation is not needed at this time 
because the Margin Proxy \178\ is sufficient to cover any gaps in 
margin requirements. Specifically, Amherst states that FICC has not 
presented the Commission with the full impact analysis of the 
supplemental Margin Proxy calculation and that the full analysis would 
reveal that the current margining process, inclusive of the Margin 
Proxy, has already significantly and materially increased Members' 
margin amounts. Therefore, Amherst states that a full analysis of the 
current supplemental Margin Proxy calculation would reveal that the 
Margin Proxy enables FICC to collect adequate levels of margin to 
protect itself during stressed periods.\179\ Similarly, IDTA states 
that the Margin Proxy allows GSD to maintain its backtesting goal at 
the 99 percent confidence level.\180\
---------------------------------------------------------------------------

    \178\ Supra note 12.
    \179\ Amherst II Letter at 2.
    \180\ IDTA Letter at 3-4.
---------------------------------------------------------------------------

    In response, FICC states that the Margin Proxy has historically 
provided a more accurate VaR Charge calculation than the full valuation 
approach, but the current VaR Charge as supplemented by the Margin 
Proxy calculation reflects relatively low market price volatility that 
has been present in the mortgage-backed securities market since the 
beginning of 2017. As such, FICC states that this current approach 
contains an insufficient amount of look-back data to ensure that the 
backtesting will remain above 99 percent if volatility returns to 
levels seen beyond the one-year look-back period that is currently used 
to calibrate the Margin Proxy for MBS.\181\ Additionally, in order to 
help ensure that it is calculating adequate margin, FICC filed 
Amendment No. 1 to accelerate the implementation of all the proposed 
changes, except for the proposed Blackout Period Exposure Adjustment 
and the removal of the existing Blackout Period Exposure Charge, which 
FICC proposes to implement in phases, through the remainder of 2018, in 
response to commenters.
---------------------------------------------------------------------------

    \181\ FICC Letter II at 3.
---------------------------------------------------------------------------

    In Amendment No. 1, FICC states that it has been discussing the 
proposed changes with Members since August 2017 in order to help 
Members prepare for and understand why FICC proposed

[[Page 26525]]

the rule changes.\182\ FICC states that it is primarily concerned that 
the look-back period that is currently used in calculating the VaR 
Charge under the Margin Proxy may not calculate sufficient margin 
amounts to cover GSD's exposure to a defaulting Member.\183\ Therefore, 
FICC proposes to accelerate the implementation of all the proposed 
changes, except for the proposed Blackout Period Exposure Adjustment 
and the removal of the existing Blackout Period Exposure Charge.\184\
---------------------------------------------------------------------------

    \182\ Id.
    \183\ Id.
    \184\ Id.
---------------------------------------------------------------------------

    The Commission believes that these proposed changes are designed to 
help FICC better identify, measure, monitor, and manage its credit 
exposure to its Members by calculating more precisely the risk 
presented by Members, which would enable FICC to assess a more reliable 
VaR Charge. Specifically, FICC's proposed change to (1) switch to a 
sensitivity approach to the VaR Charge calculation, with a 10-year 
look-back period, would help the calculation respond more effectively 
to market volatility by attributing market price moves to various risk 
factors; (2) use the Margin Proxy as a back-up to the proposed 
sensitivity calculation would help ensure that FICC is able to assess a 
VaR Charge, even if its unable to receive sensitivity data from the 
third-party vendor; (3) apply a haircut on securities that are 
ineligible for the sensitivity VaR Charge calculation would enable FICC 
to better account for the risk presented by such securities; (4) 
establish the VaR Floor would enable FICC to better calculate a VaR 
Charge for portfolios where the proposed sensitivity approach would 
yield too low a VaR Charge; (5) establish the Blackout Period Exposure 
Adjustment component would enable FICC to better address risks that 
could result from overstated values of mortgage-backed securities that 
are pledged as collateral for GCF Repo Transactions during a Blackout 
Period; (6) adjust the existing Backtesting Charge component would 
ensure that the charge applied to all Members, as appropriate, and to 
Member's intraday trading activities; and (7) use Net Capital instead 
of Excess Capital when calculating the Excess Capital Premium would 
make the Excess Capital Premium calculation for broker Members, inter-
dealer broker Members, and dealer Members more consistent with the 
equity capital measure that is used for other Members.
    In response to commenters concerns regarding the proposed change to 
the Excess Capital Premium calculation, the Commission notes that this 
proposed change would only modify the denominator used in the 
calculation. Specifically, the denominator would become larger, as the 
proposal to use Net Capital (proposed denominator) is a larger amount 
than the current use of Excess Net Capital (current denominator).\185\ 
The effect, holding all else constant, would be to lower those Members' 
Excess Capital Premium.
---------------------------------------------------------------------------

    \185\ See Form X-17A-5, line 3770, available at https://www.sec.gov/files/formx-17a-5_2.pdf.
---------------------------------------------------------------------------

    Of course, if the numerator in the calculation (i.e., a Member's 
VaR Charge amount) would increase, then the Excess Capital Premium 
could increase. However, FICC does not propose to change the numerator 
used for calculating the Excess Capital Premium. The Commission notes 
that under the Proposed Rule Change, the numerator used for calculating 
the Excess Capital Premium would be calculated using the proposed 
sensitivity approach to the VaR Charge calculation. As described 
further below, the proposed sensitivity approach would calculate margin 
commensurate with the risks associated with a Member's portfolio.
    In response to the comments that the proposed sensitivity approach 
to the VaR Charge calculation is not necessary at this time in light of 
the Margin Proxy, the Commission disagrees. In considering these 
comments, the Commission thoroughly reviewed (i) the Proposed Rule 
Change, including the supporting exhibits that provided confidential 
information on the performance of the proposed sensitivity calculation, 
impact analysis, and backtesting results; (ii) the comments received; 
and (iii) the Commission's own understanding of the performance of the 
current VaR Charge calculation, with which the Commission has 
experience from its general supervision of FICC, compared to the 
proposed sensitivity calculation. More specifically, the confidential 
Exhibit 3 submitted by FICC includes (i) 12-month rolling coverage 
backtesting results; (ii) intraday backtesting impact analysis; (iii) a 
breakdown of coverage percentages and dollar amounts, for each Member, 
under the current margin model with and without Margin Proxy and under 
the proposed sensitivity model; and (iv) an impact study of the 
proposed changes detailing the margin amounts required per Member 
during Blackout Periods and non-Blackout Periods.
    On a Member basis, the Commission notes that there is not a 
sizeable change in the amount of margin collected under the current 
margin model, supplemented by the Margin Proxy, compared to the 
proposed sensitivity model. The Commission also notes that the Margin 
Proxy was implemented as a temporary solution to issues identified with 
the current model, as it only has a one year look-back period.\186\ 
Additionally, the Commission believes that the sensitivity approach is 
simpler and more accurate as it uses a broad spectrum of sensitivity 
data that is tailored to the specific risks associated with Members' 
portfolios. Ultimately, the Commission finds that the proposed 
sensitivity approach, and the related implementation schedule proposed 
in Amendment No. 1, would provide FICC with a more robust margin 
calculation in FICC's efforts to meet the applicable regulatory 
requirements for margin coverage.
---------------------------------------------------------------------------

    \186\ See supra note 15.
---------------------------------------------------------------------------

    Therefore, for the reasons discussed above, the Commission believes 
that the changes proposed in the Proposed Rule Change are consistent 
with Rule 17Ad-22(e)(4)(i) under the Exchange Act.\187\
---------------------------------------------------------------------------

    \187\ 17 CFR 240.17Ad-22(e)(4)(i).
---------------------------------------------------------------------------

D. Consistency With Rule 17Ad-22(e)(6)(i) of the Exchange Act

    The Commission believes that the changes proposed in the Proposed 
Rule Change are consistent with Rule 17Ad-22(e)(6)(i) under the 
Exchange Act. Rule 17Ad-22(e)(6)(i) requires each covered clearing 
agency to establish, implement, maintain and enforce written policies 
and procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum considers, and produces margin levels commensurate with, the 
risks and particular attributes of each relevant product, portfolio, 
and market.\188\
---------------------------------------------------------------------------

    \188\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------

    As described above, FICC proposes a number of changes to how it 
calculates Members' margin charge through a risk-based margin system 
that considers the risks and attributes of securities that GSD clears. 
Specifically, FICC proposes to (1) move to a sensitivity approach to 
the VaR Charge calculation; (2) move from a front-weighted one-year 
look-back period to an evenly-weighted 10-year look-back period with 
the option for an additional stress period; (3) use the existing Margin 
Proxy as a back-up methodology to the proposed sensitivity approach to 
the VaR Charge calculation; (4) implement a haircut method for 
securities with insufficient sensitivity data due to inadequate 
historical pricing; (5) establish the VaR Floor; (6) establish the 
Blackout Period Exposure

[[Page 26526]]

Adjustment component; (7) adjust the existing Backtesting Charge 
component; and (8) eliminate the Blackout Period Exposure Charge, 
Coverage Charge, and augmented volatility adjustment multiplier 
components.
    Several commenters raised concerns that the proposed changes to the 
margin calculation would not produce a margin charge commensurate with 
the risks and particular attributes of Members' complete portfolios. 
Specifically, Ronin states that the use of the proposed sensitivity 
approach to the VaR Charge calculation only uses a subset of a Member's 
entire portfolio (i.e., it does not incorporate data from other 
clearing agencies) to calculate the Member's risk to FICC.\189\ Ronin 
suggests that the implementation of data sharing and cross margining 
between MBSD, GSD, and CME would provide FICC with a more accurate 
representation of the risk associated with a Member's portfolio.\190\ 
Ronin also states that the existing cross-margin agreement between FICC 
and CME needs an update to provide true cross-margin relief for all GSD 
Members.\191\ Similarly, IDTA states that FICC cannot accurately 
identify the risk associated with a Member's portfolio due to the lack 
of incentive to share data with other clearing agencies.\192\ IDTA 
suggests that FICC should develop cross-margining ability between GSD 
and MBSD and improve cross-margining with CME.\193\ KGS and Amherst 
make similar arguments. KGS states that in order to more effectively 
analyze and address Members' portfolio risks, there should be cross 
margining for Members that hold offsetting positions in GSD and MBSD, 
stating that not having such an intra-DTCC cross-margining process will 
have a distortive effect on GSD's margining system, forcing members to 
reduce their use of GSD and reduce their positions cleared through GSD, 
in effect reducing market liquidity.\194\ Amherst states that not 
implementing cross-margin capabilities will inflate the margin 
requirements and distort the liquidity profile of the Member.\195\
---------------------------------------------------------------------------

    \189\ Ronin Letter I at 1.
    \190\ Id. at 2.
    \191\ Ronin Letter II at 2.
    \192\ IDTA Letter at 11.
    \193\ Id.
    \194\ KGS Letter at 1.
    \195\ Amherst Letter II at 2.
---------------------------------------------------------------------------

    In response, FICC disagrees with Amherst's statement that FICC's 
failure to implement a cross-margining arrangement would be 
inconsistent with the requirements of Rule 17Ad-22(e)(6) under the 
Exchange Act.\196\ FICC notes that it operates under two divisions, GSD 
and MBSD, each of which has its own rules and members.\197\ As a 
registered clearing agency, FICC notes that it is subject to the 
requirements that are contained in the Exchange Act and in the 
Commission's regulations and rules thereunder.\198\
---------------------------------------------------------------------------

    \196\ FICC Letter II at 12.
    \197\ Id.
    \198\ Id.
---------------------------------------------------------------------------

    Nevertheless, FICC states that it agrees with commenters that data 
sharing and cross-margining would be beneficial to its Members and is 
exploring data sharing and cross-margining opportunities outside of the 
Proposed Rule Change.\199\ FICC states it is in the process of 
completing a proposal that would enable a margin reduction for Members 
with mortgage-backed securities (``MBS'') positions that offset between 
GSD and MBSD.\200\ FICC also states it will continue to develop a 
framework with CME that will enhance FICC's existing cross-margining 
arrangement with CME.\201\ Finally, FICC notes that the proposed 
changes to the GSD margin methodology are necessary because they 
provide appropriate risk mitigation that must be in place before FICC 
can fully evaluate potential cross-margining opportunities.\202\
---------------------------------------------------------------------------

    \199\ FICC Letter I at 5.
    \200\ FICC Letter II at 12.
    \201\ Id.
    \202\ Id.
---------------------------------------------------------------------------

    Separate from those comments, two commenters also raised concerns 
with the proposed extended look-back period. Ronin states that FICC's 
assumption of adding a continued stress period to the 10-year look-back 
calculation is employing ``statistical bias'' because it treats every 
day as if the market is in ``the midst of a financial crisis'' and 
creates over margining.\203\ Similarly, IDTA states the addition of an 
arbitrary year to the look-back period is statistically biased and 
makes the ``most volatile day'' permanent and therefore, the 
calculations are not addressing the actual risk of a portfolio.\204\ 
IDTA believes that a shorter look-back period of five years without an 
additional stress period would sufficiently margin Members for the risk 
of their portfolios.\205\
---------------------------------------------------------------------------

    \203\ Ronin Letter I at 4; Ronin Letter 2 at 5.
    \204\ IDTA Letter I at 7.
    \205\ Id.
---------------------------------------------------------------------------

    In response, FICC states that a longer look-back period will 
produce a more stable VaR estimate that adequately reflects extreme 
market moves ensuring the VaR Charge does not decrease as quickly 
during periods of low volatility nor increase as sharply during periods 
of a market crisis.\206\ Additionally, FICC states that an extended 
look-back period including stressed market conditions are necessary to 
calculate margin requirements that achieve a 99 percent confidence 
level.\207\ As part of FICC's model validation report, FICC performed a 
benchmark analysis of its calculation of the VaR Charge. FICC analyzed 
a 10-year look-back period, a five-year look-back period, and a one-
year look-back period using all Member portfolios from January 1, 2013 
through April 28, 2017.\208\ The results of FICC's analysis showed that 
a 10-year look-back period, which included a stress period, provides 
backtesting coverage above 99 percent while a five-year look-back 
period and a one-year look-back period did not.\209\
---------------------------------------------------------------------------

    \206\ FICC Letter I at 4.
    \207\ Id.
    \208\ FICC Letter II at 9.
    \209\ Id.
---------------------------------------------------------------------------

    The Commission believes that these proposed changes are designed to 
help FICC better cover its credit exposures to its Members, as the 
changes would help establish a risk-based margin system that considers 
and produces margin levels commensurate with the risks and particular 
attributes of the products cleared in GSD. Specifically, the proposal 
to (1) move to a sensitivity approach to the VaR Charge calculation 
would enable the VaR Charge calculation to respond more effectively to 
market volatility by allowing FICC to attribute market price moves to 
various risk factors; (2) establish an evenly-weighted 10-year look-
back period, with the option to add an additional stress period, would 
help FICC to ensure that the proposed sensitivity VaR Charge 
calculation contains a sufficient number of historical market 
conditions, to include stressed market conditions; (3) use the existing 
Margin Proxy as a back-up methodology system would help ensure FICC is 
able to calculate a VaR Charge for Members despite a not being able to 
receive sensitivity date; (4) to implement a haircut method for 
securities with insufficient sensitivity data would help ensure that 
FICC is able to capture the risk profile of the securities; (5) 
establish the VaR Floor would help ensure that FICC assesses a VaR 
Charge where the proposed sensitivity calculation has produce too low 
of a VaR Charge; (6) establish the Blackout Period Exposure Adjustment 
component would enable FICC to address risks that could result from 
overstated values of mortgage-backed securities that are pledged as 
collateral for GCF Repo Transactions during a Blackout Period; (7) 
adjust the existing Backtesting Charge component would enable FICC to 
ensure that the charge applies to all Members, as appropriate,

[[Page 26527]]

and to Members' intraday trading activities that could pose a risk to 
FICC in the event that such Members default during the trading day; and 
(8) eliminate the Blackout Period Exposure Charge, Coverage Charge, and 
augmented volatility adjustment multiplier components would ensure that 
FICC did not maintain elements of the prior margin calculation that 
would unnecessarily increase Members' margin under the proposed margin 
calculation.
    In response to comments regarding cross-margining and its potential 
impact upon membership levels and market liquidity, the Commission 
notes that the Proposed Rule Change does not propose to establish or 
change any cross-margining agreements, whether between GSD and MBSD or 
between GSD, MBSD, and another clearing agency. As such, cross-
margining is not one of the proposed changes under the Commission's 
review. The Commission further notes that GSD and MBSD have different 
members (although a member of one could, and some may, apply and become 
a member of the other), offer different services, and clear different 
products. To the extent there is the potential to offset risk exposure 
present across the different products, those products are still cleared 
by different services. Accordingly, FICC maintains not only separate 
rulebooks for each division but also separate liquidity resources.
    Therefore, the Commission believes that the absence of a proposal 
in the Proposed Rule Change to establish cross-margining between GSD 
and MBSD, or to expanding cross-margining between GSD and another 
clearing agency, does not render the specific changes proposed in the 
Proposed Rule Change for GSD inconsistent with the Clearing Supervision 
Act or the applicable rules discussed herein. Rather, the Commission 
believes that the proposed changes to GSD's margin calculation are 
designed to be tailored to the specific risks associated with the 
products and services offered by GSD and that the proposed GSD margin 
calculation is commensurate with the risks associated with portfolios 
held by Members in GSD.
    In response to comments about the proposed look-back period, the 
Commission believes that an evenly-weighted 10-year look-back period, 
plus an additional stress period, as needed, is an appropriate approach 
to help ensure that the proposed sensitivity VaR Charge calculation 
accounts for historical market observations of the securities cleared 
by GSD. Such a look-back period would help enable FICC to be in a 
better position to maintain backtesting coverage above 99 percent for 
GSD. As evidenced in FICC's second comment letter, a 10-year look-back 
period that includes a stress period would provide backtesting coverage 
above 99 percent, while a five-year look-back period and a one-year 
look-back period would not.\210\
---------------------------------------------------------------------------

    \210\ Id. at 9-10.
---------------------------------------------------------------------------

    Therefore, for the above discussed reasons, the Commission believes 
that the changes proposed in the Proposed Rule Change are consistent 
with Rule 17Ad-22(e)(6)(i) under the Exchange Act.\211\
---------------------------------------------------------------------------

    \211\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------

E. Consistency With Rule 17Ad-22(e)(6)(ii) of the Exchange Act

    The Commission believes that the changes proposed in the Proposed 
Rule Change are consistent with Rule 17Ad-22(e)(6)(ii) under the 
Exchange Act. Rule 17Ad-22(e)(6)(ii) requires each covered clearing 
agency to establish, implement, maintain and enforce written policies 
and procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, marks participant positions to market and collects margin, 
including variation margin or equivalent charges if relevant, at least 
daily and includes the authority and operational capacity to make 
intraday margin calls in defined circumstances.\212\
---------------------------------------------------------------------------

    \212\ 17 CFR 240.17Ad-22(e)(6)(ii).
---------------------------------------------------------------------------

    As described above, FICC proposes to adjust the existing 
Backtesting Charge component. Specifically, FICC proposes to collect 
the charge from all Members on a daily basis, as applicable, as well as 
from Members that have backtesting deficiencies during the trading day 
due to large fluctuations of intraday trading activity that could pose 
risk to FICC in the event that such Members default during the trading 
day.
    The change is designed to help improve FICC's risk-based margin 
system by authorizing FICC to assess this specific margin charge on all 
Members at least daily, as needed, and on an intra-day basis, as 
needed. Therefore, the Commission believes that the changes proposed in 
the Proposed Rule Change are consistent with Rule 17Ad-22(e)(6)(ii) 
under the Exchange Act.\213\
---------------------------------------------------------------------------

    \213\ Id.
---------------------------------------------------------------------------

F. Consistency With Rule 17Ad-22(e)(6)(iv) of the Exchange Act

    The Commission believes that the changes proposed in the Proposed 
Rule Change are consistent with Rule 17Ad-22(e)(6)(iv) under the 
Exchange Act. Rule 17Ad-22(e)(6)(iv) requires each covered clearing 
agency to establish, implement, maintain and enforce written policies 
and procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, uses reliable sources of timely price data and procedures and 
sound valuation models for addressing circumstances in which pricing 
data are not readily available or reliable.\214\
---------------------------------------------------------------------------

    \214\ 17 CFR 240.17Ad-22(e)(6)(iv).
---------------------------------------------------------------------------

    As described above, FICC proposes a number of changes to its margin 
calculation that are designed to use reliable price data and address 
circumstances in which pricing data may not be available or reliable. 
Specifically, FICC proposes to (1) replace its existing full 
revaluation VaR Charge calculation with the proposed sensitivity 
approach that relies upon the expertise of a third-party vendor to 
produce the needed sensitivity data; (2) utilize the existing Margin 
Proxy as a back-up to the proposed sensitivity VaR Charge calculation 
in the event that FICC experiences a data disruption with the third-
party vendor; (3) implement a haircut method for securities that are 
ineligible for the proposed sensitivity approach to the VaR Charge 
calculation due to inadequate historical pricing data; and (4) 
establish the VaR Floor.
    The Commission believes that these proposed changes are designed to 
help FICC better cover its credit exposures to its Members, as the 
changes would help establish a risk-based margin system that uses 
reliable sources of timely price data and procedures and sound 
valuation models for addressing circumstances in which pricing data are 
not readily available or reliable. Specifically, the proposal to (1) 
move to a sensitivity approach to the VaR Charge calculation would not 
only enable the VaR Charge calculation to respond more effectively to 
market volatility by allowing FICC to attribute market price moves to 
various risk factors but also would enable FICC to employ the expertise 
of a third-party vendor to supply applicable sensitivity data; (2) use 
the existing Margin Proxy as a back-up methodology system would help 
ensure FICC is able to calculate a VaR Charge for Members despite any 
difficulty in receiving sensitivity data from the third-party vendor; 
(3) implement a haircut method for securities with insufficient 
sensitivity data would help ensure that FICC is able to capture the 
risk profile of the securities; and (4) establish the VaR Floor would 
help ensure that FICC

[[Page 26528]]

assesses a VaR Charge where the proposed sensitivity VaR Charge 
calculation produces too low of a VaR Charge.
    Therefore, for these reasons, the Commission believes that the 
changes proposed in the Proposed Rule Change are consistent with Rule 
17Ad-22(e)(6)(iv) under the Exchange Act.\215\
---------------------------------------------------------------------------

    \215\ Id.
---------------------------------------------------------------------------

G. Consistency With Rule 17Ad-22(e)(6)(v) of the Exchange Act

    The Commission believes that the changes proposed in the Proposed 
Rule Change are consistent with Rule 17Ad-22(e)(6)(v) under the 
Exchange Act. Rule 17Ad-22(e)(6)(v) requires each covered clearing 
agency to establish, implement, maintain and enforce written policies 
and procedures reasonably designed to use an appropriate method for 
measuring credit exposure that accounts for relevant product risk 
factors and portfolio effects across products.\216\
---------------------------------------------------------------------------

    \216\ 17 CFR 240.17Ad-22(e)(6)(v).
---------------------------------------------------------------------------

    As described above, FICC proposes a number of changes to its margin 
calculation that are designed to help ensure that FICC accounts for the 
relevant product risk factors and portfolio effects across GSD's 
products when measuring its credit exposure to Members. Specifically, 
FICC proposes to (1) replace its existing full revaluation VaR Charge 
calculation with the proposed sensitivity approach to the VaR Charge 
calculation; (2) implement a haircut method for securities that are 
ineligible for the proposed sensitivity approach due to inadequate 
historical pricing data; and (3) establish the Blackout Period Exposure 
Adjustment component.
    Two commenters raised concerns regarding the Blackout Period 
Exposure Adjustment.\217\ Specifically, IDTA states that that the 
Blackout Period Exposure Adjustment results in an inaccurate 
measurement of risk and excessive margin charges.\218\ First, IDTA 
states that the Blackout Period should run from the first business day 
of the current month to the morning of the fifth business day to more 
accurately capture FICC's exposure.\219\ Second, IDTA states that the 
Blackout Period Exposure Adjustment should be calculated using 
historical pay-down rates for the MBS pools held in each Members' 
portfolio, rather than historical pay-down rates for all active MBS 
pools. Finally, IDTA states that FICC should apply a credit-risk 
weighting to the Blackout Period Exposure Adjustment instead of 
assuming a 100 percent probability of a GCF Repo Service counterparty 
default across all Members.\220\
---------------------------------------------------------------------------

    \217\ IDTA Letter; Amherst Letter II.
    \218\ IDTA Letter at 12.
    \219\ Id.
    \220\ Id.
---------------------------------------------------------------------------

    Amherst similarly states that using historical pay-down rates for 
all active MBS pools, rather than using historical pay-down rates for 
the MBS pools held in each Members' portfolio, in calculating the 
Blackout Period Exposure Adjustment would eliminate ``prudent risk and 
position management'' that Members can undertake to reduce FICC's 
exposure.\221\ Amherst states that FICC should retain its current 
approach that provides incentives for Members to ``manage the prepay 
characteristics of the mortgage-backed securities held within FICC.'' 
\222\
---------------------------------------------------------------------------

    \221\ Amherst Letter II at 5.
    \222\ Id.
---------------------------------------------------------------------------

    In response, FICC states that Blackout Period Exposure Adjustment 
collections that occur after the MBS collateral pledge would not 
mitigate the risk that a Member defaults after the collateral is 
pledged but before such Member satisfies the next day's margin.\223\ 
Therefore, FICC states that IDTA's proposed change to the timing of the 
Blackout Period Exposure Adjustment would be inconsistent with FICC's 
requirements under the Exchange Act.\224\ Additionally, FICC states it 
considered different approaches for determining the calculation of the 
Blackout Period Exposure Adjustment that would ensure FICC has 
sufficient backtesting coverage, and give Members transparency and the 
ability to plan for the Blackout Period Exposure Adjustment 
requirements.\225\ FICC notes that MBS pay-down rates are influenced by 
several factors that can be projected at the loan level, however, such 
projections would be dependent on several assumptions that may not be 
predictable and transparent to Members.\226\ Thus, FICC states that the 
proposed Blackout Period Exposure Adjustment applies weighted averages 
of pay-down rates for all active mortgage pools of the related program 
during the three most recent preceding months, and FICC believes that 
this approach would allow Members to effectively plan for the Blackout 
Period Exposure Adjustment.\227\ Finally, FICC disagrees with IDTA's 
suggestion that a probability of default approach would be more 
appropriate because a probability of default approach would provide 
lower margin coverage than the current approach.\228\ FICC notes this 
lower margin would not be sufficient to maintain the margin coverage at 
a 99 percent confidence level.\229\
---------------------------------------------------------------------------

    \223\ FICC Letter II at 13.
    \224\ Id.
    \225\ Id.
    \226\ Id.
    \227\ Id.
    \228\ Id.
    \229\ Id.
---------------------------------------------------------------------------

    The Commission believes that these proposed changes are designed to 
help FICC use an appropriate method for measuring credit exposure that 
accounts for relevant product risk factors and portfolio effects across 
products cleared by GSD. Specifically, the proposal to (1) move to a 
sensitivity approach to the VaR Charge calculation would enable the VaR 
Charge calculation to respond more effectively to market volatility by 
allowing FICC to attribute market price moves to various risk factors; 
(2) to implement a haircut method for securities with insufficient 
sensitivity data would help ensure that FICC is able to capture the 
risk profile of the securities; and (3) establish the Blackout Period 
Exposure Adjustment component would enable FICC to address risks that 
could result from overstated values of mortgage-backed securities that 
are pledged as collateral for GCF Repo Transactions during a Blackout 
Period.
    In response to commenters' concerns regarding the Blackout Period 
Exposure Adjustment collection cycle, as stated above, the Commission 
notes the proposed cycle follows the same cycle currently used for the 
Blackout Period Exposure Charge, which FICC proposes to eliminate on 
account of the proposed Blackout Period Exposure Adjustment. For both 
the current and proposed cycle, the Commission understands, based on 
its experience and expertise, that FICC's application of the charge on 
the last business day of the month, as opposed to the first business 
day of the following month, is an appropriate way to ensure that FICC 
collects the funds before realizing the risk that the charge is 
intended to mitigate (i.e., a Member defaults during the Blackout 
Period). Similarly, FICC's extension of the charge through the end of 
the day on the Factor Date, as opposed to releasing the charge during 
FICC's standard intraday margin calculation on the Factor Date, also is 
an appropriate way to mitigate the risk exposure to FICC because, 
operationally, the MBS are not released and revalued with the update 
factors by the applicable clearing bank until after FICC has already 
completed the intraday margin calculation.
    In response to commenters' concerns regarding the calculation of 
the Blackout Period Exposure Adjustment, the Commission agrees with 
FICC. Specifically, the Commission agrees that (i) given the number 
assumptions that

[[Page 26529]]

one would need to make with respect to the various factors that 
influence MBS pay-down rates, the weighted-average approach would 
provide Members more transparency and certainty around the charge; and 
(ii) a credit-risk weighting would not likely produce a sufficient 
charge amount in the event of an actual Member default, as the approach 
would assume something less than a 100 percent probability of default 
in calculating the charge.
    Therefore, for these reasons, the Commission believes that the 
changes proposed in the Proposed Rule Change are consistent with Rule 
17Ad-22(e)(6)(v) under the Exchange Act.\230\
---------------------------------------------------------------------------

    \230\ 17 CFR 240.17Ad-22(e)(6)(v).
---------------------------------------------------------------------------

H. Consistency With Rule 17Ad-22(e)(6)(vi)(B) of the Exchange Act

    Rule 17Ad-22(e)(6)(vi)(B) under the Exchange Act requires each 
covered clearing agency to establish, implement, maintain and enforce 
written policies and procedures reasonably designed to cover its credit 
exposures to its participants by establishing a risk-based margin 
system that, at a minimum, is monitored by management on an ongoing 
basis and is regularly reviewed, tested, and verified by conducting a 
sensitivity analysis \231\ of its margin model and a review of its 
parameters and assumptions for backtesting on at least a monthly basis, 
and considering modifications to ensure the backtesting practices are 
appropriate for determining the adequacy of the covered clearing 
agency's margin resources.\232\
---------------------------------------------------------------------------

    \231\ Rule 17Ad-22(a)(16)(i) under the Exchange Act defines 
sensitivity analysis to include an analysis that involves analyzing 
the sensitivity model to its assumptions, parameters, and inputs 
that consider the impact on the model of both moderate and extreme 
changes in a wide range of inputs, parameters, and assumptions, 
including correlations of price movements or returns if relevant, 
which reflect a variety of historical and hypothetical market 
conditions. 17 CFR 240.17Ad-22(a)(16)(i). Sensitivity analysis must 
use actual portfolios and, where applicable, hypothetical portfolios 
that reflect the characteristics of proprietary positions and 
customer positions. Id.
    \232\ 17 CFR 240.17Ad-22(e)(6)(vi)(B).
---------------------------------------------------------------------------

    Some of the commenters raise concerns that two of the presumptions 
assumed by FICC for backtesting, in order to determine the adequacy of 
the FICC's margin resources, are inaccurate.\233\ First, Ronin and IDTA 
claim that FICC incorrectly assumes that it would take three days to 
liquidate or hedge the portfolio of a defaulting Member in normal 
market conditions. Specifically, Ronin states that FICC's assumption 
that it would take three days to liquidate or hedge the portfolio of a 
defaulted Member is incorrect because FICC incorrectly assumes that 
liquidity needs following a default will be identical for all 
Members.\234\ Ronin states that the three-day liquidation period 
creates an ``arbitrary and extremely high hurdle'' for historical 
backtesting by overestimating the closeout-period risk posed to FICC by 
many of its Members by ``triple-counting'' a single event.\235\ 
Similarly, IDTA notes that it is arbitrary to apply the same 
liquidation period across all Members because smaller Member portfolios 
can be more easily liquidated or hedged in a short period of time.\236\ 
IDTA believes FICC should link the liquidation period to the portfolio 
size of the Member.\237\
---------------------------------------------------------------------------

    \233\ Ronin Letter I at 2-4; IDTA Letter at 6, 7.
    \234\ Ronin Letter I at 2-3; Ronin Letter II at 1.
    \235\ Ronin Letter I at 3.
    \236\ IDTA Letter at 6; Ronin Letter II at 2.
    \237\ Id.
---------------------------------------------------------------------------

    In its response, FICC states that the three-day liquidation period 
is an accurate assumption of the length of time it would take to 
liquidate a portfolio given the volume and types of securities that can 
be found in a Member's portfolio at any given time.\238\ Further, FICC 
notes that it validates the three-day liquidation period, at least 
annually, through FICC's simulated close-out, which is augmented with 
statistical and economic analysis to reflect potential liquidation 
costs of sample portfolios of various sizes.\239\ FICC also notes that 
idiosyncratic exposures cannot be mitigated quickly and that the risk 
associated with idiosyncratic exposures is present in large and small 
portfolios.\240\ Finally, FICC states that although a single market 
price shock will influence a three-day portfolio price return, the 
mark-to-market calculation will vary daily based on the day's positions 
and margin collection for each Member.\241\
---------------------------------------------------------------------------

    \238\ FICC Letter I at 3.
    \239\ Id. at 3-4.
    \240\ Id. at 4.
    \241\ Id.
---------------------------------------------------------------------------

    The Commission believes that FICC's assumption that it could take 
three days to liquidate the portfolio of a defaulted Member, regardless 
of the size of the portfolio or the type of Member, is appropriate. To 
the extent there is a difference in the time required for FICC to 
liquidate various GSD products over a three-day period, the Commission 
believes that such time is appropriate in order for FICC to focus on 
the overall risk management of the defaulted Member without creating a 
liquidation methodology that is overly complex and susceptible to 
flaws.
    Therefore, the Commission believes that the Proposed Rule Change is 
consistent with Rule 17Ad-22(e)(6)(vi)(B) under the Exchange Act.\242\
---------------------------------------------------------------------------

    \242\ 17 CFR 240.17Ad-22(e)(6)(vi)(B).
---------------------------------------------------------------------------

I. Consistency With Rule 17Ad-22(e)(23)(ii) of the Exchange Act

    Rule 17Ad-22(e)(23)(ii) under the Exchange Act requires each 
covered clearing agency to establish, implement, maintain and enforce 
written policies and procedures reasonably designed to provide 
sufficient information to enable participants to identify and evaluate 
the risks, fees, and other material costs they incur by participating 
in the covered clearing agency.\243\
---------------------------------------------------------------------------

    \243\ 17 CFR 240.17Ad-22(e)(23)(ii).
---------------------------------------------------------------------------

    Three commenters expressed concerns regarding the limited time in 
which Members have had to evaluate the data provided by FICC and the 
effects of the proposed changes.\244\ IDTA states that the proposed 
changes are complex and warrant adequate testing and transparency 
between FICC and its Members.\245\ IDTA states that FICC has not 
provided Members with adequate time to review and evaluate the 
potential impacts of the proposed changes on a Member's portfolio.\246\ 
IDTA suggests that FICC (i) provide more time for Members to adapt to 
the change; (ii) launch a calculator that enables Members to input 
sample portfolios to determine the margin required; and (iii) provide 
full disclosure of the methodology used.\247\
---------------------------------------------------------------------------

    \244\ See Amherst Letter II; IDTA Letter; Ronin II Letter.
    \245\ IDTA Letter at 5.
    \246\ Id.
    \247\ Id.
---------------------------------------------------------------------------

    Similarly, Amherst states that the proposed changes should not be 
implemented until Members have had the appropriate time and sufficient 
information to complete a comparison between the current margin 
methodology and the proposed changes.\248\ Amherst requests that FICC 
provide the appropriate tools and information to replicate the new 
sensitivity model in order to manage the risks to Members that may be 
introduced as a result of the proposed changes.\249\ Amherst also 
requests that FICC provide transparency surrounding the effects of the 
Blackout Period Exposure Adjustment and the Excess Capital Premium 
calculations in order to assess the impacts of the proposed 
changes.\250\
---------------------------------------------------------------------------

    \248\ Amherst Letter II at 2.
    \249\ Id.
    \250\ Id. at 5, 6.
---------------------------------------------------------------------------

    Similarly, Ronin states that FICC has heavily relied on parallel 
and historical studies when providing its Members

[[Page 26530]]

with data, but Members lack the necessary tools to conduct their own 
scenario analysis.\251\ Ronin notes that when trading activity or 
market conditions deviate from assumptions made under the various 
studies conducted by the FICC, Members are forced to react rather than 
proactively manage capital needs.\252\ Ronin, therefore, states it is 
significantly more difficult to manage the capital needs of a business 
when a clearing agency does not provide appropriate tools for 
calculating projected margin requirements in advance.\253\
---------------------------------------------------------------------------

    \251\ Ronin Letter II at 3.
    \252\ Id.
    \253\ Id.
---------------------------------------------------------------------------

    In response, FICC states that its Members have been provided with 
sufficient time and information to assess the impact of the proposed 
changes.\254\ FICC states that it has provided Members with numerous 
opportunities to gather information including (i) holding customer 
forums in August 2017; (ii) making individual impact studies available 
in September 2017 and December 2017; (iii) providing parallel reporting 
on a daily basis since December 18, 2017; and (iv) meeting and speaking 
with Members on an individual basis and responding to request for 
additional information since August 2017.\255\ Separately, FICC agrees 
with commenters that launching a calculator that enables Members to 
input sample portfolios to determine the margin required would be 
beneficial to its Members and is exploring creating such a calculator 
outside of the changes proposed in the Proposed Rule Change.\256\ 
Additionally, in order to provide Members with more time, FICC filed 
Amendment No. 1 to delay implementation of the Blackout Period Exposure 
Adjustment and the removal of the Blackout Period Exposure Charge.\257\ 
Such changes now would be implemented in phases throughout the 
remainder of 2018.\258\
---------------------------------------------------------------------------

    \254\ FICC Letter I at 5; FICC Letter II at 8-9.
    \255\ FICC Letter I at 5; FICC Letter II at 8-9.
    \256\ FICC Letter I at 5.
    \257\ Amendment No. 1, supra note 6.
    \258\ Id.
---------------------------------------------------------------------------

    In response to commenters, the Commission notes that the disclosure 
requirements of Rule 17Ad-22(e)(23)(ii) under the Exchange Act \259\ 
should not be conflated with the filing requirements for proposed rule 
changes under Section 19(b)(1) of the Exchange Act \260\ and Rule 19b-4 
thereunder.\261\ Section 19(b)(1) of the Exchange Act requires a self-
regulatory organization to provide the Commission with copies of any 
proposed rule or proposed change to the self-regulatory organization's 
rules, accompanied by a concise general statement of the basis and 
purpose of the proposed rule change,\262\ which FICC did in this 
case.\263\ Meanwhile, Rule 19b-4(l) under the Exchange Act requires the 
clearing agency to post the proposed rule change, and any amendments 
thereto, on its website within two business days after filing with the 
Commission,\264\ which FICC did in this case.\265\
---------------------------------------------------------------------------

    \259\ 17 CFR 240.17Ad-22(e)(23)(ii).
    \260\ 15 U.S.C. 78s(b)(1).
    \261\ 17 CFR 240.19b-4.
    \262\ 12 U.S.C. 5465(e)(1)(A).
    \263\ See Notice, supra note 3.
    \264\ See 17 CFR 240.19b-4(l).
    \265\ Available at http://www.dtcc.com/legal/sec-rule-filings.
---------------------------------------------------------------------------

    Until the Commission approves the changes proposed in a proposed 
rule change, disclosure of the proposed changes under Rule 17Ad-
22(e)(23)(ii) is not yet applicable, as there would not yet be (and 
there may not be if the Commission objects to the proposed changes) any 
risks, fees, or other material costs incurred with respect to the 
proposed changes. Nevertheless, the Commission notes that FICC has 
conducted outreach to Members, as described above, and proposes a 
staggered implementation of the proposed Blackout Period Exposure 
Adjustment and removal of the Blackout Period Exposure Charge in 
response to commenters. The Commission believes that the absence of a 
longer period of time to review the Proposed Rule Change does not 
render the proposed changes inconsistent with the Clearing Supervision 
Act or the applicable rules discussed herein.
    Therefore, the Commission believes that the changes proposed in the 
Proposed Rule Change are consistent with Rule 17Ad-22(e)(23)(ii) under 
the Exchange Act.\266\
---------------------------------------------------------------------------

    \266\ 17 CFR 240.17Ad-22(e)(23)(ii).
---------------------------------------------------------------------------

V. Accelerated Approval of Proposed Rule Change, as Modified by 
Amendment No. 1

    The Commission finds good cause to approve the Proposed Rule 
Change, as modified by Amendment No. 1, prior to the thirtieth day 
after the date of publication of the notice of Amendment No. 1 in the 
Federal Register. As discussed above, FICC submitted Amendment No. 1 to 
(1) stagger the implementation of the proposed Blackout Period Exposure 
Adjustment and the proposed removal of the Blackout Period Exposure 
Charge; (2) amend the implementation date for the remainder of the 
proposed changes contained in the Proposed Rule Change; and (3) correct 
an incorrect description of the calculation of the Excess Capital 
Premium that appears once in the narrative to the Proposed Rule Change, 
as well as in the corresponding location in the Exhibit 1A to the 
Proposed Rule Change.
    The Commission believes that Amendment No. 1 does not raise any 
novel issues: (i) Staggering the implementation of the proposed 
Blackout Period Exposure Adjustment is in response to comments 
received, as described above; (ii) accelerating the implementation date 
for the remainder of the proposed changes would enable FICC to 
implement those proposed changes sooner, which, as discussed above, 
would help FICC address issues identified with its current margin 
calculation; and (iii) the remaining change is non-substantive. 
Accordingly, the Commission finds good cause to approve the proposed 
rule change, as modified by Amendment No. 1, on an accelerated basis, 
pursuant to Section 19(b)(2) of the Exchange Act.\267\
---------------------------------------------------------------------------

    \267\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

VI. Conclusion

    On the basis of the foregoing, the Commission finds that the 
Proposed Rule Change, as modified by Amendment No. 1, is consistent 
with the requirements of the Exchange Act, in particular, with the 
requirements of Section 17A of the Exchange Act and the rules and 
regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\268\ that proposed rule change SR-FICC-2018-001, as 
modified by Amendment No. 1, be, and it hereby is, approved on an 
accelerated basis.
---------------------------------------------------------------------------

    \268\ Id.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\269\
---------------------------------------------------------------------------

    \269\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-12195 Filed 6-6-18; 8:45 am]
 BILLING CODE 8011-01-P