Document ID: SEC-2020-1566-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Fixed Income Clearing Corp.
Posted Date: 2020-10-02T04:00Z

[Federal Register Volume 85, Number 192 (Friday, October 2, 2020)]
[Notices]
[Pages 62348-62353]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-21784]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90033; File No. SR-FICC-2020-802]

Self-Regulatory Organizations; Fixed Income Clearing Corporation; 
Notice of Filing of Amendment No. 2 and Notice of No Objection to 
Advance Notice, as Modified by Amendment Nos. 1 and 2, to Introduce the 
Margin Liquidity Adjustment Charge and Include a Bid-Ask Charge in the 
VaR Charges

September 28, 2020.
    On July 30, 2020, Fixed Income Clearing Corporation (``FICC'') 
filed with the Securities and Exchange Commission (``Commission'') 
advance notice SR-FICC-2020-802 pursuant to Section 806(e)(1) of Title 
VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 
entitled Payment, Clearing and Settlement Supervision Act of 2010 
(``Clearing Supervision Act''),\1\ and Rule 19b-4(n)(1)(i) \2\ under 
the Securities Exchange Act of 1934 (``Exchange Act'') \3\ to add two 
new charges to FICC's margin methodologies. On August 13, 2020, FICC 
filed Amendment No. 1 to the advance notice, to make clarifications and 
corrections to the advance notice.\4\ The advance notice, as modified 
by Amendment No. 1, was published for public comment in the Federal 
Register on September 4, 2020,\5\ and the Commission has received no 
comments regarding the changes proposed in the advance notice as 
modified by Amendment No. 1.\6\ On August 27, 2020, FICC filed 
Amendment No. 2 to the advance notice to provide additional data for 
the Commission to consider in analyzing the advance notice.\7\ The 
advance notice, as modified by Amendment Nos. 1 and 2, is hereinafter 
referred to as the ``Advance Notice.'' The Commission is publishing 
this notice to solicit comments on Amendment No. 2 from interested 
persons and, for the reasons discussed below, is hereby providing 
notice of no objection to the Advance Notice.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ 15 U.S.C. 78a et seq.
    \4\ Amendment No. 1 made clarifications and corrections to the 
description of the advance notice and Exhibits 3 and 5 of the 
filing.
    \5\ Securities Exchange Act Release No. 89718 (September 1, 
2020), 85 FR 55341 (September 4, 2020) (File No. SR-FICC-2020-802) 
(``Notice of Filing''). On July 30, 2020, FICC also filed a related 
proposed rule change (SR-FICC-2020-009) with the Commission pursuant 
to Section 19(b)(1) of the Exchange Act and Rule 19b-4 thereunder. 
On August 13, 2020, FICC filed Amendment No. 1 to the proposed rule 
change to make similar clarifications and corrections to the 
proposed rule change. See 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4 
respectively. The proposed rule change, as amended by Amendment No. 
1, was published in the Federal Register on August 20, 2020. 
Securities Exchange Act Release No. 89560 (August 14, 2020), 85 FR 
51503 (August 20, 2020). On August 27, 2020, FICC filed Amendment 
No. 2 to the proposed rule change to provide similar additional data 
for the Commission's consideration. The proposed rule change, as 
amended by Amendment Nos. 1 and 2, is hereinafter referred to as the 
``Proposed Rule Change.'' In the Proposed Rule Change, FICC seeks 
approval of proposed changes to its rules necessary to implement the 
Advance Notice. The comment period for the related Proposed Rule 
Change filing closed on September 10, 2020, and the Commission 
received no comments.
    \6\ As the proposals contained in the Advance Notice were also 
filed as a proposed rule change, all public comments received on the 
proposal are considered regardless of whether the comments are 
submitted on the Proposed Rule Change or the Advance Notice.
    \7\ In Amendment No. 2, FICC updated Exhibit 3 to the advance 
notice to include impact analysis data with respect to the proposals 
in the advance notice. FICC filed Exhibit 3 as a confidential 
exhibit to the advance notice pursuant to 17 CFR 240.24b-2.
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I. The Advance Notice

    First, the proposals in the Advance Notice would revise the FICC 
Government Securities Division (``GSD'') Rulebook (``GSD Rules'') and 
FICC Mortgage-Backed Securities Division (``MBSD'') Clearing Rules 
(``MBSD Rules,'' and together with the GSD Rules, the ``Rules'') \8\ to 
introduce the Margin Liquidity Adjustment Charge (``MLA Charge'') as an 
additional margin component. Second, the proposals in the Advance 
Notice would revise the Rules, GSD Methodology Document--GSD Initial 
Market Risk Margin Model (``GSD QRM Methodology Document''), and MBSD 
Methodology and Model

[[Page 62349]]

Operations Document--MBSD Quantitative Risk Model (``MBSD QRM 
Methodology Document,'' and together with the GSD QRM Methodology 
Document, the ``QRM Methodology Documents'') \9\ to add a bid-ask 
spread risk charge (``Bid-Ask Spread Charge'') to the margin 
calculations of GSD and MBSD.
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    \8\ Capitalized terms not defined herein are defined in the 
Rules, available at https://www.dtcc.com/legal/rules-and-procedures.aspx.
    \9\ FICC filed the proposed changes to the QRM Methodology 
Documents as confidential exhibits to the Advance Notice pursuant to 
17 CFR 240.24b-2.
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A. Background

    FICC serves as a central counterparty (``CCP'') and provider of 
significant clearance and settlement services for cash-settled U.S. 
Treasury and agency securities and the non-private label mortgage-
backed securities markets.\10\ FICC is comprised of two divisions, GSD 
and MBSD. GSD provides real-time trade matching, clearing, risk 
management, and netting for trades in U.S. government debt issues, 
including repurchase agreements. MBSD provides real-time automated 
trade matching, trade confirmation, risk management, netting, and 
electronic pool notification to the mortgage-backed securities market. 
GSD and MBSD maintain separate Rulebooks, margin methodologies, and 
members.
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    \10\ See Securities Exchange Act Release No. 69838 (June 24, 
2013), 78 FR 39027 (June 28, 2013).
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    In its role as a CCP, a key tool that FICC uses to manage its 
credit exposure to its respective GSD and MBSD members is by 
determining and collecting an appropriate Required Fund Deposit (i.e., 
margin) for each member.\11\ The aggregate of all members' Required 
Fund Deposits constitutes the respective GSD and MBSD Clearing Funds. 
FICC would access the GSD or MBSD Clearing Fund should a defaulted 
member's own Required Fund Deposit be insufficient to satisfy losses to 
FICC caused by the liquidation of that member's portfolio.\12\
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    \11\ See GSD Rule 4 (Clearing Fund and Loss Allocation) and MBSD 
Rule 4 (Clearing Fund and Loss Allocation), supra note 8.
    \12\ See id.
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    Each member's Required Fund Deposit consists of a number of 
applicable components, which are calculated to address specific risks 
that the member's portfolio presents to FICC.\13\ Generally, the 
largest component of a member's Required Fund Deposit is the value-at-
risk (``VaR'') Charge, which is calculated using a risk-based margin 
methodology that is intended to capture the risks related to the 
movement of market prices associated with the securities in a member's 
portfolio.\14\ The VaR Charge is designed to calculate the potential 
losses on a portfolio over a three-day period of risk assumed necessary 
to liquidate the portfolio, within a 99 percent confidence level.\15\
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    \13\ See id.
    \14\ See GSD Rule 1 (Definitions), MBSD Rule 1 (Definitions), 
GSD Rule 4 (Clearing Fund and Loss Allocation), and MBSD Rule 4 
(Clearing Fund and Loss Allocation), supra note 8.
    \15\ See Notice of Filing, supra note 5 at 55342. Unregistered 
Investment Pool Clearing Members are subject to a VaR Charge with a 
minimum target confidence level assumption of 99.5 percent. See MBSD 
Rule 4, Section 2(c), supra note 8.
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    FICC states that it regularly assesses market and liquidity risks 
as such risks relate to its margin methodologies to evaluate whether 
margin levels are commensurate with the particular risk attributes of 
each relevant product, portfolio, and market.\16\ FICC states that the 
proposed MLA Charge and Bid-Ask Spread Charge are necessary for FICC's 
margin methodologies to effectively account for risks associated with 
certain types and attributes of member portfolios.\17\
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    \16\ See Notice of Filing, supra note 5 at 55342.
    \17\ See id.
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B. Margin Liquidity Adjustment Charge

    FICC's current margin methodologies do not account for the risk of 
a potential increase in market impact costs that FICC could incur when 
liquidating a defaulted member's portfolio that contains a 
concentration of large positions, as compared to the overall market, in 
either (i) a particular security or group of securities sharing a 
similar risk profile, or (ii) in a particular transaction type (e.g., 
mortgage pool transactions).\18\ In a member default, liquidating such 
large positions within a potentially compressed timeframe \19\ (i.e., 
in a fire sale) could have an impact on the underlying market, 
resulting in price moves that increases FICC's risk of incurring 
additional liquidation costs. Therefore, FICC designed the MLA Charge 
to address this specific risk.\20\
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    \18\ See id.
    \19\ FICC's risk models assume the liquidation occurs over a 
period of three business days. See Notice of Filing, supra note 5 at 
55342-43.
    \20\ See id.
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    The MLA Charge would be based on comparing the market value of 
member portfolio positions in specified asset groups \21\ to the 
available trading volume of those asset groups in the market. If the 
market value of a member's positions in a certain asset group is large 
in comparison to the available trading volume of that asset group,\22\ 
then it is more likely that FICC would have to manage reduced 
marketability and increased liquidation costs for those positions 
during a member default scenario. Specifically, FICC's margin 
methodology assumes for each asset group that a certain share of the 
market can be liquidated without price impact.\23\ Aggregate positions 
in an asset group which exceed this share are generally considered as 
large and would therefore incur application of the MLA Charge to 
anticipate and address those increased costs.
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    \21\ For GSD, the asset groups would include the following, each 
of which share similar risk profiles: (a) U.S. Treasury securities, 
which would be further categorized by maturity--those maturing in 
(i) less than one year, (ii) equal to or more than one year and less 
than two years, (iii) equal to or more than two years and less than 
five years, (iv) equal to or more than five years and less than ten 
years, and (v) equal to or more than ten years; (b) Treasury-
Inflation Protected Securities (``TIPS''), which would be further 
categorized by maturity--those maturing in (i) less than two years, 
(ii) equal to or more than two years and less than six years, (iii) 
equal to or more than six years and less than eleven years, and (iv) 
equal to or more than eleven years; (c) U.S. agency bonds; and (d) 
mortgage pools transactions.
    For MBSD, to-be-announced (``TBA'') transactions, Specified Pool 
Trades and Stipulated Trades would be included in one mortgage-
backed securities asset group. Notice of Filing, supra note 5 at 
55343.
    \22\ FICC determines average daily trading volume by reviewing 
publicly available data from the Securities Industry and Financial 
Markets Association (``SIFMA''), at https://www.sifma.org/resources/archive/research/statistics.
    \23\ FICC would establish the particular share for each asset 
group or subgroup based on empirical research which includes the 
simulation of asset liquidation over different time horizons. See 
Notice of Filing, supra note 5 at 55343.
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    To determine the market impact cost for each portfolio position in 
certain asset groups (i.e., Treasuries maturing in less than one year 
and TIPS for GSD, and in the mortgage-backed securities asset group for 
MBSD), FICC would use the directional market impact cost, which is a 
function of the position's net directional market value.\24\ To 
determine the market impact cost for all other positions in a 
portfolio, FICC would add together two components: (1) The directional 
market impact cost, as described above, and (2) the basis cost, which 
is based on the position's gross market value.\25\ FICC states that the 
calculation of market impact cost for positions in Treasuries maturing 
in less than one year, TIPS for GSD, and in the mortgage-backed 
securities asset group for MBSD would not include basis cost

[[Page 62350]]

because basis risk is negligible for these types of positions.\26\ For 
all asset groups, when determining the market impact costs, the net 
directional market value and the gross market value of the positions 
would be divided by the average daily volumes of the securities in each 
asset group over a lookback period.\27\
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    \24\ The net directional market value of an asset group within a 
portfolio is calculated as the absolute difference between the 
market value of the long positions in that asset group, and the 
market value of the short positions in that asset group. For 
example, if the market value of the long positions is $100,000, and 
the market value of the short positions is $150,000, the net 
directional market value of the asset group is $50,000. See id.
    \25\ To determine the gross market value of the positions in 
each asset group, FICC would sum the absolute value of each CUSIP in 
the asset group. See id.
    \26\ See id.
    \27\ Supra note 22; see Notice of Filing, supra note 5 at 55343.
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    FICC would then compare the calculated market impact cost to a 
portion of the VaR Charge that is allocated to positions in each asset 
group.\28\ If the ratio of the calculated market impact cost to the 
one-day VaR Charge is greater than a determined threshold, an MLA 
Charge, as described below, would be applied to that asset group. 
Correspondingly, if the ratio of these two amounts is equal to or less 
than this threshold, an MLA Charge would not be applied to that asset 
group. The threshold would be based on an estimate of the market impact 
cost that is incorporated into the calculation of the one-day VaR 
charge.\29\
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    \28\ As noted earlier, FICC's margin methodology uses a three-
day assumed period of risk. For purposes of this calculation, FICC 
would use a portion of the VaR Charge that is based on a one-day 
assumed period of risk (the ``one-day VaR Charge''). Any changes to 
what FICC determines would be the appropriate portion of the VaR 
Charge would be subject to FICC's model risk management governance 
procedures set forth in the Clearing Agency Model Risk Management 
Framework (``Model Risk Management Framework''). See Securities 
Exchange Act Release Nos. 81485 (August 25, 2017), 82 FR 41433 
(August 31, 2017) (File No. SR-FICC-2017-014); 84458 (October 19, 
2018), 83 FR 53925 (October 25, 2018) (File No. SR-FICC-2018-010); 
88911 (May 20, 2020), 85 FR 31828 (May 27, 2020) (File No. SR-FICC-
2020-004).
    \29\ FICC states that it would review the method for calculating 
the thresholds from time to time, and any changes would be subject 
to FICC's model risk management governance procedures set forth in 
the Model Risk Management Framework. See id.
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    When applicable, an MLA Charge would be calculated as a proportion 
of the product of (1) the amount by which the ratio of the calculated 
market impact cost to a portion of the VaR Charge allocated to that 
position exceeds the threshold, and (2) a portion of the VaR Charge 
allocated to that asset group. For each portfolio, FICC would total the 
MLA Charges for the positions in each asset group to determine a total 
MLA Charge for the member. On a daily basis, FICC would calculate the 
final MLA Charge for each member (if applicable), to be included as a 
component of each member's Required Fund Deposit.
    In certain circumstances, FICC may be able to partially mitigate 
the risks that the MLA Charge is designed to address by extending the 
time period for liquidating a defaulted member's portfolio beyond the 
three day period. Accordingly, the Advance Notice also describes a 
method that FICC would use to reduce a member's total MLA Charge when 
the volatility charge component of the member's margin increases beyond 
a specified point. Specifically, FICC would reduce the member's MLA 
Charge where the market impact cost of a particular portfolio, 
calculated as part of determining the MLA Charge, would be large 
relative to the one-day volatility charge for that portfolio (i.e., a 
portion of the three-day assumed margin period of risk). When the ratio 
of calculated market impact cost to the one-day volatility charge is 
lower, FICC would not adjust the MLA Charge. However, as the ratio gets 
higher, FICC would reduce the MLA Charge. FICC designed this reduction 
mechanism to avoid assessing unnecessarily large MLA Charges.\30\
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    \30\ See Notice of Filing, supra note 5 at 55343-44.
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MLA Excess Amount for GSD Sponsored Members \31\
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    \31\ See GSD Rule 3A, supra note 8. Sponsored Membership at GSD 
is a program that allows well-capitalized members to sponsor their 
eligible clients into GSD membership. Sponsored membership at GSD 
offers eligible clients the ability to lend cash or eligible 
collateral via FICC-cleared delivery-versus-payment sale and 
repurchase transactions. Sponsoring Members facilitate their 
clients' GSD trading activity and act as processing agents on their 
behalf for all operational functions including trade submission and 
settlement with FICC. A Sponsored Member may be sponsored by one or 
more Sponsoring Members.
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    For GSD, the calculation of the MLA Charge for a Sponsored Member 
that clears through a single account sponsored by a Sponsoring Member 
would be the same as described above. For a GSD Sponsored Member that 
clears through multiple accounts sponsored by multiple Sponsoring 
Members, in addition to calculating an MLA Charge for each account (as 
described above), FICC would also calculate an MLA Charge for the 
Sponsored Member's consolidated portfolio.
    If the MLA Charge of the consolidated portfolio is not higher than 
the sum of all MLA Charges for each account of the Sponsored Member, 
then the Sponsored Member would only be charged an MLA Charge for each 
sponsored account, as applicable. However, if the MLA Charge of the 
consolidated portfolio is higher than the sum of all MLA Charges for 
each account of the Sponsored Member, the Sponsored Member would be 
charged the amount of such difference (referred to as the ``MLA Excess 
Amount''), in addition to the applicable MLA Charge.
    The MLA Excess Amount is designed to capture the additional market 
impact cost that could be incurred when a Sponsored Member defaults, 
and each of the Sponsoring Members liquidates positions associated with 
that defaulted Sponsored Member. If large positions in the same asset 
group are being liquidated by multiple Sponsoring Members, the market 
impact cost to liquidate those positions could increase. The MLA Excess 
Amount would address this additional market impact cost by capturing 
any difference between the calculations of the MLA Charge for each 
sponsored account and for the consolidated portfolio.

C. Bid-Ask Spread Charge

    The bid-ask spread refers to the difference between the observed 
market price that a buyer is willing to pay for a security and the 
observed market price at which a seller is willing to sell that 
security. FICC faces the risk of potential bid-ask spread transaction 
costs when liquidating the securities in a defaulted member's 
portfolio. However, FICC's current margin methodologies do not account 
for this risk of potential bid-ask spread transaction costs to FICC in 
connection with liquidating a defaulted member's portfolio. Therefore, 
FICC designed the Bid-Ask Spread Charge to address this deficiency in 
its current margin methodologies.
    The Bid-Ask Spread Charge would be haircut-based and tailored to 
different groups of assets that share similar bid-ask spread 
characteristics.\32\ FICC would assign each asset group a specified 
bid-ask spread haircut rate (measured in basis points (``bps'')) that 
would be applied to the gross market value of the portfolio's positions 
in that particular asset group. FICC would calculate the product of the 
gross market value of the portfolio's positions in a particular asset 
group and the applicable basis point charge to obtain the bid-ask 
spread risk charge for these positions. FICC would total the applicable 
bid-ask spread risk

[[Page 62351]]

charges for each asset class in a member's portfolio to calculate the 
member's total Bid-Ask Spread Charge.
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    \32\ For GSD, the asset groups would include the following, each 
of which share similar bid-ask spread risk profiles: (a) Mortgage 
pools (``MBS''); (b) TIPS; (c) U.S. agency bonds; and (d) U.S. 
Treasury securities, which would be further segmented into separate 
classes based on maturities as follows: (i) Less than five years, 
(ii) equal to or more than five years and less than ten years, and 
(iii) equal to or more than ten years. Only the MBS asset group is 
applicable to MBSD member portfolios.
    FICC would exclude Option Contracts in to-be-announced (``TBA'') 
transactions from the Bid-Ask Spread Charge because, FICC states 
that in the event of a member default, FICC would liquidate any 
Option Contracts in TBAs in a member's portfolio at the intrinsic 
value of the Option Contract and, therefore, does not face a 
transaction cost related to the bid-ask spread. Notice of Filing, 
supra note 5 at 55344.
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    FICC determined the proposed initial haircut rates on an analysis 
of bid-ask spread transaction costs using (1) the results of FICC's 
annual member default simulation and (2) market data sourced from a 
third-party data vendor. FICC's proposed initial haircut rates are 
listed in the table below:

------------------------------------------------------------------------
                                                                Haircut
                         Asset group                             (bps)
------------------------------------------------------------------------
MBS..........................................................        0.8
TIPS.........................................................        2.1
U.S. Agency bonds............................................        3.8
U.S. Treasuries (maturing < 5 years).........................        0.6
U.S. Treasuries (maturing 5-10 years)........................        0.7
U.S. Treasuries (maturing 10+ years).........................        0.7
------------------------------------------------------------------------

    FICC proposes to review the haircut rates annually. Based on 
analyses of recent years' simulation exercises, FICC does not 
anticipate that these haircut rates would change significantly year 
over year. FICC may also adjust the haircut rates following its annual 
model validation review, to the extent the results of that review 
indicate the current haircut rates are not adequate to address the risk 
presented by transaction costs from a bid-ask spread.\33\
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    \33\ All proposed changes to the haircuts would be subject to 
FICC's model risk management governance procedures set forth in the 
Model Risk Management Framework. See supra note 28.
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    Finally, FICC would make technical changes to the QRM Methodology 
Documents to re-number the sections and tables, and update certain 
section titles, as necessary to incorporate the MLA Charge and Bid-Ask 
Spread Charge into those documents.

II. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the advance 
notice is consistent with the Clearing Supervision Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-FICC-2020-802 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FICC-2020-802. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (http://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the advance notice that are filed with the 
Commission, and all written communications relating to the advance 
notice between the Commission and any person, other than those that may 
be withheld from the public in accordance with the provisions of 5 
U.S.C. 552, will be available for website viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549, on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of such filings will also be available for inspection 
and copying at the principal office of FICC and FICC's website at 
https://www.dtcc.com/legal.
    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-2020-802 and should be 
submitted on or before October 19, 2020.

III. Discussion and Commission Findings

    Although the Clearing Supervision Act does not specify a standard 
of review for an advance notice, the stated purpose of the Clearing 
Supervision Act is instructive: to mitigate systemic risk in the 
financial system and promote financial stability by, among other 
things, promoting uniform risk management standards for SIFMUs and 
strengthening the liquidity of SIFMUs.\34\
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    \34\ See 12 U.S.C. 5461(b).
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    Section 805(a)(2) of the Clearing Supervision Act authorizes the 
Commission to prescribe regulations containing risk management 
standards for the payment, clearing, and settlement activities of 
designated clearing entities engaged in designated activities for which 
the Commission is the supervisory agency.\35\ Section 805(b) of the 
Clearing Supervision Act provides the following objectives and 
principles for the Commission's risk management standards prescribed 
under Section 805(a):\36\
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    \35\ 12 U.S.C. 5464(a)(2).
    \36\ 12 U.S.C. 5464(b).
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     to promote robust risk management;
     to promote safety and soundness;
     to reduce systemic risks; and
     to support the stability of the broader financial system.
    Section 805(c) provides, in addition, that the Commission's risk 
management standards may address such areas as risk management and 
default policies and procedures, among others areas.\37\
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    \37\ 12 U.S.C. 5464(c).
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    The Commission has adopted risk management standards under Section 
805(a)(2) of the Clearing Supervision Act and Section 17A of the 
Exchange Act (the ``Clearing Agency Rules'').\38\ The Clearing Agency 
Rules require, among other things, each covered clearing agency to 
establish, implement, maintain, and enforce written policies and 
procedures that are reasonably designed to meet certain minimum 
requirements for its operations and risk management practices on an 
ongoing basis.\39\ As such, it is appropriate for the Commission to 
review advance notices against the Clearing Agency Rules and the 
objectives and principles of these risk management standards as 
described in Section 805(b) of the Clearing Supervision Act. As 
discussed below, the Commission believes the proposal in the Advance 
Notice is consistent with the objectives and principles described in 
Section 805(b) of the Clearing Supervision Act,\40\ and in the Clearing 
Agency Rules, in particular Rules 17Ad-22(e)(4) and (e)(6).\41\
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    \38\ 17 CFR 240.17Ad-22. See Securities Exchange Act Release No. 
68080 (October 22, 2012), 77 FR 66220 (November 2, 2012) (S7-08-11). 
See also Securities Exchange Act Release No. 78961 (September 28, 
2016), 81 FR 70786 (October 13, 2016) (S7-03-14) (``Covered Clearing 
Agency Standards''). FICC is a ``covered clearing agency'' as 
defined in Rule 17Ad-22(a)(5).
    \39\ 17 CFR 240.17Ad-22.
    \40\ 12 U.S.C. 5464(b).
    \41\ 17 CFR 240.17Ad-22(e)(4) and (e)(6).
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A. Consistency With Section 805(b) of the Clearing Supervision Act

    The Commission believes that the Advance Notice is consistent with 
the stated objectives and principles of Section 805(b) of the Clearing 
Supervision Act.
    The Commission believes that adopting FICC's proposed MLA Charge 
and Bid-Ask Spread Charge would be consistent with the promotion of 
robust

[[Page 62352]]

risk management at FICC. As described above in Section I.B., FICC's 
current margin methodologies do not account for the potential increase 
in market impact costs that FICC could incur when liquidating a 
defaulted member's portfolio where the portfolio contains a 
concentration of large positions in a particular security or group of 
securities sharing a similar risk profile or in a particular 
transaction type. Additionally, as described above in Section I.C., 
FICC's current margin methodologies do not account for the risk of 
potential bid-ask spread transaction costs when liquidating the 
securities in a defaulted member's portfolio. FICC proposes to address 
these respective risks by adding the MLA Charge and Bid-Ask Spread 
Charge to its margin methodologies.\42\
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    \42\ The Commission notes that the other clearing agencies it 
regulates have charges to account for these types of risks in their 
margin methodologies, and that addressing these types of risks has 
received a great deal of industry focus in recent years.
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    Specifically, the MLA Charge should better enable FICC to manage 
the risk of incurring costs associated with the decreased marketability 
of a defaulted member's portfolio where the portfolio contains a large 
position in securities sharing similar risk profiles, resulting in 
potentially higher liquidation costs. To avoid excessive MLA Charges, 
FICC has identified circumstances that would warrant reducing a 
member's MLA Charge when FICC could otherwise partially mitigate the 
relevant risks by extending the time period for liquidating a defaulted 
member's portfolio beyond the three day period. The Commission views 
this targeted reduction in the MLA Charge as a feature of the proposal 
that demonstrates a robust approach towards managing the relevant risks 
through appropriate (i.e., not simply ``larger'') margin requirements. 
Additionally, since FICC's current margin methodologies do not account 
for bid-ask spread transaction costs when liquidating a defaulted 
member's portfolio, the Bid-Ask Spread Charge should enable FICC to 
manage such risks. Accordingly, the Commission believes that adopting 
the proposed MLA Charge and Bid-Ask Spread Charge would allow for 
measurement and targeted mitigation of risks and costs not captured 
elsewhere in FICC's current margin methodologies, and would therefore 
provide for more comprehensive management of risks in a member default 
scenario, consistent with the promotion of robust risk management.
    Further, the Commission believes that adopting FICC's proposed MLA 
Charge and Bid-Ask Spread Charge would be consistent with promoting 
safety and soundness at FICC. FICC designed the MLA Charge and Bid-Ask 
Spread Charge to ensure that FICC collects margin amounts sufficient to 
manage FICC's risk of incurring costs associated with liquidating 
defaulted member portfolios. The proposed MLA Charge and Bid-Ask Spread 
Charge would generally provide FICC with additional resources to manage 
potential losses arising out of a member default. Such an increase in 
available financial resources would decrease the likelihood that losses 
arising out of a member default would exceed FICC's resources and 
threaten the safety and soundness of FICC's ongoing operations. 
Accordingly, the Commission believes that adding the proposed MLA 
Charge and Bid-Ask Spread Charge to FICC's margin methodologies would 
be consistent with promoting safety and soundness at FICC.
    Finally, the Commission believes that adopting FICC's proposed MLA 
Charge and Bid-Ask Spread Charge would be consistent with reducing 
systemic risks and supporting the stability of the broader financial 
system. As discussed above, in a member default scenario, FICC would 
access the GSD or MBSD Clearing Fund should the defaulted member's own 
Required Fund Deposit be insufficient to satisfy losses to FICC caused 
by the liquidation of that member's portfolio. FICC proposes to add the 
MLA Charge and Bid-Ask Spread Charge to its margin methodologies to 
better manage the potential costs of liquidating a defaulted member's 
portfolio. FICC proposes to collect additional margin from members to 
cover such costs. This, in turn, could reduce the possibility that FICC 
would need to mutualize among the non-defaulting members a loss arising 
out of the close-out process. Reducing the potential for loss 
mutualization could, in turn, reduce the potential knock-on effects to 
non-defaulting members, their customers, and the broader market arising 
out of a member default. Further, the Commission notes that, to the 
extent that the MLA Charge results in any reduction in members' large 
positions in securities with similar risk profiles, it could reduce the 
potential risk of adverse market impacts that can arise from 
liquidating those large positions. However, the Commission also notes 
that the proposal to reduce the MLA Charge when FICC could otherwise 
partially mitigate the relevant risks would help ensure that FICC would 
not impose the MLA Charge without an appropriate risk management basis. 
Accordingly, the Commission believes that FICC's adoption of the 
proposed MLA Charge and Bid-Ask Spread Charge would be consistent with 
the reduction of systemic risk and supporting the stability of the 
broader financial system.
    For the reasons stated above, the Commission believes the changes 
proposed in the Advance Notice are consistent with Section 805(b) of 
the Clearing Supervision Act.\43\
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    \43\ 12 U.S.C. 5464(b).
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B. Consistency With Rule 17Ad-22(e)(4)(i)

    Rule 17Ad-22(e)(4)(i) requires that FICC establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to effectively identify, measure, monitor, and manage its 
credit exposures to participants and those arising from its payment, 
clearing, and settlement processes, including by maintaining sufficient 
financial resources to cover its credit exposure to each participant 
fully with a high degree of confidence.\44\
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    \44\ 17 CFR 240.17Ad-22(e)(4)(i).
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    As described above in Section I.B., FICC's current margin 
methodologies do not account for the risk of a potential increase in 
market impact costs that FICC could incur when liquidating a defaulted 
member's portfolio where the portfolio contains a large position in 
securities sharing similar risk profiles. Additionally, as described 
above, FICC's current margin methodologies do not account for the risk 
of potential bid-ask spread transaction costs when liquidating the 
securities in a defaulted member's portfolio. FICC proposes to address 
such risks by adding the MLA Charge and Bid-Ask Spread Charge to its 
margin methodologies. Adding these margin charges to FICC's margin 
methodologies should better enable FICC to collect margin amounts 
commensurate with the risk attributes of a broader range of its 
members' portfolios than FICC's current margin methodologies. 
Specifically, the MLA Charge should better enable FICC to manage the 
risk of increased costs to FICC associated with the decreased 
marketability of a defaulted member's portfolio where the portfolio 
contains a large position in securities sharing similar risk profiles. 
Additionally, since FICC's current margin methodologies do not account 
for bid-ask spread transaction costs associated with liquidating a 
defaulted member's portfolio, the Bid-Ask Spread Charge should enable 
FICC to manage such risks and costs.

[[Page 62353]]

    The Commission believes that adding the MLA Charge and Bid-Ask 
Spread Charge to its margin methodologies should enable FICC to more 
effectively identify, measure, monitor, and manage its credit exposures 
in connection with liquidating a defaulted member's portfolio that may 
give rise to (1) decreased marketability due to large positions of 
securities sharing similar risk profiles, and (2) bid-ask spread 
transaction costs. Accordingly, the Commission believes that adding the 
MLA Charge and Bid-Ask Spread Charge to FICC's margin methodologies 
would be consistent with Rule 17Ad-22(e)(4)(i) because these new margin 
charges should better enable FICC to maintain sufficient financial 
resources to cover FICC's credit exposure to its members fully with a 
high degree of confidence.\45\
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    \45\ Id.
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C. Consistency With Rules 17Ad-22(e)(6)(i) and (v)

    Rule 17Ad-22(e)(6)(i) requires that FICC 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.\46\ Rule 
17Ad-22(e)(6)(v) requires that FICC 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 an appropriate method for 
measuring credit exposure that accounts for relevant product risk 
factors and portfolio effects across products.\47\
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    \46\ 17 CFR 240.17Ad-22(e)(6)(i).
    \47\ 17 CFR 240.17Ad-22(e)(6)(v).
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    As described above in Section I.B, FICC's current margin 
methodologies do not account for the potential increase in market 
impact costs when liquidating a defaulted member's portfolio where the 
portfolio contains a large position in securities sharing similar risk 
profiles. FICC proposes to address this risk by adding the MLA Charge 
to its margin methodologies. To avoid excessive MLA Charges and ensure 
margin requirements are commensurate with the relevant risks, FICC also 
contemplates reducing a member's MLA Charge when FICC could otherwise 
partially mitigate the relevant risks by extending the time period for 
liquidating a defaulted member's portfolio beyond the three day period.
    Additionally, as described above in Section I.A and C, FICC's 
current margin methodologies do not account for the risk of incurring 
bid-ask spread transaction costs when liquidating the securities in a 
defaulted member's portfolio. FICC proposes to address this risk by 
adding the Bid-Ask Spread Charge to its margin methodologies. Adding 
the MLA Charge and Bid-Ask Spread Charge to FICC's margin methodologies 
should better enable FICC to collect margin amounts commensurate with 
the risk attributes of its members' portfolios than FICC's current 
margin methodologies. Specifically, the MLA Charge should better enable 
FICC to manage the risk of increased costs to FICC associated with the 
decreased marketability of a defaulted member's portfolio where the 
portfolio contains a large position in securities sharing similar risk 
profiles. Moreover, the proposal to reduce the MLA Charge when FICC 
could otherwise partially mitigate the relevant risks demonstrates how 
the proposal provides an appropriate method for measuring credit 
exposure, in that it seeks to take into account the particular 
circumstances related to a particular portfolio when determining the 
MLA Charge. Additionally, since FICC's current margin methodologies do 
not account for bid-ask spread transaction costs associated with 
liquidating a defaulted member's portfolio, the Bid-Ask Spread Charge 
should enable FICC to manage such risks.
    Accordingly, the Commission believes that adding the MLA Charge and 
Bid-Ask Spread Charge to FICC's margin methodologies would be 
consistent with Rules 17Ad-22(e)(6)(i) and (v) because these new margin 
charges should better enable FICC to establish a risk-based margin 
system that (1) considers and produces relevant margin levels 
commensurate with the risks associated with liquidating member 
portfolios in a default scenario, including decreased marketability of 
a portfolio's securities due to large positions in securities sharing 
similar risk profiles and bid-ask transaction costs, and (2) uses an 
appropriate method for measuring credit exposure that accounts for such 
risk factors and portfolio effects.\48\
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    \48\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
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IV. Conclusion

    It is therefore noticed, pursuant to Section 806(e)(1)(I) of the 
Clearing Supervision Act, that the Commission does not object to 
Advance Notice (SR-FICC-2020-802) and that FICC is authorized to 
implement the proposed change as of the date of this notice or the date 
of an order by the Commission approving Proposed Rule Change SR-FICC-
2020-009, whichever is later.

    By the Commission.
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-21784 Filed 10-1-20; 8:45 am]
BILLING CODE 8011-01-P