Document ID: SEC-2020-0125-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2020-01-30T05:00Z

[Federal Register Volume 85, Number 20 (Thursday, January 30, 2020)]
[Notices]
[Pages 5516-5519]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-01648]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88037; File No. SR-FINRA-2020-002]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing and Immediate Effectiveness of a 
Proposed Rule Change To Amend FINRA Rule 11900 To Except Certain 
Transactions in Corporate Debt Securities

January 24, 2020.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on January 17, 2020, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by FINRA. FINRA has 
designated the proposed rule change as constituting a ``non-
controversial'' rule change under paragraph (f)(6) of Rule 19b-4 under 
the Act,\3\ which renders the proposal effective upon receipt of this 
filing by the Commission. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 17 CFR 240.19b-4(f)(6).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to amend Rule 11900 (Clearance of Corporate Debt 
Securities) to except certain transactions in corporate debt 
securities.
    The text of the proposed rule change is available on FINRA's 
website at http://www.finra.org, at the principal office of FINRA and 
at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Rule 11900 under FINRA's Uniform Practice Code (the ``Rule'') sets 
forth members' obligations with respect to the use of a registered 
clearing agency (a ``clearing agency'') to clear over-the-counter 
transactions in corporate debt securities.\4\ Specifically, the Rule 
requires that a member or its agent that is a participant in a clearing 
agency must use the facilities of a clearing agency to clear eligible 
transactions between members in corporate debt securities executed over 
the counter.\5\ The Rule is intended to reduce or eliminate the risks 
and inefficiencies associated with broker-to-broker clearing in 
transactions in corporate debt securities, including trade fails and 
potential financial exposure.\6\ When FINRA (then NASD) adopted this 
requirement in 1995, NASD noted that there was a large percentage of 
corporate debt transactions cleared and settled broker-to-broker 
without using the facilities of a clearing agency, and that this 
process was error prone and time- and labor-intensive.\7\ These 
inefficiencies increased systemic clearance risk for members.\8\
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    \4\ See Rule 11900, available at https://www.finra.org/rules-guidance/rulebooks/finra-rules/11900.
    \5\ Section 17A of the Exchange Act and Rule 17Ab2-1 thereunder 
require entities to register with the Commission prior to performing 
the functions of a clearing agency. See 15 U.S.C. 78q-1; see also 17 
CFR 240.17Ab2-1.
    \6\ See Securities Exchange Act Release No. 35769 (May 25, 
1995), 60 FR 28814 (June 2, 1995) (Order Approving File No. SR-NASD-
95-11).
    \7\ See Securities Exchange Act Release No. 35642 (April 24, 
1995), 60 FR 21226 (May 1, 1995) (Notice of Filing of File No. SR-
NASD-95-11) (``Original Proposal'').
    \8\ See supra note 7.
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    FINRA is proposing to amend the Rule to provide an exception for 
over-the-counter transactions between members (the ``parties'') where 
the same

[[Page 5517]]

member (the ``carrying member'') is clearing and settling both the 
purchase and the sale side of a transaction in a corporate debt 
security, and where such clearance and settlement occurs through book-
keeping transfers between the parties' accounts at the carrying member. 
Where the same carrying member is the clearing firm for both sides of 
the transaction, the seller's delivery and the buyer's receipt of the 
corporate debt security can be effected exclusively through book-
keeping transfers between the parties' accounts at the carrying member, 
resulting in no net settlement obligation to or from a clearing agency. 
Further, where there is no net settlement obligation, the risks and 
inefficiencies that the Rule is intended to protect against (e.g., 
trade fails) are not present, and the use of a clearing agency to clear 
the transaction provides no additional benefit while nonetheless 
incurring costs for the carrying member.\9\ FINRA is, therefore, 
proposing the instant exception and believes that it is appropriate 
because the intended benefits of the Rule--i.e., to reduce or eliminate 
the risks and inefficiencies associated with broker-to-broker 
clearing--do not exist for transactions that do not result in a net 
settlement obligation on the clearing firm level.\10\ The proposed 
exception is limited to transactions where a carrying member clears for 
both the buyer and the seller in a transaction (i.e., where an 
obligation to deliver securities to, or receive securities from, a 
third party is not created with respect to the individual transaction).
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    \9\ The exception would apply only where the carrying firm 
internalizes the clearance of the transaction. Thus, the proposed 
exception would not apply to a transaction in which a member is 
clearing only the purchase or the sale side of a transaction.
    \10\ While the current Rule provides FINRA with authority to 
exempt any transaction or class of transactions to accommodate 
special circumstances related to the clearance of such transactions 
or class of transactions, we do not believe that this authority is 
well suited to the proposed exception. See Rule 11900. Because FINRA 
is seeking to provide an exception for a broad class of 
transactions, FINRA believes it is appropriate to provide the 
proposed exception as an amendment to the Rule.
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    FINRA has filed the proposed rule change for immediate 
effectiveness. The proposed rule change will become operative 30 days 
after the date of filing.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\11\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest.
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    \11\ 15 U.S.C. 78o-3(b)(6).
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    FINRA notes that the proposed exception would not alter counter-
party clearing risks, such as financial exposure, because where a 
member or its agent utilizes the exception provided for under this 
proposal, it would serve as the central party on both the purchase and 
the sale side of the transaction and would clear and settle the 
transaction internally through book-keeping transfers. As such, no net 
settlement obligation would be created on the level of the clearing 
firm, and the risks and inefficiencies that the Rule is intended to 
protect against would not be present. Thus, FINRA believes the proposed 
rule change strikes an appropriate balance between providing relief 
uniformly to members where the Rule does not provide the intended 
benefits, while preserving the protections of the Rule for all other 
eligible transactions between members in corporate debt securities 
executed over the counter. Accordingly, FINRA believes the proposal 
promotes just and equitable principles of trade, and protects investors 
and the public interest.

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. The proposed exception would 
apply uniformly where the same carrying member clears and settles both 
the purchase and the sale side of a transaction in a corporate debt 
security through book-keeping transfers between the parties' accounts 
at the carrying member. FINRA discussed the proposed exception with its 
Uniform Practice Code and Fixed Income Committees, who supported the 
proposed amendment. FINRA also discussed the proposal with SIFMA's 
Clearing Firms Committee, which also supported the proposal.
Economic Impact Assessment
Regulatory Need
    Under Rule 11900, each member or its agent that is a participant in 
a clearing agency is required to send eligible over-the-counter 
transactions between members in corporate debt securities to a clearing 
agency for clearing. For transactions where the same carrying member is 
clearing both the purchase and sale side of the transaction, the funds 
and the securities are reflected in each party's account at the 
carrying member. Thus, the clearing of such transactions can be done 
effectively through book-keeping transfers between the parties' 
accounts at the carrying member, without sending the transaction for 
central clearing. Specifically, because no net settlement obligation is 
created between the carrying member and the clearing agency for such 
transactions, clearing these transactions through a clearing agency 
does not provide the additional benefits of reducing or eliminating the 
risks and inefficiencies that central clearing usually provides.
    However, while the current rule requiring carrying members to clear 
these transactions through a clearing agency does not provide the 
benefits that the rule was designed to provide (e.g., mitigating 
counterparty risk), it nonetheless results in members incurring the 
costs associated with submitting these transactions for central 
clearing. Under the proposed amendment, carrying members would no 
longer be required to use the facilities of a clearing agency for 
clearing such transactions, and may choose to internalize the clearing 
and settlement of these transactions and avoid the fees that would be 
imposed by the clearing agency.
Economic Baseline
    Currently, each member or its agent that is a participant in a 
clearing agency is required under Rule 11900 to send eligible over-the-
counter transactions between members in corporate debt securities to a 
registered clearing agency for clearing and settlement. The National 
Securities Clearing Corporation (NSCC), a subsidiary of The Depository 
Trust & Clearing Corporation (DTCC), provides central clearing services 
for corporate debt securities, among other products. According to 
NSCC's website calculator, clearing fees consist of three parts: A 
tiered ``clearance fee'' based on the number of trades; a ``value into 
net fee'' based on the total value traded; and a ``value out of net 
fee'' based on the value that does not get netted.\12\
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    \12\ See NSCC Clearing Activity Monthly Fee Calculators, 
available at: http://www.dtcc.com/forms/clearing-fee-calculator-new.
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Economic Impacts
    When internally clearing a transaction, the delivery of the 
corporate debt security and money by the respective parties to settle a 
transaction can be effected through book-keeping transfers between the 
buyer's and seller's accounts at the carrying member. Under the 
proposed exception,

[[Page 5518]]

carrying members would be able to avoid the clearing costs imposed by 
the clearing agency while continuing to clear and settle the 
transaction on behalf of both counterparties. Potential savings from 
internalizing the clearance of these transactions may or may not be 
passed on to the customers of the carrying member. FINRA notes that 
these potential cost savings are not at the expense of losing the 
benefits offered by clearing agencies, namely mitigating counterparty 
risk and increasing efficiency. This is because, when the same carrying 
firm is clearing for both the buy and sell side of a transaction, 
counterparty risk is not inherently present as no net settlement 
obligation to or from the carrying member is created. Therefore, by 
permitting members to elect to clear these transactions internally, the 
buyers' and sellers' counterparty risk remains unchanged.
    FINRA understands that internalizing the clearance of such 
transactions alone would not affect the clearing agency's margin 
calculation for a clearing firm availing itself of the exception. Based 
on a conversation with DTCC, margin is collected when there is a net 
debit after performing mark-to-market of the trades submitted. 
Therefore, when clearing firms choose to internalize the clearance of 
transactions that create no net settlement obligations, we understand 
that the margin required by the clearing agency is not changed.
    When a carrying firm chooses to clear transactions internally, DTCC 
may lose revenues from the clearing fees collected from that firm 
(assuming the fee structure remains unchanged). NSCC generally charges 
lower clearing fees for transactions that can be netted out.\13\ Based 
on the 2014 NSCC calculator, the value fee (dollar per million traded) 
for clearing such transactions is 12.3% of the fee for clearing 
transactions that cannot be netted out.\14\
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    \13\ See supra note 12.
    \14\ See supra note 12.
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Competition and Efficiency
    FINRA expects that the proposed amendment will improve the 
efficiency of the clearing process by removing a step that does not 
provide the intended benefit and allowing over-the-counter transactions 
in corporate debt securities that create no net settlement obligation 
to be internally cleared by the carrying firm, as described above. 
Carrying firms will potentially save on clearing costs for such 
transactions in circumstances where central clearing would not provide 
the additional protections related to counterparty risks or improved 
efficiency over bilateral clearing that were envisioned at the time 
Rule 11900 was adopted.
    Clearing firms that serve more customers engaging in eligible over-
the-counter transactions in corporate debt securities likely may 
benefit more from the proposed exception. The percentage of such 
transactions that can be internalized may in turn be higher than that 
of smaller clearing firms. To the extent smaller firms have eligible 
transactions that may be internalized under the proposal, they also 
should benefit from the proposal should they choose to internalize 
clearing, where permitted, and avoid related central clearing costs.
Alternatives Considered
    No alternatives were considered for this proposal.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    FINRA received an email from Pershing LLC (``Pershing'') relating 
to the need for the proposed rule change.\15\ Pershing stated that, in 
submitting trades to NSCC where Pershing is clearing for both the buyer 
and the seller, there is no net risk mitigation because there is no net 
settlement obligation created. Further, Pershing stated that, by not 
submitting these specific transactions to NSCC, it would realize 
significant cost savings. As a result, Pershing requested that FINRA 
except from Rule 11900 the class of transactions for which a member is 
the clearing firm for both the buyer and the seller, to allow it to 
clear those transactions internally. Pershing specified that it was not 
requesting relief for any transaction in which a counterparty clears at 
an NSCC Participant other than Pershing. FINRA believes that the 
instant proposal provides the narrow relief that Pershing requested, 
and notes that the exception would be available to all members that 
meet the requirements of the exception. As discussed above, FINRA 
believes the proposed rule change strikes an appropriate balance 
between providing relief uniformly to members where the Rule does not 
provide the intended benefits, and preserving the protections of the 
Rule for all other eligible transactions between members in corporate 
debt securities executed over the counter.
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    \15\ See Exhibit 2.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the foregoing proposed rule change does not: (i) 
Significantly affect the protection of investors or the public 
interest; (ii) impose any significant burden on competition; and (iii) 
become operative for 30 days from the date on which it was filed, or 
such shorter time as the Commission may designate, it has become 
effective pursuant to Section 19(b)(3)(A) of the Act \16\ and Rule 19b-
4(f)(6) thereunder.\17\
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    \16\ 15 U.S.C. 78s(b)(3)(A).
    \17\ 17 CFR 240.19b-4(f)(6).
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    At any time within 60 days of the filing of the proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act. If the Commission 
takes such action, the Commission shall institute proceedings to 
determine whether the proposed rule should be approved or disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the 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-FINRA-2020-002 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-FINRA-2020-002. 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

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proposed rule change 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 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. 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-FINRA-2020-002 and should be submitted 
on or before February 20, 2020.
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    \18\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-01648 Filed 1-29-20; 8:45 am]
 BILLING CODE 8011-01-P