[Federal Register: January 6, 2004 (Volume 69, Number 3)]
[Notices]
[Page 712-714]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr06ja04-131]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-49003; File No. SR-FICC-2003-10]
Self-Regulatory Organizations; Fixed Income Clearing Corporation;
Order Approving Proposed Rule Change To Amend the Fixed Income Clearing
Corporation's Cross-Margining Agreements With the Chicago Mercantile
Exchange, BrokerTec Clearing Company, and the Board of Trade Clearing
Corporation and To Eliminate the Cross-Margining Agreement with the New
York Clearing Corporation
December 29, 2003.
I. Introduction
On October 6, 2003, the Fixed Income Clearing Corporation
(``FICC'') filed with the Securities and Exchange Commission
(``Commission'') and on December 11, 2003, amended \1\ proposed rule
change SR-FICC-2003-10 pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'').\2\ Notice of the proposal was published
in the Federal Register on November 21, 2003.\3\ For the reasons
discussed below, the Commission is approving the proposed rule change.
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\1\ The amendment was technical in nature and did not require
republication of the notice of filing.
\2\ 15 U.S.C. 78s(b)(1).
\3\ Securities Exchange Act Release No. 48796 (November 17,
2003), 68 FR 65753.
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II. Description
FICC is seeking to amend its cross-margining agreements with the
Chicago Mercantile Exchange (``CME''), BrokerTec Clearing Company
(``BCC''), and the Board of Trade Clearing Corporation (``BOTCC'') and
to eliminate its cross-margining agreement with the New York Clearing
Corporation (``NYCC'').
1. New Cross-Margining Agreement With CME
Through its Government Securities Division (``GSD''), FICC has a
cross-margining arrangement with CME.\4\ FICC is proposing to terminate
its existing cross-margining agreement with CME and to enter into a new
cross-margining agreement with the CME (``New FICC-CME Agreement'') to
reflect the fact that, as of January 2, 2004, the CME will begin
clearing certain Treasury and Agency futures contracts and options on
such futures contracts that are traded on the Chicago Board of Trade
(``CBOT'') and that are currently cleared by BOTCC. Under the New FICC-
CME Agreement, the FICC products that will be eligible for cross-
margining will be Treasury securities that fall into the GSD's offset
classes A through G and GCF Repo Treasury securities with equivalent
remaining maturities and non-mortgage-backed Agency securities that
fall into the GSD's offset classes e and f and GCF Repo non-mortgage-
backed Agency securities with equivalent remaining maturities. The CME
products that will be eligible for cross-margining will be of two
types: (i) The products currently eligible under the existing
arrangement between FICC and CME which are Eurodollar futures contracts
with ranges in maturity from 3 months to 10 years and options on such
future contracts cleared by CME and (ii) the CBOT products which are
Two-Year Treasury Note Futures contracts and options thereon, Five-Year
Treasury Note Futures contracts and options thereon, Ten-Year Treasury
Note Futures contracts and options thereon, Thirty-Year Treasury Bond
Futures contracts and options thereon, Five-Year Agency Note Futures
contracts and options thereon, and Ten-Year Agency Note Futures
contracts and options thereon to be cleared by CME.
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\4\ Securities Exchange Act Release No. 44301 (May 11, 2001), 66
FR 28207 (May 22, 2001) [File No. SR-GSCC-00-13].
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No significant changes are being proposed to the existing FICC-CME
cross-margining arrangement other than the addition of the CBOT
products and certain FICC products as discussed in more detail below.
The key aspects of the cross-margining arrangement, most notably, the
calculation of the cross-margining reduction and the loss sharing
provisions in the event of a participant default are not being amended.
2. Key Proposed Changes to the Existing Cross-Margining Agreement
Between FICC and CME
The addition of the CBOT products has necessitated new definitions
for ``CBOT Eligible Products,'' ``CME Eligible Products,'' and ``FICC
Eligible Products,'' as well as Offset Class tables for these products
in Appendix B of the agreement.
Appendix B of the FICC-CME Agreement is also being amended to
include FICC's GCF Repo Treasury and non-mortgage-backed Agency
products in the cross-margining arrangement.\5\ By the effective date
of the New FICC-CME Agreement, FICC will be margining its GCF Repo
Treasury and non-mortgage-
[[Page 713]]
backed Agency products based upon the specific underlying collateral,
as opposed to the current system of margining these products based upon
the longest maturity of eligible underlying collateral.\6\ Therefore,
these GCF Repo products can now be included in the cross-margining
arrangement because they will no longer be margined at a generic rate
but rather at a specific rate based on the actual underlying Treasury
and Agency collateral.
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\5\ This amendment is also being proposed for the BCC cross-
margining arrangement as discussed below.
\6\ Because of a previous inability to obtain timely data on the
actual instruments posted in support of GCF Repo positions, the GSD
has calculated affected members' clearing fund requirements based
upon the assumption that collateral providers have assigned to each
generic CUSIP the most volatile (i.e., the longest maturity)
collateral eligible. The GSD has been in the process of developing
improvements to the current margining methodology. By the effective
date of the proposed rule change, the GSD will be able to identify
the specific CUSIP posted in calculating a member's clearing fund
requirement related to its Treasury and Agency GCF Repo activity.
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As is the case with the current agreement between FICC and CME, the
parties provide in the New FICC-CME Agreement that they will agree from
time to time in a separate writing on the disallowance factors that
will be used in the cross-margining arrangement. The disallowance
factors that will be used upon implementation of the new arrangement
are the ones set forth as examples in Appendix B to the New FICC-CME
Agreement. The disallowance factors between FICC eligible products and
CME eligible products (i.e., Eurodollar products) have not changed. A
new disallowance factor table has been added for cross-margining of
FICC eligible Treasury and Agency products with CBOT Treasury and
Agency eligible products.\7\
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\7\ FICC has computed and tested disallowance factors that will
be applicable to each potential pair of positions being offset.
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Appendix C of the current agreement, which sets forth the
methodology for converting CME eligible products into Treasury cash
equivalents for purposes of ultimately calculating the cross-margining
reduction, has been made into Appendix C1, and a new Appendix C2, which
contains the methodology for converting the CBOT eligible products into
Treasury cash equivalents, has been added. This methodology is
identical to the methodology contained in the BOTCC and BCC cross-
margining agreements.
The existing agreement between FICC and CME provides for a
``Maximization Payment'' which is a cross-guaranty provision that sets
forth the mechanism for a clearing organization with a remaining
surplus after all guaranty payments in relation to cross-margining have
been made (``Aggregate Net Surplus'') to distribute funds to one or
more cross-margining partners with remaining losses. The New FICC-CME
Agreement will make it clear that: (i) The Maximization Payment is also
a guaranty payment (albeit outside of cross-margining, arising out of
the ``Maximization Payment Guaranty'') and (ii) the defaulting member
would have a reimbursement obligation with respect to such payment
(``Maximization Reimbursement Obligation''). This means that should a
clearing organization become obligated to pay the Maximization Payment,
it may rely on the defaulting member's collateral to do so.\8\
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\8\ The new guaranty provisions with respect to the Maximization
Payment Guaranty will be identical to the ones in the current cross-
margining agreement between FICC and BCC. In order to protect the
clearing organizations in the event that a court determines that any
amount of a Maximization Reimbursement Obligation may not be
recovered by the clearing organization that made a Maximization
Payment pursuant to a Maximization Payment Guaranty, a provision has
been added (Section 8C(c)) to the New FICC-CME Agreement to provide
that the payee clearing organization will be expected to return that
amount. This protective provision is also in the BCC cross-margining
agreement.
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A provision has been added to the New FICC-CME Agreement to take
into account that a regulator or other entity having supervisory
authority over FICC or CME may for safety and soundness purposes direct
the clearing organization not to liquidate a defaulting member or to
partially liquidate such member. In order to prevent the affected
clearing organization from being penalized under the agreement for
failing to liquidate or partially liquidating the member in this type
of situation, the last two paragraphs of Section 7(d) of the New FICC-
CME Agreement will provide that the affected clearing organization
would be deemed to have a cross-margin gain equal to the base amount of
the guaranty (i.e., cross-margining reduction) or a pro rated amount of
the base amount of the guaranty in a partial liquidation scenario.
A sentence has been added to Section 7(h) making clear that the
clearing organizations have security interests in the ``Aggregate Net
Surplus,'' a large component of which would be the collateral and
proceeds of positions of a defaulting member, as security for any
reimbursement obligation including any maximization reimbursement
obligation that may arise on the part of a defaulting member.
Language has been added to the cross-margining participant
agreements in Appendices D and E in order to further protect the
clearing organizations by making clear that the clearing organizations
have a security interest in the Aggregate Net Surplus and that a
participant will have a reimbursement obligation in the event that a
clearing organization becomes obligated to make a maximization payment.
Participants in the current arrangement between FICC and CME and those
in the arrangement between FICC and BOTCC to the extent they are not
the same are being asked to reexecute the revised participant
agreements in order to make them subject to the provisions of the New
FICC-CME Agreement.\9\
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\9\ Cross-margining is available to any FICC GSD netting member
(with the exception of inter-dealer broker netting members) that is,
or that has an affiliate that is, a member of a Participating CO.
The FICC member (and its affiliate, if applicable) sign an agreement
under which it (or they) agree to be bound by the cross-margining
agreement between FICC and the Participating CO and which allows
FICC or the Participating CO to apply the member's (or its
affiliate's) margin collateral to satisfy any obligation of FICC to
the Participating CO (or vice versa) that results from a default of
the member (or its affiliate). Ownership of 50 percent or more of
the common stock of an entity indicates control of the entity for
purposes of the definition of ``affiliate.''
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3. Key Proposed Changes to FICC's Cross-Margining of CBOT Products
Because FICC is currently cross-margining its products with certain
CBOT products pursuant to its agreement with BOTCC and because these
CBOT products will be cross-margined pursuant to the proposed New FICC-
CME Agreement, it is important to note the key differences between the
cross-margining of the CBOT products under the existing arrangement
with BOTCC and under the proposed new arrangement with the CME.
The minimum margin factor under FICC's cross-margining arrangement
with BOTCC is 50 percent. FICC and CME have agreed to a minimum margin
factor of 25 percent to apply to the cross-margining of CBOT products
versus FICC products. This is the same minimum margin factor as is used
in the current cross-margining arrangement with the CME with respect to
the eligible Eurodollar products and is the same minimum margin factor
used in the arrangement with BCC.
The New FICC-CME Agreement provides for inter-offset class cross-
margining whereas the BOTCC arrangement is limited to intra-offset
class cross-margining. The new agreement is consistent with the
approach in the existing arrangements between FICC and both CME and
BCC.
The current agreement between FICC and CME provides that in order
to determine the gain or loss from the liquidation of the positions
that were cross-margined resulting from a default
[[Page 714]]
of a member, only the proceeds from the side of the market that was
offset pursuant to the agreement at the last margin cycle are
considered. In the New FICC-CME Agreement, this approach will be
extended to the CBOT products in order to provide consistency in the
liquidation methods.
4. Amendments 1, 2, and 3 to the FICC-BCC Cross-Margining Agreement
FICC is proposing to amend its cross-margining agreement with BCC
with Amendment 3 to the agreement.\10\ Amendment 3 will (i) add FICC's
GCF Repo Treasury and non-mortgage-backed Agency products to the
arrangement, (ii) add FICC's non-mortgage-backed Agency offset classes
e and f, and (iii) amend the contingency procedures between the
clearing organizations (contained in Appendix I of the agreement) to
provide that FICC will not wait past 12 a.m. Eastern time for the BCC
cross-margining file in order to run its cross-margining system. With
respect to (ii), FICC has determined that even though BCC does not
currently clear non-mortgage-backed Agency futures, the parties can
still cross-margin FICC's Agency products against BCC's Treasury
products given that the agreement provides for inter-offset class
cross-margining using the appropriate correlation factors. With respect
to (iii), the operational procedures provide that FICC will wait until
3:00 a.m. Eastern time for the BCC file which is the same cut-off time
for all of its other cross-margining partners. However, FICC has
determined that the 3:00 a.m. Eastern time cut-off, which is
significantly later than the GSD's normal cross-margining processing
time, should only be used for extreme situations where not including a
particular file would be disruptive to members. Currently, this would
not be anticipated to be the case for a BCC file because of BCC's files
relatively low historical impact.\11\ Therefore, FICC has determined
that it would be more prudent from a risk management perspective to
adopt a cut-off time of 12:00 a.m. Eastern time for receipt of BCC
files.
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\10\ Securities Exchange Act Release No. 45656 (March 27, 2002),
67 FR 15646 (April 2, 2002) [File No. SR-GSCC-2002-01].
\11\ The operational and contingency procedures contained in the
FICC-BCC agreement provide that in the event FICC does not receive
BCC's file by the cut-off time, FICC will calculate the applicable
cross-margining reductions assuming that BCC submitted a file with
no positions available for cross-margining which may result in
margin calls for the affected participants by both FICC and BCC.
These margin calls would not be disruptive to members because the
cross-margining reductions in the program with the BCC are not
anticipated to be large amounts.
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As part of this proposed rule change filing, FICC will include
Amendments 1 and 2 that were previously made with respect to its
existing cross-margining agreement with BCC. The purpose of Amendment 1
was to update the list of products being cross-margined. The purposes
of Amendment 2 were to remove references to the cross-margining
agreement with NYCC from Appendix A in which the parties are required
to list other outstanding cross-margining arrangements and to update
the notice provision.
5. Amendments 1 and 2 to the FICC-BOTCC Cross-Margining Agreement
As in the case of the BCC agreement, FICC will include as part of
this proposed rule change filing Amendments 1 and 2 that were
previously made with respect to its existing cross-margining
arrangement with BOTCC.\12\ The purposes of Amendment 1 were to update
the list of products being cross-margined, add an appendix setting
forth operational contingency procedures, clarify procedures to be used
if one clearing organization discovers a calculation error, correct
cited Bankruptcy Code language, correct language in one of the
participant agreements, and refine the timing of the effectiveness of
changes to the cross-margining reduction. The purpose of Amendment 2
was to remove references to the cross-margining agreement with NYCC
from Appendix A.
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\12\ FICC currently has a cross-margining agreement in place
with BOTCC through which certain CBOT products are cross-margined
with certain FICC products. Securities Exchange Act Release No.
45335 (January 25, 2002), 67 FR 4768 (January 31, 2001) [File No.
SR-GSCC-2001-03]. BOTCC recently announced that it will become the
clearing corporation for Eurex. In the next few weeks, FICC will
determine the status of its cross-margining arrangement with BOTCC
and will submit a proposed rule change filing addressing changes to
the existing agreement, if necessary.
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6. Removal of NYCC Cross-Margining Agreement From the GSD's Rules
FICC is removing its cross-margining agreement with NYCC \13\ from
the GSD's rules. That arrangement has been dormant for some time and
the parties have agreed that should they determine to reinstitute
cross-margining, they will enter into a new cross-margining agreement
that will be similar to FICC's other cross-margining agreements. At
that time, FICC would file the appropriate proposed rule change with
the Commission.
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\13\ Securities Exchange Act Release No. 41766 (August 19,
1999), 64 FR 46737 (August 26, 1999) [File No. SR-GSCC-98-04].
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III. Discussion
Section 17A(b)(3)(F) of the Act requires that the rules of a
clearing agency be designed to facilitate the safeguarding of
securities and funds which are in its custody or control or for which
it is responsible and in general will protect investors and the public
interest.\14\ The Commission finds that FICC's proposed rule change is
consistent with this requirement because it continues FICC's cross-
margining program which provides members with significant benefits,
such as greater liquidity and more efficient use of collateral in a
prudent manner, and enhances FICC's overall risk management process.
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\14\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
in particular section 17A of the Act and the rules and regulations
thereunder.
It is therefore ordered, pursuant to section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-FICC-2003-10) be and hereby
is approved.
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\15\ 17 CFR 200.30-3(a)(12).
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For the Commission by the Division of Market Regulation, pursuant
to delegated authority.\15\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 04-220 Filed 1-5-04; 8:45 am]
BILLING CODE 8010-01-P