[Federal Register: March 23, 2005 (Volume 70, Number 55)]
[Notices]
[Page 14736-14738]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23mr05-163]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-51385; File No. SR-FICC-2004-14]
Self-Regulatory Organizations; Fixed Income Clearing Corporation;
Order Approving a Proposed Rule Change Relating to Membership
Requirements
March 16, 2005.
On July 14, 2004, the Fixed Income Clearing Corporation (``FICC'')
filed with the Securities and Exchange Commission (``Commission'') a
proposed rule change pursuant to section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'').\1\ On July 15, July 30, August 20, and
November 10, 2004, FICC filed amendments 1, 2, 3, and 4 respectively.
On January 3, 2005, FICC filed amendment 5 and withdrew amendments 1,
2, 3, and 4. Notice of the proposal was published in the Federal
Register on January 18, 2005.\2\ The Commission received three comment
letters.\3\ For the reasons discussed below, the Commission is
approving the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ Securities Exchange Act Release No. 51018 (Jan. 11, 2005),
70 FR 2911.
\3\ Letters from Kevin M. Brandt, Director, III Global Ltd., III
Finance Ltd., and III Relative Value/Macro Hub Fund Ltd. (Oct. 25,
2004) and Lawrence R. Uhlick, Executive Director and General
Counsel, Institute of International Bankers (Oct. 26, 2004, and Feb.
9, 2005). See also Memorandum to File re: Meeting with Institute of
International Bankers (Mar. 15, 2005).
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I. Description
Under the rule change, FICC will amend the rules of its Government
Securities Division (``GSD'') and Mortgage-Backed Securities Division
(``MBSD'') regarding membership requirements for non-U.S. applicants
and members.
A. Annual Audited Financial Statements
Prior to the rule change, GSD required non-U.S. members and
applicants to submit financial statements prepared in accordance with
U.S. generally accepted accounting principles (``U.S. GAAP'')
``whenever necessary and feasible.'' MBSD required non-U.S. members and
applicants to submit financial statements prepared in accordance with
U.S. GAAP. Both divisions review such financial statements as part of
their credit risk management program.
FICC is amending these requirements uniformly across both divisions
to enable non-U.S. members and applicants to submit financial
statements that are prepared according to any other generally accepted
accounting methodology (``non-U.S. GAAP''). Specifically, FICC will
increase the existing minimum financial requirements of each applicant
and member based on the type of non-U.S. GAAP that was used to prepare
the audited financial statement in the following manner:
1. For applicants and members whose financial statements are
prepared in accordance with International Financial Reporting Standards
(``IFRS''), the Companies Act of 1985 (``U.K. GAAP''), or Canadian
GAAP, the minimum financial requirements will be one and one-half times
the applicable requirements.
2. For applicants and members whole financial statements are
prepared in accordance with a European Union country GAAP (``EU GAAP'')
other than U.K. GAAP, the minimum financial requirements will be five
times the applicable requirements.
3. For applicants and members whose financial statements are
prepared in accordance with any other type of GAAP, the minimum
financial requirements will be seven times the applicable requirements.
For example, under GSD's rules, the minimum financial requirement
for a bank netting member is equity capital of US$100 million. This
will continue to be the requirement for all such members (both U.S. and
non-U.S. members) whose financial statements are prepared in accordance
with U.S. GAAP. However, if such a member's financial statements were
prepared in accordance with IFRS, U.K. GAAP, or Canadian GAAP, the
member's minimum financial requirement would be US$150 million. If such
a member's financial statements were prepared in accordance with an EU
country GAAP other than U.K. GAAP, the member's minimum financial
requirement would be US$500 million. If a member's financial statements
were prepared in accordance with any other type of GAAP, the member's
minimum financial requirement would be US$700 million.
[[Page 14737]]
In order to apply this change to non-U.S. applicants and members,
FICC will delete the terms ``Excess Liquid Capital'' and ``Excess Net
Capital'' in GSD Rule 3, Section 6, and instead will use the term
``applicable minimum regulatory capital,'' which is defined in GSD Rule
3, Section 2 as ``regulatory capital as defined by the applicant's home
country regulator.'' MBSD Article III, Rule 1, Section 2(d) will state
that the references to the terms ``net capital'' or ``liquid capital''
in, ``shall be deemed to refer to regulatory capital in cases where the
U.S. regulatory capital terms are not applicable to a non-domestic
entity.''
FICC will retain the requirement that annual audited financial
statements submitted by members and applicants be certified without
qualification. The rule change makes clear that annual audited
financial statements must be prepared in accordance with generally
accepted accounting principles. In addition, all information submitted
to FICC will have to be in English or will have to be a fair and
accurate English translation if the information is translated into
English.
The proposed rule changes will be applied to current members and
applicants.
B. Material Regulatory Filings
As part of its credit risk management, FICC requires applicants and
members to submit interim financial data. In the case of U.S. bank and
broker-dealer members, GSD and MBSD are able to obtain this financial
information through regulatory reports. Non-U.S. MBSD members are
required to submit unaudited monthly financial statements to MBSD. Non-
U.S. GSD netting members are required to submit certain quarterly
financial information to GSD. In addition, the GSD rules currently
require non-U.S. members and applicants to also submit all ``material
regulatory filings'' that the entity makes with its primary regulator
in its home jurisdiction. However, FICC cannot specifically identify
all such material regulatory filings for non-U.S. members and
applicants with confidence.
Under the rule change, which will be adopted uniformly across both
FICC divisions, FICC will require non-U.S. members (other than those
organized or established in the U.K. and regulated by the Financial
Services Authority (``FSA'')) to provide specific monthly or quarterly
financial data, as applicable, directly to FICC. FICC will provide the
non-U.S. members with a form requesting specific financial data related
to capital, assets, liabilities, revenue, pertinent ratios, and various
capital requirements, as applicable. Each non-U.S. member will be
required to complete the form, have it signed by the entity's chief
financial officer, chief executive officer, or similar high-ranking
official, and return it to FICC by a prescribed deadline.
Broker-dealers and banks that are organized or established in the
U.K. and regulated by the FSA will be required to submit certain
regulatory monthly or quarterly reports, as applicable, that are filed
with the FSA.\4\ Because FICC will be able to obtain the necessary
financial data from these reports, these U.K. firms will not be
required to complete and submit FICC's financial reporting form as are
other non-U.S. members. FICC's rules will provide that failure to
submit the financial form or the U.K. regulatory reports, as
applicable, to FICC within the timeframes established by FICC will
subject a member to the same consequences, including a fine, as is
currently provided for in FICC's rules for late submission of required
financial documents.
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\4\ Although FICC currently has no U.K. members, FICC is
familiar with the regulatory reports filed by banks and broker-
dealers that are organized or established in the U.K. and regulated
by the FSA.
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FICC recognizes that certain regulatory filings provide warnings of
possible concerns regarding a member's compliance with regulatory
standards and its financial status. For example, under FICC's current
rules, GSD's and MBSD's U.S. broker-dealer members are required to
submit to FICC SEC Rule 17a-11 reports. GSD's netting members, MBSD's
U.S. non-broker-dealer members, and all non-U.S. members must submit to
FICC, concurrently with their submission to their relevant regulator,
copies of regulatory notifications required to be made when a member's
capital levels or other financial requirements fall below prescribed
levels.\5\
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\5\ Securities Exchange Act Release Nos. 49947 (June 30, 2004),
69 FR 41316 (July 8, 2004) [File No. SR-FICC-2003-01] and 49156
(Jan. 30, 2004), 69 FR 5881 (Feb. 6, 2004) [File No. SR-MBSCC-2001-
06].
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The rule change expands this by requiring members to submit to FICC
any regulatory notifications required to be made when it does not
comply with its financial reporting and responsibility standards set by
its home country regulator and when it becomes subject to a
disciplinary action by its home country regulator. In addition, the
rule change makes the late submission of any such filing subject to a
fine and other related consequences that have been recently approved by
or are pending with the Commission.\6\ This rule change requires that
such filings be submitted to FICC in English or be in a fair and
accurate English translation if they have been translated into English.
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\6\ Securities Exchange Act. Release Nos. 50659 (Nov. 15, 2004),
69 FR 67767 (Nov. 19, 2004) [File No. SR-FICC-2004-11] and 51146
(Feb. 7, 2005), 70 FR 7984 (Feb. 16, 2005) [File No. SR-FICC-2004-
13].
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Finally, the rule change requires MBSD non-U.S. regulated
applicants to certify that they are in compliance with the financial
reporting and responsibility standards of their home country. This
requirement was recently added to GSD's rules.\7\
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\7\ Securities Exchange Act Release No. 50617 (Nov. 1, 2004), 69
FR 64796 (Nov. 8, 2004) [File No. SR-FICC-2004-01].
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C. Legal Risk
FICC members that are incorporated outside of the U.S. present FICC
with increased legal risk in the event they become insolvent.\8\
Notwithstanding the protections for clearing agencies contained in the
U.S. federal laws \9\ and the New York Banking Law (which is applicable
to GSD foreign netting members with New York state-licensed branches
and agencies), there is a risk that a U.S. court could determine not to
apply New York law to the adjudication of FICC's rights against an
insolvent non-U.S. member.\10\ In such event, the foregoing protections
may not be available to FICC.
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\8\ At this time, GSD will continue to only permit non-U.S.
banks operating out of U.S. branches or agencies to be Foreign
Netting Members.
\9\ E.g., the Federal Deposit Insurance Corporation Improvement
Act of 1991 and the U.S. Bankruptcy Code.
\10\ This particular matter is currently being adjudicated in a
case that will be argued before the Second Circuit. The case
involves a Serbian governmental agency that has brought a U.S.
Bankruptcy Code Section 304 proceeding seeking to have the
disposition of the assets of certain Yugoslavian banks with New York
state-licensed agencies be considered under home country law. See
Agency for Deposit Ins., Rehab., Bankr. & Liquidation of Banks v.
Superintendent of Banks, Case No. 03-CV-9320 (JSR), Case No. 03-CV-
9321 (JSR), 2004 U.S. Dist. LEXIS 10848 (S.D.N.Y. June 2004).
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In order to mitigate this risk, FICC has required and will continue
to require non-U.S. GSD netting and MBSD clearing applicants to submit
non-U.S. legal opinions drafted by outside counsel from the
jurisdiction in which the member is incorporated and/or primarily
conducts its business. As is its current practice, FICC will continue
to make a case-by-case determination, based on its analysis of the
legal opinion, of the legal risks presented by the home country laws of
such applicants. In doing so, FICC will now retain U.S. outside counsel
to review the legal opinions and to advise FICC of any risks presented.
The rule change makes clear that, based on its review of the legal
opinion, FICC will determine
[[Page 14738]]
what, if any, protective measures it will impose to mitigate any legal
risks. Protective action may, for example, take the form of requiring
the member to post additional collateral and/or requiring a member to
post a certain percentage of its collateral requirement in a certain
form (such as letters of credit).
In order to protect FICC against any adverse changes in home
country law that may have arisen since the members submitted their
legal opinions as a part of the membership/application process and in
order to determine whether any positive developments in home country
law would support eliminating or relaxing any collateral premiums that
may have been imposed on any members,\11\ FICC will require all of its
current non-U.S. members (except those members whose opinions have been
issued within the past 18 months) to submit a current legal opinion
from outside non-U.S. counsel addressing the non-U.S. legal issues or
to provide a letter on their outside counsel's letterhead stating that
no material changes have occurred in home country law since the date of
the original legal opinions. FICC will require its current members to
submit these updated legal opinions (or letters) within three months of
the approval of this filing by the Commission. FICC will then review
with the assistance of its outside counsel all such revised legal
opinions and those original legal opinions that counsel indicates
remain current and will determine whether protective measures need to
be taken or whether the current increased collateral requirements
should continue, be relaxed, or be eliminated.
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\11\ GSD currently has three non-U.S. netting members that are
subject to increased clearing fund requirements due to past
determinations of heightened legal risk presented by the insolvency
laws of their home jurisdictions. These members are currently
posting 100 percent of their clearing fund requirement in the form
of one or more letters of credit and an additional 30 percent in the
form of cash or securities.
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The rule change will also require all non-U.S. members to provide
an annual update of their non-U.S. legal opinion or to provide a letter
from their outside counsel stating that no material issues have arisen
since the issuance of the opinion or the last update. FICC may impose
such additional requirements on non-U.S. members as described above
based on review of such updated legal opinions.
D. Additional Changes
The rule change will delete all references to certifications by the
chief executive officer, chief financial officer, or other that
accompany financial statements, financial data, or regulatory reports.
These certifications do not appear to be standard documentation, and
FICC historically has not received such certifications. If a need to
request a certification with respect to a particular member or
applicant arises, FICC will have the authority to request it pursuant
to the general authority that it has in both division's rules to seek
additional information.
In addition, in a previous rule change, FICC amended its rules with
the intention of giving FICC the option to request that financial
figures be submitted in U.S. dollar equivalents.\12\ This rule change
deletes this option from FICC's rules as FICC performs these
calculations itself, intends to continue doing so, and believes that
the pending language has the potential for confusion.
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\12\ Supra note 8, SR-FICC-2004-01.
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Finally, the rule change will amend the number of recent routine
regulatory reports that a U.S. GSD netting applicant or MBSD clearing
applicant is required to submit to FICC to the number of such reports
that the entity has filed during the preceding 12 months or a lesser
period if the applicant has been in business or has been registered or
licensed for a lesser period. For example, a GSD U.S. broker-dealer
applicant that is a monthly FOCUS filer would need to submit copies of
all of its FOCUS reports filed during the preceding 12 months. With
respect to 17a-11 reports, where the current rules do not specify the
necessary time period, the proposed rule change requires U.S. broker-
dealer applicants to submit all 17a-11 reports filed during the
preceding 24 months.
II. Comments
The Institute of International Bankers (``IIB'') submitted two
comment letters. While the first letter objected to the increased
financial requirements for entities submitting financial statements
prepared using non-U.S. GAAP, its primarily focus was on its objections
to standard clearing fund premiums for all non-U.S. members. After FICC
amended the proposal to remove the standard clearing fund premiums for
non-U.S. members, the IIB wrote in support of the proposed rule change,
particularly with respect to the provisions that address how FICC will
manage the legal risk arising from the participation in FICC by
branches of international banks that operate in the United States.
The III Global Ltd., III Finance Ltd., and III Relative Value/Macro
Hub Fund Ltd. investment companies submitted a comment letter also
objecting to standard clearing fund premiums for non-U.S. members.
However, as with the IIB's first letter, this letter also addressed a
version of the proposed rule change that the Commission had not yet
published for comment and that FICC substantively modified.
III. Discussion
Section 17A(b)(3)(F) of the Act requires, among other things, that
the rules of a clearing be designed to assure the safeguarding of
securities and funds which are in its custody or control.\13\ The
proposed rule change should enhance FICC's surveillance and assessment
of applicants' and members' financial and legal condition. In addition,
the proposed rule change will harmonize both of FICC's division's
application and membership requirements and will make clear to all
applicants and members of the breadth of financial and legal
information that FICC will require and review in order to develop an
accurate risk profile to evaluate an applicant's or member's financial
condition. Accordingly, the proposed rule should appropriately enhance
FICC's ability to mitigate financial risk to itself and to its members
and therefore should help FICC to assure the safeguarding of securities
and funds that are in its custody or control or for which it is
responsible.
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\13\ 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
proposal is consistent with the requirements of the Act and in
particular with the requirements of Section 17A of the Act \14\ and the
rules and regulations thereunder.
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\14\ 15 U.S.C. 78q-1.
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It is therefore ordered, pursuant to section 19(b)(2) of the Act,
that the proposed rule change (File No. SR-FICC-2004-14) be, and hereby
is, approved.
For the Commission by the Division of Market Regulation,
pursuant to delegated authority.\15\
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\15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-1257 Filed 3-22-05; 8:45 am]
BILLING CODE 8010-01-P