[Federal Register Volume 86, Number 153 (Thursday, August 12, 2021)]
[Notices]
[Pages 44482-44527]
[FR Doc No: 2021-17076]

Vol. 86

Thursday,

No. 153

August 12, 2021

Part II

 Securities And Exchange Commission

-----------------------------------------------------------------------

 Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Filing of Proposed Rule Change To Establish the
Securities Financing Transaction Clearing Service and Make Other
Changes; Notice

Federal Register / Vol. 86 , No. 153 / Thursday, August 12, 2021 /
Notices

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-92570; File No. SR-NSCC-2021-010]

Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Filing of Proposed Rule Change To Establish the
Securities Financing Transaction Clearing Service and Make Other
Changes

August 5, 2021.
    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 July 22, 2021, National Securities Clearing Corporation (``NSCC'')
filed with the Securities and Exchange Commission (``Commission'') the
proposed rule change as described in Items I, II and III below, which
Items have been prepared by the clearing agency.\3\ The Commission is
publishing this notice to solicit comments on the proposed rule change
from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ NSCC filed this proposed rule change as an advance notice
(SR-NSCC-2021-803) with the Commission pursuant to Section 806(e)(1)
of Title VIII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act entitled the Payment, Clearing, and Settlement
Supervision Act of 2010, 12 U.S.C. 5465(e)(1), and Rule 19b-
4(n)(1)(i) under the Act, 17 CFR 240.19b-4(n)(1)(i). A copy of the
advance notice is available at http://www.dtcc.com/legal/sec-rule-filings.aspx.
---------------------------------------------------------------------------

I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change

    The proposed rule change consists of proposed modifications to the
NSCC Rules & Procedures (``Rules'') \4\ that would (i) establish new
membership categories and requirements for sponsoring members and
sponsored members whereby existing Members would be permitted to
sponsor certain institutional firms into membership, (ii) establish a
new membership category and requirements for agent clearing members
whereby existing Members would be permitted to submit, on behalf of
their customers, transactions to NSCC for novation, (iii) establish the
securities financing transaction clearing service (``Securities
Financing Transaction Clearing Service'' or ``SFT Clearing Service'')
to make central clearing available at NSCC for equity securities
financing transactions, which are, broadly speaking, transactions where
the parties exchange equity securities against cash and simultaneously
agree to exchange the same securities and cash, plus or minus a rate
payment, on a future date (collectively, ``Securities Financing
Transactions'' or ``SFTs''), and (iv) make other amendments and
clarifications to the Rules, as described in greater detail below.
---------------------------------------------------------------------------

    \4\ Capitalized terms not defined herein are defined in the
Rules, available at http://www.dtcc.com/~/media/Files/Downloads/
legal/rules/nscc_rules.pdf.
---------------------------------------------------------------------------

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change

    In its filing with the Commission, the clearing agency 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. The clearing agency has prepared summaries,
set forth in sections A, B, and C below, of the most significant
aspects of such statements.

(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change

1. Purpose
    The purpose of this proposed rule change is to (i) establish new
membership categories and requirements for sponsoring members and
sponsored members whereby existing Members would be permitted to
sponsor certain institutional firms into membership, (ii) establish a
new membership category and requirements for agent clearing members
whereby existing Members would be permitted to submit, on behalf of
their customers, transactions to NSCC for novation, (iii) establish the
SFT Clearing Service to make central clearing available at NSCC for
SFTs, and (iv) make other amendments and clarifications to the Rules,
as described in greater detail below.
(i) Background
    NSCC is proposing to introduce central clearing for SFTs, which
are, broadly speaking, securities lending transactions where parties
exchange equity securities against cash and simultaneously agree to
exchange the same securities and cash, plus or minus a rate payment, on
a future date. In particular, the proposed SFT Clearing Service would
expand central clearing at NSCC to include SFTs with a one Business Day
term (i.e., overnight SFTs) in eligible equity securities that are
entered into by Members, institutional firms that are sponsored into
NSCC by a Sponsoring Member (as defined below and in the proposed rule
change), or Agent Clearing Members (as defined below and in the
proposed rule change) on behalf of Customers (as defined below and in
the proposed rule change), as applicable.
    SFTs involve the owner of securities (typically a registered
investment company, pension plan, sovereign wealth fund or other
institutional firm) transferring those securities temporarily to a
borrower (typically a hedge fund). SFTs are often facilitated and
intermediated by broker-dealers and agent lenders (i.e., custodial
banks or other institutions that lend out securities as agent on behalf
of institutional firms). In return for the lent securities, the
borrower transfers collateral, and a net rate payment is typically
transferred to either the lender or the borrower that reflects the
liquidity of the lent securities, as well as interest on any cash
collateral.\5\ NSCC understands that SFTs provide liquidity to markets
and facilitates the ability of market participants to make delivery on
short-sales, and thereby avoid failures to deliver, ``naked'' shorts,
and similar situations. On a typical Business Day, The Depository Trust
Company (``DTC''), an NSCC affiliate, processes deliver orders related
to securities lending transactions on securities having a value of
approximately $150 billion.
---------------------------------------------------------------------------

    \5\ This rate payment is typically calculated in a manner
similar to interest on the principal balance of a loan and accrues
on a daily basis. As a result, the rate payment is typically
calculated as the product of a specified balance (typically the
amount of cash collateral unless the collateral consists of
securities) and a specified rate (reflecting both the liquidity of
the securities and the ability of the lender to re-use the cash
collateral), divided by 360 or a similar day count fraction.
---------------------------------------------------------------------------

Capital Efficiency Opportunities
    The Basel III \6\ capital and leverage requirements, as implemented
by the U.S. banking regulators, constrain the ability of agent lenders
and brokers to intermediate and facilitate SFTs.\7\ NSCC believes
central clearing of SFTs would be able to address these constraints,
which may otherwise impair market participants' ability to engage in
SFTs.
---------------------------------------------------------------------------

    \6\ Basel III is an internationally agreed set of measures
developed by the Basel Committee on Banking Supervision in response
to the financial crisis of 2007-2009.
    \7\ See, e.g., 12 CFR part 3 (Office of the Comptroller of the
Currency--Capital Adequacy Standards); 12 CFR part 217 (Federal
Reserve--Capital Adequacy of Bank Holding Companies, Savings and
Loan Holding Companies, and State Member Banks); 12 CFR part 252,
subpart Q (Single Counterparty Credit Limits); 12 CFR part 324
(Federal Deposit Insurance Corporation--Capital Adequacy of FDIC-
Supervised Institutions).
---------------------------------------------------------------------------

    For example, NSCC believes it is uniquely positioned to create
balance sheet netting opportunities for market participants (i.e., the
ability to offset

cash payables and receivables versus NSCC) by becoming the legal
counterparty to both pre-novation counterparties to an SFT through
novation. Specifically, market participants that borrow securities
through NSCC and then onward lend those securities, or other
securities, to another NSCC Member through the proposed SFT Clearing
Service may have the ability to net down the cash collateral return
obligations and entitlements related to such SFTs. By contrast, for
bilateral SFTs, market participants may be required to record those
payables and receivables on their balance sheets on a gross (rather
than netted) basis. A netted balance sheet can create significant
capital benefits for market participants because it can reduce the
amount of regulatory capital they must hold against SFTs under the U.S.
``supplementary leverage ratio'' and other capital requirements that
favor a netted balance sheet.\8\
---------------------------------------------------------------------------

    \8\ See 12 CFR 217.10(c)(4)(ii)(E)-(F).
---------------------------------------------------------------------------

    In addition, under Basel III, bank holding companies that have
broker-dealer subsidiary borrowers are required to reserve capital
against their exposures to institutional firm lenders of securities in
relation to the cash collateral posted by such borrowers. Those capital
requirements can vary depending on the credit profile of the
institutional firm lender, and generally are well in excess of those
applied to exposures to qualifying central counterparties, such as
NSCC.\9\ The counterparty risk weight of a qualifying central
counterparty, like NSCC, is 2%,\10\ which may result in considerable
capital savings to these bank holding companies, to the extent they
participate in central clearing.
---------------------------------------------------------------------------

    \9\ See 12 CFR 217.32 and 217.37 generally.
    \10\ See 12 CFR 217.35(c)(3).
---------------------------------------------------------------------------

    Moreover, agent lending banks and bank holding company parents of
broker-dealer borrowers that participate in central clearing could
receive beneficial treatment under the single counterparty credit
limits, which exempt exposures to qualifying central
counterparties.\11\
---------------------------------------------------------------------------

    \11\ See 12 CFR 252.77(a)(3).
---------------------------------------------------------------------------

    In light of the potential for central clearing to alleviate the
aforementioned capital constraints otherwise applicable to bilateral
SFTs, NSCC believes that central clearing of SFTs may increase the
capacity of market participants to engage in SFTs.\12\
---------------------------------------------------------------------------

    \12\ Members should discuss this matter with their accounting
and regulatory capital experts.
---------------------------------------------------------------------------

Fire Sale Risk Mitigation
    In addition to creating capital efficiency opportunities for market
participants, NSCC believes that broadening the scope of central
clearing at NSCC to SFTs would also reduce the potential for market
disruption from fire sales.
    In the case of securities lending transactions, the primary risk of
fire sales \13\ relates to the reinvestment of cash collateral by
institutional firms that are the lenders in securities lending
transactions. Those institutional firms will typically reinvest the
cash collateral they receive from the borrower into other securities.
If the borrower of the securities thereafter defaults, the
institutional firm lenders generally need to quickly liquidate the
securities representing the reinvestment in order to raise cash to
purchase the originally lent security. A substantial number of
disconnected and competing liquidations by multiple lenders can create
fire sale conditions for the securities being liquidated, which can
harm not only the institutional firm lenders by potentially lowering
the amount of cash they can raise in the sale of such securities, but
also create market losses for all holders of such securities.\14\
---------------------------------------------------------------------------

    \13\ Fire sale risk is the risk of rapid sales of assets in
large amounts that temporarily depress market prices of such assets
and create financial instability.
    \14\ See Financial Stability Board, Strengthening Oversight and
Regulation of Shadow Banking: Policy Framework for Addressing Shadow
Banking Risks in Securities Lending and Repos, at 5 (August 29,
2013) available at https://www.fsb.org/wp-content/uploads/r_130829b.pdf?page_moved=1. See also United States Securities and
Exchange Commission: Securities Lending and Short Sale Roundtable
Transcript (September 29, 2009), Former Chairman Schapiro's Remarks,
at 2-3, available at https://www.sec.gov/news/openmeetings/2009/roundtable-transcript-092909.pdf.
---------------------------------------------------------------------------

    Moreover, if an institutional firm lender should default and fail
to return the cash collateral back to its borrowers, the borrowers
would typically be looking to liquidate the borrowed securities in
order to make themselves whole for the cash collateral they delivered
to the institutional firm lender. Competing and disconnected sales of
such securities could similarly create fire sale conditions and not
only harm the borrowers to the extent the value of the securities
decline, but also create market losses for all holders of the borrowed
securities.
    NSCC believes that broadening the scope of central clearing at NSCC
to SFTs would reduce the potential for market disruption from fire
sales for a number of reasons. First, in the event of a default, NSCC
would conduct a centralized, orderly liquidation of the defaulter's SFT
Positions (as defined below and in the proposed rule change). Such an
organized liquidation should result in substantially less price
depreciation and market disruption than multiple independent non-
defaulting parties racing against one another to liquidate the
positions. Second, NSCC would only need to liquidate the defaulter's
net positions. By contrast, in the context of a default by a broker-
dealer intermediary that runs a matched book in the bilateral
securities market, both the ultimate lender and the ultimate borrower
need to liquidate the defaulter's gross positions. Limiting the
positions that need to be liquidated to the defaulter's net positions
should reduce the volume of required sales activity, which in turn
should limit the price and market impact of the close-out of the
defaulter's positions. Lastly, NSCC would use its risk management
resources to provide confidence to market participants that they will
receive back their cash or securities, as applicable, which should
limit the propensity for market participants to seek to unwind their
transactions in a stressed market scenario.
Liquidity Drain Risk Mitigation
    Liquidity risk may also arise if, in the context of a stressed
market scenario, borrowers or lenders concerned about their
counterparties' creditworthiness seek to unwind their securities
lending transactions and obtain the return of their cash collateral or
securities. This occurred to a certain extent in 2008, when borrowers
began demanding to return borrowed securities in exchange for the cash
collateral the borrowers had posted to institutional firm lenders.\15\
These ``runs'' may require institutional firm lenders to quickly sell
off securities that are the subject of their cash reinvestments to
raise cash to return to the borrowers, thereby also creating potential
fire sale conditions with respect to the reinvestment securities, as
described above. Similarly, borrowers may need to purchase or re-borrow
securities in stressed market conditions, leading to potentially
significant losses.
---------------------------------------------------------------------------

    \15\ See, e.g., id.
---------------------------------------------------------------------------

    NSCC believes that having SFTs be centrally cleared by NSCC would
lower the risk of a liquidity drain in a stress scenario. Specifically,
NSCC believes that having it clear SFT activity would provide
confidence to borrowers and lenders that they will receive back their
cash or securities and thereby lessen parties' inclination to rush to
unwind their transactions in a stressed market scenario.

Addition of New Membership Categories for Institutional Firm SFT
Activity
    When evaluating the opportunity to expand its cleared offerings to
SFTs, NSCC engaged in extensive discussions with numerous market
participants, including agent lenders, brokers, institutional firms,
and critical third parties, such as matching service providers and
books and records service providers. NSCC also organized several
industry working groups to discuss the possibility of clearing SFTs.
Each constituency has a unique perspective on the proposed SFT Clearing
Service. By capturing their differing viewpoints in the design, NSCC
has sought to ensure that the proposed SFT Clearing Service would
reflect their needs and facilitate industry adoption of the proposed
SFT Clearing Service.
    There was a considerable amount of discussion between NSCC and
market participants regarding the appropriate model(s) through which
institutional firms should access central clearing. Some market
participants expressed interest in allowing Members to sponsor
institutional firms into NSCC membership in a manner similar to that
provided for under the sponsoring member/sponsored member program at
the Government Securities Division (``GSD'') of Fixed Income Clearing
Corporation (``FICC''), an NSCC affiliate (``FICC's Sponsoring Member/
Sponsored Member Program'').\16\ Under FICC's Sponsoring Member/
Sponsored Member Program, sponsoring members may submit to FICC
transactions entered into on a principal-to-principal basis between the
sponsoring member and the sponsored member.\17\ On the other hand,
certain other market participants, including in particular certain
agent lending banks, requested that the central clearing service
accommodate agent-style trading (i.e., where the agent lender enters
into the transaction on behalf of the institutional firm, rather than
as principal counterparty). As NSCC understands it, agent-style trading
is the way such agent lenders are typically approved to transact in
securities lending transactions on behalf of their institutional firm
clients today.\18\
---------------------------------------------------------------------------

    \16\ See Rule 3A (Sponsoring Members and Sponsored Members) of
the FICC GSD Rulebook (``GSD Rules''), available at http://dtcc.com/
~media/Files/Downloads/legal/rules/ficc_gov_rules.pdf.
    \17\ FICC's Sponsoring Member/Sponsored Member Program also
allows sponsoring members to submit to FICC transactions entered
into between a sponsored member and a third-party netting member.
However, based on feedback from market participants, NSCC has
decided to address this type of trading via the proposed agent
clearing model for SFT.
    \18\ In addition, certain other agent lenders who are not
themselves banks or broker-dealers (and so are not eligible to
become Members of NSCC) preferred a model where the institutional
firm client becomes the direct member of NSCC with no obligations
running between the agent lender and the clearing agency.
---------------------------------------------------------------------------

    NSCC considered all of this input, as well as the recent
experiences of FICC in expanding the suite of both transactions and
participants eligible for FICC's Sponsoring Member/Sponsored Member
Program,\19\ and ultimately decided to incorporate both the sponsoring/
sponsored membership type (to facilitate principal style trading for
institutional firms and their sponsoring members) as well as the Agent
Clearing Member membership type (to facilitate agent-style trading by
agent lenders on behalf of institutional firm clients) into the
proposed SFT Clearing Service.\20\ NSCC expects these proposed new
membership types would help expand access to central clearing for
institutional firms and facilitate industry adoption of the proposed
SFT Clearing Service.
---------------------------------------------------------------------------

    \19\ See Securities Exchange Act Release Nos. 80563 (May 1,
2017), 82 FR 21284 (May 5, 2017) (SR-FICC-2017-003) (Expand the
types of entities that are eligible to participate in FICC as
Sponsored Members), 85470 (March 29, 2019), 84 FR 13328 (April 4,
2019) (SR-FICC-2018-013) (Expand Sponsoring Member Eligibility in
the GSD Rulebook), and 88262 (February 21, 2020), 85 FR 11401
(February 27, 2020) (SR-FICC-2019-007) (Close-Out and Funds-Only
Settlement Processes Associated with the Sponsoring Member/Sponsored
Member Service).
    \20\ NSCC decided at this time not to incorporate a direct model
for institutional firm clearing into the proposed SFT Clearing
Service because in its experience with a similar model in FICC (the
CCIT Service), the requirements that a clearing agency, such as
NSCC, would be required to apply to an institutional firm that
participated as a direct member (e.g., Clearing Fund and loss
allocation) would, as a general matter, not likely be compatible
with the regulatory requirements and investment guidelines
applicable to many of the regulated institutional firms that NSCC
anticipates would be interested in participating in the proposed SFT
Clearing Service.
---------------------------------------------------------------------------

    The proposed SFT Clearing Service would also allow for the
submission of broker-to-broker activity as well as client-to-client
activity (credit intermediated by Sponsoring Members and/or Agent
Clearing Members) into the NSCC system.
(ii) Key Parameters of the Proposed SFT Clearing Service
Overnight SFTs
    NSCC is proposing central clearing for SFTs with a one Business Day
term (i.e., overnight SFTs) in eligible equity securities that are
entered into by Members, institutional firms that are sponsored into
NSCC by Sponsoring Members, or Agent Clearing Members on behalf of
customers. NSCC has determined that overnight term SFTs with a daily
pair off option are more appropriate for the proposed SFT Clearing
Service than open transactions with mark-to-market collections. This is
because, as NSCC understands it, open transactions are not eligible for
balance sheet netting given they do not have a scheduled off-leg/
settlement date. As described above, the proposed SFT Clearing Service
is designed to offer both balance sheet netting and capital efficiency
opportunities to market participants. NSCC therefore finds it
appropriate to make overnight term SFTs with a scheduled date for Final
Settlement (as defined below and in the proposed rule change) of the
next Business Day, rather than open transactions, eligible for central
clearing through the proposed SFT Clearing Service.
    For example, assume that a Transferor (as defined below and in the
proposed rule change) and Transferee (as defined below and in the
proposed rule change) enter into an SFT pursuant to which: (i) In the
Initial Settlement (as defined below and in the proposed rule change)
on Monday, the Transferor will transfer 100 shares of security X to the
Transferee against $100 per share; and (ii) in the Final Settlement on
Tuesday, the Transferee will transfer 100 shares of security X to the
Transferor against $100 per share. After the Initial Settlement occurs
on Monday, the Final Settlement of the SFT is novated to NSCC. In the
Final Settlement on Tuesday, the Transferee will return 100 shares of
security X to the Transferor for $100 per share. The Rate Payment (as
defined below and in the proposed rule change) would be passed by NSCC
as between the Transferor and Transferee on Tuesday as part of NSCC's
end-of-day final money settlement process.
SFT Counterparties
    The proposed SFT Clearing Service would only be available for SFTs
entered into between (i) a Member and another Member, (ii) a Sponsoring
Member and its Sponsored Member (as defined below and in the proposed
rule change), and (iii) an Agent Clearing Member acting on behalf of a
Customer and either (x) a Member or (y) the same or another Agent
Clearing Member acting on behalf of a Customer. As used in the Rules,
``Member'' includes full-service NSCC clearing members, but not
Sponsored Members.\21\ In addition, as

proposed, the only SFTs entered into by Sponsored Members that would be
eligible for novation to NSCC would be SFTs between the Sponsored
Member and its Sponsoring Member.\22\
---------------------------------------------------------------------------

    \21\ As defined in Rule 1 (Definitions and Descriptions), the
term ``Member'' means any Person specified in Section 2.(i) of Rule
2 who has qualified pursuant to the provisions of Rule 2A. As such,
the term ``Member'' does not include a Sponsored Member. Supra note
4.
    \22\ See Section 5 of proposed Rule 56, which provides that a
Sponsoring Member shall be permitted to submit to NSCC SFTs between
itself and its Sponsored Members.
---------------------------------------------------------------------------

Approved SFT Submitters
    Consistent with the manner in which NSCC accepts cash market
transactions, SFTs would be required to be submitted to NSCC on a
locked-in/matched basis by an Approved SFT Submitter (as defined below
and in the proposed rule change) in accordance with the communication
links, formats, timeframes and deadlines established by NSCC for such
purpose. Approved SFT Submitters would be selected by the SFT Members
(as defined below and in the proposed rule change), subject to NSCC's
approval. An Approved SFT Submitter could either be a Member or a
third-party vendor. SFTs submitted to NSCC by an Approved SFT Submitter
would be valid and binding obligations of each SFT Member designated by
the Approved SFT Submitter as a party thereto.
Eligible Equity Securities and per Share Price Minimum
    NSCC will maintain eligibility criteria for the securities that may
underlie an SFT that NSCC will accept for novation. Consistent with
NSCC's general approach to eligibility for securities, the eligibility
criteria would not be a rule, but a separate document maintained by
NSCC and available to Members. It is currently contemplated that
eligible securities for SFTs in the proposed SFT Clearing Service will
be limited to CNS-eligible securities.
    In light of the fact that central clearing of SFTs would be a new
service for NSCC, and market participants would be able to elect which
of their eligible SFTs to novate to NSCC (i.e., central clearing of
SFTs would not be mandatory for Members), NSCC is not able to
anticipate at this time the size and composition of the SFT portfolios
that would be novated to NSCC. Due to this lack of history, NSCC would,
as an initial matter, provide proposed SFT Clearing Service for only
those SFTs where the underlying securities are CNS-eligible equity
securities that have a per share price of $5 or more. NSCC selected $5
as the per share price minimum for underlying equity securities that
could be the subject of a novated SFT because $5 is a common share
price minimum adopted in brokerage margin eligibility schedules.
    This proposed share price limitation would be implemented
systemically by NSCC as one of the eligibility criteria for determining
whether an equity security is eligible to be the subject of a novated
SFT (rather than as a rule), and such per share price limitation could
be modified by NSCC \23\ at a later date after NSCC gains more
experience with the nature of the SFT portfolios submitted for
clearing. In addition, if the share price of underlying securities of
an SFT that has already been novated to NSCC falls below $5, such SFT
would continue to be novated to NSCC, but the Required SFT Deposit (as
defined below and in the proposed rule change) for the affected Members
would include an amount equal to 100% of the market value of such
underlying securities until such time as the per share price of the
underlying securities equals or exceeds $5.
---------------------------------------------------------------------------

    \23\ The per share price limitation could be modified by NSCC
without any regulatory filings; however, any change in the per share
price limitation would be announced by NSCC via an Important Notice
posted to its website.
---------------------------------------------------------------------------

Cash Collateral
    Consistent with the cash market transactions NSCC clears today
where cash is used to satisfy Members' purchase obligations in eligible
securities, cash would likewise be the only eligible form of collateral
for novated SFTs under the proposed SFT Clearing Service.\24\ More
specifically, NSCC would limit the SFTs that it is willing to novate to
SFTs that have SFT Cash (as defined below and in the proposed rule
change) equal to or greater than 100% market value of the lent
securities, and would not novate any obligations to return collateral
consisting of securities.\25\
---------------------------------------------------------------------------

    \24\ This is referred to as ``SFT Cash'' in the proposed rule
text.
    \25\ See Section 5(a) of proposed Rule 56 and the definition of
``Securities Financing Transaction''.
---------------------------------------------------------------------------

    NSCC would novate the Final Settlement obligations of an SFT as of
the time the Initial Settlement of such SFT is completed, unless the
SFT is a Bilaterally Initiated SFT (as defined below and in the
proposed rule change) or a Sponsored Member Transaction (as defined
below and in the proposed rule change), in which case novation of the
Final Settlement obligations would occur upon NSCC reporting to the
Approved SFT Submitter that the SFT has been validated and novated to
NSCC.
    As described above, each SFT would be collateralized by cash equal
to no less than 100% of the market value of the lent securities. In
addition, in order to address regulatory and investment guideline
requirements applicable to certain institutional firms,\26\ a Member
would be permitted (but not required) to transfer an additional cash
haircut above 100% (e.g., 102%) to such institutional firms, i.e.,
Independent Amount SFT Cash (as defined below and in the proposed rule
change), as part of the Initial Settlement of the SFT. The Sponsoring
Member or Agent Clearing Member, as applicable, that receives the
Independent Amount SFT Cash in the Initial Settlement would also
receive a commensurate Clearing Fund call, i.e., an Independent Amount
SFT Cash Deposit Requirement (as defined below and in the proposed rule
change), from NSCC to reflect the value received by such Member above
the market price of the equity security lent. NSCC's novation of Final
Settlement obligations related to Independent Amount SFT Cash would be
tied to the time the Sponsoring Member or Agent Clearing Member, as
applicable, satisfies the related Independent Amount SFT Cash Deposit
Requirement in cash.
---------------------------------------------------------------------------

    \26\ As an example, a registered investment company that lends
securities through an agent may be required under Section 17(f) of
the Investment Company Act of 1940 and Rule 17f-2 thereunder to
collect cash collateral equal to no less than 102% of the market
value of the lent securities. See, e.g., The Adams Express Company,
SEC No-Action Letter (Oct. 8, 1984). Other institutional firms may
be subject to similar requirements under their established
investment guidelines or applicable rules, regulations or guidance.
---------------------------------------------------------------------------

RVP/DVP Settlement at DTC
    The Final Settlement obligations of each SFT, other than a
Sponsored Member Transaction, that is novated to NSCC would settle
receive-versus-payment/delivery-versus-payment (``RVP/DVP'') at
DTC.\27\ SFT deliver orders would be processed in accordance with DTC's
rules and procedures, including provisions relating to risk controls.
DTC would accept delivery instructions for an SFT from NSCC, as agent
for DTC participants that are SFT Members.\28\
---------------------------------------------------------------------------

    \27\ As described below, the Final Settlement and other
obligations of each Sponsored Member Transaction would, at the
direction of NSCC, settle on the books and records of the relevant
Sponsoring Member.
    \28\ On July 22, 2021, DTC submitted a proposed rule change to
provide DTC participants that are also NSCC Members with settlement
services in connection with NSCC's proposed SFT Clearing Service.
See SR-DTC-2021-014, which was filed with the Commission but has not
yet been published in the Federal Register. A copy of this proposed
rule change is available at http://www.dtcc.com/legal/sec-rule-filings.aspx.
---------------------------------------------------------------------------

    Pre-novation counterparties to an SFT that is due to settle may
elect to pair off (i.e., offset) the Final Settlement

obligations of such SFT against the Initial Settlement obligations of a
new SFT between the same parties on the same securities. NSCC believes
that such offsets would minimize the operational burden of settling
overnight obligations. NSCC would calculate and process the difference
in cash collateral between the paired off SFTs, i.e., Price
Differential (as defined below and in the proposed rule change). Price
Differential would also be processed in accordance with DTC rules and
procedures, including provisions relating to risk controls. DTC would
accept Price Differential payment orders for an SFT from NSCC, as agent
for DTC participants that are SFT Members.
    Settlement of the Rate Payment obligations and payment obligations
arising from certain mandatory corporate actions and cash dividends
would be processed as part of NSCC's end-of-day final money settlement
process.
    As an example of an SFT with a full pair off (i.e., offset), assume
that a Transferor and Transferee enter into an SFT pursuant to which:
(i) In the Initial Settlement on Monday, the Transferor will transfer
100 shares of security X to the Transferee against $100 per share; and
(ii) in the Final Settlement on Tuesday, the Transferee will transfer
100 shares of security X to the Transferor against $100 per share.
After the Initial Settlement occurs on Monday, the Final Settlement of
the SFT is novated to NSCC. At the end of day on Monday, the share
price of security X is $99 per share. On Tuesday, the Approved SFT
Submitter, on behalf of the Transferor and the Transferee, instructs
NSCC to pair off the parties' Final Settlement obligations on the
Settling SFT (as defined below and in the proposed rule change) with a
Linked SFT (as defined below and in the proposed rule change) pursuant
to which (i) in the Initial Settlement on Tuesday, the Transferor will
transfer 100 shares of security X to the Transferee against $99 per
share; and (ii) in the Final Settlement on Wednesday, the Transferee
will transfer 100 shares of security X to the Transferor against $99
per share. NSCC would, on Tuesday, collect $1 per share in Price
Differential from the Transferor and pay $1 per share in Price
Differential to the Transferee in connection with the pair off. In
addition, the Rate Payment for the Settling SFT would be passed by NSCC
as between the Transferor and Transferee on Tuesday as part of NSCC's
end-of-day final money settlement process. In the Final Settlement on
Wednesday, the Transferee will return 100 shares of security X to the
Transferor for $99 per share. The Rate Payment for the Linked SFT would
be passed by NSCC as between the Transferor and Transferee on Wednesday
as part of NSCC's end-of-day final money settlement process.
    As an example of an SFT with a partial pair off (i.e., offset),
assume that a Transferor and Transferee enter into an SFT pursuant to
which: (i) In the Initial Settlement on Monday, the Transferor will
transfer 100 shares of security X to the Transferee against $100 per
share; and (ii) in the Final Settlement on Tuesday, the Transferee will
transfer 100 shares of security X to the Transferor against $100 per
share. After the Initial Settlement occurs on Monday, the Final
Settlement of the SFT is novated to NSCC. At the end of day on Monday,
the share price of security X is $99 per share. On Tuesday, the
Approved SFT Submitter, on behalf of the Transferor and the Transferee,
instructs NSCC to partially pair off the parties' Final Settlement
obligations on the Settling SFT with a Linked SFT pursuant to which (i)
in the Initial Settlement on Tuesday, the Transferor will transfer 25
shares of security X to the Transferee against $99 per share; and (ii)
in the Final Settlement on Wednesday, the Transferee will transfer 25
shares of security X to the Transferor against $99 per share. In the
Final Settlement on Tuesday for the remaining Settling SFT, the
Transferee will return 75 shares of security X to the Transferor for
$100 per share. NSCC would, on Tuesday, collect $1 per share in Price
Differential from the Transferor and pay $1 per share in Price
Differential to the Transferee in relation to the shares subject to
pair off (i.e., 25 shares of security X). In addition, the Rate Payment
for the Settling SFT (i.e., 100 shares of security X) would be passed
by NSCC as between the Transferor and Transferee on Tuesday as part of
NSCC's end-of-day final money settlement process. In the Final
Settlement on Wednesday for the Linked SFT, the Transferee will return
25 shares of security X to the Transferor for $99 per share. The Rate
Payment on the Linked SFT (i.e., 25 shares of security X) would be
passed by NSCC as between the Transferor and Transferee on Wednesday as
part of NSCC's end-of-day final money settlement process.
Buy-In, Recall and Accelerated Settlement
    It is occasionally the case in the securities lending market that a
borrower is solvent and able to satisfy its general obligations as they
become due but unable to deliver the lent securities to the lender
within the timeline requested by the lender. The contractual remedy
that has developed in the bilateral securities lending market for these
situations is a ``buy-in.'' Under this remedy, the lender may purchase
securities equivalent to the borrowed securities in the market and
charge the borrower for the cost of this purchase. This serves to
benefit the lender because it allows the lender to recover the
securities within its required timeline, and it benefits the borrower
by avoiding a situation in which the borrower's failure to perform
under a single transaction results in an event of default and close-out
of all of its securities lending transactions (and potentially other
positions through a cross-default). Similarly, in the bilateral space,
securities borrowers may have the need to accelerate settlement of
securities lending transactions if they lose a ``permitted purpose''
for such loans under Regulation T. The proposed SFT Clearing Service
would seek to retain the buy-in and acceleration mechanisms, as they
ensure the smooth functioning of securities markets without causing
unnecessary and disorderly defaults or regulatory violations.\29\
---------------------------------------------------------------------------

    \29\ NSCC does not believe retaining the buy-in and acceleration
mechanisms would undermine novation because NSCC would remain the
obligor and obligee in respect of the Final Settlement, Rate
Payment, and Distribution Payment (as defined below and in the
proposed rule change) entitlements and obligations. These mechanisms
simply affect the timing and manner in which those obligations are
discharged.
---------------------------------------------------------------------------

    Consistent with their rights under industry-standard documentation
for bilateral SFTs, as proposed, Transferors would have the right to
submit a Recall Notice (as defined below and in the proposed rule
change) to NSCC in respect of a novated SFT for which Final Settlement
obligations have not yet been satisfied. If the Transferee does not
return the lent securities by the Recall Date (as defined below and in
the proposed rule change) specified in such notice, and the Transferor
would be eligible to Buy-In (as defined below and in the proposed rule
change), in accordance with such timeframes and deadlines as
established by NSCC for such purpose, such securities.
    For example, assume that a Transferor and Transferee enter into an
SFT pursuant to which: (i) In the Initial Settlement on Monday, the
Transferor will transfer 100 shares of security X to the Transferee
against $100 per share; and (ii) in the Final Settlement on Tuesday,
the Transferee will transfer 100 shares of security X to the Transferor
against $100 per share. After the Initial Settlement occurs on

Monday, the Final Settlement of the SFT is novated to NSCC. At the end
of day on Monday, the share price of security X is $99 per share. On
Tuesday, the Approved SFT Submitter, on behalf of the Transferor and
the Transferee, instructs NSCC to pair off (i.e., offset) the parties'
Final Settlement obligations on the Settling SFT with a Linked SFT
pursuant to which (i) in the Initial Settlement on Tuesday, the
Transferor will transfer 100 shares of security X to the Transferee
against $99 per share; and (ii) in the Final Settlement on Wednesday,
the Transferee will transfer 100 shares of security X to the Transferor
against $99 per share. NSCC would, on Tuesday, collect $1 per share in
Price Differential from the Transferor and pay $1 per share in Price
Differential to the Transferee in connection with the pair off. In
addition, the Rate Payment for the Settling SFT would be passed by NSCC
as between the Transferor and Transferee on Tuesday as part of NSCC's
end-of-day final money settlement process.
    Later in the day on Tuesday, the Transferor determines it now needs
100 shares of security X back in its inventory, and so the Approved SFT
Submitter submits a Recall Notice to NSCC, prior to the deadline
established by NSCC, on behalf of the Transferor for 100 shares of
security X with a Recall Date of Thursday. At the end of day on
Tuesday, the share price of security X is $98 per share. Upon receipt
of the Recall Notice, the SFT would be treated as a Non-Returned SFT
(as defined below and in the proposed rule change) by NSCC pursuant to
Section 9(e) of proposed Rule 56 (Securities Financing Transaction
Clearing Service). Accordingly, pursuant to Section 9(a) of proposed
Rule 56, the Final Settlement Date (as defined below and in the
proposed rule change) of the SFT would be rescheduled to Thursday, and
NSCC would, on Wednesday collect $1 per share in Price Differential
from the Transferor and pay $1 per share in Price Differential to the
Transferee on the Non-Returned SFT. The Rate Payment for the Non-
Returned SFT would also be passed by NSCC as between the Transferor and
Transferee on Wednesday as part of NSCC's end-of-day final money
settlement process.
    Assume further that the Transferee does not transfer the 100 shares
of security X on Wednesday and that the end of day price of security X
on Wednesday is $97 per share. On Thursday, NSCC would again collect $1
per share in Price Differential from the Transferor and pay $1 per
share in Price Differential to the Transferee on the Non-Returned SFT.
The Rate Payment for the Non-Returned SFT would also be passed by NSCC
as between the Transferor and Transferee on Thursday as part of NSCC's
end-of-day final money settlement process. In addition, since the
Recall Notice specified Thursday as the Recall Date, the Transferor
would be entitled to purchase (or deem itself to have purchased) 100
shares of security X in accordance with the provisions of Section 9(b)
of proposed Rule 56. Assuming that the Transferor paid a price of $95
per share for security X and submitted a written notice to NSCC of its
Buy-In Costs (as defined below and in the proposed rule change) on
Thursday, the Transferor would owe NSCC a Buy-In Amount (as defined
below and in the proposed rule change) of $2 per share ($100 per share
of SFT Cash received by the Transferor at the Initial Settlement of the
SFT, less the $95 per share Buy-In Costs of the Transferor, minus $3
per share Price Differential paid by the Transferor to NSCC), and such
Buy-In Amount would be debited by NSCC from the Transferor and credited
to the Transferee as part of NSCC's end-of-day final money settlement
process on Friday.
    Similarly, consistent with their rights under industry-standard
documentation for bilateral SFTs, Transferees would have the right to
accelerate the scheduled Final Settlement of a novated SFT through
notice from the Approved SFT Submitter to NSCC of such accelerated
settlement.
    For example, assume that a Transferor and Transferee enter into an
SFT pursuant to which: (i) In the Initial Settlement on Monday, the
Transferor will transfer 100 shares of security X to the Transferee
against $100 per share; and (ii) in the Final Settlement on Tuesday,
the Transferee will transfer 100 shares of security X to the Transferor
against $100 per share. After the Initial Settlement occurs on Monday,
the Final Settlement of the SFT is novated to NSCC. At the end of day
on Monday, the share price of security X is $99 per share. On Tuesday,
the Approved SFT Submitter, on behalf of the Transferor and the
Transferee, instructs NSCC to net the parties' Final Settlement
obligations on the Settling SFT with a Linked SFT pursuant to which (i)
in the Initial Settlement on Tuesday, the Transferor will transfer 100
shares of security X to the Transferee against $99 per share; and (ii)
in the Final Settlement on Wednesday, the Transferee will transfer 100
shares of security X to the Transferor against $99 per share. NSCC
would, on Tuesday, collect $1 per share in Price Differential from the
Transferor and pay $1 per share in Price Differential to the Transferee
in connection with the pair off. Later in the day on Tuesday, the
Transferee loses permitted purpose under Regulation T for the borrowing
of 100 shares of security X. Therefore, pursuant to Section 11 of
proposed Rule 56 (Securities Financing Transaction Clearing Service),
the Approved SFT Submitter submits a notice to NSCC on behalf of the
Transferee to accelerate the Final Settlement of the Linked SFT to
Tuesday. The Transferee then on Tuesday returns 100 shares of security
X to NSCC for $99 per share, and NSCC returns 100 shares of security X
to the Transferor for $99 per share. The Rate Payment would be passed
by NSCC for the Settling SFT as between the Transferor and Transferee
on Tuesday as part of NSCC's end-of-day final money settlement process.
Risk Management of SFT Positions
    Under the proposal, NSCC is requiring a deposit to the Clearing
Fund \30\ for SFT Positions, i.e., Required SFT Deposit. From a market
risk standpoint, SFT activity would be risk managed by NSCC in a manner
consistent with Members' CNS positions but would be margined
independently of the Member's other positions,\31\ and a Required SFT
Deposit would be collected by NSCC for all SFT activity of an SFT
Member, subject to a $250,000 minimum deposit.\32\ Specifically, NSCC
is proposing to calculate an SFT Member's Required SFT Deposit by
applying the sections of Procedure XV (Clearing Fund Formula and Other
Matters) specified in Section 12 of proposed Rule 56 (i.e., Sections
I.(A)(1)(a), (b), (d), (f), (g), (h) of Procedure XV as well as the
additional Clearing Fund formula in Section I.(B)(5) (Intraday Mark-to-
Market Charge) of Procedure XV as such sections apply to CNS
Transactions, and the additional Clearing Fund formula in Sections
I.(B)(1) (Additional Deposits

for Members on the Watch List); (2) (Excess Capital Premium), (3)
(Backtesting Charge), (4) (Bank Holiday Charge); Minimum Clearing Fund
and Additional Deposit Requirements in Sections II.(A)1(a)-(b), II.(B),
II.(C); as well as Section III (Collateral Value of Eligible Clearing
Fund Securities) of Procedure XV, as such sections apply to Members).
Furthermore, NSCC would require an additional Required SFT Deposit for
Non-Returned SFTs that is intended to mirror the premium charged for
CNS Fails Positions. NSCC would also apply the Independent Amount SFT
Cash Deposit Requirement for SFTs that have Incremental Additional
Independent Amount SFT Cash. NSCC is also proposing that, for the
purpose of applying Section I.(A)(1)(h) of Procedure XV (Margin
Liquidity Adjustment (``MLA'') charge), SFT Positions shall be netted
with Net Unsettled Positions.\33\
---------------------------------------------------------------------------

    \30\ As currently defined in Rule 1 (Definitions and
Descriptions), the term ``Clearing Fund'' means the fund created
pursuant to Rule 4. Supra note 4.
    \31\ NSCC is not proposing at this time to portfolio margin a
Member's SFT Positions with any CNS positions of the Member. NSCC
may reconsider this position after it obtains a reasonable amount of
experience observing the nature and volume of SFT activity submitted
by Members to NSCC for novation through the proposed SFT Clearing
Service.
    \32\ This $250,000 minimum deposit is a requirement that is
separate from NSCC's proposed change to a Member's minimum (non-SFT)
Clearing Fund deposit requirement, although it is designed to be
consistent with such proposed change. See Securities Exchange Act
Release No. 91809 (May 10, 2021), 86 FR 26588 (May 14, 2021) (SR-
NSCC-2021-005).
    \33\ ``Net Unsettled Positions'' include a Member's net of
unsettled Regular Way, When-Issued and When-Distributed pending
positions (i.e., net positions that have not yet passed Settlement
Date) and fail positions (i.e., net positions that did not settle on
Settlement Date). See Procedure XV, supra note 4.
---------------------------------------------------------------------------

    Consistent with the manner in which clearing fund requirements are
satisfied by members of FICC for their cleared securities financing
transactions, NSCC would require that (i) a minimum of 40% of an SFT
Member's Required SFT Deposit consist of a combination of cash and
Eligible Clearing Fund Treasury Securities and (ii) the lesser of
$5,000,000 or 10% of an SFT Member's Required SFT Deposit (but not less
than $250,000) \34\ consist of cash.\35\ NSCC would also have the
discretion to require an SFT Member to post its Required SFT Deposit in
proportion of cash higher than would otherwise be required as described
above. NSCC's determination to impose any such requirement would be
made in view of market conditions and other financial and operational
capabilities of the relevant SFT Member. For example, as proposed in
Section 12 of Rule 56, if NSCC had specific concerns about a particular
SFT Member's financial or operational capabilities, but NSCC had not
yet come to the determination that ceasing to act for the SFT Member
would be appropriate (but could potentially become appropriate within
the near term), NSCC may request that a greater portion of the SFT
Member's Required SFT Deposit to the Clearing Fund be in the form of
cash in order to simplify any potential close-out liquidation required
in the event of that SFT Member's default. Separately, pursuant to
Section II.(A)1(a) of Procedure XV, if an SFT Member's deposit of
Eligible Clearing Fund Agency Securities or Eligible Clearing Fund
Mortgage-Backed Securities is in excess of 25% of the SFT Member's
Required Fund Deposit, NSCC would subject the deposit to an additional
haircut.
---------------------------------------------------------------------------

    \34\ This $250,000 minimum cash deposit requirement is designed
to be consistent with NSCC's proposed change to the minimum amount
of cash that must be used to satisfy a Member's (non-SFT) Clearing
Fund deposit requirement. See Securities Exchange Act Release No.
91809 (May 10, 2021), 86 FR 26588 (May 14, 2021) (SR-NSCC-2021-005).
NSCC believes a $250,000 minimum cash deposit would serve to
strengthen NSCC's liquidity resources. Cash may also be easier to
access upon a Member's default, further reducing the risk of losses
and using non-defaulting Member's securities or funds, or NSCC
funds.
    \35\ These requirements are designed to be consistent with FICC
GSD's clearing fund requirements of its members given that NSCC
anticipates that there would be considerable overlap between the
membership of FICC GSD that participate in FICC for purposes of
clearing their securities financing transaction activity (including
in particular sponsored repo activity) and the Members that would
elect to participate in the proposed SFT Clearing Service.
Specifically, FICC GSD Rule 4, Section 3 requires (i) a minimum of
40 percent of a member's required fund deposit to be in the form of
cash and/or eligible clearing fund treasury securities and (ii) the
lesser of $5,000,000 or 10 percent of the required fund deposit,
with a minimum of $100,000, be made and maintained in cash. See Rule
4 (Clearing Fund and Loss Allocation) of the FICC GSD Rulebook,
supra note 16.
---------------------------------------------------------------------------

    The Sponsoring Member Required Fund Deposits (as defined below and
in the proposed rule change) and Agent Clearing Member Required Fund
Deposits (as defined below and in the proposed rule change) would each
be calculated on a gross basis, and no offsets for netting of positions
as between different Sponsored Members or different Customers,\36\ as
applicable, would be permitted. This is to ensure that NSCC's
volatility-based Clearing Fund deposit requirements represent the sum
of each individual institutional firm's activity.
---------------------------------------------------------------------------

    \36\ See Section 7(c) of proposed Rule 2C and Section 6(c) of
proposed 2D.
---------------------------------------------------------------------------

    As proposed, the SFT Clearing Service would mitigate NSCC's
liquidity risk associated with satisfaction of Final Settlement
obligations owing to non-defaulting SFT Members on novated SFTs in the
event of an SFT Member default by providing for satisfaction of such
Final Settlement obligations to occur in accordance with the normal
settlement cycle for the purchase or sale of securities, as
applicable.\37\ NSCC would accordingly be able to satisfy such Final
Settlement obligations through market action (if necessary) rather than
through its own liquidity resources. More specifically, NSCC would be
able to sell the securities lent by a Defaulting SFT Member (as defined
below and in the proposed rule change) and/or purchase the securities
borrowed by a Defaulting SFT Member and use the proceeds of such sales
and/or the securities purchased to satisfy the Defaulting SFT Member's
Final Settlement obligations to non-defaulting SFT Members. In the
absence of this provision, NSCC would need to rely exclusively on its
liquidity resources to satisfy Final Settlement obligations owing to
non-defaulting SFT Members, since it would not receive the proceeds of
any market action to liquidate the Defaulting SFT Member's SFT
Positions until after Final Settlement obligations were due.
---------------------------------------------------------------------------

    \37\ See proposed Rule 56, Section 14(b)(viii).
---------------------------------------------------------------------------

    The proposal would also provide that NSCC could further delay its
satisfaction of Final Settlement obligations to non-defaulting SFT
Members beyond the normal settlement cycle for the purchase or sale of
securities to the extent NSCC determines that taking market action to
close-out some or all of the defaulted SFT Member's novated SFT
Positions would create a disorderly market in the relevant SFT
Securities.\38\ For example, to the extent that market action is
required by NSCC to close-out the positions of a Defaulting SFT Member,
and selling out or buying in (as applicable) the entire quantity of
securities would move the market and create disorder, NSCC would adhere
to pre-determined market volume limits as set forth in NSCC's internal
procedures and execute its hedging strategy in order to meet its
default management objectives. In such a situation, non-defaulting SFT
Members would not be able to effect a recall or an associated buy-in,
since such market activity would exacerbate the disorderly conditions
that NSCC's delay is designed to prevent, nor would non-defaulting SFT
Members otherwise be able to or accelerate the delayed Final Settlement
obligations, as any such acceleration would frustrate the purpose of
the delay, i.e., to avoid creating a disorderly market in the relevant
SFT Securities.
---------------------------------------------------------------------------

    \38\ Id.
---------------------------------------------------------------------------

    However, in any case, until NSCC has satisfied the Final Settlement
obligations owing to non-defaulting SFT Members, NSCC would continue
paying to and receiving from non-defaulting SFT Members the applicable
Price Differential (i.e., the change in market value of the relevant
securities) with respect to their novated SFTs.\39\ By continuing to
process these Price

Differential payments until Final Settlement occurs, NSCC would ensure
that non-defaulting SFT Members are kept in the same position as if the
Defaulting SFT Member had not defaulted and the pre-novation
counterparties had instead agreed to roll the SFTs. To the extent NSCC
is required to pay a Price Differential to a non-defaulting SFT Member,
NSCC would rely on the NSCC Clearing Fund, including the Required SFT
Deposit, in order to cover the liquidity need associated with any such
Price Differential obligation.\40\ In addition, NSCC would anticipate
being in regular communication with the non-defaulting SFT Members as
to the timing of the satisfaction of any Final Settlement obligations
related to a defaulting SFT Member.
---------------------------------------------------------------------------

    \39\ See proposed Rule 56, Section 14(b)(ix).
    \40\ For example, assume that a Transferor and Transferee enter
into an SFT pursuant to which: (i) In the Initial Settlement on
Monday, the Transferor will transfer 100 shares of security X to the
Transferee against $100 per share; and (ii) in the Final Settlement
on Tuesday, the Transferee will transfer 100 shares of security X to
the Transferor against $100 per share. Assume further that at
midnight on Monday, NSCC ceases to act for the Transferor.
    On Tuesday, NSCC executes a sale of 100 shares of security X for
$99 per share. In accordance with the regular way settlement cycle
for purchases and sales of equity securities, this sale will settle
on Thursday.
    Pursuant to Section 14(b)(viii) of proposed Rule 56 (Securities
Financing Transaction Clearing Service), NSCC would likewise settle
the Final Settlement obligations of the defaulting Transferor's SFT
with the non-defaulting Transferee on Thursday.
    Assume further that the end-of-day price of security X on
Tuesday is $99 per share. On Wednesday, NSCC would pay $1 per share
in Price Differential to the non-defaulting Transferee pursuant to
Section 14(b)(ix) of proposed Rule 56. Assume further that the end-
of-day price of security X on Wednesday is $98 per share.
    On Thursday, NSCC would pay an additional $1 per share in Price
Differential to the non-defaulting Transferee pursuant to Section
14(b)(ix) of proposed Rule 56. The Transferee would then return 100
shares of security X to NSCC and receive $98 per share (i.e., the
current market price for security X) from NSCC. As such, the non-
defaulting Transferee would be made whole by NSCC for the $100 per
share it transferred in the Initial Settlement of the Defaulted-
Related SFT (as defined below and in the proposed rule change) since
NSCC would have transferred to it $98 per share in Final Settlement
plus an additional $2 per share in Price Differential.
    NSCC would incur a net loss of $1 per share in this example
since it would have sold security X for $99 per share and paid the
non-defaulting Transferee a total of $100 per share (i.e., $98 per
share in Final Settlement proceeds plus $2 per share in Price
Differential). NSCC would be entitled to deduct this amount from the
defaulted Transferor's Clearing Fund deposits (including its SFT
Deposit).
---------------------------------------------------------------------------

(iii) Sponsoring Members and Sponsored Members
    NSCC is proposing a sponsored membership program to allow Members
to play the role of pre-novation counterparty and credit intermediary
for their institutional firm clients in clearing.
    NSCC has modeled a number of the aspects of the proposed sponsored
member program, including the eligibility criteria and many of the risk
management requirements, on FICC's Sponsoring Member/Sponsored Member
Program. FICC's Sponsoring Member/Sponsored Member Program allows an
FICC Netting Member to sponsor an entity that satisfies certain
requirements and submit to FICC for novation certain securities
transactions between the Netting Member and the sponsored entity. These
securities transactions generally include the off-leg of repurchase
transactions on U.S. government or agency securities or straight
purchase and sales of such securities. Such transactions present
similar risk management, legal, accounting, and operation
considerations to SFTs, as both involve an obligation of a sponsored
member and a sponsoring member to exchange cash against securities.
Since 2005, FICC has worked with its members to improve its Sponsoring
Member/Sponsored Member Program to address these considerations. Based
on feedback from Members and its own internal assessments, NSCC
believes that leveraging the provisions of FICC's Sponsoring Member/
Sponsored Member program and the learning over the past decade and a
half would allow NSCC to provide a sponsored member program that has a
solid risk management, accounting, legal and operational foundation.
Sponsoring Members
    Under the proposal, all Members would be eligible to apply to
become Sponsoring Members in NSCC, subject to credit criteria that are
designed to be substantially similar to those applicable to category 2
sponsoring members in FICC's Sponsoring Member/Sponsored Member Program
for the reasons described above in Item II(A)1(iii) ``Sponsoring
Members and Sponsored Members.'' \41\ A Member whose application to
become a Sponsoring Member has been approved by the Board of Directors
or NSCC, as applicable, pursuant to proposed Rule 2C (``Sponsoring
Member'') would be permitted to sponsor their institutional firm
clients into membership as Sponsored Members. Such Sponsoring Members
would then be able to facilitate their institutional firm clients'
cleared activity via two back-to-back principal SFTs, i.e., client-to-
Sponsoring Member and Sponsoring Member-to-broker (or to another
institutional firm client that the Sponsoring Member has sponsored into
membership), and each of such transactions would be eligible for
novation to NSCC.
---------------------------------------------------------------------------

    \41\ If a Member is a Registered Broker-Dealer, then such Member
would only be eligible to apply to become a Sponsoring Member if it
satisfies the credit criteria in proposed Rule 2C (Sponsoring
Members and Sponsored Members) (i.e., if it has (i) Net Worth of at
least $25 million and (ii) excess net capital over the minimum net
capital requirement imposed by the SEC (or such higher minimum
capital requirement imposed by the Member's designated examining
authority) of at least $10 million). Such credit criteria are
comparable to the credit criteria applicable to category 2
sponsoring members that are registered broker-dealers in FICC's
Sponsoring Member/Sponsored Member Program. A Sponsoring Member
applicant would be viewed and surveilled as the credit counterparty
to NSCC in respect to its Sponsored Member Sub-Account(s) (as
defined below and in the proposed rule change) in light of its
responsibility to NSCC as the processing agent and unconditional
guarantor of its Sponsored Members' performance to NSCC.
     In addition, NSCC may require that a Person be a Member for a
time period deemed necessary by NSCC before that Person may be
considered to become a Sponsoring Member. This requirement may be
imposed by NSCC on a new Member that has yet to demonstrate a track
record of financial responsibility and operational capability.
     Furthermore, as proposed, the application of a Member to be a
Sponsoring Member at NSCC that is an Agent Clearing Member or an
existing FICC sponsoring member would not be required to be approved
by the NSCC Board of Directors. NSCC believes this approach to Board
of Director's approval for Sponsoring Members is appropriate in
light of the fact that the critical components of the FICC
sponsoring member application as well as the NSCC Sponsoring Member
and Agent Clearing Member applications and the criteria that the
respective boards assess when determining whether to admit a Member
in such respective capacities are substantially similar.
Nonetheless, NSCC would apply the same rigorous counterparty credit
review process to any Member applying to be a Sponsoring Member at
NSCC, whether or not the Member is an existing FICC sponsoring
member.
---------------------------------------------------------------------------

    Consistent with the requirements applicable to sponsoring members
in FICC's Sponsoring Member/Sponsored Member Program for the reasons
described above in Item II(A)1(iii) ``Sponsoring Members and Sponsored
Members,'' a Sponsoring Member would be responsible for (i) submitting
data on its Sponsored Members' SFTs to NSCC or appointing a third-party
Approved SFT Submitter to do so, (ii) posting to NSCC all of the
Clearing Fund associated with the SFT activity of its Sponsored
Members, which would be calculated on a gross basis (i.e., SFT activity
would not be netted across Sponsored Members for Clearing Fund
purposes), (iii) providing an unconditional guaranty to NSCC for its
Sponsored Members' Final Settlement and other obligations to NSCC, and
(iv) covering any default loss allocable to its Sponsored Members (in
addition to its own default loss allocation as a Member).

    Specifically, as proposed, a Sponsoring Member would be permitted
to submit to NSCC for novation Sponsored Member Transactions, subject
to an activity limit designed to be substantially similar to that
applicable to category 2 sponsoring members in FICC's Sponsoring
Member/Sponsored Member Program for the reasons described above in Item
II(A)1(iii) ``Sponsoring Members and Sponsored Members.'' Under the
proposal, if the sum of the Volatility Charges (as defined below and in
the proposed rule change) applicable to a Sponsoring Member's Sponsored
Member Sub-Accounts (as defined below and in the proposed rule change)
and its other accounts at NSCC exceeds its Net Member Capital (as
defined below and in the proposed rule change), the Sponsoring Member
would not be permitted to submit activity into its Sponsored Member
Sub-Accounts, unless otherwise determined by NSCC in order to promote
orderly settlement. As defined in Section 5 of proposed Rule 2C,
Sponsored Member Transactions are SFTs between a Sponsoring Member and
its Sponsored Members.
    The Sponsoring Member would establish one or more accounts at NSCC
for its Sponsored Members' positions arising from such Sponsored Member
Transactions, i.e., Sponsored Member Sub-Accounts, which would be
separate from the Sponsoring Member's proprietary accounts. For
operational and administrative purposes, NSCC would interact solely
with the Sponsoring Member as agent of its Sponsored Members.
    Sponsoring Members would be responsible for providing NSCC with a
Sponsoring Member Guaranty (as defined below and in the proposed rule
change) whereby the Sponsoring Member guarantees to NSCC the payment
and performance by its Sponsored Members of their obligations under the
Sponsored Member Transactions submitted by the Sponsoring Member for
novation. Although Sponsored Members are principally liable to NSCC for
their own settlement obligations under such transactions in accordance
with the Rules, the Sponsoring Member Guaranty requires the Sponsoring
Member to satisfy those settlement obligations on behalf of a Sponsored
Member if the Sponsored Member defaults and fails perform its
settlement obligations.
    In addition, a Sponsoring Member would be responsible for posting
to NSCC all of the Clearing Fund associated with the Sponsored Member
Transactions (which would not be netted across Sponsored Members for
Clearing Fund purposes) and covering any default loss allocable to its
Sponsored Members, as well as its own default loss allocation as a
Member.\42\
---------------------------------------------------------------------------

    \42\ The following example illustrates how loss allocation would
occur with respect to Sponsoring Members and Sponsored Members:
Assume NSCC incurs a $100 million aggregate loss from a Defaulting
Member Event. In addition, assume that the Corporate Contribution
amount that NSCC would first apply to any loss from a Defaulting
Member Event is $25 million. This means NSCC would allocate the
remaining $75 million losses (i.e., $100 million minus $25 million)
to Members pursuant to Section 4 of Rule 4 (Clearing Fund),
including Sponsored Member Sub-Accounts as if each were a Member. If
the allocated losses to a Sponsoring Member's Sponsored Member Sub-
Accounts is $1 million and the allocated losses to its Sponsoring
Member in its capacity as a Member is $2 million, the Sponsoring
Member would be responsible for a total of $3 million loss
allocation ($1 million for its Sponsored Member Sub-Account loss
allocation amount and $2 million for its own default loss allocation
as a Member).
---------------------------------------------------------------------------

    As proposed, consistent with FICC's Sponsoring Member/Sponsored
Member Program for the reasons described above in Item II(A)1(iii)
``Sponsoring Members and Sponsored Members,'' NSCC would also provide a
mechanism by which a Sponsoring Member may cause the termination and
liquidation of a Sponsored Member's positions arising from Sponsored
Member Transactions between the Sponsoring Member and such Sponsored
Member that have been novated to NSCC.\43\
---------------------------------------------------------------------------

    \43\ See Section 14 of proposed Rule 2C (Sponsoring Members and
Sponsored Members).
---------------------------------------------------------------------------

Sponsored Members
    Consistent with the requirements applicable to sponsored members in
FICC's Sponsoring Member/Sponsored Member Program for the reasons
described above in Item II(A)1(iii) ``Sponsoring Members and Sponsored
Members,'' any Person that has been approved by NSCC to be sponsored
into membership by a Sponsoring Member pursuant to proposed Rule 2C
(``Sponsored Member'') would be required to be either a ``qualified
institutional buyer'' as defined by Rule 144A\44\ under the Securities
Act of 1933, as amended (``Securities Act''),\45\ or a legal entity
that, although not organized as an entity specifically listed in
paragraph (a)(1)(i)(H) of Rule 144A under the Securities Act, satisfies
the financial requirements necessary to be a ``qualified institutional
buyer'' as specified in that paragraph.
---------------------------------------------------------------------------

    \44\ 17 CFR 230.144A.
    \45\ 15 U.S.C. 77a et seq.
---------------------------------------------------------------------------

(iv) Agent Clearing Members and Customers
    NSCC is proposing an agent clearing membership designed to allow
Members to play the role of agent and credit intermediary for their
institutional firm clients in clearing. This membership type is being
proposed in response to the request of certain market participants,
including in particular certain agent lending banks, that the proposed
SFT Clearing Service accommodate agent-style trading (i.e., where the
agent lender enters into the transactions on behalf of its
institutional firm clients with a third-party market participant,
rather than acting as its institutional firm clients' principal pre-
novation counterparty). Agent-style trading is the manner in which such
agent lenders are typically approved to transact in securities lending
transactions on behalf of their institutional firm clients. Under the
proposal, a Member that enters into transactions on behalf of its
institutional firm clients in accordance with the provisions of
proposed Rule 2D (``Agent Clearing Member'') would be permitted to
submit SFTs executed by it (as agent on behalf of its institutional
firm clients, with each such client referred to as a ``Customer'') with
a Member participating in the proposed SFT Clearing Service (which
could include a Member acting in a proprietary capacity within the
proposed SFT Clearing Service as well as an Agent Clearing Member).
    All Members would be eligible to apply to become Agent Clearing
Members in NSCC, subject to credit criteria that are substantially
similar to those applicable to Sponsoring Members as well as category 2
sponsoring members in FICC's Sponsoring Member/Sponsored Member
Program.\46\
---------------------------------------------------------------------------

    \46\ If a Member is a Registered Broker-Dealer, then such Member
would only be eligible to apply to become an Agent Clearing Member
if it satisfies the credit criteria in proposed Rule 2D (i.e., if it
has (i) Net Worth of at least $25 million and (ii) excess net
capital over the minimum net capital requirement imposed by the SEC
(or such higher minimum capital requirement imposed by the Member's
designated examining authority) of at least $10 million). Such
credit criteria are comparable to the credit criteria applicable to
sponsoring members that are registered broker-dealers in FICC's
Sponsoring Member/Sponsored Member Program. Similar to the review of
a Sponsoring Member applicant, an Agent Clearing Member applicant
would also be viewed and surveilled as the credit counterparty to
NSCC in light of its role as the Member with respect to its Agent
Clearing Member Customer Omnibus Account(s).
     In addition, NSCC may require a Person be a Member for a time
period deemed necessary by NSCC before that Person may be considered
to become an Agent Clearing Member. This requirement may be imposed
by NSCC on a new Member that has yet to demonstrate a track record
of financial responsibility and operational capability.
    Furthermore, as proposed, the application of a Member to be an
Agent Clearing Member at NSCC that is a Sponsoring Member or an
existing FICC sponsoring member would not be required to be approved
by the NSCC Board of Directors. NSCC believes this approach to the
Board of Director's approval for Agent Clearing Members is
appropriate in light of the fact that the critical components of the
FICC sponsoring member application as well as the NSCC Sponsoring
Member and Agent Clearing Member applications and the criteria that
the respective boards assess when determining whether to admit a
Member in such respective capacities are substantially similar.
Nonetheless, NSCC would apply the same rigorous counterparty credit
review process to any Member applying to be an Agent Clearing Member
at NSCC, whether or not the Member is an existing FICC sponsoring
member.

---------------------------------------------------------------------------

    Under the proposal, the requirements to be imposed on Agent
Clearing Members would largely mirror those imposed on Sponsoring
Members. However, NSCC is not proposing to impose the same types of
requirements on an Agent Clearing Member's Customers as it does on
Sponsored Members because a Customer would not be a direct member of
NSCC.
    Specifically, as proposed, an Agent Clearing Member would be
permitted to submit to NSCC for novation Agent Clearing Member
Transactions (as defined below and in the proposed rule change), on
behalf of one or more of its Customers, subject to an activity limit.
Specifically, under the proposal, if the sum of the Volatility Charges
applicable to an Agent Clearing Member's Agent Clearing Member Customer
Omnibus Account(s) (as defined below and in the proposed rule change)
and its other accounts at NSCC exceeds its Net Member Capital, the
Agent Clearing Member would not be permitted to submit activity into
its Agent Clearing Member Customer Omnibus Account(s), unless otherwise
determined by NSCC in order to promote orderly settlement. As defined
in Section 4 of proposed Rule 2D, Agent Clearing Member Transactions
are SFTs that an Agent Clearing Member submits to NSCC on behalf of one
or more Customers.
    The Agent Clearing Member would establish one or more accounts at
NSCC for its Customers' positions, i.e., an Agent Clearing Member
Customer Omnibus Account, that would be in the name of the Agent
Clearing Member for the benefit of its Customers; however, each Agent
Clearing Member Customer Omnibus Account may only contain activity
where the Agent Clearing Member is acting as Transferor on behalf of
its Customers, or as Transferee on behalf of its Customers, but not
both (i.e., activity would not be netted across Customers for Clearing
Fund purposes). Under the proposal, the Agent Clearing Member would act
solely as agent of its Customers in connection with the clearing of
Agent Clearing Member Transactions; however, the Agent Clearing Member
would remain fully liable for the performance of all obligations to
NSCC arising in connection with Agent Clearing Member Transactions.
    In addition, as proposed under the sponsoring/sponsored membership
model, the Agent Clearing Member would be responsible for posting to
NSCC all of the Clearing Fund associated with the activity of its
Customers and covering any default loss allocable to its Customers, as
well as its own default loss allocation as a Member; \47\ however,
unlike a Sponsoring Member, an Agent Clearing Member would not be
required to provide an unconditional guaranty to NSCC for its
Customer's obligations. This is because, as described above, the Agent
Clearing Member would be fully liable for all obligations of its
Customers under the Agent Clearing Member Transactions that it
submitted to NSCC as the Member.
---------------------------------------------------------------------------

    \47\ The following example illustrates how loss allocation would
occur with respect to Agent Clearing Members: Assume NSCC incurs a
$100 million aggregate loss from a Defaulting Member Event. In
addition, assume that the Corporate Contribution amount that NSCC
would first apply to any loss from a Defaulting Member Event is $25
million. This means NSCC would allocate the remaining $75 million
losses (i.e., $100 million minus $25 million) to Members pursuant to
Section 4 of Rule 4 (Clearing Fund), including Agent Clearing Member
Customer Omnibus Accounts as if each were a Member. If the allocated
losses to an Agent Clearing Member's Agent Clearing Member Customer
Omnibus Account is $1 million and the allocated losses to the Agent
Clearing Member in its capacity as a Member is $2 million, the Agent
Clearing Member would be responsible for a total of $3 million loss
allocation ($1 million for its Agent Clearing Member Customer
Omnibus Account loss allocation amount and $2 million for its own
default loss allocation as a Member).
---------------------------------------------------------------------------

    As proposed, NSCC would also provide a mechanism by which an Agent
Clearing Member may, upon a default of a Customer and consent of NSCC,
transfer Agent Clearing Member Transactions of the Customer established
in one or more of the Agent Clearing Member's Agent Clearing Member
Customer Omnibus Accounts from such Agent Clearing Member Customer
Omnibus Accounts to the Agent Clearing Member's proprietary account at
NSCC as a Member.\48\
---------------------------------------------------------------------------

    \48\ See Section 11 of proposed Rule 2D (Agent Clearing
Members).
---------------------------------------------------------------------------

(v) Sponsoring Member/Sponsored Member vs. Agent Clearing Member/
Customers
    The direct costs of central clearing (i.e., Clearing Fund, loss
allocation, fees and performance on behalf of an institutional firm
clients) would be largely equivalent as between what NSCC proposes to
apply to a Sponsoring Member and what NSCC proposes to apply to an
Agent Clearing Member. Likewise, the capital costs to Sponsoring
Members and Agent Clearing Members of intermediating institutional firm
activity as between the two buy-side clearing models would be largely
equivalent. That being said, because Sponsoring Members would be
required to ensure that (i) each of their clients separately onboards
with NSCC as a Sponsored Member (which NSCC understands is generally
required from an accounting perspective in order for the Sponsoring
Member to net on its balance sheet its SFTs with Sponsored Members
against the Sponsoring Member's other NSCC-cleared SFTs),\49\ (ii) each
of their client's SFTs is individually submitted to NSCC for clearing,
and (iii) each Sponsored Member continues to remain in compliance with
the financial standards applicable to Sponsored Members throughout the
course of its membership, Sponsoring Members may incur more legal,
onboarding, operational and ongoing administrative costs than Agent
Clearing Members with respect to their institutional firm clearing
activity.
---------------------------------------------------------------------------

    \49\ Supra note 11.
---------------------------------------------------------------------------

    However, the sponsoring/sponsored membership model allows for
principal-style trading between a Sponsoring Member and its Sponsored
Member where the Sponsoring Member and Sponsored Member are pre-
novation counterparties, which would generally create the opportunity
for a Sponsoring Member to make an economic spread between its trade
with its Sponsored Member and its offsetting trades with other NSCC
Members or Sponsored Members. The opportunity for such economic spread
and the ability of a Sponsoring Member to achieve balance sheet netting
and capital efficiency on such trading activity through the novation of
SFTs to NSCC could, for some market participants, offset the indirect
additional costs associated with acting as a Sponsoring Member, rather
than acting as an Agent Clearing Member.
    On the other hand, as NSCC understands it, for some market
participants, particularly agent lenders, their business models are not
typically predicated on principal-style trading. Rather, these agency
businesses typically charge fees for their services (rather than taking
economic spreads) and their business models and their agreed upon
investment guidelines with their institutional firm customers may only
permit agented (rather than principal-style) trading for securities
lending transactions. So, for such

market participants, participating in clearing at NSCC as an Agent
Clearing Member may be a better fit for their overall business model.
    From the perspective of an institutional firm client, the costs of
clearing that may be passed through to it by its intermediary
(depending on their commercial arrangements) would be largely
equivalent. That said, some institutional firms that engage in
securities lending may be prohibited from acting as Sponsored Members
and engaging in principal-style trading with their intermediary in
clearing for regulatory and/or investment guideline reasons. For those
institutional firms, being able to transact SFTs as a Customer within
an Agent Clearing Member Customer Omnibus Account would offer them a
means to access central clearing that would otherwise not be available
to them if the sponsoring/sponsored membership model were the only
model available for buy-side clearing.
(vi) Proposed Rule Changes
(A) Proposed Rule 2C--Sponsoring Members and Sponsored Members
    NSCC is proposing to add Rule 2C, entitled ``Sponsoring Members and
Sponsored Members.'' This new rule would govern the proposed sponsored
membership and would be comprised of 14 sections, each of which is
described below.
Proposed Rule 2C, Section 1 (General)
    Section 1 of proposed Rule 2C would be a general provision
regarding the Rules applicable to Sponsoring Members and Sponsored
Members.
    Section 1 of proposed Rule 2C would provide that NSCC will permit
the establishment of a sponsored membership relationship between a
Member that is approved as a Sponsoring Member and one or more Persons
that are accepted by NSCC as Sponsored Members of that particular
Sponsoring Member. Section 1 of proposed Rule 2C would further provide
that the rights, liabilities and obligations of Sponsoring Members and
Sponsored Members shall be governed by proposed Rule 2C, and that
references to the term ``Member'' in other Rules would not apply to
Sponsoring Members and to Sponsored Members, in their respective
capacities as such, unless specifically noted as such in proposed Rule
2C or in such other Rules.
    Section 1 of proposed Rule 2C would also provide that a Sponsoring
Member shall continue to have all of the rights, liabilities and
obligations as set forth in the Rules and in any agreement between it
and NSCC pertaining to its status as a Member, and such rights,
liabilities and obligations shall be separate from its rights,
liabilities and obligations as a Sponsoring Member except as
contemplated under Sections 7, 8 and 9 of proposed Rule 2C and under
the Sponsoring Member Guaranty.
Proposed Rule 2C, Section 2 (Qualifications of Sponsoring Members, the
Application Process and Continuance Standards)
    Section 2 of proposed Rule 2C would establish the eligibility
requirements for Members that wish to become Sponsoring Members, the
membership application process that would be required of each Member to
become a Sponsoring Member, the on-going membership requirements that
would apply to Sponsoring Members, as well as the requirements
regarding a Sponsoring Member's election to voluntarily terminate its
membership.
    Under Section 2(a) of proposed Rule 2C, any Member would be
eligible to apply to become a Sponsoring Member; however, if a Member
is a Registered Broker-Dealer, such Member would only be permitted to
apply to become a Sponsoring Member if it has (1) Net Worth (as defined
below and in the proposed rule change) of at least $25 million and (2)
excess net capital over the minimum net capital requirement imposed by
the Commission (or such higher minimum capital requirement imposed by
the Member's designated examining authority) of at least $10
million.\50\ In connection therewith, NSCC is proposing ``Net Worth''
to mean, as of a particular date, the amount equal to the excess of the
assets of a Person over the liabilities of such Person, computed in
accordance with generally accepted accounting principles, and for
Registered Broker-Dealers, Net Worth shall include liabilities that are
subordinated to the claims of creditors pursuant to a satisfactory
subordination agreement, as defined in Appendix D to Rule 15c3-1 of the
Act.\51\ As proposed, NSCC may require that a Person be a Member for a
certain time period before that Person may be considered to become a
Sponsoring Member.
---------------------------------------------------------------------------

    \50\ NSCC is proposing these financial minimums for Registered
Broker-Dealer Sponsoring Member applicants to reflect the additional
responsibility that the applicant would undertake as a Sponsoring
Member. These financial minimums are determined based on NSCC's
assessment of the minimum capital that would be necessary for a
broker-dealer to conduct meaningful level of NSCC-cleared activity
while serving as a credit counterparty in respect of others' trades.
In its assessment, NSCC considered various factors, such as the
amount of a Registered Broker-Dealer Member's capital and its impact
on such Member's financial responsibility and operational
capability, comparability with the financial requirements of other
clearing agencies, and the desire to strike a balance between credit
risk mitigation and member accessibility. For the reasons described
above in Item II(A)1(iii) ``Sponsoring Members and Sponsored
Members,'' these financial minimums are also designed to be
consistent with the requirements applicable to registered broker/
dealers that are sponsoring members in FICC's Sponsoring Member/
Sponsored Member Program.
    \51\ 17 CFR 240.15c3-1d.
---------------------------------------------------------------------------

    Section 2(b) of proposed Rule 2C would provide that each Member
applicant to become a Sponsoring Member would be required to provide an
application and other information requested by NSCC. Sponsoring Member
applications shall first be reviewed by NSCC and would require the
Board of Directors' approval, unless the Member applicant is already an
Agent Clearing Member under proposed Rule 2D or a sponsoring member of
FICC.\52\ NSCC believes this approach to the Board of Director's
approval for Sponsoring Members is appropriate in light of the fact
that the critical components of the FICC sponsoring member application
as well as the NSCC Sponsoring Member and Agent Clearing Member
applications and the criteria that the respective boards assess when
determining whether to admit a Member in such respective capacities are
substantially similar.
---------------------------------------------------------------------------

    \52\ It is NSCC's understanding that FICC is evaluating a change
to the GSD Rules to provide that the application of an FICC
sponsoring member applicant that is already an NSCC Sponsoring
Member or Agent Clearing Member would not require approval of FICC's
board of directors.
---------------------------------------------------------------------------

    Under Section 2(c) of proposed Rule 2C, if the Sponsoring Member
application is denied, such denial would be handled in accordance with
Section 1 of Rule 2A (Initial Membership Requirements).
    As proposed in Section 2(d) of proposed Rule 2C, NSCC may impose
additional financial requirements on a Sponsoring Member applicant
based upon the level of the anticipated positions and obligations of
such applicant, the anticipated risk associated with the volume and
types of transaction such applicant proposes to process through NSCC as
a Sponsoring Member and the overall financial condition of such
applicant. Under the proposal, with respect to an application of a
Member to become a Sponsoring Member that requires the Board of
Directors' approval, the Board of Directors shall also approve any
increased financial requirements imposed by NSCC in connection with the
approval of the application, and NSCC would thereafter regularly review
such Sponsoring Member regarding its

compliance with the increased financial requirements.\53\
---------------------------------------------------------------------------

    \53\ If the increased financial requirements are imposed in
connection with a Sponsoring Member application that does not
require the Board of Directors' approval, the increased financial
requirements would not be subject to the Board of Directors'
approval. Nonetheless, once a Sponsoring Member application is
approved with increased financial requirements, NSCC would
thereafter regularly review such Sponsoring Member regarding its
continued adherence to such increased financial requirements as well
as determine whether such increased financial requirements are still
appropriate. If the Sponsoring Member is unable to adhere to the
increased financial requirements, the Board of Directors may,
pursuant to Section 10 of proposed Rule 2C, suspend, prohibit or
limit the Sponsoring Member's access to NSCC's services.
---------------------------------------------------------------------------

    In addition, under Section 2(e) of proposed Rule 2C, NSCC may
require each Sponsoring Member or any Sponsoring Member applicant to
furnish adequate assurances of such Sponsoring Member or Sponsoring
Member applicant's financial responsibility and operational capability
within the meaning of Rule 15 (Assurances of Financial Responsibility
and Operational Capability), as NSCC may at any time or from time to
time deem necessary or advisable in order to protect NSCC, its
participants, creditors or investors, to safeguard securities and funds
in the custody or control of NSCC and for which NSCC is responsible, or
to promote the prompt and accurate clearance, settlement and processing
of securities transactions.\54\
---------------------------------------------------------------------------

    \54\ As an example, NSCC may require a Sponsoring Member or a
Sponsoring Member applicant to furnish adequate assurances of such
Sponsoring Member or Sponsoring Member applicant's financial
responsibility and operational capability if NSCC has concerns about
such Sponsoring Member or Sponsoring Member applicant's overall
financial health or credit rating.
---------------------------------------------------------------------------

    Section 2(f) of proposed Rule 2C would provide that each Member
whose Sponsoring Member application is approved would sign and deliver
to NSCC (i) an agreement between NSCC and the Member and specifies the
terms and conditions deemed by NSCC to be necessary in order to protect
itself and its participants (``Sponsoring Member Agreement''), (ii) a
guaranty, in the form and substance acceptable to NSCC, whereby the
Member, in its capacity as a Sponsoring Member, guarantees to NSCC the
payment and performance by its Sponsored Members of their obligations
under the Rules in respect of the Sponsoring Member's Sponsored Member
Sub-Accounts, including, without limitation all of the settlement
obligations of its Sponsored Members in respect of such Sponsored
Member Sub-Accounts (``Sponsoring Member Guaranty''), and a related
legal opinion in a form satisfactory to NSCC. In addition, Section 2(f)
of proposed Rule 2C would provide that nothing in the Rules shall
prohibit a Sponsoring Member from seeking reimbursement from a
Sponsored Member for payments made by the Sponsoring Member (whether
pursuant to the Sponsoring Member Guaranty, out of Clearing Fund
deposits or otherwise) with respect to obligations as to which the
Sponsored Member is a principal obligor under the Rules, or as
otherwise may be agreed by the Sponsored Member and Sponsoring Member.
    Section 2(g) of proposed Rule 2C would provide that each Sponsoring
Member shall submit to NSCC, within the timeframes and in the formats
required by NSCC, the reports and information that all Members are
required to submit regardless of type of Member and the reports and
information required to be submitted for its respective type of Member,
all pursuant to Section 2 of Rule 2B (Ongoing Membership Requirements
and Monitoring) and, if applicable, Addendum O (Admission of Non-US
Entities as Direct NSCC Members).
    Section 2(h) of proposed Rule 2C would provide that a Sponsoring
Member's books and records, insofar as they relate to the Sponsored
Member Transactions submitted to NSCC, shall be open to the inspection
of the duly authorized representatives of NSCC to the same extent
provided in Rule 2A (Initial Membership Requirements) for other
Members.
    Section 2(i) of proposed Rule 2C would provide that a Sponsoring
Member shall promptly inform NSCC, both orally and in writing, if it is
no longer in compliance with the relevant standards and qualifications
for applying to become a Sponsoring Member set forth in the proposed
Rule 2C. Notification must take place immediately and in no event later
than 2 Business Days from the date on which the Sponsoring Member first
learns of its non-compliance. As proposed, NSCC would assess a fine in
accordance with the Fine Schedule in Addendum P against any Sponsoring
Member that fails to so notify NSCC.\55\ If the Sponsoring Member fails
to remain in compliance with the relevant standards and qualifications,
NSCC would, if necessary, undertake appropriate action to determine the
status of the Sponsoring Member and its continued eligibility as such.
In addition, NSCC may review the financial responsibility and
operational capability of the Sponsoring Member, and otherwise require
from the Sponsoring Member additional reports of its financial or
operational condition at such intervals and in such detail as NSCC
shall determine. In addition, if NSCC has reason to believe that a
Sponsoring Member may fail to comply with any of the Rules applicable
to Sponsoring Members, it may require the Sponsoring Member to provide
it, within such timeframe, and in such detail, and pursuant to such
manner as NSCC shall determine, with assurances in writing of a
credible nature that the Sponsoring Member shall not, in fact, violate
any of the Rules.
---------------------------------------------------------------------------

    \55\ See Addendum P (Fine Schedule), supra note 4.
---------------------------------------------------------------------------

    Section 2(j) of proposed Rule 2C would provide that in the event
that a Sponsoring Member fails to remain in compliance with the
relevant requirements of the Rules, the Sponsoring Member Agreement or
the Sponsoring Member Guaranty, NSCC shall have the right to cease to
act for the Sponsoring Member in its capacity as a Sponsoring Member
pursuant to Section 10 of proposed Rule 2C, unless the Sponsoring
Member requests that such action not be taken and NSCC determines that,
depending upon the specific circumstances and the record of the
Sponsoring Member, it is appropriate instead to establish for such
Sponsoring Member a time period, which shall be determined by NSCC and
which shall be no longer than 30 calendar days unless otherwise
determined by NSCC, during which the Sponsoring Member must resume
compliance with such requirements. As proposed, in the event that the
Sponsoring Member is unable to satisfy such requirements within the
time period specified by NSCC, NSCC shall, pursuant to the Rules, cease
to act for the Sponsoring Member in its capacity as a Sponsoring Member
pursuant to Section 10 of the proposed Rule 2C.
    Section 2(k) of proposed Rule 2C would provide that if the sum of
the Volatility Charges applicable to a Sponsoring Member's Sponsored
Member Sub-Accounts and its other accounts at NSCC exceeds its Net
Member Capital (as defined below and in the proposed rule change), the
Sponsoring Member shall not be permitted to submit activity into its
Sponsored Member Sub-Accounts, unless otherwise determined by NSCC in
order to promote orderly settlement.\56\ As proposed, ``Volatility

Charge'' would mean, in respect to a Member, the amount of its Required
Fund Deposit calculated by NSCC by applying Sections I.(A)(1)(a)(i)-
(iv) of Procedure XV (Clearing Fund Formula and Other Matters); ``Net
Member Capital'' would mean Net Capital (as defined below and in the
proposed rule change), net assets or equity capital, as applicable to a
Member, based on the type of regulation, and in particular the capital
requirements, to which the Member is subject; and ``Net Capital'' would
mean, as of a particular date, the amount equal to the net capital of a
Registered Broker-Dealer as defined in Rule 15c3-1(c)(2) of the
Act,\57\ or any successor rule or regulation thereto.
---------------------------------------------------------------------------

    \56\ NSCC selected the Volatility Charges and Net Member Capital
as the criteria for purposes of establishing the activity limit for
Sponsoring Members. This is because a Sponsoring Member's total
Volatility Charges being in excess of its Net Member Capital is an
important indicator that the Sponsoring Member's financial
resources, as measured by its Net Capital, net assets or equity
capital, may be insufficient to meet the largest component of its
Required Fund Deposit (i.e., Volatility Charges).
    \57\ 17 CFR 240.15c3-1(c)(2).
---------------------------------------------------------------------------

    Section 2(l) of proposed Rule 2C would provide that a Sponsoring
Member may voluntarily elect to terminate its status as a Sponsoring
Member, with respect to all Sponsored Members or with respect to one or
more Sponsored Members from time to time, by providing NSCC with a
written notice from a Sponsoring Member to NSCC that the Sponsoring
Member is voluntarily electing to terminate its status as a Sponsoring
Member with respect to all of its Sponsored Members or with respect to
one or more of its Sponsored Members (``Sponsoring Member Voluntary
Termination Notice''). The Sponsoring Member shall specify in the
Sponsoring Member Voluntary Termination Notice the Sponsored Member(s)
in respect of which the Sponsoring Member is terminating its status
(the ``Former Sponsored Members'') and a desired date for such
termination, which date shall not be prior to the scheduled Final
Settlement Date of any remaining obligation owed by the Sponsoring
Member to NSCC with respect to the Former Sponsored Members as of the
time such Sponsoring Member Voluntary Termination Notice is submitted
to NSCC, unless otherwise approved by NSCC.
    Section 2(l) of proposed Rule 2C would also provide that such
termination would not be effective until accepted by NSCC, which shall
be no later than 10 Business Days after the receipt of the Sponsoring
Member Voluntary Termination Notice from such Sponsoring Member. NSCC's
acceptance shall be evidenced by a notice to NSCC's participants
announcing the termination of the Sponsoring Member's status as such
with respect to the Former Sponsored Members and the date on which the
termination of the Sponsoring Member's status as a Sponsoring Member
becomes effective (``Sponsoring Member Termination Date''). As
proposed, after the close of business on the Sponsoring Member
Termination Date, the Sponsoring Member shall no longer be eligible to
submit Sponsored Member Transactions on behalf of the Former Sponsored
Members, and each Former Sponsored Member shall cease to be a Sponsored
Member unless it is the Sponsored Member of another Sponsoring Member.
If any Sponsored Member Transactions is submitted to NSCC by the
Sponsoring Member on behalf of a Former Sponsored Member that is
scheduled to settle after the Sponsoring Member Termination Date, such
Sponsoring Member's Sponsoring Member Voluntary Termination Notice
would be deemed void, and the Sponsoring Member would remain subject to
the proposed Rule 2C as if it had not given such Sponsoring Member
Voluntary Termination Notice.
    Section 2(m) of proposed Rule 2C would provide that a Sponsoring
Member's voluntary termination of its status as such, in whole or in
part, shall not affect its obligations to NSCC, or the rights of NSCC,
including under the Sponsoring Member Guaranty, with respect to
Sponsored Member Transactions submitted to NSCC before the applicable
Sponsoring Member Termination Date. Any such Sponsored Member
Transactions that have been novated to NSCC shall continue to be
processed by NSCC. The return of the Sponsoring Member's Clearing Fund
deposit shall be governed by Section 7 of Rule 4 (Clearing Fund). If an
Event Period were to occur after a Sponsoring Member has submitted the
Sponsoring Member Voluntary Termination Notice but on or prior to the
Sponsoring Member Termination Date, in order for the Sponsoring Member
to benefit from its Loss Allocation Cap pursuant to Section 4 of Rule
4, the Sponsoring Member would need to comply with the provisions of
Section 6 of Rule 4 and submit a Loss Allocation Withdrawal Notice,
which notice, upon submission, shall supersede and void any pending
Sponsoring Member Voluntary Termination Notice previously submitted by
the Sponsoring Member.
    Section 2(n) of proposed Rule 2C would provide that any non-public
information furnished to NSCC pursuant to proposed Rule 2C shall be
held in confidence as may be required under the laws, rules and
regulations applicable to NSCC that relate to the confidentiality of
records. Section 2(n) would also provide that each Sponsoring Member
shall maintain DTCC Confidential Information in confidence to the same
extent and using the same means it uses to protect its own confidential
information, but no less than a reasonable standard of care, and shall
not use DTCC Confidential Information or disclose DTCC Confidential
Information to any third party except as necessary to perform such
Sponsoring Member's obligations under the Rules or as otherwise
required by applicable law. Section 2(n) would further provide that
each Sponsoring Member acknowledges that a breach of its
confidentiality obligations under the Rules may result in serious and
irreparable harm to NSCC and/or DTCC for which there is no adequate
remedy at law. In addition, Section 2(n) would provide that in the
event of such a breach by the Sponsoring Member, NSCC and/or DTCC shall
be entitled to seek any temporary or permanent injunctive or other
equitable relief in addition to any monetary damages thereunder.\58\
---------------------------------------------------------------------------

    \58\ Section 2(n) of proposed Rule 2C is designed to be
consistent with NSCC's proposed change to revise certain provisions
in the Rules relating to the confidentiality of information
furnished by participants. See Securities Exchange Act Release No.
92334 (July 7, 2021), 86 FR 36815 (July 13, 2021) (SR-NSCC-2021-
007).
---------------------------------------------------------------------------

Proposed Rule 2C, Section 3 (Qualifications of Sponsored Members,
Approval Process and Continuance Standards)
    Section 3 of proposed Rule 2C would establish the eligibility
requirements for Sponsored Members, the membership application process
that would be required of each Sponsored Member, the on-going
membership requirements that would apply to Sponsored Members, as well
as the requirements regarding a Sponsored Member's election to
voluntarily terminate its membership.
    Section 3(a) of proposed Rule 2C would provide that a Person shall
be eligible to apply to become a Sponsored Member if: (x) It is
sponsored into membership by a Sponsoring Member, and (y) it (1) is a
``qualified institutional buyer'' as defined by Rule 144A \59\ under
the Securities Act,\60\ or (2) is a legal entity that, although not
organized as an entity specifically listed in paragraph (a)(1)(i)(H) of
Rule 144A under the Securities Act, satisfies the financial
requirements necessary to be a ``qualified institutional buyer'' as
specified in that paragraph. NSCC would have the right to rely on the
representation provided by the

Sponsoring Member regarding satisfaction of (y).
---------------------------------------------------------------------------

    \59\ 17 CFR 230.144A.
    \60\ 15 U.S.C. 77a et seq.
---------------------------------------------------------------------------

    Section 3(b) of proposed Rule 2C would provide that each time that
a Sponsoring Member wishes to sponsor a Person into membership, it
shall provide NSCC with the representation referred to in Section 3(a)
of proposed Rule 2C, as well as any additional information in such form
as may be prescribed by NSCC. NSCC shall approve or disapprove Persons
as Sponsored Members. If NSCC denies the request of a Sponsoring Member
to add a Person as a Sponsored Member, such denial shall be handled in
the same manner as set forth in Section 1 of Rule 2A (Initial
Membership Requirements) with respect to membership applications except
that the written statement referred to therein shall be provided to
both the Sponsoring Member and the Person seeking to become a Sponsored
Member.
    Section 3(c) of proposed Rule 2C would provide that each Person to
become a Sponsored Member shall sign and deliver to NSCC an agreement
whereby the Person shall agree to any terms and conditions deemed by
NSCC to be necessary in order to protect itself and its participants
(the ``Sponsored Member Agreement''). Each Person to become a Sponsored
Member that shall be an FFI Member must be FATCA Compliant.
    Section 3(d) of proposed Rule 2C would provide that a Sponsored
Member shall immediately inform its Sponsoring Member, both orally and
in writing, if the Sponsored Member is no longer in compliance with the
requirements of Section 3(a) of proposed Rule 2C. A Sponsoring Member
shall promptly inform NSCC, both orally and in writing, if a Sponsored
Member is no longer in compliance with the requirements of Section 3(a)
of proposed Rule 2C. Notification to NSCC by the Sponsoring Member must
take place within one (1) Business Day from the date on which the
Sponsoring Member first learns of the Sponsored Member's non-
compliance. NSCC would assess a fine in accordance with the Fine
Schedule in Addendum P against any Sponsoring Member that fails to so
notify NSCC.\61\
---------------------------------------------------------------------------

    \61\ See Addendum P (Fine Schedule), supra note 4.
---------------------------------------------------------------------------

    Section 3(e) of proposed Rule 2C would provide that a Sponsored
Member may voluntarily elect to terminate its membership by providing
NSCC with a written notice from the Sponsored Member to NSCC that the
Sponsored Member is voluntarily electing to terminate its membership
(``Sponsored Member Voluntary Termination Notice''). The Sponsored
Member shall specify in the Sponsored Member Voluntary Termination
Notice a desired date for the termination, which date shall not be
prior to the scheduled Final Settlement Date of any remaining
obligation owed by the Sponsored Member to NSCC as of the time such
Sponsored Member Voluntary Termination Notice is submitted to NSCC,
unless otherwise approved by NSCC.
    In addition, Section 3(e) of proposed Rule 2C would provide that
such termination would not be effective until accepted by NSCC, which
shall be no later than 10 Business Days after the receipt of the
Sponsored Member Voluntary Termination Notice from such Sponsored
Member. NSCC's acceptance shall be evidenced by a notice to NSCC's
participants announcing the termination of the Sponsored Member and the
date on which the termination of the Sponsored Member becomes effective
(``Sponsored Member Termination Date''). After the close of business on
the Sponsored Member Termination Date, the relevant Sponsoring Member
shall no longer be eligible to submit Sponsored Member Transactions on
behalf of the Sponsored Member. If any Sponsored Member Transaction is
submitted to NSCC by the relevant Sponsoring Member on behalf of the
Sponsored Member that is scheduled to settle after the Sponsored Member
Termination Date, such Sponsored Member's Sponsored Member Voluntary
Termination Notice would be deemed void, and the Sponsored Member would
remain subject to the proposed Rule 2C as if it had not given such
Sponsored Member Voluntary Termination Notice.
    Section 3(f) of proposed Rule 2C would provide that a Sponsored
Member's voluntary termination shall not affect its obligations to
NSCC, or the rights of NSCC, including under the Sponsoring Member
Guaranty, with respect to Sponsored Member Transactions submitted to
NSCC before the Sponsored Member Termination Date, and the Sponsoring
Member Guaranty shall remain in effect to cover all outstanding
obligations of the Sponsored Member to NSCC that are within the scope
of such Sponsoring Member Guaranty.
Proposed Rule 2C, Section 4 (Compliance With Laws)
    Section 4 of proposed Rule 2C would provide that each Sponsoring
Member and Sponsored Member shall comply in all material respects with
all applicable laws, including applicable laws relating to securities,
taxation and money laundering, as well as global sanctions laws, in
connection with the use of NSCC's services.
Proposed Rule 2C, Section 5 (Sponsored Member Transactions)
    Section 5 of proposed Rule 2C would provide that a Sponsoring
Member shall be permitted to submit to NSCC SFTs between itself and its
Sponsored Members (``Sponsored Member Transactions'') in accordance
with proposed Rule 56, as described below. Section 5 of proposed Rule
2C would further provide that NSCC directs each Sponsored Member and
Sponsoring Member to settle all Final Settlement, Rate Payment, Price
Differential, and other securities delivery and payment obligations
arising under a Sponsored Member Transaction that has been novated to
NSCC by causing the relevant cash and securities to be transferred to
the Transferor or Transferee, as applicable, on the books and records
of the Sponsoring Member, and each Sponsored Member and Sponsoring
Member agrees that any such transfer shall satisfy NSCC's corresponding
obligation with respect to such Sponsored Member Transaction.
Proposed Rule 2C, Section 6 (Sponsoring Member Agent Obligations)
    Section 6 of proposed Rule 2C would provide that a Sponsored Member
shall appoint its Sponsoring Member to act as agent with respect to the
Sponsored Member's satisfaction of its settlement obligations arising
under Sponsored Member Transactions between the Sponsored Member and
the Sponsoring Member and for performing all functions and receiving
reports and information set forth in the Rules. NSCC's provision of
such reports and information to the Sponsoring Member shall constitute
satisfaction of any obligation of NSCC to provide such reports and
information to the affected Sponsored Members. As proposed,
notwithstanding the foregoing and any other activities the Sponsoring
Member may perform in its capacity as agent for Sponsored Members, each
Sponsored Member shall be obligated as principal to NSCC with respect
to all settlement obligations under the Rules, and the Sponsoring
Member shall not be a principal under the Rules with respect to
settlement obligations of its Sponsored Members.
Proposed Rule 2C, Section 7 (Clearing Fund Obligations)
    Section 7 of proposed Rule 2C would set forth the Clearing Fund
obligations.

    Section 7(a) of proposed Rule 2C would provide that NSCC shall
maintain a ledger maintained on the books and records of NSCC for a
Sponsoring Member that reflects the outstanding SFTs that a Sponsoring
Member enters into in respect of a Sponsored Member and that have been
novated to NSCC, the SFT Positions or SFT Cash associated with those
transactions and any debits or credits of cash associated with such
transactions effected pursuant to Rule 12 (Settlement) (each a
``Sponsored Member Sub-Account''). Each Sponsoring Member shall make
and maintain so long as such Member is a Sponsoring Member a deposit to
the Clearing Fund as a Required Fund Deposit to support the activity in
its Sponsored Member Sub-Accounts (the ``Sponsoring Member Required
Fund Deposit''). Deposits to the Clearing Fund would be held by NSCC or
its designated agents, to be applied as provided in the Rules.
    Section 7(b) of proposed Rule 2C would provide that, in the
ordinary course, for purposes of satisfying the Sponsoring Member's
Clearing Fund requirements under the Rules for its Member activity, its
Sponsoring Member activity, and, to the extent applicable, its Agent
Clearing Member activity, the Sponsoring Member's proprietary accounts,
its Sponsored Member Sub-Accounts, and its Agent Clearing Member
Customer Omnibus Account(s), if any, shall be treated separately, as if
they were accounts of separate entities. Notwithstanding the previous
sentence, however, NSCC may, in its sole discretion, at any time and
without prior notice to the Sponsoring Member (but being obligated to
give notice to the Sponsoring Member as soon as possible thereafter)
and whether or not the Sponsoring Member or any of its Sponsored
Members is in default of its obligations to NSCC, treat the Sponsoring
Member's accounts as a single account for the purpose of applying
Clearing Fund deposits; apply Clearing Fund deposits made by the
Sponsoring Member with respect to any account as necessary to ensure
that the Sponsoring Member meets all of its obligations to NSCC under
any other account(s); and otherwise exercise all rights to offset and
net against the Clearing Fund deposits any net obligations among any or
all of the accounts, whether or not any other Person is deemed to have
any interest in such account.\62\
---------------------------------------------------------------------------

    \62\ NSCC believes it unlikely that it would exercise this
authority, as the Clearing Fund deposits associated with each
Sponsored Member Sub-Account, Agent Clearing Member Customer Omnibus
Account and proprietary account of a Sponsoring Member are designed
to be sufficient to cover the obligations of such account or sub-
account. However, if a Sponsoring Member defaults or fails to
perform and the Clearing Fund deposits associated with a given
account or sub-account of such Sponsoring Member are not sufficient
to discharge the Sponsoring Member's obligations in relation to such
account or sub-account, NSCC would look to the Clearing Fund
deposits related to the Sponsoring Member's other accounts or sub-
accounts. For example, if NSCC ceased to act for a Sponsoring Member
and the close-out of the SFT Positions established in the Sponsoring
Member's Sponsored Member Sub-Accounts resulted in a loss to NSCC in
excess of the Clearing Fund previously posted by the Sponsoring
Member in relation to such SFT Positions, NSCC may apply to the
excess any other Clearing Fund deposits posted by the Sponsoring
Member to NSCC, such as Clearing Fund posted in connection with the
proprietary positions of the Sponsoring Member. Similarly, if a
Sponsoring Member failed to perform under the Sponsoring Member
Guaranty outside the context of a cease-to-act situation and the
Clearing Fund previously posted by the Sponsoring Member in relation
to the SFT Positions established in the Sponsoring Member's
Sponsored Member Sub-Accounts was not sufficient to satisfy the
obligations under the Sponsoring Member Guaranty, NSCC may apply to
the remainder any other Clearing Fund deposits posted by the
Sponsoring Member to NSCC.
    NSCC believes this is appropriate because the Clearing Fund
deposits of a Sponsoring Member are the proprietary assets of the
Sponsoring Member, and NSCC generally has the right to apply the
Clearing Fund deposits of a Member to any of the Member's
obligations to NSCC, regardless of whether those were the
obligations that generated the Clearing Fund deposit requirement.
NSCC therefore believes that, consistent with the FICC Sponsoring
Member/Sponsored Member Program for the reasons described above in
Item II(A)1(iii) ``Sponsoring Members and Sponsored Members,'' a
Sponsoring Member's Clearing Fund deposits should be available to
satisfy any of the Sponsoring Member's guaranty or other obligations
to NSCC.
---------------------------------------------------------------------------

    Section 7(c) of proposed Rule 2C would provide that the Sponsoring
Member Required Fund Deposit for each Sponsored Member Sub-Account
shall be calculated separately based on the Sponsored Member
Transactions in such Sponsored Member Sub-Account, and the Sponsoring
Member shall, as principal, be required to satisfy the Sponsoring
Member Required Fund Deposit for each of the Sponsoring Member's
Sponsored Member Sub-Accounts.
    Section 7(d) of proposed Rule 2C would provide that Sections 1, 2,
4, 5, 6, 7, 8, 9, 10, 11 and 12 of Rule 4 (Clearing Fund) shall apply
to the Sponsoring Member Required Fund Deposit with respect to
obligations of a Sponsoring Member under the Rules, including its
obligations arising under the Sponsored Member Sub-Accounts, and the
obligations of a Sponsoring Member under its Sponsoring Member Guaranty
to the same extent as such sections apply to any Required Fund Deposit
and any other obligations of a Member. For purposes of Section 1 of
Rule 4, obligations and liabilities of a Member to NSCC that shall be
secured shall include, without limitation, a Member's obligations as a
Sponsoring Member under the Rules, including, without limitation, any
obligation of any such Sponsoring Member to provide the Sponsoring
Member Required Fund Deposit, such Sponsoring Member's obligations
arising under the Sponsored Member Sub-Accounts of such Sponsoring
Member and such Sponsoring Member's obligations under its Sponsoring
Member Guaranty.
    Section 7(e) of proposed Rule 2C would provide that a Sponsoring
Member shall be subject to such fines as may be imposed in accordance
with the Rules for any late satisfaction of a Clearing Fund deficiency
call.
Proposed Rule 2C, Section 8 (Right of Offset)
    Section 8 of proposed Rule 2C would provide that in the ordinary
course, with respect to satisfaction of any Sponsored Member's
obligations under the Rules, the Sponsoring Member's Sponsored Member
Sub-Accounts, the Sponsoring Member's proprietary accounts, and the
Sponsoring Member's Agent Clearing Member Customer Omnibus Accounts, if
any, at NSCC shall be treated separately, as if they were accounts of
separate entities. Notwithstanding the previous sentence, however, NSCC
may, in its sole discretion, at any time any obligation of the
Sponsoring Member arises under the Sponsoring Member Guaranty to pay or
perform thereunder with respect to any Sponsored Member, exercise a
right of offset and net any such obligation of the Sponsoring Member
under its Sponsoring Member Guaranty against any obligations of NSCC to
the Sponsoring Member in respect of such Sponsoring Member's
proprietary accounts at NSCC.\63\ NSCC would generally anticipate
exercising this right if, upon a Sponsoring Member default, the
Sponsoring Member owed an amount under the Sponsoring Member Guaranty
and was owed an amount by NSCC in relation to the Sponsoring

Member's proprietary or other obligations.
---------------------------------------------------------------------------

    \63\ NSCC believes the most likely circumstance in which it
would exercise this authority would be in the context of a
Sponsoring Member default. If, in such circumstance, NSCC realizes a
profit in closing out the positions associated with a proprietary
account of the Sponsoring Member, but incurs a loss in closing out
the positions associated with the Sponsored Member Sub-Accounts of
the Sponsoring Member, it would offset its obligation to turn over
to the Sponsoring Member the gains in relation to the Sponsoring
Member's proprietary account against the obligations of the
Sponsoring Member under the Sponsoring Member Guaranty.
---------------------------------------------------------------------------

Proposed Rule 2C, Section 9 (Loss Allocation Obligations)
    Section 9 of proposed Rule 2C would establish loss allocation
obligations under the sponsored membership model.
    Section 9(a) of proposed Rule 2C would provide that Sponsored
Members shall not be obligated for allocations, pursuant to Rule 4
(Clearing Fund), of loss or liability incurred by NSCC. To the extent
that a loss or liability is determined by NSCC to arise in connection
with Sponsored Member Transactions (i.e., in connection with the
insolvency or default of a Sponsoring Member), the Sponsored Members
shall not be responsible for or considered in the loss allocation
calculation, but rather such loss shall be allocated to other Members
in accordance with the principles set forth in Section 4 of Rule 4.
    Section 9(b) of proposed Rule 2C would provide that, to the extent
NSCC incurs a loss or liability from a Defaulting Member Event or a
Declared Non-Default Loss Event and a loss allocation obligation
arises, that would be the responsibility of a Sponsored Member Sub-
Account as if the Sponsored Member Sub-Account were a Member, NSCC
shall calculate such loss allocation obligation as if the affected
Sponsored Member were subject to such allocations pursuant to Section 4
of Rule 4, but the Sponsoring Member shall be responsible for
satisfying such obligations.
    Section 9(c) of proposed Rule 2C would provide that the entire
amount of the Required Fund Deposit associated with the Sponsoring
Member's proprietary accounts at NSCC and the entire amount of the