[Federal Register Volume 81, Number 230 (Wednesday, November 30, 2016)]
[Notices]
[Pages 86348-86355]
[FR Doc No: 2016-28771]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79391; File No. SR-NSCC-2016-803]

Self-Regulatory Organizations; National Securities Clearing
Corporation; Notice of Filing of Advance Notice To Accelerate Its Trade
Guaranty, Add New Clearing Fund Components, Enhance Its Intraday Risk
Management, Provide for Loss Allocation of ``Off-the-Market
Transactions,'' and Make Other Changes

November 23, 2016.
    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 (``Clearing
Supervision Act'') \1\ and Rule 19b-4(n)(1)(i) under the Securities
Exchange Act of 1934 (``Act''),\2\ notice is hereby given that on
October 25, 2016, National Securities Clearing Corporation (``NSCC'' or
the ``Corporation'') filed with the Securities and Exchange Commission
(``Commission'') the advance notice SR-NSCC-2016-803 (``Advance
Notice'') as described in Items I, II and III below, which Items have
been prepared primarily by the clearing agency.\3\ The Commission is
publishing this notice to solicit comments on the Advance Notice from
interested persons.
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    \1\ 12 U.S.C. 5465(e)(1).
    \2\ 17 CFR 240.19b-4(n)(1)(i).
    \3\ On October 25, 2016, NSCC filed this Advance Notice as a
proposed rule change (SR-NSCC-2016-005) with the Commission pursuant
to Section 19(b)(1) of the Act, 15 U.S.C. 78s(b)(1) and Rule 19b-4,
17 CFR 240.19b-4. A copy of the proposed rule change is available at
http://www.dtcc.com/legal/sec-rule-filings.aspx.
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I. Clearing Agency's Statement of the Terms of Substance of the Advance
Notice

    This Advance Notice consists of amendments to NSCC's Rules &
Procedures (``Rules'') \4\ in order to (i) accelerate NSCC's trade
guaranty from midnight of one day after trade date (``T+1'') to the
point of trade comparison and validation for bilateral submissions or
to the point of trade validation for locked-in submissions, (ii) add
three new components to the Clearing Fund formula and eliminate the
current Specified Activity charge from the Clearing Fund formula, (iii)
amend Procedure II to remove language that permits NSCC to delay
processing and reporting for certain index receipt transactions, (iv)
enhance NSCC's current intraday mark-to-market margin process and
clarify the circumstances and criteria for its intraday risk management
monitoring and intraday collections of mark-to-market margin, (v)
introduce a new loss allocation provision for any trades that fall
within the proposed definition of ``Off-the-Market Transactions'' and
(vi) make a technical change to Procedure XV to remove the reference to
ID Net Subscribers, as described below.
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    \4\ Capitalized terms not defined herein are defined in the
Rules, available at http://dtcc.com/~/media/Files/Downloads/legal/
rules/nscc_rules.pdf.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Advance Notice

    In its filing with the Commission, the clearing agency included
statements concerning the purpose of and basis for the Advance Notice
and discussed any comments it received on the Advance Notice. 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 and B below, of the most significant aspects of such
statements.

(A) Clearing Agency's Statement on Comments on the Advance Notice
Received From Members, Participants, or Others

    NSCC has not received any written comments relating to this
proposed rule change. NSCC will notify the Commission of any written
comments it receives.

(B) Advance Notice Filed Pursuant to Section 806(e) of the Payment,
Clearing and Settlement Supervision Act

Description of Change
(i) Accelerate the NSCC Trade Guaranty
    Pursuant to Addendum K of the Rules, NSCC currently guarantees the
completion of trades that are cleared and settled through NSCC's
Continuous Net Settlement (``CNS'') \5\ system (``CNS trades'') and
through its Balance Order Accounting Operation \6\ (``Balance Order
trades'') that have reached the later of midnight of T+1 or midnight of
the day they are reported to Members.\7\ NSCC proposes to amend its
Rules in order to guarantee the completion of CNS trades and Balance
Order trades upon comparison and validation for bilateral submissions
to NSCC or upon validation for locked-in submissions to NSCC.
Validation refers to the process whereby NSCC validates a locked-in
trade, or compares and validates a bilateral trade, to confirm such
trade has sufficient and correct information for clearance and
settlement processing. For purposes of this description in the proposed
rule change, the process of comparing and validating bilateral
submissions and the process for validating locked-in submissions are
collectively referred to as ``trade validation.''
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    \5\ CNS and its operation are described in Rule 11 and Procedure
VII.
    \6\ The Balance Order Accounting Operation is described in Rule
5 and Procedure V. NSCC does not become a counterparty to Balance
Order trades, but it does provide a trade guaranty to the receive
and deliver parties that remains effective through close of business
on the originally scheduled settlement date.
    \7\ Today, shortened process trades, such as same-day and next-
day settling trades, are already guaranteed upon comparison or trade
recording processing.
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    NSCC has previously shortened the time at which its trade guaranty
applied to trades in response to processing developments and risk
management considerations and to follow industry settlement cycles.\8\
Since implementation of the current trade guaranty policy, the
marketplace has experienced significant change. The proposed
accelerated trade guaranty and related proposed changes described
herein would benefit the industry by mitigating counterparty risk and
enhancing counterparties' ability to assess that risk by having NSCC
become the central counterparty to CNS trades and by applying the trade
guaranty to Balance Order trades at an earlier point in the settlement
cycle.
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    \8\ See Securities Exchange Act Release Nos. 44648 (August 2,
2001), 66 FR 42245 (August 10, 2001) (SR-NSCC-2001-11); 35442 (March
3, 1995), 60 FR 13197 (March 10, 1995) (SR-NSCC-95-02); 35807 (June
5, 1995), 60 FR 31177 (June 13, 1995) (SR-NSCC-95-03); and 27192
(August 29, 1989), 54 FR 37010 (approving SR-NSCC-87-04, SR-MCC-87-
03, and SR-SCCP-87-03 until December 31, 1990).
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    The transfer of counterparty credit risk from Members to NSCC at an
earlier point in the settlement cycle facilitates a shortened holding
period of bilateral credit risk for counterparties by transferring the
obligation onto NSCC, which is better equipped to manage that
counterparty credit risk, including potential systemic impact, compared
to the counterparties themselves.

    In order to implement this proposed change, NSCC would amend
Addendum K of its Rules \9\ to provide that CNS trades and Balance
Order trades would be guaranteed by NSCC at the point of trade
validation.\10\
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    \9\ Supra note 4.
    \10\ The proposed accelerated trade guaranty would not apply to
items not currently guaranteed today.
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    NSCC also proposes to clarify in Addendum K \11\ that the guaranty
of obligations arising out of the exercise or assignment of options
that are settled at NSCC is not governed by Addendum K \12\ but by a
separate arrangement between NSCC and The Options Clearing Corporation,
as referred to in Procedure III of the Rules.\13\
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    \11\ Supra note 4.
    \12\ Id.
    \13\ Id.
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(ii) Proposed Enhancements to NSCC's Clearing Fund Formula
    In conjunction with accelerating the trade guaranty, NSCC would
enhance its Clearing Fund formula to address the risks posed by the
expanded trade guaranty. Specifically, NSCC proposes to amend Procedure
XV \14\ (Clearing Fund Formula and Other Matters) to include three new
components: The Margin Requirement Differential (``MRD''), the Coverage
Component and the Intraday Backtesting Charge.
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    \14\ Id.
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    NSCC also proposes to add to Procedure XV \15\ a description of the
enhanced intraday mark-to-market component of the Clearing Fund formula
that clarifies the circumstances and criteria for the assessment of an
intraday mark-to-market call. In addition, NSCC proposes to delete the
Specified Activity charge, a component of the Clearing Fund formula
that mitigates shortened cycle risk (that is, the risk of the trade
guaranty attaching prior to collection of daily Clearing Fund). This
charge would no longer be necessary because the MRD would mitigate
those same risks.
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    \15\ Id.
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    A more detailed description of the foregoing changes follows:
A. The Required Deposit and the Accelerated Trade Guaranty
    NSCC collects Required Deposits from all Members as margin to
protect NSCC against losses in the event of a Member's default. The
objective of the Required Deposit is to mitigate potential losses to
NSCC associated with liquidation of the Member's portfolio if NSCC
ceases to act for a Member (hereinafter referred to as a ``default'').
NSCC determines Required Deposit amounts using a risk-based margin
methodology that is intended to capture market price risk. The
methodology uses historical market moves to project or forecast the
potential gains or losses on the liquidation of a defaulting Member's
portfolio, assuming that a portfolio would take three days to liquidate
or hedge in normal market conditions. The projected liquidation gains
or losses are used to determine the Member's Required Deposit, which is
calculated to cover projected liquidation losses to be at or above a 99
percent confidence level (the ``Coverage Target''). The aggregate of
all Members' Required Deposits constitutes NSCC's Clearing Fund, which
NSCC would be able to access if a defaulting Member's own Required
Deposit is insufficient to satisfy losses to NSCC caused by the
liquidation of the Member's portfolio.
    NSCC calculates and collects Required Deposits from Members daily.
Each Member's daily Required Deposit is calculated based on the end-of-
day positions from the prior day and is generally collected by 10:00
a.m. ET. NSCC's current trade guaranty does not generally attach to
trades until midnight of T+1, after Required Deposits reflecting these
trades have been collected. Therefore, Members' Required Deposits are
generally sufficient to cover projected liquidation losses for
guaranteed trades. However, under the accelerated trade guaranty
proposal, NSCC's trade guaranty would attach to current-day trades
immediately upon trade validation, before Required Deposits reflecting
these trades have been collected (which NSCC refers to herein as the
``coverage gap'').\16\ Therefore, Members' Required Deposits may not be
sufficient to cover the projected liquidation losses of trades
guaranteed by NSCC upon trade validation, and NSCC, absent the proposed
Clearing Fund formula enhancements, could incur a loss associated with
those trades if it ceases to act for a Member.
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    \16\ The coverage gap is the period between the time that NSCC
would guarantee a trade and the time that NSCC would collect
additional margin to cover such trade.
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B. Addition of the MRD to the Clearing Fund Formula
    The MRD is designed to help mitigate the risks posed to the
Corporation by day-over-day fluctuations in a Member's portfolio by
forecasting future changes in a Member's portfolio based on a
historical look-back at each Member's portfolio over a given time
period. A Member's portfolio may fluctuate significantly from one
trading day to the next as the Member executes trades throughout the
day. Currently, daily fluctuations in a Member's portfolio resulting
from such trades do not pose any additional or different risk to NSCC
because those trades are not guaranteed by NSCC until a Required
Deposit reflecting such trades is collected by NSCC. However, under the
accelerated trade guaranty proposal, trades would be guaranteed by NSCC
upon trade validation and therefore may result in large un-margined
intraday portfolio fluctuations during the coverage gap. The MRD would
increase Members' Required Deposits by an amount calculated to cover
forecasted fluctuations in Members' portfolios, based upon historical
activity.
    The MRD would be calculated and charged on a daily basis as a part
of each Member's Required Deposit and consists of two components: The
``MRD VaR'' and the ``MRD MTM.'' The MRD VaR looks at historical day-
over-day positive changes in the start of day (``SOD'') volatility
component of a Member's Required Deposit \17\ (``Volatility Charge'')
over a 100-day look-back period and would be calculated to equal the
exponentially weighted moving average (``EWMA'') of such changes to the
Member's Volatility Charge during the look-back period. The MRD MTM
looks at historical day-over-day increases to the SOD mark-to-market
component of a Member's Required Deposit \18\ over a 100-day look-back
period and would be calculated to equal the EWMA of such changes to the
Member's SOD mark-to-market component during the look-back period. The
MRD is calculated to equal the sum of MRD VaR and MRD MTM times a
multiplier calibrated based on backtesting results. NSCC has determined
that a 100-day look-back period would provide it with a sufficient time
series to reflect current market conditions.
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    \17\ The volatility component of the Clearing Fund formula for
CNS trades and Balance Order trades is described in Procedure XV,
Sections I.(A)(1)(a) and I.(A)(2)(a), respectively.
    \18\ The SOD mark-to-market component of the Clearing Fund
formula for CNS trades consists of Regular Mark-to-Market and ID Net
Mark-to-Market, which are described in Procedure XV, Sections
I.(A)(1)(b) and I.(A)(1)(c), respectively. The SOD mark-to-market
component of the Clearing Fund formula for Balance Order trades is
described in Procedure XV, Section I.(A)(2)(b).
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    By addressing the day-over-day changes to each Member's SOD
Volatility Charge and SOD mark-to-market component, the MRD would help
mitigate the risks posed to the Corporation by un-margined day-over-day
fluctuations to a Member's portfolio resulting from intraday trading
activity

that would be guaranteed during the coverage gap.
C. Addition of the Coverage Component to the Clearing Fund Formula
    The ``Coverage Component'' is designed to mitigate the risks
associated with a Member's Required Deposit being insufficient to cover
projected liquidation losses to the Coverage Target by adjusting a
Member's Required Deposit towards the Coverage Target. The Corporation
would face increased exposure to a Member's un-margined portfolio as a
result of the proposed accelerated trade guaranty and would have an
increased need to have each Member's Required Deposit meet the Coverage
Target. The Coverage Component would supplement the MRD by preemptively
increasing a Member's Required Deposit in an amount calculated to
forecast potential deficiencies in the margin coverage of a Member's
guaranteed portfolio. The preemptive nature of the Coverage Component
differentiates it from the Regular Backtesting Charge and the Intraday
Backtesting Charge, both of which are reactive measures to increase the
Member's Required Deposit to above the Coverage Target.
    The Coverage Component would be calculated and charged on a daily
basis as a part of each Member's Required Deposit. To calculate the
Coverage Component, NSCC would compare the simulated liquidation profit
and loss of a Member's portfolio, using the actual positions in the
Member's portfolio and the actual historical returns on the security
positions in the portfolio, against the sum of each of the following
components of the Clearing Fund formula: The Volatility Charge, the
MRD, the Illiquid Charge and the Market Maker domination charge
(collectively, the ``Market Risk Components''), to determine if there
were any deficiencies between the amounts collected by these components
and the simulated profit and loss of the Member's portfolio that would
have been realized had it been liquidated during a 100-day look-back
period. NSCC would then determine a daily ``peak deficiency'' amount
for each Member equal to the maximum deficiency over a rolling 10
business day period for the preceding 100 days. The Coverage Component
would be calculated to equal the EWMA of the peak deficiencies over the
100-day look-back period.
    In working to bring each Member's Required Deposit towards the
Coverage Target by preemptively collecting an amount designed to cover
projected liquidation profit and loss of a Member's portfolio,
including the trades guaranteed during the coverage gap, NSCC would
further mitigate the risks posed to it by the proposed accelerated
trade guaranty.
D. Addition of the Intraday Backtesting Charge to the Clearing Fund
Formula
    NSCC employs daily backtesting to determine the adequacy of each
Member's Required Deposit. NSCC compares the Required Deposit \19\ for
each Member with the simulated liquidation profit and loss using the
actual positions in the Member's portfolio and the actual historical
returns on the security positions in the portfolio. NSCC investigates
the cause(s) of any backtesting deficiencies. As a part of this
investigation, NSCC pays particular attention to Members with
backtesting deficiencies that bring the results for that Member below
the Coverage Target to determine if there is an identifiable cause of
repeat backtesting deficiencies. NSCC also evaluates whether multiple
Members experience backtesting deficiencies for the same underlying
reason. Upon implementation of the accelerated trade guaranty, NSCC
would employ a similar backtesting process on an intraday basis to
determine the adequacy of each Member's Required Deposit. However,
instead of backtesting a Member's Required Deposit against the Member's
SOD portfolio, NSCC would use portfolios from two intraday time
slices.\20\
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    \19\ For backtesting comparisons, NSCC uses the Required Deposit
amount without regard to the actual collateral posted by the Member.
    \20\ Intraday time slices are subject to change based upon
market conditions and would include the positions from SOD plus any
additional positions up to that time.
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1. Calculation of the Intraday Backtesting Charge
    The objective of the Intraday Backtesting Charge is to increase
Required Deposits for Members that are likely to experience intraday
backtesting deficiencies on the basis described above by an amount
sufficient to maintain such Member's intraday backtesting coverage
above the Coverage Target. Members that maintain consistent end of day
positions but have a high level of intraday trading activity pose risk
to NSCC if they were to default intraday.
    Because the intraday trading activity and size of the intraday
backtesting deficiencies vary among impacted Members, NSCC must assess
an Intraday Backtesting Charge that is specific to each impacted
Member. To do so, NSCC examines each impacted Member's historical
intraday backtesting deficiencies observed over the prior 12-month
period to identify the five largest intraday backtesting deficiencies
that have occurred during that time. The presumptive Intraday
Backtesting Charge amount would equal that Member's fifth largest
historical intraday backtesting deficiency, subject to adjustment as
further described below. NSCC believes that applying an additional
margin charge equal to the fifth largest historical intraday
backtesting deficiency to a Member's Required Deposit would have
brought the Member's historically observed intraday backtesting
coverage above the Coverage Target.\21\
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    \21\ Intraday backtesting would include 500 observations per
year (twice per day over 250 observation days). Each occurrence of a
backtesting deficiency would reduce a Member's overall backtesting
coverage by 0.2 percent (1 exception/500 observations). Accordingly,
an Intraday Backtesting Charge equal to the fifth largest
backtesting deficiency would have brought backtesting coverage up to
99.2 percent.
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    The Intraday Backtesting Charge would only be applicable to those
Members whose overall 12-month trailing intraday backtesting coverage
falls below the Coverage Target.
    Although the fifth largest historical backtesting deficiency for a
Member would be used as the Intraday Backtesting Charge in most cases,
NSCC would retain discretion to adjust the charge amount based on other
circumstances that might be relevant for assessing whether an impacted
Member is likely to experience future backtesting deficiencies and the
estimated size of such deficiencies. Examples of relevant circumstances
that could be considered by NSCC in calculating the final, applicable
Intraday Backtesting Charge amount include material differences among
the Member's five largest intraday backtesting deficiencies observed
over the prior 12-month period, variability in the net settlement
activity after the collection of the Member's Required Deposit and
observed market price volatility in excess of the Member's historical
Volatility Charge. Based on NSCC's assessment of the impact of these
circumstances on the likelihood, and estimated size, of future intraday
backtesting deficiencies for a Member, NSCC may, in its discretion,
adjust the Intraday Backtesting Charge for such Member in an amount
that NSCC determines to be more appropriate for maintaining such
Member's intraday backtesting results above the Coverage Target.
    The resulting Intraday Backtesting Charge would be added to the
Required

Deposit for such Member and would be imposed on a daily basis for a
one-month period.
    In order to differentiate the Backtesting Charge assessed on the
start of the day portfolio from the Backtesting Charge assessed on an
intraday basis, NSCC would amend the Rules by adding a defined term
``Regular Backtesting Charge'' to Procedure XV, Section I.(B)(3).\22\
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    \22\ Supra note 4.
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2. Communication With Members and Imposition of the Intraday
Backtesting Charge
    If NSCC determines that an Intraday Backtesting Charge should apply
to a Member who was not assessed an Intraday Backtesting Charge during
the immediately preceding month or that the Intraday Backtesting Charge
applied to a Member during the previous month should be increased, NSCC
would notify the Member on or around the 25th calendar day of the month
prior to the assessment of the Intraday Backtesting Charge or prior to
the increase to the Intraday Backtesting Charge, as applicable, if not
earlier.
    NSCC would impose the Intraday Backtesting Charge as an additional
charge applied to each impacted Member's Required Deposit on a daily
basis for a one-month period and would review each applied Intraday
Backtesting Charge each month. If an impacted Member's trailing 12-
month intraday backtesting coverage exceeds the Coverage Target
(without taking into account historically imposed Intraday Backtesting
Charges), the Intraday Backtesting Charge would be removed.
E. Removal of the Specified Activity Charge From the Clearing Fund
Formula
    Currently, NSCC collects a Specified Activity charge, which is
designed to cover the risk posed to NSCC by transactions that settle on
a shortened cycle.\23\ Such transactions pose an increased risk to NSCC
because these trades settle on a shortened settlement cycle and may be
guaranteed by NSCC prior to the collection of margin on them. The
Specified Activity charge currently mitigates this risk by increasing
the Required Deposit for a Member in relation to the number of
Specified Activity trades submitted by the Member to NSCC over a 100-
day look-back period. However, the risk posed to NSCC by Specified
Activity would no longer be unique to such trade activity--the proposed
accelerated trade guaranty would result in a similar risk to NSCC. The
addition of the MRD and Coverage Components to the Clearing Fund
formula would mitigate the risks posed by trades guaranteed by NSCC
prior to the collection of margin on those trades. As a result, NSCC
proposes to eliminate the Specified Activity charge because imposing a
separate Specified Activity charge would no longer be necessary once
the MRD and Coverage Components are added to the Clearing Fund formula.
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    \23\ Examples of these trades can include next day settling
trades, same day settling trades, cash trades or sellers' options.
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F. Enhanced Intraday Mark-to-Market Margining
    NSCC proposes to enhance its current intraday margining to further
mitigate the intraday coverage gap risk that may be introduced to the
Corporation as a result of the proposed accelerated trade guaranty. By
way of background, NSCC currently collects a SOD mark-to-market margin,
which is designed to mitigate the risk arising out of the value change
between the contract/settlement value of a Member's open positions and
the current market value, as part of its Clearing Fund formula. A
Member's SOD mark-to-market margin is calculated and collected as part
of a Member's daily Required Deposit based on the Member's prior end-
of-day positions. The SOD mark-to-market component of the daily
Required Deposit is calculated to cover a Member's exposure due to
market moves and/or trading and settlement activity by bringing the
portfolio of open positions up to the current market value. However,
because the SOD mark-to-market component is calculated only once daily
using the prior end-of-day positions and prices, it will not cover a
Member's exposure arising out of any intraday changes to position and
market value in a Member's portfolio. Accordingly, NSCC currently
collects intraday mark-to-market margin from Members to cover
additional risk exposure arising out of intraday position and market
value changes to the Member's portfolio if the additional risks are
sufficiently large to warrant the collection of an intraday margin.
    NSCC has determined that it is not necessary to collect intraday
margin from every Member that experiences an intraday mark-to-market
change because the Volatility Charge already collected as part of
Members' daily Required Deposits is calculated to cover projected
changes in the contract/settlement value of a Member's portfolio and
likely cover intraday changes to a Member's portfolio. However, in
certain instances, Members may have intraday mark-to-market changes
that are significant enough that NSCC is exposed to an increased risk
of loss as a result of such Member's intraday activities. In
particular, NSCC measures each Member's intraday mark-to-market
exposure against the Volatility Charge. NSCC collects an intraday mark-
to-market amount from any Member that has an intraday mark-to-market
exposure that meets or exceeds a threshold percentage as compared to
the Member's Volatility Charge. NSCC believes that such Members pose an
increased risk of loss to the Corporation because the coverage provided
by the Volatility Charge, which is designed to cover estimated losses
to a portfolio over a specified time period, would be exhausted by an
intraday mark-to-market exposure so large that the Member's Required
Deposit would potentially be unable to absorb further intraday losses
to the Member's portfolio.
    In order to further mitigate the risk posed to NSCC by the proposed
accelerated trade guaranty, NSCC is proposing to enhance its collection
of intraday mark-to-market margin. NSCC would impose the intraday mark-
to-market margin amount at a lower threshold. Currently, NSCC makes an
intraday mark-to-market margin call if a Member's intraday mark-to-
market exposure meets or exceeds 100 percent of such Member's
Volatility Charge; however, such threshold may be reduced by NSCC
during volatile market conditions. With this proposal, NSCC would make
an intraday margin call if a Member's intraday mark-to-market exposure
meets or exceeds 80 percent of such Member's Volatility Charge, where
such threshold may still be reduced by NSCC during volatile market
conditions. This proposed change would serve to collect intraday margin
earlier and more proactively preserve the coverage provided by a
Member's Volatility Charge and Required Deposit.
    In addition, NSCC would monitor intraday changes to Member's mark-
to-market exposure at regular intervals to further mitigate the risk
posed to NSCC by the accelerated trade guaranty. By doing so, NSCC
would be able to make intraday margin calls more frequently to those
Members whose intraday mark-to-market exposures exceed the Volatility
Charge threshold. Enhancing the collection of the intraday mark-to-
market amount so that it occurs earlier and more frequently would allow
NSCC to reduce the amount of uncovered risk during the coverage gap and
would therefore further mitigate the risk posed to the Corporation by
the accelerated trade guaranty.
    NSCC proposes to amend Procedure XV to include a description of the

enhanced intraday mark-to-market margin charge that clarifies the
circumstances and criteria for the assessment of an intraday mark-to-
market call. This would ensure that Members are aware that the
Corporation regularly monitors and considers intraday mark-to-market as
part of its regular Clearing Fund formula.
G. Adjustments to the Calculation of the Excess Capital Premium
Component
    The Excess Capital Premium \24\ is designed to address spikes in a
Member's Required Deposit based upon any one day of activity. It is not
designed to provide additional Required Deposits over an extended
period of time. Currently, the Excess Capital Premium for a Member is
calculated based upon the Member's Clearing Fund Required Deposit and
the Member's excess net capital. With the addition of the MRD and the
Coverage Component, NSCC proposes to exclude these charges from the
calculation of the Excess Capital Premium. The MRD and the Coverage
Component all utilize a historical look-back period, which accounts for
the risk of such activity well after the relevant trades have settled.
Risks related to such trades would be reflected in increased amounts
assessed for these components over the subsequent time periods. If
these components are included in the calculation of the Excess Capital
Premium, especially during periods following an increase in activity,
then the increased MRD and Coverage Component could lead to more
frequent Excess Capital Premium charges over an extended period of
time. This is not the intended purpose of the Excess Capital Premium
and could place an unnecessary burden on Members.
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    \24\ The Excess Capital Premium is a charge imposed on a Member
when the Member's Required Deposit exceeds its excess net capital,
as described in Procedure XV.
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(iii) Proposed Changes to Procedure II (Trade Comparison and Recording
Service)
    Next day settling index receipts may be guaranteed prior to the
collection of margin reflecting such trades and thus carry a very
similar risk as Specified Activity trades described above. More
specifically, because these trades are settled on the day after they
are received and validated by NSCC, NSCC currently attaches its
guaranty to them at the time of validation, prior to the collection of
a Required Deposit that reflects such trades. Unlike the risk from
Specified Activity trades, which is mitigated by the Specified Activity
charge, the risk for next day settling index receipts is currently
mitigated by permitting NSCC to delay the processing and reporting of
these trades if a Member's Required Deposit is not paid on time.
However, like the risk associated with Specified Activity, under the
proposed rule change, this risk would generally be mitigated by the
addition of the MRD and the Coverage Component. Therefore, NSCC
proposes to amend Procedure II \25\ (Trade Comparison and Recording
Service) to remove the language that permits NSCC to delay the
processing and reporting of next day settling index receipts until the
applicable margin on these transactions is paid.
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    \25\ Supra note 4.
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(iv) Loss Allocation Provision for Off-the-Market Transactions
    NSCC proposes to introduce a new loss allocation provision for any
trades that fall within the proposed definition of ``Off-the-Market
Transactions'' in order to limit NSCC's exposure to certain trades that
have a price that differs significantly from the prevailing market
price for the underlying security at the time the trade is executed.
This provision would apply in the event that NSCC ceases to act for a
Member that engaged in Off-the-Market Transactions and only to the
extent that NSCC incurs a net loss in the liquidation of such
Transactions.\26\
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    \26\ A net loss on liquidation of the Off-the-Market Transaction
means that the loss on liquidation of the Member's portfolio exceeds
the collected Required Deposit of the Member and such loss is
attributed to the Off-the-Market Transaction. Such loss would be
allocated directly and entirely to the Member that submitted the
Off-the-Market Transaction, or on whose behalf the Off-the-Market
Transaction was submitted, to NSCC; however, no allocation would be
made if such Member has satisfied all applicable intraday mark-to-
market margin charges assessed by NSCC with respect to the Off-the-
Market Transaction.
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    NSCC would define ``Off-the-Market Transactions'' as either a
single transaction or a series of transactions settled within the same
cycle with greater than $1 million in gross proceeds and either higher
or lower than the most recently observed market price by a percentage
amount based on market conditions and factors that impact trading
behavior of the underlying security, including volatility, liquidity
and other characteristics of such security.
    The proposed rule change would establish the loss allocation for
Off-the-Market Transactions. NSCC would allocate any losses to NSCC
resulting from the liquidation of any guaranteed, open Off-the-Market
Transaction of a defaulted Member directly and entirely to the
surviving counterparty to that transaction. Losses would be allocated
to counterparties in proportion to their specific Off-the-Market
Transaction gain and would be allocated only to the extent of NSCC's
loss; however, no allocation shall be made if the defaulted Member has
satisfied all requisite intraday mark-to-market margin assessed by NSCC
with respect to the Off-the-Market Transaction.\27\
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    \27\ A Member's Off-the-Market Transaction that has been marked
to market is, by definition, no longer an Off-the-Market Transaction
when the mark-to-market component of the Member's Required Deposit
is satisfied.
---------------------------------------------------------------------------

    This proposed change would allow NSCC to mitigate the risk of loss
associated with guaranteeing these Off-the-Market Transactions. The
proposal recognizes that applying the accelerated trade guaranty to
transactions whose price significantly differs from the most recently
observed market price could inappropriately increase the loss that NSCC
may incur if a Member that has engaged in Off-the-Market Transactions
defaults and its open, guaranteed positions are liquidated. Members not
involved in Off-the-Market Transactions, or not involved in Off-the-
Market Transactions that result in losses to NSCC, would not be
included in this process. This exclusion would apply only to losses
that are attributable to Off-the-Market Transactions and would not
exclude Members from other obligations that may result from any loss or
liabilities incurred by NSCC from a Member default.
    In order to implement this proposed change, NSCC would amend Rule 4
\28\ (Clearing Fund) to provide that, if a loss or liability of NSCC is
determined by NSCC to arise in connection with the liquidation of any
Off-the-Market Transactions, such loss or liability would be allocated
directly to the surviving counterparty to the Off-the-Market
Transaction that submitted the transaction to NSCC for clearing. NSCC
would also amend Rule 1 \29\ (Definitions and Descriptions) to include
a definition of Off-the-Market Transactions.
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    \28\ Supra note 4.
    \29\ Id.
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(v) Technical Proposed Rule Change
    NSCC is proposing a change to Procedure XV \30\ to clarify the
calculation of the Regular Mark-to-Market component for CNS
transactions. NSCC's historical and current policy for the calculation
of any mark-to-market component of the Clearing Fund calculation for
CNS trades and Balance Order trades is that where a credit is derived
from a Member's mark-to-

market calculation, the value of the calculation is adjusted to zero.
When NSCC implemented the ID Net service,\31\ a provision was added to
Procedure XV \32\ that explicitly stated this policy as it relates to
CNS transactions of subscribers to the ID Net service. This change
inadvertently created an implication that the calculation of Regular
Mark-to-Market credit for Members who were not ID Net Subscribers would
not be set to zero. NSCC is proposing to revise the applicable
provision to remove the reference to ID Net Subscribers.
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    \30\ Id.
    \31\ NSCC's ID Net service is defined further in Rule 65. Rules,
supra note 4. See Securities Exchange Act Release No. 57901 (June 2,
2008), 73 FR 32373 (June 6, 2008) (SR-NSCC-2007-14).
    \32\ Supra note 4.
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Expected Effect on Risks to the Clearing Agency, Its Participants and
the Market
    The proposed rule changes would mitigate Member's counterparty
risks and would enhance Members' ability to assess that risk by having
NSCC become the central counterparty to CNS trades and by applying the
trade guaranty to Balance Order trades at an earlier point in the
settlement cycle.
    Although the transfer of counterparty credit risk from Members to
NSCC at an earlier point in the settlement cycle facilitates a
shortened holding period of bilateral credit risk for the Members, it
does increase risk to NSCC. However, as discussed below, NSCC believes
that it is better equipped to manage that counterparty credit risk,
including potential systemic impact, compared to the counterparties
themselves.
Management of Identified Risks
    The proposal is designed to mitigate counterparty risk while still
protecting NSCC and its membership.
    The proposed rule changes to (i) add the new components to the
Clearing Fund formula and (ii) enhance the intraday mark-to-market
margin process would allow NSCC to appropriately collect additional
margin to mitigate the exposure presented to NSCC by the accelerated
trade guaranty. The proposal to introduce a new loss allocation
provision for Off-the-Market Transactions would help NSCC to limit its
exposure to Off-the-Market Transactions.
    Specifically, the proposal to add the MRD, the Coverage Component
and the Intraday Backtesting Charge to the Clearing Fund formula and to
collect intraday mark-to-market margin at a lower threshold would
mitigate the exposure presented to NSCC by the accelerated trade
guaranty and permit NSCC to enhance its margin requirements to better
limit its credit exposures to participants under normal market
conditions.
    In addition, NSCC's proposal to expand its current intraday margin
collection to include (a) the collection of intraday mark-to-market
margin at a lower threshold and (b) the collection of the Intraday
Backtesting Charge would further enhance its intraday monitoring and
its ability to measure credit exposures at least once a day.
    Similarly, the proposed rule changes to introduce a new loss
allocation provision for any trades that fall within the proposed
definition of Off-the-Market Transactions would help NSCC to limit its
exposure to certain trades that have a price that differs significantly
from the most recently observed market price for the underlying
security. Therefore, the reduction of NSCC's exposure to Off-the-Market
Transactions would assist NSCC in responding to a Member default and
would minimize potential losses to NSCC and its non-defaulting Members.
    NSCC has also taken actions outside of the proposals described in
this filing to strengthen its liquidity resources and to enable it to
cover its total liquidity needs, including any liquidity needs that
would arise from the accelerated trade guaranty. NSCC calculates its
liquidity need by assuming the failure of the Member (including the
simultaneous default of the Member's affiliated family) that has the
largest net settlement debit in extreme but plausible market
conditions.\33\ Although the proposal would increase the number of days
for which NSCC would be required, under its Rules, to guarantee
settlement to include T and T+1 trades, the Rules currently provide
that it may, although it is not legally obligated to, optionally
guarantee these trades. Given NSCC's role in promoting safety,
soundness and stability in the U.S. equities markets, NSCC currently
includes these trades in its daily liquidity need analyses to account
for the circumstances where this optional guaranty would be called
upon. NSCC has never actually experienced a liquidity shortfall in the
close out of a defaulted Member.
---------------------------------------------------------------------------

    \33\ Every day NSCC measures the liquidity obligations of each
of NSCC's Members by taking the sum of their purchase obligations on
that day from CNS and for the following three settlement days, and
then, taking into account certain adjustments, assumptions and
offsets, NSCC identifies the largest Member liquidity need on each
day and, determines if the available liquidity resources are
adequate to cover that largest liquidity need or if there is a
projected liquidity shortfall.
---------------------------------------------------------------------------

    NSCC measures the potential liquidity impact of the accelerated
trade guaranty on a daily basis. NSCC has enhanced its liquidity
resources through the implementation of NSCC's supplemental liquidity
deposit (``SLD'') requirements.\34\ NSCC's SLD requirements were
designed to require Members with historically elevated options activity
to provide supplemental liquidity deposits in advance of and in
anticipation of options expiry periods, as well as to accept voluntary
pre-funded supplemental liquidity deposits from other Members who
anticipate elevated liquidity needs during these periods. As such, the
SLD requirements provide NSCC with the needed liquidity resources to
address any liquidity shortfalls that may be experienced under the
accelerated trade guaranty settlement cycle. Furthermore, NSCC has
established a liquidity program to raise prefunded liquidity through
the issuance and private placement of short-term, unsecured notes
(``Prefunded Liquidity Program''), which may consist of a combination
of commercial paper notes and extendible notes.\35\ Proceeds from the
Prefunded Liquidity Program further supplement NSCC's existing default
liquidity risk management resources.
---------------------------------------------------------------------------

    \34\ Securities Exchange Act Release No. 70999 (December 5,
2013), 78 FR 75413 (December 11, 2013) (SR-NSCC-2013-02).
    \35\ Securities Exchange Act Release No. 75730 (August 19,
2015), 80 FR 51638 (August 25, 2015) (SR-NSCC-2015-802).
---------------------------------------------------------------------------

Consistency With the Clearing Supervision Act
    The objectives and principles of the Clearing Supervision Act are
to promote robust risk management, promote safety and soundness, reduce
systemic risks, and support the stability of the broader financial
system.\36\
---------------------------------------------------------------------------

    \36\ 12 U.S.C. 5464(b).
---------------------------------------------------------------------------

    The proposal to accelerate the time that NSCC's trade guaranty
attaches to trades submitted to it for clearing has been designed to
promote robust risk management, promote safety and soundness, reduce
systemic risks and support the stability of the broader financial
system in furtherance of the Clearing Supervision Act.
    Specifically, NSCC would provide a trade guaranty to CNS trades and
Balance Order trades at an earlier point in the settlement cycle. The
proposed rule changes would mitigate counterparty risk and would
enhance NSCC Members' ability to assess that risk by having NSCC become
the central counterparty to CNS trades and by applying the trade
guaranty to Balance Order trades at an earlier point in the settlement
cycle. The transfer of

counterparty credit risk from Members to NSCC at an earlier point in
the settlement cycle facilitates a shortened holding period of
bilateral credit risk for the counterparties by transferring the
obligation onto NSCC, which is better equipped to manage that
counterparty credit risk, including potential systemic impact, compared
to the counterparties themselves. Therefore, NSCC believes the proposal
to accelerate the trade guaranty would promote robust risk management,
promote safety and soundness, reduce systemic risks and support the
stability of the broader financial system, consistent with the
objectives and principles of Section 805(b) of the Clearing Supervision
Act cited above.
    The proposed rule changes to enhance the Clearing Fund formula and
to introduce a new loss allocation provision for Off-the-Market
Transactions have been designed to promote robust risk management and
promote safety and soundness in furtherance of the Clearing Supervision
Act. In conjunction with the enhanced trade processing in the form of
the accelerated trade guaranty, the proposed additional Clearing Fund
components and enhancements to NSCC's current intraday mark-to-market
margin process would allow NSCC to appropriately manage its risk by
collecting additional margin to mitigate the exposure presented to NSCC
by the accelerated trade guaranty. Additionally, the proposal to
introduce a new loss allocation provision for any trades that fall
within a proposed definition of ``Off-the-Market Transactions'' would
help NSCC to limit its exposure to certain trades that have a price
that differs significantly from the most recently observed market price
for the underlying security. Together, the collection of additional
margin and the reduction of NSCC's exposures to ``Off-the-Market
Transactions'' would assist NSCC in responding to a Member default and
would minimize potential losses to NSCC and its non-defaulting Members.
Therefore, NSCC believes the proposed enhancements to the Clearing Fund
formula and the introduction of an Off-the-Market Transaction
allocation process would also promote robust risk management and
promote safety and soundness, consistent with objectives and principles
of Section 805(b) of the Clearing Supervision Act, cited above.
    NSCC believes that the proposal is also consistent with Rules 17Ad-
22(b)(1) and (b)(2), promulgated under the Act. Rule 17Ad-22(b)(1)
requires NSCC to establish, implement, maintain and enforce written
policies and procedures reasonably designed to measure its credit
exposures to its participants at least once a day and limit its
exposures to potential losses from defaults by its participants under
normal market conditions so that the operations of NSCC would not be
disrupted and non-defaulting participants would not be exposed to
losses that they cannot anticipate or control.\37\ NSCC's proposal to
expand its current intraday margin collection to include (a) the
collection of intraday mark-to-market margin at a lower threshold and
(b) the collection of the Intraday Backtesting Charge would further
enhance its intraday monitoring and its ability to measure credit
exposures at least once a day. The proposal to enhance the amount of
margin collected from each Member would help NSCC to limit its exposure
to potential losses from defaults by its participants under normal
market conditions and reduce risk of loss mutualization to the NSCC
membership. Similarly, the proposal to introduce a new loss allocation
provision for Off-the-Market Transactions would also help NSCC to limit
its exposure to potential losses from defaults by its participants
under normal market conditions. Therefore, NSCC believes the proposals
are consistent with the requirements of Rule 17Ad-22(b)(1), promulgated
under the Act, cited above.
---------------------------------------------------------------------------

    \37\ 17 CFR 240.17Ad-22(b)(1).
---------------------------------------------------------------------------

    Rule 17Ad-22(b)(2) requires NSCC to establish, implement, maintain
and enforce written policies and procedures reasonably designed to
``use margin requirements to limit its credit exposures to participants
under normal market conditions and use risk-based models and parameters
to set margin requirements.'' \38\ The proposal to add the MRD, the
Coverage Component and the Intraday Backtesting Charge to the Clearing
Fund formula and to collect intraday mark-to-market margin at a lower
threshold in order to mitigate the exposure presented to NSCC by the
accelerated trade guaranty would enable NSCC to enhance its margin
requirements to better limit its credit exposures to participants under
normal market conditions. Therefore, NSCC believes the proposed changes
are consistent with the requirements of Rule 17Ad-22(b)(2), promulgated
under the Act, cited above.
---------------------------------------------------------------------------

    \38\ 17 CFR 240.17Ad-22(b)(2).
---------------------------------------------------------------------------

    The proposed changes to NSCC's Clearing Fund formula and the
intraday margin process are also designed to be consistent with Rules
17Ad-22(e)(4) and (e)(6) of the Act, which were recently adopted by the
Commission.\39\ Rule 17Ad-22(e)(4) will require NSCC to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to effectively identify, measure, monitor, and
manage its credit exposures to participants and those exposures arising
from its payment, clearing, and settlement processes.\40\ NSCC's
proposal to expand its current intraday margin collection to include
(a) the collection of intraday mark-to-market margin at a lower
threshold and (b) the collection of the Intraday Backtesting Charge
would enhance its ability to identify, measure, monitor and manage its
credit exposures to participants. The proposal to enhance the amount of
margin NSCC collected from each Member and to introduce a new loss
allocation provision for Off-the-Market Transactions would further help
NSCC to manage its credit exposures to participants and those exposures
arising from its payment, clearing, and settlement processes.
Therefore, NSCC believes these proposals are consistent with the
requirements of Rule 17Ad-22(e)(4), promulgated under the Act, cited
above.
---------------------------------------------------------------------------

    \39\ The Commission adopted amendments to Rule 17Ad-22,
including the addition of new section 17Ad-22(e), on September 28,
2016. See Securities Exchange Act Release No. 78961 (September 28,
2016), 81 FR 70786 (October 13, 2016) (S7-03-14). The amendments to
Rule 17Ad-22 become effective on December 12, 2016. Id. NSCC is a
``covered clearing agency'' as defined in Rule 17Ad-22(a)(5) and
must comply with new section (e) of Rule 17Ad-22 by April 11, 2017.
Id.
    \40\ See Securities Exchange Act Release No. 78961 (September
28, 2016), 81 FR 70786 (October 13, 2016) (S7-03-14).
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(6) will require NSCC to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to cover its credit exposures to its participants by
establishing a risk-based margin system that is monitored by management
on an ongoing basis and regularly reviewed, tested, and verified.\41\
The proposal to add the MRD, the Coverage Component and the Intraday
Backtesting Charge to the Clearing Fund formula and to collect intraday
mark-to-market margin at a lower threshold would help NSCC to cover its
credit exposures to its participants by establishing a risk-based
margin system that is monitored by management on an ongoing basis and
regularly reviewed, tested, and verified. Therefore, NSCC believes this
proposal is consistent with the requirements of Rule 17Ad-22(e)(6),
promulgated under the Act, cited above.
---------------------------------------------------------------------------

    \41\ Id.

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

Implementation Timeframe
    Pending Commission approval, Members would be advised of the
implementation date of this proposal through issuance of an NSCC
Important Notice. NSCC expects to run the proposed changes in a test
environment for a parallel period of at least three months prior to
implementation. Details and dates regarding such test period would be
communicated to Members through an NSCC Important Notice.

III. Date of Effectiveness of the Advance Notice, and Timing for
Commission Action

    The proposed change may be implemented if the Commission does not
object to the proposed change within 60 days of the later of (i) the
date that the proposed change was filed with the Commission or (ii) the
date that any additional information requested by the Commission is
received. The clearing agency shall not implement the proposed change
if the Commission has any objection to the proposed change.
    The Commission may extend the period for review by an additional 60
days if the proposed change raises novel or complex issues, subject to
the Commission providing the clearing agency with prompt written notice
of the extension. A proposed change may be implemented in less than 60
days from the date the advance notice is filed, or the date further
information requested by the Commission is received, if the Commission
notifies the clearing agency in writing that it does not object to the
proposed change and authorizes the clearing agency to implement the
proposed change on an earlier date, subject to any conditions imposed
by the Commission.
    The clearing agency shall post notice on its Web site of proposed
changes that are implemented.
    The proposal shall not take effect until all regulatory actions
required with respect to the proposal are completed.

IV. Solicitation of Comments

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

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to<EMAIL_ADDRESS>Please include
File Number SR-NSCC-2016-803 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-NSCC-2016-803. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the Advance Notice that are filed
with the Commission, and all written communications relating to the
Advance Notice between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for Web site viewing and printing in
the Commission's Public Reference Room, 100 F Street NE., Washington,
DC 20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of NSCC and on DTCC's Web site
(http://dtcc.com/legal/sec-rule-filings.aspx). All comments received
will be posted without change; the Commission does not edit personal
identifying information from submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number SR-NSCC-2016-803 and should be submitted on
or before December 15, 2016.

    By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2016-28771 Filed 11-29-16; 8:45 am]
 BILLING CODE 8011-01-P