[Federal Register Volume 83, Number 139 (Thursday, July 19, 2018)]
[Notices]
[Pages 34193-34213]
[FR Doc No: 2018-15366]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83631; File No. SR-FICC-2017-022]

Self-Regulatory Organizations; Fixed Income Clearing Corporation;
Notice of Filing of Amendment No. 1 to a Proposed Rule Change To Amend
the Loss Allocation Rules and Make Other Changes

July 13, 2018.
    On December 18, 2017, Fixed Income Clearing Corporation (``FICC'')
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') and Rule 19b-4 thereunder, proposed rule change SR-FICC-2017-
022 (``Proposed Rule Change'') to amend the loss allocation rules and
make other changes; the Proposed Rule Change was published for comment
in the Federal Register on January 8, 2018.\1\ On February 8, 2018, the
Commission designated a longer period within which to approve,
disapprove, or institute proceedings to determine whether to approve or
disapprove the Proposed Rule Change.\2\ On March 20, 2018, the
Commission instituted proceedings to determine whether to approve or
disapprove the Proposed Rule Change; on June 25, 2018, the Commission
designated a longer period for Commission action on the proceedings to
determine whether to approve or disapprove the Proposed Rule Change.\3\
On June 28, 2018, FICC filed Amendment No. 1 to the Proposed Rule
Change to amend and replace in its entirety the Proposed Rule Change as
originally submitted on December 18, 2017.\4\ As of the date of this
release, the Commission has not received any comments on the Proposed
Rule Change.
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    \1\ 15 U.S.C. 78s(b)(1) and 17 CFR 240.19b-4, respectively.
Securities Exchange Act Release No. 82427 (January 2, 2018), 83 FR
854 (January 8, 2018) (SR-FICC-2017-022). On December 18, 2017, FICC
filed the Proposed Rule Change as advance notice SR-FICC-2017-806
(``Advance Notice'') 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 (``Clearing Supervision Act'')
and Rule 19b-4(n)(1)(i) of the Act. (12 U.S.C. 5465(e)(1) and 17 CFR
240.19b-4(n)(1)(i), respectively.) On January 30, 2018, the
Commission published in the Federal Register notice of filing of the
Advance Notice. The notice also extended the review period for the
Advance Notice pursuant to Section 806(e)(1)(H) of the Clearing
Supervision Act. (12 U.S.C. 5465(e)(1)(H).) See Securities Exchange
Act Release No. 82583 (January 24, 2018), 83 FR 4358 (January 30,
2018) (SR-FICC-2017-806). On April 10, 2018, the Commission required
additional information for consideration of the Advance Notice,
pursuant to Section 806(e)(1)(D) of the Clearing Supervision Act,
which provided the Commission with an additional 60-days in the
review period beginning on the date that the information requested
is received by the Commission. (12 U.S.C. 5465(e)(1)(D).) See
Memorandum from the Office of Clearance and Settlement Supervision,
Division of Trading and Markets, titled ``Commission's Request for
Additional Information,'' available at http://www.sec.gov/rules/sro/ficc-an.shtml. On June 28, 2018, FICC filed Amendment No. 1 to the
Advance Notice. To promote the public availability and transparency
of its post-notice amendment, FICC submitted a copy of Amendment No.
1 through the Commission's electronic public comment letter
mechanism. Accordingly, Amendment No. 1 to the Advance Notice has
been posted on the Commission's website at https://www.sec.gov/rules/sro/ficc-an.htm and thus been publicly available since June
29, 2018. On July 6, 2018, the Commission received the information
requested, which added an additional 60-days to the review period
pursuant to Sections 806(e)(1)(E) and (G) of the Clearing
Supervision Act. (12 U.S.C. 5465(e)(1)(E) and (G).) See Memorandum
from the Office of Clearance and Settlement Supervision, Division of
Trading and Markets, titled ``Response to the Commission's Request
for Additional Information,'' available at http://www.sec.gov/rules/sro/ficc-an.shtml. The proposal, as set forth in both the Advance
Notice and the Proposed Rule Change, shall not take effect until all
required regulatory actions are completed.
    \2\ Securities Exchange Act Release No. 82670 (February 8,
2018), 83 FR 6626 (February 14, 2018) (SR-DTC-2017-022; SR-FICC-
2017-022; SR-NSCC-2017-018).
    \3\ Securities Exchange Act Release No. 82909 (March 20, 2018),
83 FR 12990 (March 26, 2018) (SR-FICC-2017-022); Securities Exchange
Act Release No. 83510 (June 25, 2018), 83 FR 30791 (June 29, 2018)
(SR-DTC-2017-022; SR-FICC-2017-022; SR-NSCC-2017-018).
    \4\ To promote the public availability and transparency of its
post-notice amendment, FICC submitted a copy of Amendment No. 1
through the Commission's electronic public comment letter mechanism.
Accordingly, Amendment No. 1 to the Proposed Rule Change has been
posted on the Commission's website at https://www.sec.gov/rules/sro/ficc.htm and thus been publicly available since June 29, 2018.
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    The Proposed Rule Change, as amended by Amendment No. 1, is
described in Items I and II below, which Items have been prepared by
FICC. The Commission is publishing this notice to solicit comments on
the Proposed Rule Change, as amended by Amendment No. 1, from
interested persons.

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

    The proposed rule change consists of modifications to FICC's
Government Securities Division (``GSD'') Rulebook (``GSD Rules'') and
Mortgage-Backed Securities Division (``MBSD'' and, together with GSD,
the ``Divisions'' and, each, a ``Division'') Clearing Rules (``MBSD
Rules,'' and collectively with the GSD Rules, the ``Rules'') in order
to amend provisions in the Rules regarding loss allocation as well as
make other changes, as described in greater detail below.\5\
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    \5\ Capitalized terms not defined herein are defined in the GSD
Rules, available at http://www.dtcc.com/~/media/Files/Downloads/
legal/rules/ficc_gov_rules.pdf, and the MBSD Rules, available at
www.dtcc.com/~/media/Files/Downloads/legal/rules/
ficc_mbsd_rules.pdf.
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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 III 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
Description of Amendment No. 1
    This filing constitutes Amendment No. 1 (``Amendment'') to rule
filing SR-FICC-2017-022 (``Rule Filing'') previously filed by FICC on
December 18, 2017.\6\ This Amendment amends and replaces the Rule
Filing in its entirety. FICC submits this Amendment in order to further
clarify the operation of the proposed rule changes on loss allocation
by providing additional information and examples. In particular, this
Amendment would:
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    \6\ See Securities Exchange Act Release No. 82427 (January 2,
2018), 83 FR 854 (January 8, 2018) (SR-FICC-2017-022).
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    (i) Clarify which Tier One Netting Members and Tier One Members
would be subject to loss allocation with respect to Defaulting Member
Events (as defined below and in the proposed rule change) and Declared
Non-Default Loss Events (as defined below and in the proposed rule
change) occurring during an Event Period (as defined below and in the
proposed rule change). Specifically, pursuant to the Amendment,
proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would provide that
each Tier One Netting Member or Tier One Member, as applicable, that is
a Tier One Netting Member or Tier One Member on the first day of an
Event Period would be obligated to pay its pro rata share of losses and
liabilities arising out of or relating to each Defaulting Member Event
(other than a Defaulting Member Event with respect to which it is the
Defaulting Member (as defined below and in the proposed rule change))
and each Declared Non-Default Loss Event occurring during the Event
Period. Proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would also
make it clear

that any Tier One Netting Member or Tier One Member, as applicable, for
which FICC ceases to act on a non-Business Day, triggering an Event
Period that commences on the next Business Day, would be deemed to be a
Tier One Netting Member or Tier One Member, as applicable, on the first
day of that Event Period.
    (ii) Clarify the obligations and Loss Allocation Cap (as defined
below and in the proposed rule change) of a Tier One Netting Member or
a Tier One Member, as applicable, that withdraws from membership in
respect of a loss allocation round. Specifically, pursuant to the
Amendment, proposed Section 7b of GSD Rule 4 and MBSD Rule 4 would
provide that the Tier One Netting Member or Tier One Member, as
applicable, would nevertheless remain obligated for its pro rata share
of losses and liabilities with respect to any Event Period for which it
is otherwise obligated under GSD Rule 4 or MBSD Rule 4, as applicable;
however, its aggregate obligation would be limited to the amount of its
Loss Allocation Cap as fixed in the round for which it withdrew.
    (iii) Clarify that a member would be obligated to FICC for all
losses and liabilities incurred by FICC arising out of or relating to
any Defaulting Member Event with respect to the member. Specifically,
pursuant to the Amendment, proposed Section 7 of GSD Rule 4 and MBSD
Rule 4 would provide that each member would be obligated to FICC for
the entire amount of any loss or liability incurred by FICC arising out
of or relating to any Defaulting Member Event with respect to such
member.
    (iv) Clarify that, although a Defaulting Member would not be
allocated a ratable share of losses and liabilities arising out of or
relating to its own Defaulting Member Event, it would remain obligated
to FICC for all such losses and liabilities. Specifically, pursuant to
the Amendment, proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would
provide that no loss allocation under GSD Rule 4 or MBSD Rule 4, as
applicable, would constitute a waiver of any claim FICC may have
against a GSD Member or MBSD Member, as applicable, for any loss or
liability to which the GSD Member or MBSD Member is subject under the
GSD Rules or MBSD Rules, as applicable, including, without limitation,
any loss or liability to which it may be subject under GSD Rule 4 or
MBSD Rule 4, as applicable.
    In addition, pursuant to the Amendment, FICC is making other
clarifying and technical changes to the proposed rule change, as
proposed herein.
Nature of the Proposed Change
    The primary purpose of this proposed rule change is to amend GSD's
and MBSD's loss allocation rules in order to enhance the resiliency of
the Divisions' loss allocation processes so that each Division can take
timely action to address multiple loss events that occur in succession
during a short period of time (defined and explained in detail below).
In connection therewith, the proposed rule change would (i) align the
loss allocation rules of the three clearing agencies of The Depository
Trust & Clearing Corporation (``DTCC''), namely The Depository Trust
Company (``DTC''), National Securities Clearing Corporation (``NSCC''),
and FICC (collectively, the ``DTCC Clearing Agencies''), so as to
provide consistent treatment, to the extent practicable and
appropriate, especially for firms that are participants of two or more
DTCC Clearing Agencies, (ii) increase transparency and accessibility of
the loss allocation rules by enhancing their readability and clarity,
(iii) amend language regarding FICC's use of MBSD Clearing Fund, and
(iv) make conforming and technical changes.
(i) Background
    Central counterparties (``CCPs'') play a key role in financial
markets by mitigating counterparty credit risk on transactions between
market participants. CCPs achieve this by providing guaranties to
participants and, as a consequence, are typically exposed to credit
risks that could lead to default losses. In addition, in performing its
critical functions, a CCP could be exposed to non-default losses that
are otherwise incident to the CCP's clearance and settlement business.
    A CCP's rulebook should provide a complete description of how
losses would be allocated to participants if the size of the losses
exceeded the CCP's pre-funded resources. Doing so provides for an
orderly allocation of losses, and potentially allows the CCP to
continue providing critical services to the market and thereby results
in significant financial stability benefits. In addition, a clear
description of the loss allocation process offers transparency and
accessibility to the CCP's participants.
Current FICC Loss Allocation Process
    As CCPs, FICC's Divisions' loss allocation processes are key
components of their respective risk management processes. Risk
management is the foundation of FICC's ability to guarantee settlement
in each Division, as well as the means by which FICC protects itself
and its members from the risks inherent in the clearance and settlement
process. FICC's risk management processes must account for the fact
that, in certain extreme circumstances, the collateral and other
financial resources that secure FICC's risk exposures may not be
sufficient to fully cover losses resulting from the liquidation of the
portfolio of a member for whom a Division has ceased to act.\7\
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    \7\ GSD is permitted to cease to act for (i) a GSD Member
pursuant to GSD Rule 21 (Restrictions on Access to Services) and GSD
Rule 22 (Insolvency of a Member), (ii) a Sponsoring Member pursuant
to Section 14 and Section 16 of GSD Rule 3A (Sponsoring Members and
Sponsored Members), and (iii) a Sponsored Member pursuant to Section
13 and Section 15 of GSD Rule 3A (Sponsoring Members and Sponsored
Members). MBSD is permitted to cease to act for an MBSD Member
pursuant to MBSD Rule 14 (Restrictions on Access to Services) and
MBSD Rule 16 (Insolvency of a Member). GSD Rule 22A (Procedures for
When the Corporation Ceases to Act) and MBSD Rule 17 (Procedures for
When the Corporation Ceases to Act) set out the types of actions
FICC may take when it ceases to act for a member. Supra note 5.
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    The GSD Rules and the MBSD Rules each currently provide for a loss
allocation process through which both FICC (by applying up to 25% of
its retained earnings in accordance with Section 7(b) of GSD Rule 4 and
Section 7(c) of MBSD Rule 4) and its members would share in the
allocation of a loss resulting from the default of a member for whom a
Division has ceased to act pursuant to the Rules. The GSD Rules and the
MBSD Rules also recognize that FICC may incur losses outside the
context of a defaulting member that are otherwise incident to each
Division's clearance and settlement business.
    The current GSD and MBSD loss allocation rules provide that, in the
event the Division ceases to act for a member, the amounts on deposit
to the Clearing Fund from the defaulting member, along with any other
resources of, or attributable to, the defaulting member that FICC may
access under the GSD Rules or the MBSD Rules (e.g., payments from
Cross-Guaranty Agreements), are the first source of funds the Division
would use to cover any losses that may result from the closeout of the
defaulting member's guaranteed positions. If these amounts are not
sufficient to cover all losses incurred, then each Division will apply
the following available resources, in the following loss allocation
waterfall order:
    First, as provided in the current Section 7(b) of GSD Rule 4 and
Section 7(c) of MBSD Rule 4, FICC's corporate contribution of up to 25
percent of FICC's retained earnings existing at the time of the failure
of a defaulting member to fulfill its obligations to FICC,

or such greater amount as the Board of Directors may determine; and
    Second, if a loss still remains, use of the Clearing Fund of the
Division and assessing the Division's Members in the manner provided in
GSD Rule 4 and MBSD Rule 4, as the case may be. Specifically, FICC will
divide the loss ratably between Tier One Netting Members and Tier Two
Members with respect to GSD, or between Tier One Members and Tier Two
Members with respect to MBSD, based on original counterparty activity
with the defaulting member. Then the loss allocation process applicable
to Tier One Netting Members or Tier One Members, as applicable, and
Tier Two Members will proceed in the manner provided in GSD Rule 4 and
MBSD Rule 4, as the case may be.
    Specifically, the applicable Division will first assess each Tier
One Netting Member or Tier One Member, as applicable, an amount up to
$50,000, in an equal basis per such member. If a loss remains, the
Division will allocate the remaining loss ratably among Tier One
Netting Members or Tier One Members, as applicable, in accordance with
the amount of each Tier One Netting Member's or Tier One Member's, as
applicable, respective average daily Required Fund Deposit over the
prior twelve (12) months. If a Tier One Netting Member or Tier One
Member, as applicable, did not maintain a Required Fund Deposit for
twelve (12) months, its loss allocation amount will be based on its
average daily Required Fund Deposit over the time period during which
such member did maintain a Required Fund Deposit.
    Pursuant to current Section 7(g) of GSD Rule 4 and MBSD Rule 4, if,
as a result of the Division's application of the Required Fund Deposit
of a member, a member's actual Clearing Fund deposit is less than its
Required Fund Deposit, it will be required to eliminate such deficiency
in order to satisfy its Required Fund Deposit amount. In addition to
losses that may result from the closeout of the defaulting member's
guaranteed positions, Tier One Netting Members or Tier One Members, as
applicable, can also be assessed for non-default losses incident to
each Division's clearance and settlement business, pursuant to current
Section 7(f) of GSD Rule 4 and MBSD Rule 4.
    The Rules of both Divisions currently provide that Tier Two Members
are only subject to loss allocation to the extent they traded with the
defaulting member and their trades resulted in a liquidation loss. FICC
will assess Tier Two Members ratably based on their loss as a
percentage of the entire remaining loss attributable to Tier Two
Members.\8\ Tier Two Members are required to pay their loss allocation
obligations in full and replenish their Required Fund Deposits as
needed and as applicable. The current Rule provisions which provide for
loss allocation of non-default losses incident to each Division's
clearance and settlement business (i.e., Section 7(f) of GSD Rule 4 and
MBSD Rule 4) do not apply to Tier Two Members.
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    \8\ GSD Rule 3B, Section 7 (Loss Allocation Obligations of CCIT
Members) provides that CCIT Members will be allocated losses as Tier
Two Members and will be responsible for the total amount of loss
allocated to them. With respect to CCIT Members with a Joint Account
Submitter, loss allocation will be calculated at the Joint Account
level and then applied pro rata to each CCIT Member within the Joint
Account based on the trade settlement allocation instructions. Supra
note 5.
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Overview of the Proposed Rule Changes
A. Changes To Enhance Resiliency of GSD's and MBSD's Loss Allocation
Processes
    In order to enhance the resiliency of GSD's and MBSD's loss
allocation processes, FICC proposes to change the manner in which each
of the aspects of the loss allocation waterfall described above would
be employed. GSD and MBSD would retain the current core loss allocation
process following the application of the defaulting member's resources,
i.e., first, by applying FICC's corporate contribution, and second, by
pro rata allocations to Tier One Netting Members or Tier One Members,
as applicable, and Tier Two Members. However, GSD and MBSD would
clarify or adjust certain elements and introduce certain new loss
allocation concepts, as further discussed below. The proposal would
also retain the types of losses that can be allocated to Tier One
Netting Members or Tier One Members, as applicable, and Tier Two
Members as stated above. In addition, the proposed rule change would
address the loss allocation process as it relates to losses arising
from or relating to multiple default or non-default events in a short
period of time, also as described below.
    Accordingly, FICC is proposing five (5) key changes to enhance each
Division's loss allocation process:
(1) Changing the Calculation and Application of FICC's Corporate
Contribution
    As stated above, Section 7(b) of GSD Rule 4 and Section 7(c) of
MBSD Rule 4 currently provide that FICC will contribute up to 25% of
its retained earnings (or such higher amount as the Board of Directors
shall determine) to a loss or liability that is not satisfied by the
defaulting member's Clearing Fund deposit. Under the proposal, FICC
would amend the calculation of its corporate contribution from a
percentage of its retained earnings to a mandatory amount equal to 50%
of the FICC General Business Risk Capital Requirement.\9\ FICC's
General Business Risk Capital Requirement, as defined in FICC's
Clearing Agency Policy on Capital Requirements,\10\ is, at a minimum,
equal to the regulatory capital that FICC is required to maintain in
compliance with Rule 17Ad-22(e)(15) under the Act.\11\ The proposed
Corporate Contribution (as defined below and in the proposed rule
change) would be held in addition to FICC's General Business Risk
Capital Requirement.
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    \9\ FICC calculates its General Business Risk Capital
Requirement as the amount equal to the greatest of (i) an amount
determined based on its general business profile, (ii) an amount
determined based on the time estimated to execute a recovery or
orderly wind-down of FICC's critical operations, and (iii) an amount
determined based on an analysis of FICC's estimated operating
expenses for a six (6) month period.
    \10\ See Securities Exchange Act Release No. 81105 (July 7,
2017), 82 FR 32399 (July 13, 2017) (SR-FICC-2017-007).
    \11\ 17 CFR 240.17Ad-22(e)(15).
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    Currently, the Rules do not require FICC to contribute its retained
earnings to losses and liabilities other than those from member
defaults. Under the proposal, FICC would apply its corporate
contribution to non-default losses as well. The proposed Corporate
Contribution would apply to losses arising from Defaulting Member
Events and Declared Non-Default Loss Events (as such terms are defined
below and in the proposed rule change), and would be a mandatory
contribution by FICC prior to any allocation of the loss among the
applicable Division's members.\12\ As proposed, if the Corporate
Contribution is fully or partially used against a loss or liability
relating to an Event Period by one or both Divisions, the Corporate
Contribution would be reduced to the remaining unused amount, if any,
during the following two hundred fifty (250) Business Days in order to
permit FICC to replenish the Corporate Contribution.\13\ To ensure
transparency,

all GSD Members and MBSD Members would receive notice of any such
reduction to the Corporate Contribution. There would be one FICC
Corporate Contribution, the amount of which would be available to both
Divisions and would be applied against a loss or liability in either
Division in the order in which such loss or liability occurs, i.e.,
FICC would not have two separate Corporate Contributions, one for each
Division. In the event of a loss or liability relating to an Event
Period, whether arising out of or relating to a Defaulting Member Event
or a Declared Non-Default Loss Event, attributable to only one
Division, the Corporate Contribution would be applied to that Division
up to the amount then available. If a loss or liability relating to an
Event Period, whether arising out of or relating to a Defaulting Member
Event or a Declared Non-Default Loss Event, occurs simultaneously at
both Divisions, the Corporate Contribution would be applied to the
respective Divisions in the same proportion that the aggregate Average
RFDs (as defined below and in the proposed rule change) of all members
in that Division bear to the aggregate Average RFDs of all members in
both Divisions.\14\
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    \12\ The proposed rule change would not require a Corporate
Contribution with respect to the use of each Division's Clearing
Fund as a liquidity resource; however, if FICC uses a Division's
Clearing Fund as a liquidity resource for more than 30 calendar
days, as set forth in proposed Section 5 of GSD Rule 4 and MBSD Rule
4, then FICC would have to consider the amount used as a loss to the
respective Division's Clearing Fund incurred as a result of a
Defaulting Member Event and allocate the loss pursuant to proposed
Section 7 of Rule 4, which would then require the application of
FICC's Corporate Contribution.
    \13\ FICC believes that two hundred and fifth (250) Business
Days would be a reasonable estimate of the time frame that FICC
would require to replenish the Corporate Contribution by equity in
accordance with FICC's Clearing Agency Policy on Capital
Requirements, including a conservative additional period to account
for any potential delays and/or unknown exigencies in times of
distress.
    \14\ FICC believes that if a loss or liability relating to an
Event Period, whether arising out of or relating to a Defaulting
Member Event or a Declared Non-Default Loss Event, occurs
simultaneously at both Divisions, allocating the Corporate
Contribution ratably between the two Divisions based on the
aggregate Average RFDs of their respective members is appropriate
because the aggregate Average RFDs of all members in a Division
represent the amount of risks that those members bring to FICC over
the look-back period of seventy (70) Business Days.
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    As compared to the current approach of applying ``up to'' a
percentage of retained earnings to defaulting member losses, the
proposed Corporate Contribution would be a fixed percentage of FICC's
General Business Risk Capital Requirement, which would provide greater
transparency and accessibility to members. The proposed Corporate
Contribution would apply not only towards losses and liabilities
arising out of or relating to Defaulting Member Events but also those
arising out of or relating to Declared Non-Default Loss Events, which
is consistent with the current industry guidance that ``a CCP should
identify the amount of its own resources to be applied towards losses
arising from custody and investment risk, to bolster confidence that
participants' assets are prudently safeguarded.'' \15\
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    \15\ See Resilience of central counterparties (CCPs): Further
guidance on the PFMI, issued by the Committee on Payments and Market
Infrastructures and the International Organization of Securities
Commissions, at 42 (July 2017), available at www.bis.org/cpmi/publ/d163.pdf.
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    Under current Section 7(b) of GSD Rule 4 and Section 7(c) of MBSD
Rule 4, FICC has the discretion to contribute amounts higher than the
specified percentage of retained earnings, as determined by the Board
of Directors, to any loss or liability incurred by FICC as result of
the failure of a Defaulting Member to fulfill its obligations to FICC.
This option would be retained and expanded under the proposal so that
it would be clear that FICC can voluntarily apply amounts greater than
the Corporate Contribution against any loss or liability (including
non-default losses) of the Divisions, if the Board of Directors, in its
sole discretion, believes such to be appropriate under the factual
situation existing at the time.
    The proposed rule changes relating to the calculation and
application of Corporate Contribution are set forth in proposed
Sections 7 and 7a of GSD Rule 4 and Sections 7 and 7a of MBSD Rule 4,
as further described below.
(2) Introducing an Event Period
    In order to clearly define the obligations of each Division and its
respective Members regarding loss allocation and to balance the need to
manage the risk of sequential loss events against members' need for
certainty concerning their maximum loss allocation exposures, FICC is
proposing to introduce the concept of an ``Event Period'' to the GSD
Rules and the MBSD Rules to address the losses and liabilities that may
arise from or relate to multiple Defaulting Member Events and/or
Declared Non-Default Loss Events that arise in quick succession in a
Division. Specifically, the proposal would group Defaulting Member
Events and Declared Non-Default Loss Events occurring in a period of
ten (10) Business Days (``Event Period'') for purposes of allocating
losses to Members of the respective Divisions in one or more rounds (as
described below), subject to the limitations of loss allocation set
forth in the proposed rule change and as explained below.\16\ In the
case of a loss or liability arising from or relating to a Defaulting
Member Event, an Event Period would begin on the day one or both
Divisions notify their respective members that FICC has ceased to act
\17\ for the GSD Defaulting Member and/or the MBSD Defaulting Member
(or the next Business Day, if such day is not a Business Day). In the
case of a loss or liability arising from or relating to a Declared Non-
Default Loss Event, an Event Period would begin on the day that FICC
notifies members of the respective Divisions of the Declared Non-
Default Loss Event (or the next Business Day, if such day is not a
Business Day). If a subsequent Defaulting Member Event or Declared Non-
Default Loss Event occurs during an Event Period, any losses or
liabilities arising out of or relating to any such subsequent event
would be resolved as losses or liabilities that are part of the same
Event Period, without extending the duration of such Event Period. An
Event Period may include both Defaulting Member Events and Declared
Non-Default Loss Events, and there would not be separate Event Periods
for Defaulting Member Events or Declared Non-Default Loss Events
occurring during overlapping ten (10) Business Day periods.
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    \16\ FICC believes that having a ten (10) Business Day Event
Period would provide a reasonable period of time to encompass
potential sequential Defaulting Member Events or Declared Non-
Default Loss Events that are likely to be closely linked to an
initial event and/or a severe market dislocation episode, while
still providing appropriate certainty for members concerning their
maximum exposure to mutualized losses with respect to such events.
    \17\ Supra note 7.
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    The amount of losses that may be allocated by each Division,
subject to the required Corporate Contribution, and to which a Loss
Allocation Cap would apply for any member that elects to withdraw from
membership in respect of a loss allocation round, would include any and
all losses from any Defaulting Member Events and any Declared Non-
Default Loss Events during the Event Period, regardless of the amount
of time, during or after the Event Period, required for such losses to
be crystallized and allocated.\18\
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    \18\ As discussed below, each Tier One Netting Member or Tier
One Member, as applicable, that is a Tier One Netting Member or Tier
One Member on the first day of an Event Period would be obligated to
pay its pro rata share of losses and liabilities arising out of or
relating to each Defaulting Member Event (other than a Defaulting
Member Event with respect to which it is the Defaulting Member) and
each Declared Non-Default Loss Event occurring during the Event
Period.
---------------------------------------------------------------------------

    The proposed rule changes relating to the implementation of an
Event Period are set forth in proposed Section 7 of GSD Rule 4 and
Section 7 of MBSD Rule 4, as further described below.
(3) Introducing the Concept of ``Rounds'' and Loss Allocation Notice
    Pursuant to the proposed rule change, a loss allocation ``round''
would mean a series of loss allocations relating to an Event Period,
the aggregate amount of which is limited by the sum of the Loss

Allocation Caps of affected Tier One Netting Members or Tier One
Members, as applicable (a ``round cap''). When the aggregate amount of
losses allocated in a round equals the round cap, any additional losses
relating to the applicable Event Period would be allocated in one or
more subsequent rounds, in each case subject to a round cap for that
round. FICC may continue the loss allocation process in successive
rounds until all losses from the Event Period are allocated among Tier
One Netting Members or Tier One Members, as applicable, that have not
submitted a Loss Allocation Withdrawal Notice (as defined below and in
the proposed rule change) in accordance with proposed Section 7b of GSD
Rule 4 or MBSD Rule 4.
    Each loss allocation would be communicated to Tier One Netting
Members or Tier One Members, as applicable, by the issuance of a notice
that advises the Tier One Netting Members or Tier One Members, as
applicable, of the amount being allocated to them (``Loss Allocation
Notice''). Each Tier One Netting Member's or Tier One Member's, as
applicable, pro rata share of losses and liabilities to be allocated in
any round would be equal to (i) the average of its Required Fund
Deposit for the seventy (70) business days preceding the first day of
the applicable Event Period or such shorter period of time that the
member has been a member (each member's ``Average RFD''), divided by
(ii) the sum of Average RFD amounts of all members subject to loss
allocation in such round.
    Each Loss Allocation Notice would specify the relevant Event Period
and the round to which it relates. The first Loss Allocation Notice in
any first, second, or subsequent round would expressly state that such
Loss Allocation Notice reflects the beginning of the first, second, or
subsequent round, as the case may be, and that each Tier One Netting
Member or Tier One Member, as applicable, in that round has five (5)
Business Days from the issuance of such first Loss Allocation Notice
for the round to notify FICC of its election to withdraw from
membership with GSD or MBSD, as applicable, pursuant to proposed
Section 7b of GSD Rule 4 or MBSD Rule 4, as applicable, and thereby
benefit from its Loss Allocation Cap.\19\ The ``Loss Allocation Cap''
of a Tier One Netting Member or Tier One Member, as applicable, would
be equal to the greater of (x) its Required Fund Deposit on the first
day of the applicable Event Period and (y) its Average RFD.
---------------------------------------------------------------------------

    \19\ Pursuant to current Section 7(g) of GSD Rule 4 and MBSD
Rule 4, the time period for a member to give notice, pursuant to
Section 13 of GSD Rule 3 and MBSD Rule 3, of its election to
terminate its membership in GSD or MBSD, as applicable, in respect
of an allocation arising from any Remaining Loss allocated by FICC
pursuant to Section 7(d) of GSD Rule 4 or Section 7(e) of MBSD Rule
4, as applicable, and any Other Loss, is the Close of Business on
the Business Day on which the loss allocation payment is due to
FICC. Current Section 13 of GSD Rule 4 and MBSD Rule 4 requires a
10-day notice period. Supra note 5.
    FICC believes that it is appropriate to shorten such time period
from 10 days to five (5) Business Days because FICC needs timely
notice of which Tier One Netting Members or Tier One Members, as
applicable, would remain in its membership for purpose of
calculating the loss allocation for any subsequent round. FICC
believes that five (5) Business Days would provide Tier One Netting
Members or Tier One Members, as applicable, with sufficient time to
decide whether to cap their loss allocation obligations by
withdrawing from their membership in GSD or MBSD, as applicable.
---------------------------------------------------------------------------

    After a first round of loss allocations with respect to an Event
Period, only Tier One Netting Members or Tier One Members, as
applicable, that have not submitted a Loss Allocation Withdrawal Notice
in accordance with proposed Section 7b of GSD Rule 4 or MBSD Rule 4, as
applicable, would be subject to further loss allocation with respect to
that Event Period.
    The amount of any second or subsequent round cap may differ from
the first or preceding round cap because there may be fewer Tier One
Netting Members or Tier One Members, as applicable, in a second or
subsequent round if Tier One Netting Members or Tier One Members, as
applicable, elect to withdraw from membership with GSD or MBSD, as
applicable, as provided in proposed Section 7b of GSD Rule 4 or MBSD
Rule 4, as applicable, following the first Loss Allocation Notice in
any round.
    For example, for illustrative purposes only, after the required
Corporate Contribution, if FICC has a $5 billion loss determined with
respect to an Event Period and the sum of Loss Allocation Caps for all
Tier One Netting Members or Tier One Members, as applicable, subject to
the loss allocation is $4 billion, the first round would begin when
FICC issues the first Loss Allocation Notice for that Event Period.
FICC could issue one or more Loss Allocation Notices for the first
round until the sum of losses allocated equals $4 billion. Once the $4
billion is allocated, the first round would end and FICC would need a
second round in order to allocate the remaining $1 billion of loss.
FICC would then issue a Loss Allocation Notice for the $1 billion and
this notice would be the first Loss Allocation Notice for the second
round. The issuance of the Loss Allocation Notice for the $1 billion
would begin the second round.
    The proposed rule change would link the Loss Allocation Cap to a
round in order to provide Tier One Netting Members or Tier One Members,
as applicable, the option to limit their loss allocation exposure at
the beginning of each round. As proposed and as described further
below, a Tier One Netting Member or Tier One Member, as applicable,
could limit its loss allocation exposure to its Loss Allocation Cap by
providing notice of its election to withdraw from membership within
five (5) Business Days after the issuance of the first Loss Allocation
Notice in any round.
    The proposed rule changes relating to the implementation of
``rounds'' and Loss Allocation Notices are set forth in proposed
Section 7 of GSD Rule 4 and Section 7 of MBSD Rule 4, as further
described below.
(4) Implementing a Revised ``Look-Back'' Period To Calculate a Member's
Loss Allocation Pro Rata Share and Its Loss Allocation Cap
    Currently, the GSD Rules and the MBSD Rules calculate a Tier One
Netting Member's or a Tier One Member's pro rata share for purposes of
loss allocation based on the member's average daily Required Fund
Deposit over the prior twelve (12) months (or such shorter period as
may be available in the case of a member which has not maintained a
deposit over such time period). The Rules currently do not anticipate
the possibility of more than one Defaulting Member Event or Declared
Non-Default Loss Event in quick succession.
    GSD and MBSD are proposing to calculate each Tier One Netting
Member's or Tier One Member's, as applicable, pro rata share of losses
and liabilities to be allocated in any round (as described above and in
the proposed rule change) to be equal to (i) the member's Average RFD
divided by (ii) the sum of Average RFD amounts for all members that are
subject to loss allocation in such round.
    Additionally, as described above and in the proposed rule change,
if a Tier One Netting Member or Tier One Member, as applicable,
withdraws from membership pursuant to proposed Section 7b of GSD Rule 4
or MBSD Rule 4, as applicable, GSD and MBSD are proposing that the
member's Loss Allocation Cap be equal to the greater of (i) its
Required Fund Deposit on the first day of the applicable Event Period
or (ii) its Average RFD.
    FICC believes that employing a revised look-back period of seventy
(70)

Business Days instead of twelve (12) months to calculate a Tier One
Netting Member's or a Tier One Member's, as applicable, loss allocation
pro rata share and Loss Allocation Cap is appropriate, because FICC
recognizes that the current look-back period of twelve (12) months is a
very long period during which a member's business strategy and outlook
could have shifted significantly, resulting in material changes to the
size of its portfolios. A look-back period of seventy (70) Business
Days would minimize that issue yet still would be long enough to enable
FICC to capture a full calendar quarter of such members' activities and
smooth out the impact from any abnormalities and/or arbitrariness that
may have occurred.
    The proposed rule changes relating to the implementation of the
revised look-back period are set forth in proposed Section 7 of GSD
Rule 4 and Section 7 of MBSD Rule 4, as further described below.
(5) Capping Withdrawing Members' Loss Allocation Exposure and Related
Changes
    Currently, pursuant to Section 7(g) of GSD Rule 4 and MBSD Rule 4,
a member can withdraw from membership in order to avail itself of a cap
on loss allocation if the member notifies FICC via a written notice, in
accordance with Section 13 of GSD Rule 3 or MBSD Rule 3, as applicable,
of its election to terminate its membership. Such notice must be
provided by the Close of Business on the Business Day on which the loss
allocation payment is due to FICC and, if properly provided to FICC,
would limit the member's liability for a loss allocation to its
Required Fund Deposit for the Business Day on which the notification of
allocation is provided to the member.\20\ As discussed above, the
proposed rule change would continue providing members the opportunity
to limit their loss allocation exposure by offering withdrawal options;
however, the cap on loss allocation would be calculated differently and
the associated withdrawal process would also be modified as it relates
to withdrawals associated with the loss allocation process. In
particular, the proposed rule change would shorten the withdrawal
notification period from 10 days to five (5) Business Days, as further
described below.
---------------------------------------------------------------------------

    \20\ Current Section 13 of GSD Rule 3 and MBSD Rule 3 requires a
member to provide FICC with 10 days written notice of the member's
termination; however, FICC, in its discretion, may accept such
termination within a shorter notice period. Supra note 5.
---------------------------------------------------------------------------

    As proposed, if a member timely provides notice of its withdrawal
from membership in respect of a loss allocation round, the maximum
amount of losses it would be responsible for would be its Loss
Allocation Cap,\21\ provided that the member complies with the
requirements of the withdrawal process in proposed Section 7b of GSD
Rule 4 and Section 7b of MBSD Rule 4.
---------------------------------------------------------------------------

    \21\ If a member's Loss Allocation Cap exceeds the member's
then-current Required Fund Deposit, it must still cover the excess
amount.
---------------------------------------------------------------------------

    Currently, pursuant to Section 7(g) of GSD Rule 4 and MBSD Rule 4,
if notification is provided to a member that an allocation has been
made against the member pursuant to GSD Rule 4 or MBSD Rule 4, as
applicable, and that application of the member's Required Fund Deposit
is not sufficient to satisfy such obligation to make payment to FICC,
the member is required to deliver to FICC by the Close of Business on
the next Business Day, or by the Close of Business on the Business Day
of issuance of the notification if so determined by FICC, that amount
which is necessary to eliminate any such deficiency, unless the member
elects to terminate its membership in FICC. To increase transparency of
the timeframe under which FICC would require funds from members to
satisfy their loss allocation obligations, FICC is proposing that
members would receive two (2) Business Days' notice of a loss
allocation, and members would be required to pay the requisite amount
no later than the second Business Day following issuance of such
notice.\22\ Members would have five (5) Business Days \23\ from the
issuance of the first Loss Allocation Notice in any round of an Event
Period to decide whether to withdraw from membership.
---------------------------------------------------------------------------

    \22\ FICC believes that allowing members two (2) Business Days
to satisfy their loss allocation obligations would provide Members
sufficient notice to arrange funding, if necessary, while allowing
FICC to address losses in a timely manner.
    \23\ Supra note 19.
---------------------------------------------------------------------------

    Each round would allow a Tier One Netting Member or Tier One
Member, as applicable, the opportunity to notify FICC of its election
to withdraw from membership after satisfaction of the losses allocated
in such round. Multiple Loss Allocation Notices may be issued with
respect to each round to allocate losses up to the round cap.
    Specifically, the first round and each subsequent round of loss
allocation would allocate losses up to a round cap of the aggregate of
all Loss Allocation Caps of those Tier One Netting Members or Tier One
Members, as applicable, included in the round. If a Tier One Netting
Member or Tier One Member, as applicable, provides notice of its
election to withdraw from membership, it would be subject to loss
allocation in that round, up to its Loss Allocation Cap. If the first
round of loss allocation does not fully cover FICC's losses, a second
round will be noticed to those members that did not elect to withdraw
from membership in the previous round; however, as noted above, the
amount of any second or subsequent round cap may differ from the first
or preceding round cap because there may be fewer Tier One Netting
Members or Tier One Members, as applicable, in a second or subsequent
round if Tier One Netting Members or Tier One Members, as applicable,
elect to withdraw from membership with GSD or MBSD, as applicable, as
provided in proposed Section 7b of GSD Rule 4 or MBSD Rule 4, as
applicable, following the first Loss Allocation Notice in any round.
    Pursuant to the proposed rule change, in order to avail itself of
its Loss Allocation Cap, a Tier One Netting Member or Tier One Member,
as applicable, would need to follow the requirements in proposed
Section 7b of GSD Rule 4 or MBSD Rule 4, as applicable, which would
provide that the Tier One Netting Member or Tier One Member, as
applicable, must: (i) Specify in its Loss Allocation Withdrawal Notice
an effective date of withdrawal, which date shall not be prior to the
scheduled final settlement date of any remaining obligations owed by
the member to FICC, unless otherwise approved by FICC, and (ii) as of
the time of such member's submission of the Loss Allocation Withdrawal
Notice, cease submitting transactions to FICC for processing, clearance
or settlement, unless otherwise approved by FICC.
    As proposed, a Tier One Netting Member or a Tier One Member, as
applicable, that withdraws in compliance with proposed Section 7b of
GSD Rule 4 or MBSD Rule 4, as applicable, would remain obligated for
its pro rata share of losses and liabilities with respect to any Event
Period for which it is otherwise obligated under GSD Rule 4 or MBSD
Rule 4, as applicable; however, its aggregate obligation would be
limited to the amount of its Loss Allocation Cap (as fixed in the round
for which it withdrew).
    The proposed rule changes are designed to enable FICC to continue
the loss allocation process in successive rounds until all of FICC's
losses are allocated. To the extent that the Loss Allocation Cap of a
Tier One Netting Member or Tier One Member, as applicable, exceeds such
member's

Required Fund Deposit on the first day of an Event Period, FICC may in
its discretion retain any excess amounts on deposit from the member, up
to the Loss Allocation Cap of a Tier One Netting Member or Tier One
Member, as applicable.
    The proposed rule changes relating to capping withdrawing members'
loss allocation exposure and related changes to the withdrawal process
are set forth in proposed Sections 7 and 7b of GSD Rule 4 and Sections
7 and 7b of MBSD Rule 4, as further described below.
B. Changes To Align Loss Allocation Rules
    The proposed rule changes would align the loss allocation rules, to
the extent practicable and appropriate, of the three DTCC Clearing
Agencies so as to provide consistent treatment, especially for firms
that are participants of two or more DTCC Clearing Agencies. As
proposed, the loss allocation waterfall and certain related provisions,
e.g., returning a former member's Clearing Fund, would be consistent
across the DTCC Clearing Agencies to the extent practicable and
appropriate. The proposed rule changes of FICC that would align loss
allocation rules of the DTCC Clearing Agencies are set forth in
proposed Sections 1, 5, 6, 10, and 11 of GSD Rule 4 and MBSD Rule 4, as
further described below.
C. Clarifying Changes Relating to Loss Allocation
    The proposed rule changes are intended to make the provisions in
the Rules governing loss allocation more transparent and accessible to
members. In particular, FICC is proposing the following changes
relating to loss allocation to clarify members' obligations for
Declared Non-Default Loss Events.
    Aside from losses that FICC might face as a result of a Defaulting
Member Event, FICC could incur non-default losses incident to each
Division's clearance and settlement business.\24\ The GSD Rules and the
MBSD Rules currently permit FICC to apply Clearing Fund to non-default
losses.\25\ Section 5 of GSD Rule 4 and MBSD Rule 4 provides that the
use of Clearing Fund deposits is limited to satisfaction of losses or
liabilities of FICC, which includes losses or liabilities that are
otherwise incident to the operation of the clearance and settlement
business of FICC, although the application of Clearing Fund to such
losses or liabilities is more limited under MBSD Rule 4 when compared
to GSD Rule 4.\26\ Section 7(f) of GSD Rule 4 and MBSD Rule 4 provides
that any loss or liability incurred by the Corporation incident to its
clearance and settlement business arising other than from a Remaining
Loss shall be allocated among Tier One Netting Members or Tier One
Members, as applicable, ratably, in accordance with their Average
Required Clearing Fund Deposits.\27\
---------------------------------------------------------------------------

    \24\ Non-default losses may arise from events such as damage to
physical assets, a cyber-attack, or custody and investment losses.
    \25\ Arguably there is an ambiguity created by the first
paragraph of Section 7 in both GSD Rule 4 and MBSD Rule 4, which
suggests that losses or liabilities may only be allocated in a
member default scenario, while Section 5 in both GSD Rule 4 and MBSD
Rule 4 makes it clear that the applicable Division's Clearing Fund
may be used to satisfy non-default losses.
    \26\ Section 5 of GSD Rule 4 provides that ``The use of the
Clearing Fund deposits shall be limited to satisfaction of losses or
liabilities of the Corporation . . . otherwise incident to the
clearance and settlement business of the Corporation . . .'' Supra
note 5.
     Section 5 of MBSD Rule 4 provides that ``The use of the
Clearing Fund deposits and assets and property on which the
Corporation has a lien on shall be limited to satisfaction of losses
or liabilities of the Corporation . . . otherwise incident to the
clearance and settlement business of the Corporation with respect to
losses and liabilities to meet unexpected or unusual requirements
for funds that represent a small percentage of the Clearing Fund. .
.'' Supra note 5.
    \27\ Section 7(f) of GSD Rule 4 provides that ``Any loss or
liability incurred by the Corporation incident to its clearance and
settlement business . . . arising other than from a Remaining Loss
(hereinafter, an ``Other Loss'') shall be allocated among Tier One
Netting Members, ratably, in accordance with the respective amounts
of their Average Required FICC Clearing Fund Deposits. Supra note 5.
     Section 7(f) of MBSD Rule 4 provides that ``Any loss or
liability incurred by the Corporation incident to its clearance and
settlement business . . . arising other than from a Remaining Loss
(hereinafter, an ``Other Loss''), shall be allocated among Tier One
Members, ratably, in accordance with the respective amounts of their
Average Required Clearing Fund Deposits. Supra note 5.
---------------------------------------------------------------------------

    If there is a failure of FICC following a non-default loss, such
occurrence would affect members in much the same way as a failure of
FICC following a Defaulting Member Event. Accordingly, FICC is
proposing rule changes to enhance the provisions relating to non-
default losses by clarifying members' obligations for such losses and
aligning the non-default loss provisions in the GSD Rules and the MBSD
Rules.
    Specifically, for both the GSD Rules and the MBSD Rules, FICC is
proposing enhancement of the governance around non-default losses that
would trigger loss allocation to Tier One Netting Members or Tier One
Members, as applicable, by specifying that the Board of Directors would
have to determine that there is a non-default loss that may be a
significant and substantial loss or liability that may materially
impair the ability of FICC to provide clearance and settlement services
in an orderly manner and will potentially generate losses to be
mutualized among the Tier One Netting Members or Tier One Members, as
applicable, in order to ensure that FICC may continue to offer
clearance and settlement services in an orderly manner. The proposed
rule change would provide that FICC would then be required to promptly
notify members of this determination (a ``Declared Non-Default Loss
Event''). In addition, FICC is proposing to better align the interest
of FICC with those of its members by stipulating a mandatory Corporate
Contribution apply to a Declared Non-Default Loss Event prior to any
allocation of the loss among members, as described above. Additionally,
FICC is proposing language to clarify members' obligations for Declared
Non-Default Loss Events.
    Under the proposal, FICC would clarify the Rules of both Divisions
to make clear that Tier One Netting Members or Tier One Members, as
applicable, are subject to loss allocation for non-default losses
(i.e., Declared Non-Default Loss Events under the proposal) and Tier
Two Members are not subject to loss allocation for non-default losses.
    The proposed rule changes relating to Declared Non-Default Loss
Events and members' obligations for such events are set forth in
proposed Section 7 of GSD Rule 4 and Section 7 of MBSD Rule 4, as
further described below.
D. Amending Language Regarding FICC's Use of MBSD Clearing Fund
    The proposed rule change would delete language currently in Section
5 of MBSD Rule 4 that limits certain uses by FICC of the MBSD Clearing
Fund to ``unexpected or unusual'' requirements for funds that represent
a ``small percentage'' of the MBSD Clearing Fund. FICC believes that
these limiting phrases (which appear in connection with FICC's use of
MBSD Clearing Fund to cover losses and liabilities incident to its
clearance and settlement business outside the context of an MBSD
Defaulting Member Event as well as to cover certain liquidity needs)
are vague and imprecise, and should be replaced in their entirety.
Specifically, FICC is proposing to delete the limiting language with
respect to FICC's use of MBSD Clearing Fund to cover losses and
liabilities incident to its clearance and settlement business outside
the context of an MBSD Defaulting Member Event so as to not have such
language be interpreted as impairing FICC's ability to access the MBSD
Clearing Fund in order to manage non-default losses. FICC is also
proposing to delete

the limiting language with respect to FICC's use of MBSD Clearing Fund
to cover certain liquidity needs because the effect of the limitation
in this context is confusing and unclear.
    The proposed rule changes relating to FICC's use of MBSD Clearing
Fund are set forth in proposed Section 5 of MBSD Rule 4, as further
described below.
    The foregoing changes as well as other changes (including a number
of conforming and technical changes) that FICC is proposing in order to
improve the transparency and accessibility of the Rules are described
in detail below.
E. Loss Allocation Waterfall Comparison
    The following example \28\ illustrates the differences between the
current and proposed loss allocation provisions:
---------------------------------------------------------------------------

    \28\ For purposes of this example, FICC has assumed that no
losses have arisen that apply to Tier Two Netting Members, Tier Two
Members, or CCIT Members.
---------------------------------------------------------------------------

Assumptions
    (i) Firms A, B, and X are each a GSD Netting Member and an MBSD
Clearing Member and are referred to as Member A, Member B, and Member
X, respectively.
    (ii) Member A defaults on a Business Day (Day 1). On the same day,
FICC ceases to act for Member A and notifies members of the cease to
act. After liquidating Member A's portfolio and applying Member A's
Clearing Fund deposit, FICC has a total loss of $350 million, with $200
million in GSD and $150 million in MBSD.
    (iii) Member X voluntarily retires from membership five (5)
Business Days after FICC ceases to act for Member A (Day 6).
    (iv) Member B defaults seven (7) Business Days after FICC ceases to
act for Member A (Day 8). On the same day, FICC ceases to act for
Member B and notifies members of the cease to act. After liquidating
Member B's portfolio and applying Member B's Clearing Fund deposit,
FICC has a total loss of $350 million, with $200 million in GSD and
$150 million in MBSD.
    (v) The current FICC loss provisions require FICC to contribute up
to 25% of its retained earnings as a corporate contribution. For the
purposes of this example, it is assumed that FICC will contribute 25%
of its retained earnings. The amount of FICC's retained earnings is
$176 million.
    (vi) FICC's General Business Risk Capital Requirement is $98
million.
Current Loss Allocation
    Under the current loss allocation provisions, with respect to the
losses arising out of Member A's default, FICC will contribute a total
of $44 million ($176 million * 25%) from retained earnings,\29\ with
approximately $25 million ($44 million* ($200 million/$350 million))
for GSD and approximately $19 million ($44 million* ($150 million/$350
million)) for MBSD. FICC will then allocate the remaining GSD loss of
$175 million ($200 million - $25 million) to GSD Tier One Netting
Members and the remaining MBSD loss of $131 million ($150 million - $19
million) to MBSD Tier One Members.
---------------------------------------------------------------------------

    \29\ The retained earnings are applied to the respective
Divisions in the same proportion that the losses of that Division
bear to the total losses of both Divisions.
---------------------------------------------------------------------------

    With respect to losses arising out of Member B's default, FICC will
contribute a total of approximately $33 million (($176 million - $44
million) * 25%) from retained earnings, with approximately $19 million
($33 million * ($200 million/$350 million)) for GSD and approximately
$14 million ($33 million * ($150 million/$350 million)) for MBSD. FICC
will then allocate the remaining GSD loss of $181 million ($200 million
- $19 million) to GSD Tier One Netting Members and the remaining MBSD
loss of $136 million ($150 million - $14 million) to MBSD Tier One
Members.
    Altogether, with respect to losses arising out of defaults of
Member A and Member B, FICC will contribute a total of approximately
$77 million of retained earnings, with approximately $44 million for
GSD and approximately $33 million for MBSD. FICC will allocate losses
of $356 million to GSD Tier One Netting Members and $267 million to
MBSD Tier One Members.
Proposed Loss Allocation
    Under the proposed loss allocation provisions, a Defaulting Member
Event with respect to Member A's default would have occurred on Day
One, and a Defaulting Member Event with respect to Member B's default
would have occurred on Day 8. Because the Defaulting Member Events
occurred during a 10-business day period, they would be grouped
together into an Event Period for purposes of allocating losses to
members. The Event Period would begin on the 1st business day and end
on the 10th business day.
    With respect to losses arising out of Member A's default, FICC
would apply a Corporate Contribution of $49 million ($98 million *
50%),\30\ with approximately $32 million ($49 million * ($10 billion/
$15.2 billion)) for GSD and approximately $17 million ($49 million *
($5.2 billion/$15.2 billion)) for MBSD. FICC would then allocate the
remaining GSD loss of $168 million ($200 million - $32 million) to GSD
Tier One Netting Members and the remaining MBSD loss of $133 million
($150 million - $17 million) to MBSD Tier One Members. With respect to
losses arising out of Member B's default, FICC would not apply a
Corporate Contribution since it would have already contributed the
maximum Corporate Contribution of 50% of its General Business Risk
Capital Requirement. With respect to losses arising out of Member B's
default, FICC would allocate the GSD loss of $200 million to GSD Tier
One Netting Members and the MBSD loss of $150 million to MBSD Tier One
Members. Because Member X was a member in both Divisions on the first
day of the Event Period, Member X would be subject to loss allocation
with respect to all events occurring during the Event Period, even if
the event occurred after its retirement. Therefore, Member X would be
subject to loss allocation with respect to Member B's default.
---------------------------------------------------------------------------

    \30\ The Corporate Contribution would be applied to the
respective Divisions in the same proportion that the aggregate
Average RFDs of all members in that Division bear to the aggregate
Average RFDs of all members in both Divisions. For the purposes of
this example, FICC has assumed that the aggregate Average RFDs of
all GSD members is $10 billion and the aggregate Average RFDs of all
MBSD members is $5.2 billion.
---------------------------------------------------------------------------

    Altogether, with respect to losses arising out of defaults of
Member A and Member B, FICC would apply a Corporate Contribution of $49
million, with approximately $32 million for GSD and approximately $17
million for MBSD. FICC would allocate losses of $368 million to GSD
Tier One Netting Members and $283 million to MBSD Tier One Members.
    The principal differences in the above example are due to (i) the
proposed changes to the calculation and application of the Corporate
Contribution and (ii) the proposed introduction of an Event Period.
(ii) Detailed Description of the Proposed Rule Changes Related to Loss
Allocation
A. Proposed Changes to GSD Rule 4 (Clearing Fund and Loss Allocation)
and MBSD Rule 4 (Clearing Fund and Loss Allocation)
Overview of GSD Rule 4 and MBSD Rule 4
    GSD Rule 4 and MBSD Rule 4 currently address Clearing Fund
requirements and loss allocation obligations, as well as permissible
uses of the Clearing Fund. These Rules address the various Clearing
Fund calculations for each Division's Clearing

Fund and set forth rights, obligations and other aspects associated
with each Division's Clearing Fund, as well as each Division's loss
allocation process. GSD Rule 4 and MBSD Rule 4 are each currently
organized into 12 sections. Sections of these Rules that FICC is
proposing to change are described below.
Section 1 of GSD Rule 4 and MBSD Rule 4
    Currently, Section 1 of GSD Rule 4 and MBSD Rule 4 set forth the
requirement that each GSD Netting Member and each MBSD Clearing Member
make and maintain a deposit to the Clearing Fund at the minimum level
set forth in the respective Rule 4 and note that the timing of such
payment is set forth in another section of the respective Rule 4.
Current Section 1 of the respective rule also provides that the
deposits to the Clearing Fund will be held by FICC or its designated
agents. Current Section 1 of MBSD Rule 4 also defines the term
``Transaction'' for purposes of MBSD Rule 4 and references a Member's
obligation to replenish the deficit in its Required Fund Deposit if it
is charged by FICC under certain circumstances.
    FICC is proposing to rename the subheading of Section 1 of Rule 4
in both the GSD Rules and MBSD Rules from ``General'' to ``Required
Fund Deposits'' and to restructure the wording of the provisions for
clarity and readability.
    Under the proposed rule change, Section 1 of GSD Rule 4 and Section
1 of MBSD Rule 4 would continue to have the same provisions as they
relate to Netting Members or Clearing Members, as applicable, except
for the following: (i) The language throughout the sections would be
reorganized, streamlined and clarified, and (ii) language would be
added regarding additional deposits maintained by the Netting Members
or Clearing Members, as applicable, at FICC, and highlight for members
that such additional deposits would be deemed to be part of the
Clearing Fund and the member's Actual Deposit (as discussed below and
as defined in the proposed rule change) but would not be deemed to be
part of the member's Required Fund Deposit.
    The proposed language regarding maintenance of a member's Actual
Deposit would also make it clear that FICC will not be required to
segregate such deposit, but shall maintain books and records concerning
the assets that constitute each member's Actual Deposit.
    In addition, FICC proposes a technical change to update a cross
reference in Section 1 of GSD Rule 4 and MBSD Rule 4.
    Furthermore, in Section 1 of MBSD Rule 4, FICC is proposing to move
the definition of ``Transactions'' to proposed Section 2(a) of MBSD
Rule 4, where the first usage of ``Transactions'' in MBSD Rule 4
appears. FICC is also proposing to delete the last sentence in Section
1 of MBSD Rule 4, which references a Member's obligation to replenish
the deficit in its Required Fund Deposit if it is charged by FICC under
certain circumstances, because it would no longer be relevant under the
proposed rule change to Section 7 of MBSD Rule 4, as FICC would require
members to pay their loss allocation amounts instead of charging their
Required Fund Deposits for Clearing Fund losses.
Section 2 of GSD Rule 4 and MBSD Rule 4
    Current Section 2 of GSD Rule 4 and MBSD Rule 4 set forth more
detailed requirements pertaining to members' Required Fund Deposits.
FICC is proposing to rename the subheadings in these sections from
``Required Fund Deposit'' to ``Required Fund Deposit Requirements'' in
order to better reflect the purpose of this section.
    In addition, FICC is proposing to expand the definition of ``Legal
Risk'' in both the GSD and MBSD provisions (current Section 2(e) of GSD
Rule 4 and Section 2(f) of MBSD Rule 4) by revising the parameters of
Legal Risk so that it would not be limited to laws applicable to a
member's insolvency or bankruptcy, as FICC believes that Legal Risk may
arise outside the context of an insolvency or bankruptcy event
regarding a member, and FICC should be permitted to adequately protect
itself in those non- insolvency/bankruptcy circumstances as well.
    For better organization of Rule 4, FICC is also proposing to
relocate the provision on minimum Clearing Fund cash requirements
(current Section 2(b) of GSD Rule 4 and Section 2(d) of MBSD Rule 4) to
the section in each of GSD Rule 4 and MBSD Rule 4 dealing specifically
with the form of Clearing Fund deposits (proposed Section 3 of GSD Rule
4 and MBSD Rule 4). This would necessitate the re-lettering of the
provisions in Section 2. In addition, as stated above, the provision
regarding the definition of ``Transactions'' for purposes of MBSD Rule
4 would be moved to proposed Section 2(a) from current Section 1.
    FICC is proposing technical changes to correct typographical errors
in current Section 2 of GSD Rule 4.
Sections 3, 3a and 3b of GSD Rule 4 and MBSD Rule 4
    Currently, Sections 3, 3a and 3b of GSD Rule 4 and MBSD Rule 4
address the permissible form of Clearing Fund deposits and contain
detailed requirements regarding each form. FICC is proposing changes to
improve the readability of these sections.
    In addition, for better organization of the subject matter, FICC is
proposing to move certain paragraphs from one section to another,
including (i) moving clauses (b) and (d) in current Section 2 of GSD
Rule 4 and MBSD Rule 4, respectively, to proposed Section 3 of GSD Rule
4 and MBSD Rule 4 and (ii) moving the last paragraph of current Section
3 in GSD Rule 4 and MBSD Rule 4 to proposed Section 3b of GSD Rule 4
and MBSD Rule 4.
    Under the proposed rule change, FICC is also proposing to update
the cash investment provision in Section 3a of GSD Rule 4 and MBSD Rule
4 to reflect the Clearing Agency Investment Policy adopted by FICC \31\
and to define Clearing Fund Cash as (i) cash deposited by a Netting
Member or Clearing Member, as applicable, as part of its Actual
Deposit, (ii) the proceeds of (x) any loans made to FICC secured by the
pledge by FICC of Eligible Clearing Fund Securities pledged to FICC or
(y) any sales of Eligible Clearing Fund Securities pledged to FICC,
(iii) cash receipts from any investment of, repurchase or reverse
repurchase agreements relating to, or liquidation of, Clearing Fund
assets, and (iv) cash payments on Eligible Letters of Credit. Lastly,
FICC is proposing technical changes to correct typographical errors in
current Section 3 of MBSD Rule 4 and current Section 3b of GSD Rule 4.
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    \31\ See Securities Exchange Act Release No. 79528 (December 12,
2016), 81 FR 91232 (December 16, 2016) (SR-FICC-2016-005). The
Clearing Agency Investment Policy (the ``Policy'') governs the
management, custody, and investment of cash deposited to the GSD and
MBSD Clearing Funds, the proprietary liquid net assets (cash and
cash equivalents) of FICC and other funds held by FICC. The Policy
sets forth guiding principles for the investment of those funds,
which include adherence to a conservative investment philosophy that
places the highest priority on maximizing liquidity and avoiding
risk, as well as mandating the segregation and separation of funds.
The Policy also addresses the process for evaluating credit ratings
of counterparties and identifies permitted investments within
specified parameters. In general, assets are required to be held by
regulated and creditworthy financial institution counterparties and
invested in financial instruments that, with respect to the GSD and
MBSD Clearing Funds, may include deposits with banks, including the
Federal Reserve Bank of New York, collateralized reverse-repurchase
agreements, direct obligations of the U.S. government and money-
market mutual funds.

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Section 4 of GSD Rule 4 and MBSD Rule 4
    Currently, Section 4 of GSD Rule 4 and MBSD Rule 4 address the
granting of a first priority perfected security interest by each
Netting Member or Clearing Member, as applicable, in all assets and
property placed by the member in the possession of FICC (or its agents
acting on its behalf). FICC is not proposing any substantive changes to
these sections except for streamlining the provisions for readability
and clarity, and adding ``Actual Deposit'' as a defined term to refer
to Eligible Clearing Fund Securities, funds and assets pledged to FICC
to secure any and all obligations and liabilities of a Netting Member
or a Clearing Member, as applicable, to FICC.
Section 5 of GSD Rule 4 and MBSD Rule 4
    Currently, Section 5 of GSD Rule 4 and MBSD Rule 4 describe the use
of each Division's Clearing Fund. FICC is proposing to rename the
subheading of this section from ``Use of Deposits and Payments'' to
``Use of Clearing Fund'' to better reflect the purpose of the section.
    Under the proposed rule change, FICC is also proposing changes to
streamline this section for clarity and readability and to align the
GSD Rules and MBSD Rules. Specifically, FICC is proposing to delete the
first paragraph of current Section 5 of GSD Rule 4 and MBSD Rule 4 and
replace it with clearer language that sets forth the permitted uses of
each Division's Clearing Fund. Specifically, the proposed Section 5 of
GSD Rule 4 and MBSD Rule 4 provides that each Division's Clearing Fund
would only be used by FICC (i) to secure each member's performance of
obligations to FICC, including, without limitation, each member's
obligations with respect to any loss allocations as set forth in
proposed Section 7 of GSD Rule 4 and MBSD Rule 4 and any obligations
arising from a Cross-Guaranty Agreement pursuant to GSD Rule 41 or MBSD
Rule 32, as applicable, or a Cross-Margining Agreement pursuant to GSD
Rule 43, (ii) to provide liquidity to FICC to meet its settlement
obligations, including, without limitation, through the direct use of
cash in the GSD Clearing Fund or MBSD Clearing Fund, as applicable, or
through the pledge or rehypothecation of pledged Eligible Clearing Fund
Securities in order to secure liquidity, and (iii) for investment as
set forth in proposed Section 3a of GSD Rule 4 and MBSD Rule 4.
    The current first paragraph of Section 5 of GSD Rule 4 and MBSD
Rule 4 provides that if FICC pledges, hypothecates, encumbers, borrows,
or applies any part of the respective Division's Clearing Fund deposits
to satisfy any liability, obligation, or liquidity requirements for
more than thirty (30) days, FICC, at the Close of Business on the 30th
day (or on the first Business Day thereafter) will consider the amount
used as an actual loss to the respective Division's Clearing Fund and
immediately allocate such loss in accordance with Section 7 of GSD Rule
4 or MBSD Rule 4, as applicable. As proposed, FICC would retain this
provision conceptually but replace it with clearer and streamlined
language that provides that each time FICC uses any part of the
respective Division's Clearing Fund for more than 30 calendar days to
provide liquidity to FICC to meet its settlement obligations,
including, without limitation, through the direct use of cash in the
Clearing Fund or through the pledge or rehypothecation of pledged
Eligible Clearing Fund Securities in order to secure liquidity, FICC,
at the Close of Business on the 30th calendar day (or on the first
Business Day thereafter) from the day of such use, would consider the
amount used but not yet repaid as a loss to the Clearing Fund incurred
as a result of a Defaulting Member Event and immediately allocate such
loss in accordance with proposed Section 7 of GSD Rule 4 or MBSD Rule
4, as applicable.
    The proposed rule change also includes deleting language currently
in Section 5 of MBSD Rule 4 that limits certain uses by FICC of the
MBSD Clearing Fund to ``unexpected or unusual'' requirements for funds
that represent a ``small percentage'' of the MBSD Clearing Fund. FICC
believes that these limiting phrases (which appear in connection with
FICC's use of MBSD Clearing Fund to cover losses and liabilities
incident to its clearance and settlement business outside the context
of an MBSD Defaulting Member Event as well as to cover certain
liquidity needs) are vague and imprecise, and should be replaced in
their entirety. Specifically, FICC is proposing to delete the limiting
language with respect to FICC's use of MBSD Clearing Fund to cover
losses and liabilities incident to its clearance and settlement
business outside of an MBSD Defaulting Member Event so as to not have
such language be interpreted as impairing FICC's ability to access the
MBSD Clearing Fund in order to manage non-default losses. FICC is also
proposing to delete the limiting language with respect to FICC's use of
MBSD Clearing Fund to cover certain liquidity needs because the effect
of the limitation in this context is confusing and unclear.
    In addition, FICC is proposing to delete the last paragraph in
current Section 5 of GSD Rule 4 and MBSD Rule 4 because these
paragraphs address the application of a member's deposits to the
applicable Clearing Fund to cover the allocation of a loss or liability
incurred by FICC. These paragraphs would no longer be relevant,
because, under the proposed Section 7 of GSD Rule 4 and MBSD Rule 4
(discussed below), FICC would not apply the member's deposit to the
Clearing Fund unless the member does not satisfy payment of its
allocated loss amount within the required timeframe. These paragraphs
also currently include provisions regarding other agreements, such as a
Cross-Guaranty Agreement, that pertain to a Defaulting Member, and such
provisions would now be covered by proposed Section 6 of GSD Rule 4 and
MBSD Rule 4.
Section 6 of GSD Rule 4 and MBSD Rule 4
    Currently, Section 6 of GSD Rule 4 and MBSD Rule 4 are reserved for
future use. FICC is proposing to use this section for provisions
relating to the application of deposits to the respective Division's
Clearing Fund and other amounts held by FICC to a Defaulting Member's
obligations.
    FICC is proposing to add a subheading of ``Application of Clearing
Fund Deposits and Other Amounts to Defaulting Members' Obligations'' to
Section 6 of GSD Rule 4 and MBSD Rule 4. Under the proposed rule
change, for better organization by subject matter, FICC is also
proposing to relocate certain provisions to these sections from the
respective current Section 7 of GSD Rule 4 and MBSD Rule 4, which
addresses FICC's application of Clearing Fund deposits and other assets
held by FICC securing a Defaulting Member's obligations to FICC.
    For additional clarity and for consistency with the loss allocation
rules of the other DTCC Clearing Agencies, FICC proposes to add a
provision which makes it clear that, if FICC applies a Defaulting
Member's Clearing Fund deposits, FICC may take any and all actions with
respect to the Defaulting Member's Actual Deposits, including
assignment, transfer, and sale of any Eligible Clearing Fund
Securities, that FICC determines is appropriate.
Sections 7, 7a and 7b of GSD Rule 4 and MBSD Rule 4
    Current Section 7 of GSD Rule 4 and MBSD Rule 4 contains FICC's
current loss allocation waterfall for losses or

liabilities incurred by FICC. With respect to any loss or liability
incurred by FICC as the result of the failure of a Defaulting Member to
fulfill its obligations to FICC, the loss allocation waterfall for each
Division currently provides:
    (i) Application of any Clearing Fund deposits and other collateral
held by FICC securing a Defaulting Member's obligations to FICC and
additional resources as are applicable to the Defaulting Member.
    (ii) If a loss or liability remains after the application of the
Defaulting Member's collateral and resources, FICC would apply up to
25% of FICC's existing retained earnings, or such higher amount as the
Board of Directors determines.
    (iii) If a loss or liability still remains after the application of
the retained earnings, FICC would apply the loss or liability to
members as follows:
    (a) If the remaining loss or liability is attributable to Tier One
Netting Members or Tier One Members, as applicable, then FICC will
allocate such loss or liability to Tier One Netting Members or Tier One
Members, as applicable, by assessing the Required Fund Deposit
maintained by each such member an amount up to $50,000, in an equal
basis per Tier One Netting Member or Tier One Member, as applicable.
    (b) If the remaining loss or liability is attributable to Tier Two
Members, then FICC will allocate such loss or liability to Tier Two
Members based upon their trading activity with the Defaulting Member
that resulted in a loss.
    (iv) If there is any loss or liability that still remains after the
application of (ii) and (iii) above that is attributable to Tier One
Netting Members or Tier One Members, as applicable, then FICC will
allocate such loss or liability among Tier One Netting Members or Tier
One Members, as applicable, ratably based on the amount of each Tier
One Netting Member's or Tier One Member's Required Fund Deposit and
based on the average daily level of such deposit over the prior twelve
(12) months (or such shorter period as may be available if the member
has not maintained a deposit over such time period).
    Current Section 7(f) of GSD Rule 4 and MBSD Rule 4 also provides
that Other Losses shall be allocated among Tier One Netting Members or
Tier One Members, as applicable, ratably in accordance with the
respective amounts of each Tier One Netting Member's or Tier One
Member's Required Fund Deposit and based on the average daily level of
such deposit over the prior twelve (12) months (or such shorter period
as may be available if the member has not maintained a deposit over
such time period).
    Currently, pursuant to Section 7(e) of GSD Rule 4, an Inter-Dealer
Broker Netting Member, or a Non-IDB Repo Broker with respect to
activity in its Segregated Broker Account, will not be subject to an
aggregate allocation loss for any single loss-allocation event that
exceeds $5 million. FICC believes that it is appropriate for GSD to
retain this cap under the proposed rule change because the Inter-Dealer
Broker Netting Members are required to limit their business as provided
in Section 8(e) of GSD Rule 3, which would in turn minimize the
potential losses or liabilities that could be incurred by FICC from
Inter-Dealer Broker Netting Members.\32\ FICC believes that it is also
appropriate for GSD to retain this cap under the proposed rule change
for Non-IDB Repo Brokers because their activity in their respective
Segregated Broker Accounts would be subject to similar limitations as
the Inter-Dealer Broker Netting Members. However, the proposal would
apply the cap to an Event Period instead of a single loss event in
order to conform with the concept of the Event Period under the
proposal. FICC believes applying the cap to an Event Period would
continue to reasonably represent the risk profiles of the Inter-Dealer
Broker Netting Members, and Non-IDB Repo Brokers with respect to their
Segregated Broker Accounts, because they submit affirmed trades from
their systems to GSD, with each trade already matched to the
counterparty that will ultimately deliver or receive the securities.
Therefore, Inter-Dealer Broker Netting Members, and Non-IDB Repo
Brokers with respect to their Segregated Broker Accounts, do not
generally maintain positions with FICC and present minimal risk to
FICC. FICC is also proposing technical changes to replace (i) the term
``Segregated Broker Account'' with ``Segregated Repo Account'' and (ii)
the term ``Non-IDB Broker'' with ``Non-IDB Repo Broker,'' both of which
are the correct terms defined in GSD Rule 1.
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    \32\ Pursuant to Section 8(e) of GSD Rule 3, an Inter-Dealer
Broker Netting Member is required to (A) limit its business to
acting exclusively as a broker, (B) conduct all of its business in
Repo Transactions with Netting Members, and (C) conduct at least 90
percent of its business in transactions that are not Repo
Transactions with Netting Members. If an Inter-Dealer Broker Netting
Member fails to comply with these requirements, then the Inter-
Dealer Broker Netting Member shall be considered by FICC as a Dealer
Netting Member. Supra note 5.
---------------------------------------------------------------------------

    Current Section 7(g) of GSD Rule 4 and MBSD Rule 4 further provides
that if the Required Fund Deposit of the member being allocated the
loss is not sufficient to satisfy its loss allocation obligation, the
member is required to deliver to FICC an amount that is necessary to
eliminate the deficiency by the Close of Business on the next Business
Day, or by the Close of Business on the Business Day of issuance of the
notification if so determined by FICC. Under the current Rules, a
member may elect to terminate its membership, which would limit its
loss allocation to the amount of its Required Fund Deposit for the
Business Day on which the notification of such loss allocation is
provided to the member. If the member does not elect to terminate its
membership and fails to satisfy its Required Fund Deposit within the
timeframe specified in the Rules, FICC will cease to act generally with
regard to such member pursuant to GSD Rules 21 and 22A or MBSD Rules 14
and 17, as applicable, and may take disciplinary action against such
member pursuant to GSD Rule 48 or MBSD Rule 38, as applicable.
    Current Section 7(h) of GSD Rule 4 and MBSD Rule 4 requires FICC to
promptly notify members and the Commission of the amount involved and
the causes if a Remaining Loss or Other Loss occurs. In addition,
current Section 7(i) of GSD Rule 4 and MBSD Rule 4 also provides that
any increase in Clearing Fund deposit as required by subsection (f) of
current Section 2 of GSD Rule 4 or provisions of MBSD Rule 4 regarding
special charges or other premiums will not be taken into account when
calculating loss allocation based on a GSD Member's Average Required
FICC Clearing Fund Deposit amount or an MBSD Member's Average Required
Fund Deposit amount, as applicable, under current Section 7 of GSD Rule
4 and MBSD Rule 4.
    Under the proposed rule change, FICC is proposing to rename the
subheading of Section 7 of GSD Rule 4 and MBSD Rule 4 to ``Loss
Allocation Waterfall, Off-the-Market Transactions.'' In addition, FICC
is proposing to restructure its loss allocation waterfall as described
below.
    For better organization of the subject matter, FICC is proposing to
move certain paragraphs from one section to another, including (i)
relocating the last sentence of current Section 7(h) of GSD Rule 4 and
MBSD Rule 4 regarding recovery of allocated losses or liabilities by
FICC to the fifth paragraph of proposed Section 7 of GSD Rule 4 and
MBSD Rule 4, (ii) relocating from current Section 7(a) of GSD Rule 4
and MBSD Rule 4 provisions which address FICC's application of Clearing
Fund deposits and other assets held by FICC

securing a Defaulting Member's obligations to FICC to proposed Section
6 of GSD Rule 4 and MBSD Rule 4, (iii) relocating from current Section
7 of GSD Rule 4 to proposed Section 6 of GSD Rule 4 the provision
regarding FICC's right to treat certain payments to an FCO under a
Cross-Margining Guaranty as a loss to be allocated, (iv) relocating the
provisions in current Section 7(i) of GSD Rule 4 and MBSD Rule 4
regarding certain increases in Clearing Fund deposits not being taken
into account when calculating loss allocation so that such provisions
would come right after the loss allocation calculation provision, with
an updated reference to proposed renumbered Sections 2(d) and 2(e) in
GSD Rule 4 and MBSD Rule 4, respectively, and (v) relocating the
provision regarding withdrawing members reapplying to become members
\33\ in the second paragraph of current Section 7(g) of GSD Rule 4 and
MBSD Rule 4 to come right after the paragraph regarding the election of
a Tier One Netting Member or Tier One Member, as applicable, to
withdraw from membership in proposed Section 7 of GSD Rule 4 and MBSD
Rule 4. Furthermore, in order to enhance readability and clarity, FICC
is proposing a number of changes to streamline the language in these
provisions.
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    \33\ Current Section 7(g) of GSD Rule 4 provides that a Member
that elects to terminate its membership pursuant to alternative (ii)
in Section 7(g) of GSD Rule 4 in lieu of being liable to pay an
additional assessment amount above its Required Fund Deposit shall
not be eligible to re-apply to become a Comparison-Only Member or a
Netting Member unless, prior to submitting such application, it
makes the payment to FICC provided for in alternative (i) in Section
7(g) of GSD Rule 4, together with interest on that amount at the
average of the Federal Funds Rate plus one percent, calculated from
the date on which the Remaining Loss or Other Loss was incurred by
FICC until the date of such payment. Supra note 5.
    Current Section 7(g) of MBSD Rule 4 provides that a Member that
elects to terminate its membership pursuant to alternative (ii) in
Section 7(g) of MBSD Rule 4 in lieu of being liable to pay an
additional assessment amount above its Required Fund Deposit shall
not be eligible to re-apply to become a Clearing Member unless,
prior to submitting such application, it makes the payment to FICC
provided for in alternative (i) in Section 7(g) of MBSD Rule 4,
together with interest on that amount at the average of the Federal
Funds Rate plus one percent, calculated from the date on which the
Remaining Loss or Other Loss was incurred by FICC until the date of
such payment. Supra note 5.
    The condition for re-application was historically in the rules
of Government Securities Clearing Corporation (``GSCC'') (FICC's
predecessor) to solidify GSCC's membership base and thereby
discourage members from withdrawing from membership during a time of
stress solely to avoid their loss allocation obligations. This
condition was later incorporated into the GSD Rules and MBSD Rules.
In the interest of continuing to encourage members to remain in FICC
central clearing in order to preserve the robustness of the Treasury
and mortgage-backed securities markets, FICC would like to retain
this condition for re-application in the GSD and MBSD Rules as is.
As the provision applies to a remote contingency and, without an
immediate business need, NSCC and DTC would prefer not to add this
provision at this time.
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    In Section 7 of GSD Rule 4 and MBSD Rule 4, as applicable, FICC is
proposing to make it clear that no loss allocation under proposed GSD
Rule 4 or proposed MBSD Rule 4, as applicable, would constitute a
waiver of any claim FICC may have against a member for any losses or
liabilities to which the member is subject under the Rules, including,
without limitation, any loss or liability to which it may be subject
under proposed GSD Rule 4 or proposed MBSD Rule 4, as applicable. FICC
is proposing this change to preserve its legal rights and to make it
clear to members that loss allocation under proposed GSD Rule 4 and
proposed MBSD Rule 4 would not be deemed as FICC waiving any claims it
may have against a member for any losses or liabilities to which the
member is subject under the Rules.
    Under the proposal, Section 7 of GSD Rule 4 and MBSD Rule 4 would
make clear that the loss allocation waterfall applies to losses and
liabilities (i) arising out of or relating to a default of a member or
(ii) otherwise incident to the clearance and settlement business of
FICC (i.e., non-default losses). The loss allocation waterfall would be
triggered if FICC incurs a loss or liability arising out of or relating
to a Defaulting Member Event or a Declared Non-Default Loss Event.
    As proposed, Section 7 of GSD Rule 4 and MBSD Rule 4 would provide
that, for the purposes of GSD Rule 4 or MBSD Rule 4, as applicable, the
term ``Defaulting Member'' would mean a GSD Member or MBSD Member, as
applicable, for which FICC has ceased to act pursuant to GSD Rule 21 or
GSD Rule 22,\34\ or MBSD Rule 14 or MBSD Rule 16,\35\ as applicable,
the term ``Defaulting Member Event'' would mean the determination by
FICC to cease to act for a GSD Member or MBSD Member, as applicable,
pursuant to GSD Rule 21 or GSD Rule 22, or MBSD Rule 14 or MBSD Rule
16, as applicable, and the term ``Declared Non-Default Loss Event''
would mean the determination by the Board of Directors that a loss or
liability incident to the clearance and settlement business of FICC may
be a significant and substantial loss or liability that may materially
impair the ability of FICC to provide clearance and settlement services
in an orderly manner and will potentially generate losses to be
mutualized among members in order to ensure that FICC may continue to
offer clearance and settlement services in an orderly manner.
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    \34\ FICC may cease to act for a GSD Member pursuant to any of
the circumstances set forth under GSD Rule 21 (Restrictions on
Access to Services) or GSD Rule 22 (Insolvency of a Member). Supra
note 5.
    \35\ FICC may cease to act for an MBSD Member pursuant to any of
the circumstances set forth under MBSD Rule 14 (Restrictions on
Access to Services) or MBSD Rule 16 (Insolvency of a Member). Supra
note 5.
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    As proposed, each member would be obligated to FICC for the entire
amount of any loss or liability incurred by FICC arising out of or
relating to any Defaulting Member Event with respect to such member.
Under the proposal, to the extent that such loss or liability is not
satisfied pursuant to proposed Section 6 of GSD Rule 4 or MBSD Rule 4,
as applicable, FICC would apply a Corporate Contribution thereto and
charge the remaining amount of such loss or liability ratably to other
members, as provided in proposed Section 7 of GSD Rule 4 and MBSD Rule
4.
    Under proposed Section 7 of GSD Rule 4 and MBSD Rule 4, the loss
allocation waterfall would begin with a corporate contribution from
FICC (``Corporate Contribution''), as is the case under the current
Rules, but in a different form than under the current Section 7 of GSD
Rule 4 and MBSD Rule 4 described above. Today, Section 7(b) of GSD Rule
4 and Section 7(c) of MBSD Rule 4 provide that, if FICC incurs any loss
or liability as the result of the failure of a Defaulting Member to
fulfill its obligations to FICC, FICC will contribute up to 25% of its
existing retained earnings (or such higher amount as the Board of
Directors shall determine), to such loss or liability; however, no
corporate contribution from FICC is currently required for losses
resulting other than those from Member impairments. Under the proposal,
FICC would add a proposed new Section 7a to GSD Rule 4 and MBSD Rule 4
with a subheading of ``Corporate Contribution'' and define FICC's
Corporate Contribution with respect to any loss allocation pursuant to
proposed Section 7 of GSD Rule 4 or MBSD Rule 4, whether arising out of
or relating to a Defaulting Member Event or a Declared Non-Default Loss
Event, as an amount that is equal to fifty (50) percent of the amount
calculated by FICC in respect of its General Business Risk Capital
Requirement as of the end of the calendar quarter immediately preceding
the Event Period.\36\ The proposed rule change would specify

that FICC's General Business Risk Capital Requirement, as defined in
FICC's Clearing Agency Policy on Capital Requirements,\37\ is, at a
minimum, equal to the regulatory capital that FICC is required to
maintain in compliance with Rule 17Ad-22(e)(15) under the Act.\38\
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    \36\ Supra note 9.
    \37\ Supra note 10.
    \38\ Supra note 11.
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    As proposed, if FICC applies the Corporate Contribution to a loss
or liability arising out of or relating to one or more Defaulting
Member Events or Declared Non-Default Loss Events relating to an Event
Period, then for any subsequent Event Periods that occur during the two
hundred fifty (250) Business Days thereafter,\39\ the Corporate
Contribution would be reduced to the remaining unused portion of the
Corporate Contribution amount that was applied for the first Event
Period. Proposed Section 7a of both GSD Rule 4 and MBSD Rule 4 would
require FICC to notify members of any such reduction to the Corporate
Contribution.
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    \39\ Supra note 13.
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    Proposed Section 7a to GSD Rule 4 and MBSD Rule 4 would also make
clear that there would be one FICC Corporate Contribution, the amount
of which would be available to both Divisions and would be applied
against a loss or liability in either Division in the order in which
such loss or liability occurs, i.e., FICC would not have two separate
Corporate Contributions, one for each Division. As proposed, in the
event of a loss or liability relating to an Event Period, whether
arising out of or relating to a Defaulting Member Event or a Declared
Non-Default Loss Event, attributable to only one Division, the
Corporate Contribution would be applied to that Division up to the
amount then available. Under the proposal, if a loss or liability
relating to an Event Period, whether arising out of or relating to a
Defaulting Member Event or a Declared Non-Default Loss Event, occurs
simultaneously at both Divisions, the Corporate Contribution would be
applied to the respective Divisions in the same proportion that the
aggregate Average RFDs of all members in that Division bears to the
aggregate Average RFDs of all members in both Divisions.\40\
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    \40\ Supra note 14.
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    Currently, the Rules do not require FICC to contribute its retained
earnings to losses and liabilities other than those from member
defaults. Under the proposal, FICC would expand the application of its
corporate contribution beyond losses and liabilities as the result of
the failure of a Defaulting Member to fulfill its obligations to FICC.
The proposed Corporate Contribution would apply to losses or
liabilities relating to or arising out of Defaulting Member Events and
Declared Non-Default Loss Events, and would be a mandatory loss
contribution by FICC prior to any allocation of the loss among the
applicable Division's members.
    Current Section 7(b) of GSD Rule 4 and Section 7(c) of MBSD Rule 4
provide FICC the option to contribute amounts higher than the specified
percentage of retained earnings as determined by the Board of
Directors, to any loss or liability incurred by FICC as the result of
the failure of a Defaulting Member to fulfill its obligations to FICC.
This option would be retained and expanded under the proposal to also
cover non-default losses. Proposed Section 7a of GSD Rule 4 and MBSD
Rule 4 would provide that nothing in the Rules would prevent FICC from
voluntarily applying amounts greater than the Corporate Contribution
against any FICC loss or liability, whether arising out of or relating
to a Defaulting Member Event or a Declared Non-Default Loss Event, if
the Board of Directors, in its sole discretion, believes such to be
appropriate under the factual situation existing at the time.
    Proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would provide that
FICC shall apply the Corporate Contribution to losses and liabilities
that arise out of or relate to one or more Defaulting Member Events
and/or (ii) Declared Non-Default Loss Events that occur within an Event
Period. The proposed rule change also provides that if losses and
liabilities with respect to such Event Period remain unsatisfied
following application of the Corporate Contribution, FICC would
allocate such losses and liabilities to members, as described below.
    As proposed, Section 7 of GSD Rule 4 and MBSD Rule 4 would retain
the differentiation in allocating losses to Tier One Netting Members or
Tier One Members, as applicable, and Tier Two Members. Specifically, as
is the case today, losses or liabilities that arise out of or relate to
one or more Defaulting Member Events would be attributable to Tier One
Netting Members or Tier One Members, as applicable, and Tier Two
Members, while losses or liabilities that arise out of or relate to one
or more Declared Non-Default Loss Events would only be attributable to
Tier One Netting Members or Tier One Members, as applicable. Tier Two
Members would not be subject to loss allocation with respect to
Declared Non-Default Loss Events.
    Under the proposal, FICC would delete the provision in current
Section 7(h) of GSD Rule 4 and MBSD Rule 4 that requires FICC to
promptly notify members and the Commission of the amounts involved and
the causes if a Remaining Loss or Other Loss occurs because such
notification would no longer be necessary under the proposed rule
change. Under the proposed rule change, FICC would notify members
subject to loss allocation of the amounts being allocated to them in
one or more Loss Allocation Notices for both Defaulting Member Events
and Declared Non-Default Loss Events. As such, in order to conform to
the proposed rule change, FICC is proposing to eliminate the
notification to members regarding the amounts involved and the causes
if a Remaining Loss or Other Loss occurs that is required under current
Section 7(h) of GSD Rule 4 and MBSD Rule 4. FICC is also proposing to
delete the notification to the Commission regarding the amounts
involved and the causes if a Remaining Loss or Other Loss occurs as
required in the same section. While as a practical matter, FICC would
notify the Commission of a decision to loss allocate, FICC does not
believe such notification needs to be specified in the Rules.
    In addition, FICC is proposing to clarify the provision related to
Off-the-Market Transactions so that it is clear that loss or liability
of FICC in connection with the close-out or liquidation of an Off-the-
Market Transaction in the portfolio of a Defaulting Member would be
allocated to the Member that was the counterparty to such transaction.
Tier One Netting Members/Tier One Members
    For Tier One Netting Members or Tier One Members, as applicable,
proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would establish the
concept of an ``Event Period'' to provide for a clear and transparent
way of handling multiple loss events occurring in a period of ten (10)
Business Days, which would be grouped into an Event Period.\41\ As
stated above, both Defaulting Member Events or Declared Non-Default
Loss Events could occur within the same Event Period.
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    \41\ Supra note 16.
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    Under the proposal, an Event Period with respect to a Defaulting
Member Event would begin on the day FICC notifies members that it has
ceased to act for the Defaulting Member (or the next Business Day, if
such day is not a Business Day). In the case of a Declared Non-Default
Loss Event, an Event Period

would begin on the day that FICC notifies members of the Declared Non-
Default Loss Event (or the next Business Day, if such day is not a
Business Day). If a subsequent Defaulting Member Event or Declared Non-
Default Loss Event occurs during an Event Period, any losses or
liabilities arising out of or relating to any such subsequent event
would be resolved as losses or liabilities that are part of the same
Event Period, without extending the duration of such Event Period.
    Proposed Section 7 of GSD Rule 4 and MBSD Rule 4 would also retain
the requirement of loss allocation among Tier One Netting Members or
Tier One Members, as applicable, if a loss or liability remains after
the application of the Corporate Contribution, as described above. In
contrast to the current Section 7 where FICC would assess the Required
Fund Deposits of Tier One Netting Members or Tier One Members, as
applicable, to allocate losses, under the proposal, FICC would require
Tier One Netting Members or Tier One Members, as applicable, to pay
their loss allocation amounts (leaving their Required Fund Deposits
intact).\42\ Loss allocation obligations would continue to be
calculated based upon a Tier One Netting Member's or Tier One Member's,
as applicable, pro rata share of losses and liabilities (although the
pro rata share would be calculated differently than it is today), and
Tier One Netting Members or Tier One Members, as applicable, would
still retain the ability to voluntarily withdraw from membership and
cap their loss allocation obligation (although the loss allocation
obligation would also be calculated differently than it is today).
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    \42\ FICC believes that shifting from the two-step methodology
of applying the respective Division's Clearing Fund and then
requiring members to immediately replenish it to requiring direct
payment would increase efficiency, while preserving the right to
charge the member's Clearing Fund deposits in the event the member
does not timely pay. Such a failure to pay would trigger recourse to
the Clearing Fund deposits of the member under proposed Section 6 of
GSD Rule 4 or MBSD Rule 4, as applicable. In addition, this change
would provide greater stability for FICC in times of stress by
allowing FICC to retain the respective Division's Clearing Fund, its
critical prefunded resource, while charging loss allocations. FICC
believes doing so would allow FICC to cover the respective
Division's current credit exposures to its Members at all times. By
retaining the GSD and MBSD Clearing Funds as proposed, FICC could
use the Clearing Funds to secure the performance obligations of
Members to their respective Division, including their payment
obligation for any loss allocation, while maintaining access to
prefunded resources. By being able to manage the respective
Division's current credit exposures throughout the loss allocation
process, FICC would be able to continue to provide its critical
operations and services during what would be expected to be a
stressful period.
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    The proposed rule change to Section 7 of GSD Rule 4 and MBSD Rule 4
would clarify that each Tier One Netting Member or Tier One Member, as
applicable, that is a Tier One Netting Member or Tier One Member on the
first day of an Event Period would be obligated to pay its pro rata
share of losses and liabilities arising out of or relating to each
Defaulting Member Event (other than a Defaulting Member Event with
respect to which it is the Defaulting Member) and each Declared Non-
Default Loss Event occurring during the Event Period. The proposal
would make it clear that any Tier One Netting Member or Tier One
Member, as applicable, for which FICC ceases to act on a non-Business
Day, triggering an Event Period that commences on the next Business
Day, shall be deemed to be a Tier One Netting Member or Tier One
Member, as applicable, on the first day of that Event Period.
    Under the proposed rule change, a loss allocation ``round'' would
mean a series of loss allocations relating to an Event Period, the
aggregate amount of which is limited by the round cap. When the
aggregate amount of losses allocated in a round equals the round cap,
any additional losses relating to the applicable Event Period would be
allocated in one or more subsequent rounds, in each case subject to a
round cap for that round. FICC may continue the loss allocation process
in successive rounds until all losses from the Event Period are
allocated among Tier One Netting Members or Tier One Members, as
applicable, that have not submitted a Loss Allocation Withdrawal Notice
in accordance with proposed Section 7b of GSD Rule 4 or MBSD Rule 4.
    As proposed, each loss allocation would be communicated to the Tier
One Netting Members or Tier One Members, as applicable, by the issuance
of a Loss Allocation Notice. Under the proposal, each Tier One Netting
Member's or Tier One Member's, as applicable, pro rata share of losses
and liabilities to be allocated in any round would be equal to (i) the
member's Average RFD divided by (ii) the sum of Average RFD amounts of
all members subject to loss allocation in such round.
    Each Loss Allocation Notice would specify the relevant Event Period
and the round to which it relates. The first Loss Allocation Notice in
any first, second, or subsequent round would expressly state that such
Loss Allocation Notice reflects the beginning of the first, second, or
subsequent round, as the case may be, and that each Tier One Netting
Member or Tier One Member, as applicable, in that round has five (5)
Business Days from the issuance of such first Loss Allocation Notice
for the round to notify FICC of its election to withdraw from
membership with GSD or MBSD, as applicable, pursuant to proposed
Section 7b of GSD Rule 4 or MBSD Rule 4, as applicable, and thereby
benefit from its Loss Allocation Cap.\43\ As proposed, the ``Loss
Allocation Cap'' of a Tier One Netting Member or a Tier One Member, as
applicable, would be equal to the greater of (x) its Required Fund
Deposit on the first day of the applicable Event Period and (y) its
Average RFD.
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    \43\ Supra note 19.
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    FICC is proposing to clarify that after a first round of loss
allocation with respect to an Event Period, only Tier One Netting
Members or Tier One Members, as applicable, that have not submitted a
Loss Allocation Withdrawal Notice in accordance with proposed Section
7b of GSD Rule 4 or MBSD Rule 4, as applicable, would be subject to
further loss allocation with respect to that Event Period.
    As proposed, each such member's pro rata share of losses and
liabilities to be allocated in any round would be equal to (i) the
member's Average RFD, divided by (ii) the sum of the Average RFD
amounts of all members subject to loss allocation in such round. Each
such member would have a maximum payment obligation with respect to any
loss allocation round that would be equal to the greater of (x) its
Required Fund Deposit on the first day of the applicable Event Period
or (y) its Average RFD (such amount would be each member's ``Loss
Allocation Cap''). Therefore, the sum of the Loss Allocation Caps of
the members subject to loss allocation would constitute the maximum
amount that FICC would be permitted to allocate in each round. FICC
would retain the loss allocation limit of $5 million for Inter-Dealer
Broker Netting Members, or Non-IDB Repo Brokers with respect to
activities in their Segregated Broker Accounts, as discussed above.
    As proposed, Section 7 of GSD Rule 4 and MBSD Rule 4, would also
provide that, to the extent that a Tier One Netting Member's or Tier
One Member's, as applicable, Loss Allocation Cap exceeds such member's
Required Fund Deposit on the first day of the applicable Event Period,
FICC may, in its discretion, retain any excess amounts on deposit from
the member, up to the Loss Allocation Cap of the Tier One Netting
Member or Tier One Member, as applicable.

    As proposed, Tier One Netting Members or Tier One Members, as
applicable, would have two (2) Business Days after FICC issues a first
round Loss Allocation Notice to pay the amount specified in any such
notice.\44\ On a subsequent round (i.e., if the first round did not
cover the entire loss of the Event Period because FICC was only able to
allocate up to the round cap), these members would also have two (2)
Business Days after notice by FICC to pay their loss allocation amounts
(again subject to their Loss Allocation Caps), unless the members have
notified (or will timely notify) FICC of their election to withdraw
from membership with respect to a prior loss allocation round.
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    \44\ Supra note 22.
---------------------------------------------------------------------------

    Under the proposal, if a Tier One Netting Member or Tier One
Member, as applicable, fails to make its required payment in respect of
a Loss Allocation Notice by the time such payment is due, FICC would
have the right to proceed against such member as a Defaulting Member
that has failed to satisfy an obligation in accordance with proposed
Section 6 of GSD Rule 4 or MBSD Rule 4 described above. Members who
wish to withdraw from membership would be required to comply with the
requirements in proposed Section 7b of GSD Rule 4 and MBSD Rule 4,
described further below. Specifically, proposed Section 7 of GSD Rule 4
and MBSD Rule 4 would provide that if, after notifying FICC of its
election to withdraw from membership pursuant to proposed Section 7b of
GSD Rule 4 or MBSD Rule 4, as applicable, the Tier One Netting Member
or Tier One Member, as applicable, fails to comply with the provisions
of proposed Section 7b of GSD Rule 4 or MBSD Rule 4, as applicable, its
notice of withdrawal would be deemed void and any further losses
resulting from the applicable Event Period may be allocated against it
as if it had not given such notice.
    FICC is proposing to delete the provisions in the current GSD Rule
4 and MBSD Rule 4 that require FICC to assess the Required Fund Deposit
maintained by each Tier One Netting Member or Tier One Member, as
applicable, an amount up to $50,000, in an equal basis per such member,
before allocating losses to Tier One Netting Members or Tier One
Members, as applicable, ratably, in accordance with each such member's
Required Fund Deposit and Average Required FICC Clearing Fund Deposit
or Average Required Clearing Fund Deposit, as applicable. FICC believes
that in the event of a loss or liability, this assessment is unlikely
to alleviate the need for loss mutualization and creates an unnecessary
administrative burden for each Division. FICC believes that moving
straight to the loss mutualization described herein would be more
practical. This proposed change would also streamline each Division's
loss allocation waterfall processes and align such processes with those
of the other DTCC Clearing Agencies.
Tier Two Members
    FICC is not proposing any substantive change to the provisions
regarding Tier Two Members in current Section 7 of GSD Rule 4 and MBSD
Rule 4, except to (i) add a subheading of ``Tier Two Members'' in the
beginning of these provisions for ease of identification and (ii) add a
paragraph that makes it clear that if a Tier Two Member fails to make
its required payment in respect of a Loss Allocation Notice by the time
such payment is due, FICC would have the right to proceed against such
member as a Defaulting Member that has failed to satisfy an obligation
in accordance with proposed Section 6 of GSD Rule 4 or MBSD Rule 4
described above, consistent with the proposed change regarding Tier One
Netting Members or Tier One Members, as applicable.
Withdrawal From Membership
    Proposed Section 7b of GSD Rule 4 and MBSD Rule 4 would include the
provisions regarding withdrawal from membership currently covered by
Section 7(g) of GSD Rule 4 and MBSD Rule 4. FICC believes that
relocating the provisions on withdrawal from membership as it pertains
to loss allocation, so that it comes right after the section on the
loss allocation waterfall, would provide for the better organization of
GSD Rule 4 and MBSD Rule 4. As proposed, the subheading for Section 7b
of GSD Rule 4 and MBSD Rule 4 would read ``Withdrawal Following Loss
Allocation.''
    Currently, Section 7(g) of GSD Rule 4 and MBSD Rule 4 provides that
a member may, pursuant to current Section 13 of GSD Rule 3 or MBSD Rule
3, notify FICC by the Close of Business on the Business Day on which a
payment in an amount necessary to cover losses allocated to such member
after the application of its Required Fund Deposit is due, of its
election to terminate its membership and thereby avail itself of a cap
on loss allocation, which is currently its Required Fund Deposit as
fixed on the Business Day the pro rata charge loss allocation
notification is provided to such member.
    As stated above, under the proposed rule change, Section 7 of GSD
Rule 4 and MBSD Rule 4 would provide that a Tier One Netting Member or
a Tier One Member, as applicable, who wishes to withdraw from
membership in respect of a loss allocation round must provide notice of
its election to withdraw (``Loss Allocation Withdrawal Notice'') within
five (5) Business Days from the issuance of the first Loss Allocation
Notice in any round.\45\ In order to avail itself of its Loss
Allocation Cap, such member would need to follow the requirements in
proposed Section 7b of GSD Rule 4 and MBSD Rule 4, as applicable, which
would provide that such member must: (i) Specify in its Loss Allocation
Withdrawal Notice an effective date for withdrawal from membership,
which date shall not be prior to the scheduled final settlement date of
any remaining obligations owed by the member to FICC, unless otherwise
approved by FICC, and (ii) as of the time of such member's submission
of the Loss Allocation Withdrawal Notice, cease submitting transactions
to FICC for processing, clearance or settlement, unless otherwise
approved by FICC.
---------------------------------------------------------------------------

    \45\ Supra note 19.
---------------------------------------------------------------------------

    Proposed Section 7b of GSD Rule 4 and MBSD Rule 4 would provide
that a Tier One Netting Member or a Tier One Member, as applicable,
that withdraws in compliance with the requirements of proposed Section
7b of GSD Rule 4 or MBSD Rule 4, as applicable, would nevertheless
remain obligated for its pro rata share of losses and liabilities with
respect to any Event Period for which it is otherwise obligated under
proposed GSD Rule 4 or MBSD Rule 4, as applicable; however, the Tier
One Netting Member's or Tier One Member's, as applicable, aggregate
obligation would be limited to the amount of its Loss Allocation Cap
(as fixed in the round for which it withdrew).
    FICC is proposing to include a sentence in proposed Section 7b of
GSD Rule 4 and MBSD Rule 4 to make it clear that if the Tier One
Netting Member or Tier One Member, as applicable, fails to comply with
the requirements set forth in that section, its Loss Allocation
Withdrawal Notice will be deemed void, and such member will remain
subject to further loss allocations pursuant to proposed Section 7 of
GSD Rule 4 and MBSD Rule 4 as if it had not given such notice.
    For better organization of the subject matter, FICC is also
proposing to move the provision that covers members' obligations to
eliminate any deficiency in their Required Fund Deposits from the last
sentence in the first paragraph of current Section 7(g) of GSD Rule 4

and MBSD Rule 4 to proposed Section 9 of GSD Rule 4 and MBSD Rule 4.
Section 8
    As proposed, Section 8 of GSD Rule 4 and MBSD Rule 4 would cover
the provisions on the return of a member's Clearing Fund deposit that
are currently covered by Section 10 of GSD Rule 4 and MBSD Rule 4.
Proposed Section 8's subheading would be ``Return of Members' Clearing
Fund Deposits.''
    FICC is proposing changes to streamline and enhance the clarity and
readability of this section, including adding language to clarify that
a member's obligations to FICC would include both matured as well as
contingent obligations, but is otherwise retaining the substantive
provisions of this section.
Section 9
    FICC is proposing to renumber Section 8 of GSD Rule 4 and MBSD Rule
4, which addresses the timing of members' payment of the respective
Division's Clearing Fund. Under the proposal, this section would be
renumbered as Section 9 of GSD Rule 4 and MBSD Rule 4 and retitled to
``Initial Required Fund Deposit and Changes in Members' Required Fund
Deposits'' to better reflect the subject matter of this section.
    Currently, Section 8 of GSD Rule 4 and MBSD Rule 4 requires members
to satisfy any increase in their Required Fund Deposit requirement
within such time as FICC requires. FICC is proposing to clarify that at
the time the increase becomes effective, the member's obligations to
FICC will be determined in accordance with the increased Required Fund
Deposit whether or not the member has satisfied such increased amount.
FICC is also proposing to add language to clarify that (i) if FICC
applies a GSD Netting Member's or an MBSD Clearing Member's Clearing
Fund deposits as permitted pursuant to GSD Rule 4 or MBSD Rule 4, as
applicable, FICC may take any and all actions with respect to the GSD
Netting Member's or MBSD Clearing Member's Actual Deposit, including
assignment, transfer, and sale of any Eligible Clearing Fund
Securities, that FICC determines is appropriate, and (ii) if such
application results in any deficiency in the GSD Netting Member's or
MBSD Clearing Member's, as applicable, Required Fund Deposit, such
member shall immediately replenish it. These clarifications are
consistent with the Divisions' rights as set forth in current Sections
4 and 11 of GSD Rule 4 and current Sections 4 and 11 of MBSD Rule 4. In
addition, the provisions in clause (ii) of the previous sentence is
consistent with the requirements in current Section 1 of GSD Rule 4 and
MBSD Rule 4 that a member must maintain its Required Fund Deposit.
    As discussed above, for better organization of the subject matter,
FICC is proposing to move the provision that covers members'
obligations to eliminate any deficiency in their Required Fund Deposits
from the last sentence in the first paragraph of current Section 7(g)
of GSD Rule 4 and MBSD Rule 4 to proposed Section 9 of GSD Rule 4 and
MBSD Rule 4.
Section 10
    Currently, Section 9 of GSD Rule 4 and MBSD Rule 4 addresses
situations where a member has excess on deposit in the Clearing Fund
(i.e., amounts above its Required Fund Deposit). The current provision
provides that FICC will notify a member of any Excess Clearing Fund
Deposit as FICC determines from time to time. Upon the request of a
member, FICC will return an excess amount requested by a member that
follows the formats and timeframe established by FICC for such request.
The current provision makes clear that FICC may, in its discretion,
withhold any or all of a member's Excess Clearing Fund Deposit (i) if
the member has an outstanding payment obligation to FICC, (ii) if FICC
determines that the member's anticipated activity over the next 90
calendar days may reasonably be expected to be materially different
than the prior 90 calendar days, or (iii) if the member has been placed
on the Watch List. Section 9 also makes clear that the return of an
Excess Clearing Fund Deposit to any member is subject to (i) such
return of Excess Clearing Fund Deposit not being done in a manner that
would cause the member to violate any other section of the Rules, (ii)
such return not reducing the amount of the member's Cross-Guaranty
Repayment Deposit to the Clearing Fund below the amount required to be
maintained by the member pursuant to GSD Rule 41 or MBSD Rule 32, as
applicable, and (iii) with respect to GSD Members only, such return not
reducing the amount of a GSD Member's Cross-Margining Repayment Deposit
to the Clearing Fund below the amount required to be maintained by the
GSD Member pursuant to GSD Rule 43.
    FICC is proposing to renumber Section 9 as Section 10 for both GSD