Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of No Objection To Advance Notice To Amend the Supplemental Liquidity Deposit Requirements

I. Introduction

On March 5, 2021, National Securities Clearing Corporation (“NSCC”) filed with the Securities and Exchange Commission (“Commission”) advance notice SR-NSCC-2021-801 (“Advance Notice”) pursuant to Section 806(e)(1) of Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, entitled Payment, Clearing and Settlement Supervision Act of 2010 (“Clearing Supervision Act”) and Rule 19b-4(n)(1)(i) under the Securities Exchange Act of 1934 (“Exchange Act”) to amend its Supplemental Liquidity Deposit Requirements. The Advance Notice was published for comment in the Federal Register on March 24, 2021, and the Commission has received comments in support of the changes proposed in the Advance Notice. The Commission is hereby providing notice of no objection to the Advance Notice.

II. The Advance Notice

A. Background

As a central counterparty (“CCP”), NSCC occupies an important role in the securities settlement system by interposing itself between counterparties to financial transactions, becoming the buyer to each seller and seller to each buyer to ensure the performance of the contract, thereby reducing the risk faced by its Members and contributing to global financial stability. NSCC's liquidity risk management plays an integral part in NSCC's ability to perform its role as a CCP. If a Member defaults, NSCC, as a CCP, would need to complete settlement of guaranteed transactions on the failing Member's behalf from the date of default through the remainder of the settlement cycle (currently two days for securities that settle on a regular way basis in the U.S. markets). To do so, and to meet its related regulatory requirements, NSCC seeks to maintain sufficient liquid resources in order to meet the potential funding required to settle outstanding transactions of a defaulting Member in a timely manner, as well as to hold qualifying liquid resources sufficient to meet its minimum liquidity resource requirement in each relevant currency for which it has payment obligations owed to its Members.

NSCC has a number of default liquidity resources that it considers to be qualifying liquid resources for the purposes of Rule 17Ad-22(a)(14). These resources include: (1) Cash deposits to the NSCC Clearing Fund; (2) the proceeds of the issuance and private placement of (a) short-term, unsecured notes in the form of commercial paper and extendable notes (“Commercial Paper Program”), and (b) term debt (“Term Debt Issuance”); (3) cash that would be obtained by drawing on NSCC's committed 364-day credit facility with a consortium of banks (“Line of Credit”); and (4) supplemental liquidity deposits, collected pursuant to NSCC Rule 4(A), as discussed further below.

B. Current Rules Relating to Supplemental Liquidity Deposits

Currently, NSCC only collects supplemental liquidity deposits during monthly options expiry periods in order to cover the heightened liquidity exposure resulting from increased trading activity around options expiration. NSCC only collects supplemental liquidity deposits from its 30 largest Members or group of affiliated Members (hereinafter, “Providers”). NSCC calculates each Provider's supplemental liquidity obligation for an upcoming options expiry period using an estimate based on NSCC's highest liquidity need and the Provider's settlement activity during the prior 24-months. Providers, in turn, must fund their supplemental liquidity obligations two business days prior to the start of the options expiry period, which NSCC will return seven business days after the end of that period.

In order to ensure NSCC maintains adequate liquidity resources throughout the options expiry period, providers may voluntarily prefund additional supplemental liquidity deposits at the start of the period, if it anticipates increases in its trading activity, compared to its historical activity, will create a liquidity shortfall at NSCC. In the event a Provider fails to provide adequate voluntary prefunded deposits, NSCC may require the Provider to fund additional supplemental liquidity deposits if NSCC experiences a resulting liquidity shortfall, which NSCC may hold for up to 90 days. The 90-day lock-up incentivizes Providers to voluntarily prefund their supplemental liquidity deposits in order to ensure NSCC maintains adequate liquidity resources throughout the options expiry period.

C. Proposed Changes to the Rules Relating to Supplemental Liquidity Deposits

As discussed above, NSCC may only collect supplemental liquidity deposits during monthly options expiry periods under its current Rules. However, NSCC can face sudden liquidity shortfalls on any business day, not just those business days that fall within monthly options expiry periods, particularly during volatile market conditions unrelated to options expiration. To address this issue, NSCC proposes to change the frequency at which it may collect supplemental liquidity deposits to each business day, based on a daily calculation. This proposed approach to collecting supplemental liquidity deposits should allow NSCC to respond quickly to any sudden liquidity shortfalls arising from a Provider's activity, regardless of when those shortfalls occur.

NSCC also proposes an alternative pro rata daily calculation in the rare event its regular daily calculation would inadvertently result in collecting supplement liquidity deposits from multiple Providers that, taken together, would significantly exceed NSCC's liquidity needs on that day. Additionally, NSCC proposes the ability to collect supplemental liquidity deposits on an intraday basis in certain instances where sudden intraday increases in liquidity risk justify shortening the amount of time NSCC is exposed to that risk, including a mandatory intraday collection in connection with monthly options expiry periods.

1. Proposed Daily Calculation of Supplemental Liquidity Deposits

A Provider will be obligated to provide a supplemental liquidity deposit on each business day in which its settlement activity causes a liquidity shortfall at NSCC. NSCC will provide a notice to each Provider of the amount of its supplemental liquidity deposit, which the Provider will be required to fund within one hour of such notice. NSCC proposes to return supplemental liquidity deposits on the next business day.

NSCC states that, under its proposed calculation, it will no longer need to estimate its liquidity need for a Provider's expected settlement activity based on the Provider's historical settlement activity. Instead, each Provider's deposit will be calculated based on NSCC's actual liquidity need based on the Provider's daily settlement activity in the event the Provider defaulted on that day, which NSCC believes will provide both NSCC and Providers with a more reliable measure of the liquidity risks posed to NSCC.

NSCC provided the Commission with the results of an impact study comparing the proposal against the observed regulatory liquidity needs and NSCC's qualifying liquid resources available during the period from 2016 through 2020. The study assessed both pro-forma and hypothetical impacts of the proposal under various liquidity scenarios. The study also analyzed historical trends including the average composition and rankings of the top 30 Providers at NSCC during the 2016 to 2020 period. Based on the pro-forma/hypothetical impact as well analysis of the top Providers, the study's results generally indicate that the proposal would continue to allow NSCC to meet its regulatory liquidity obligations, and the largest Members would continue to be the ones affected by supplemental liquidity obligations.

2. Proposed Pro Rata Calculation of Supplemental Liquidity Deposits

As a potential alternative to the calculation described above, NSCC proposes a discretionary pro rata calculation that could apply in the event two or more Providers each would be obligated to provide a supplemental liquidity deposit of more than $2 billion on a business day pursuant to the calculation described above. Under the proposed alternative, NSCC will have the option to allocate, on a pro rata basis, its largest liquidity need on a business day to all Providers that are required to make a supplemental liquidity deposit on that day, thereby reducing all such Providers' obligations to NSCC on that day. NSCC's determination will be based on the market conditions at that time. For example, NSCC may determine that, in certain market conditions, this alternative approach would be appropriate to alleviate liquidity pressures on all Providers required to make a supplemental liquidity deposit on that day. NSCC states this alternative would allow NSCC to use this pro rata calculation to sufficiently cover its liquidity exposure on that day, without requiring that all Providers fund the total amount of its calculated supplemental liquidity deposit on that day.

3. Proposed Intraday Supplemental Liquidity Calls

NSCC also proposes to establish intraday supplemental liquidity calls, which are intended to allow NSCC to calculate and collect additional supplemental liquidity deposits on an intraday basis if a Provider's increased daily activity levels or projected settlement activity causes a NSCC liquidity shortfall during a given day. NSCC believes the proposed intraday supplemental liquidity calls will help to mitigate increased liquidity exposures presented to NSCC on an intraday basis in specified circumstances, as discussed further below.

i. Proposed Mandatory Intraday Supplemental Liquidity Call

First, NSCC proposes to establish a mandatory monthly intraday supplemental liquidity call that is calculated and collected, when applicable, on the first business day (typically a Friday) of an options expiry period. A Provider's mandatory intraday supplemental liquidity call will be the difference between, on the one hand, NSCC's qualifying liquid resources and, on the other hand, NSCC's daily liquidity need based on the Provider's settlement activity at the start of the business day, recalculated to account for both the Provider's actual settlement activity submitted to NSCC over the course of the day, and the Provider's projected settlement activity in stock options expected to be submitted to NSCC. Because NSCC's recalculated daily liquidity need will not factor in late day trades or other off-setting settlement activity, NSCC proposes to adjust its re-calculated daily liquidity need using an estimated netting percentage based on each Provider's average percentage of netting from its off-setting settlement activity observed over the prior 24 months. NSCC states that the actual settlement activity flowing into NSCC for cash settlement of stocks underlying expiring options is typically lower than the projected settlement activity NSCC receives from OCC on the Thursday before the start of the options expiry period due to late day offsetting trades in stock options on that Friday; therefore, applying this netting percentage should more accurately reflect the actual liquidity exposures that will be presented to NSCC from the Providers.

ii. Proposed Discretionary Intraday Supplemental Liquidity Call

Second, NSCC proposes to establish a discretionary intraday supplemental liquidity call on any business day other than the first business day during options expiry periods. Under this provision, NSCC will have the discretion to call for additional supplemental liquidity deposits on an intraday basis on any such business day if a Provider's increased activity levels during that day would cause a liquidity shortfall at NSCC. The amount of a Provider's intraday supplemental liquidity call, pursuant to NSCC's discretion, would be the difference between NSCC's daily liquidity need, recalculated to take into account the increase in the Provider's settlement activity during the day, and NSCC's qualifying liquid resources.

NSCC states that it would collect a discretionary intraday call in circumstances where NSCC believes it should accelerate the collection of a Provider's supplemental liquidity obligation because that Provider's intraday settlement activity would cause NSCC's liquidity needs to exceed its liquidity resources. For example, NSCC may impose an intraday supplemental liquidity call on a Provider if NSCC determines that Provider is unlikely to meet its projected settlement obligations through the settlement cycle due to rapidly escalating financial stress. NSCC will make this determination based on a variety of factors, including NSCC's assessment of the Provider's ability to meet its obligations to NSCC (i.e., an assessment of the Provider's creditworthiness on a particular business day) or estimates of settlement activity that could offset settlement exposures and are not reflected in NSCC's liquidity estimates.

III. Discussion and Commission Findings

Although the Clearing Supervision Act does not specify a standard of review for an advance notice, the stated purpose of the Clearing Supervision Act is instructive: To mitigate systemic risk in the financial system and promote financial stability by, among other things, promoting uniform risk management standards for SIFMUs and strengthening the liquidity of SIFMUs.

Section 805(a)(2) of the Clearing Supervision Act authorizes the Commission to prescribe regulations containing risk management standards for the payment, clearing, and settlement activities of designated clearing entities engaged in designated activities for which the Commission is the supervisory agency. Section 805(b) of the Clearing Supervision Act provides the following objectives and principles for the Commission's risk management standards prescribed under Section 805(a):

• To promote robust risk management;
• to promote safety and soundness;
• to reduce systemic risks; and
• to support the stability of the broader financial system.

Section 805(c) provides, in addition, that the Commission's risk management standards may address such areas as risk management and default policies and procedures, among other areas.

The Commission has adopted risk management standards under Section 805(a)(2) of the Clearing Supervision Act and Section 17A of the Exchange Act (the “Clearing Agency Rules”). The Clearing Agency Rules require, among other things, each covered clearing agency to establish, implement, maintain, and enforce written policies and procedures that are reasonably designed to meet certain minimum requirements for its operations and risk management practices on an ongoing basis. As such, it is appropriate for the Commission to review advance notices against the Clearing Agency Rules and the objectives and principles of these risk management standards as described in Section 805(b) of the Clearing Supervision Act. As discussed below, the Commission finds the proposal in the Advance Notice is consistent with the objectives and principles described in Section 805(b) of the Clearing Supervision Act, and in the Clearing Agency Rules, in particular Rule 17Ad-22(e)(7)(i) and (ii).

A. Consistency With Section 805(b) of the Clearing Supervision Act

The Commission finds that the Advance Notice is consistent with the stated objectives and principles of Section 805(b) of the Clearing Supervision Act. Specifically, the Commission finds that the changes proposed in the Advance Notice are consistent with promoting robust risk management in the area of liquidity risk, promoting safety and soundness, reducing systemic risks, and supporting the broader financial system.

The Commission finds that the changes proposed in the Advance Notice are consistent with promoting robust risk management, in particular the management of liquidity risk presented to NSCC. As a CCP and a SIFMU, it is imperative that NSCC maintains adequate resources to satisfy liquidity needs arising from its settlement obligations, including in the event of a Member default. As described above in Section II.C.1, NSCC currently may only collect supplemental liquidity deposits during monthly options expiry periods. However, NSCC can also face increased liquidity exposure from a Member's activity outside of these periods, even if unrelated to options settlement activity. The ability to calculate and collect supplemental liquidity deposits, as applicable, on a daily basis should help NSCC more accurately manage its daily liquidity exposures based on Members' actual activity, as opposed to only being able to collect additional liquidity resources from Members during monthly options expiry. Moreover, the proposal would allow NSCC to determine the amount of supplemental liquidity deposits based on Members' actual activity, providing more precise and, potentially, lower charges for Members than provided under the current methodology, which uses estimates based on a look-back period and can, on occasion, result in NSCC collecting more resources than needed to cover its exposure.

Additionally, as described above in Section II.C.3, NSCC also proposes to include both mandatory and discretionary intraday supplemental liquidity calls which would allow NSCC to calculate and collect additional supplemental liquidity deposits on an intraday basis if a Provider's increased activity levels during that day or projected settlement activity causes NSCC's daily liquidity need to exceed its qualifying liquid resources. The Commission finds that the mandatory monthly intraday supplemental liquidity calls on the first business day of the monthly options expiry periods should help NSCC continue to manage the potential increased liquidity exposures that may arise from options settlement-related activity by allowing it to accelerate the collection of supplemental liquidity deposits on that day, as opposed to waiting for the proposed daily collection that would occur on the morning of the following business day. Moreover, the proposed discretionary intraday supplemental liquidity calls should collect additional supplemental liquidity deposits from Members whose activity outside of the monthly options expiry periods may cause a sudden increase in NSCC's liquidity needs on an overnight basis. Therefore, because NSCC's proposal is designed to enable NSCC to better limit its liquidity exposures that could arise in the event of a Member default, the Commission finds the changes proposed in the Advance Notice promote robust risk management, specifically in the area of liquidity risk.

The Commission also finds that the changes proposed in the Advance Notice are consistent with promoting safety and soundness, reducing systemic risks, and promoting the stability of the broader financial system. As described above, NSCC's proposal to calculate and collect, if applicable, supplemental liquidity deposits on a daily basis could provide NSCC with additional liquidity resources, including on days outside of monthly Options Expiration Activity Periods, in the event of a Member default. Therefore, the changes proposed would promote safety and soundness by enabling NSCC to obtain additional liquid resources to cover a liquidity gap that could arise in the event of a Member default. By covering such a gap, the proposal bolsters NSCC's ability to meet its settlement obligations in the event of a Member default and its ability to continue to provide CCP services to its Members.

In addition, the proposed changes should reduce the potential procyclicality of NSCC's liquidity demands, which could reduce the potential for unexpected liquidity stress to market participants in certain situations. Because NSCC would now calculate and collect, if applicable, supplemental liquidity deposits on a daily basis, the proposal should reduce the likelihood that NSCC would have to call on its Members to contribute additional liquidity in periods of financial stress, when liquidity may be most costly. Therefore, the Commission finds that by enhancing NSCC's ability to address losses and liquidity pressures that otherwise might cause financial distress to NSCC or its Members, the Advance Notice promotes safety and soundness.

Maintaining adequate liquidity resources to help meet settlement obligations in the event of a Member default also enhances NSCC's ability to manage systemic risk and to support the broader financial system. NSCC's ability to obtain additional liquid resources for use in the event of a Member default should reduce the risk of loss contagion (i.e., the risk of losses arising at other NSCC Members if NSCC is unable to deliver cash or securities on the defaulting Member's behalf). Reducing the risk of loss contagion would reduce the potential transmission of financial shocks from defaulting Members to non-defaulting Members, thereby enhancing the ability of NSCC and its Members to continue to provide stability and safety to the financial markets that they serve.

Additionally, establishing an optional alternative pro rata calculation of supplemental liquidity deposits could help NSCC alleviate any unintended but significant liquidity constraints on its Members, while still enabling NSCC to meet its regulatory requirements with respect to liquidity without collecting more liquidity resources than needed. The proposed pro rata calculation would provide NSCC with a method to reduce the supplemental liquidity deposits owed by all Providers who would otherwise be obligated to provide such a deposit, which would be appropriate in light of the likely stressed market conditions that would result in two or more Providers presenting a potential supplemental liquidity deposit of over $2 billion. Likewise, because NSCC would recalculate supplemental liquidity deposit obligations each business day, NSCC will no longer need to hold supplemental liquidity deposits for the extended periods under its current Rule 4(A), which could also alleviate liquidity pressures on its Members. Accordingly, the Commission finds the proposal is consistent with reducing systemic risks, and promoting the stability of the broader financial system as contemplated in Section 805(b) of the Clearing Supervision Act.

For the reasons stated above, the Commission finds the changes proposed in the Advance Notice are consistent with Section 805(b) of the Clearing Supervision Act.

B. Consistency With Rule 17Ad-22(e)(7)(i) and (ii)

The Commission finds the changes proposed in the Advance Notice are consistent with Rules 17Ad-22(e)(7)(i) and (ii), each promulgated under the Exchange Act, for the reasons described below.

Rule 17Ad-22(e)(7)(i) under the Exchange Act requires that a covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain sufficient liquid resources at the minimum in all relevant currencies to effect same-day and, where appropriate, intraday and multiday settlement of payment obligations with a high degree of confidence under a wide range of foreseeable stress scenarios that includes, but is not limited to, the default of the participant family that would generate the largest aggregate payment obligation for the covered clearing agency in extreme but plausible market conditions. Rule 17Ad-22(e)(7)(ii) under the Act requires that a cover clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to hold qualifying liquid resources sufficient to meet the minimum liquidity resource requirement under Rule 17Ad-22(e)(7)(i) in each relevant currency for which the covered clearing agency has payment obligations owed to its clearing members.

As described above, the changed proposed in the Advance Notice would help strengthen NSCC's ability to maintain sufficient liquid resources to complete end-of-day settlement in the event of the Member default by allowing NSCC to calculate and collect, when applicable, supplemental liquidity deposits every business day, or on an intraday basis, from those Members that pose the largest liquidity exposures to NSCC on that day. These resources would be available to NSCC to complete end-of-day settlement in the event of the default of a Member. Moreover, the Commission has reviewed and considered the impact study results provided by NSCC comparing the proposal against the observed regulatory liquidity needs and NSCC's qualifying liquid resources available during the period from 2016 through 2020, to assess both pro-forma and hypothetical impacts of the proposal under various liquidity scenarios, and finds that these results generally indicated that the proposal would continue allow NSCC to meet its regulatory liquidity obligations.

In addition, deposits made to satisfy supplemental liquidity deposit obligations are currently and will continue to be required to be made as cash deposits, which will continue to be held by NSCC at either its cash deposit account at the Federal Reserve Bank of New York, at a creditworthy commercial bank, or in other investments pursuant to NSCC's Clearing Agency Investment Policy. Therefore, supplemental liquidity deposits would continue to be considered a qualifying liquid resource, as defined by Rule 17Ad-22(a)(14), and would support NSCC's ability to hold qualifying liquid resources sufficient to meet the minimum liquidity resource requirement under Rule 17Ad-22(e)(7)(i), as required by Rule 17Ad-22(e)(7)(ii).

Accordingly, the Commission finds that implementation of the proposed amendments to supplemental liquidity deposits would be consistent with Rule 17Ad-22(e)(7)(i) and (ii) under the Exchange Act.

IV. Conclusion

It is therefore noticed, pursuant to Section 806(e)(1)(I) of the Clearing Supervision Act, that the Commission does not object to Advance Notice (SR-NSCC-2021-801) and that NSCC is authorized to implement the proposed change as of the date of this notice or the date of an order by the Commission approving proposed rule change SR-NSCC-2021-002, whichever is later.