Self-Regulatory Organizations; National Securities Clearing Corporation; Order Approving Proposed Rule Change, as Modified by Amendment Nos. 1, 2, and 3, To Revise the Excess Capital Premium Charge

I. Introduction

On May 20, 2022, National Securities Clearing Corporation (“NSCC”) filed with the Securities and Exchange Commission (“Commission”) proposed rule change SR-NSCC-2022-005 pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder. The proposed rule change was published for comment in the Federal Register on June 8, 2022, and the Commission has received comments regarding the proposed rule change.

On July 11, 2022, pursuant to Section 19(b)(2) of the Act, the Commission designated a longer period within which to approve, disapprove, or institute proceedings to determine whether to disapprove the proposed rule change. On September 1, 2022, the Commission instituted proceedings, pursuant to Section 19(b)(2)(B) of the Act, to determine whether to approve or disapprove the proposed rule change.

On July 6, 2022, NSCC filed a partial amendment (“Amendment No. 2”) to modify the proposed rule change. On November 28, 2022, NSCC filed another amendment (“Amendment No. 3”) to modify the proposed rule change. On December 1, 2022, the Commission published notice of filing of Amendment Nos. 2 and 3 and of an extension to the action date for the proposed rule change.

For the reasons discussed below, the Commission is approving the proposed rule change, as modified by Amendment Nos. 1, 2 and 3 (hereinafter, “proposed rule change”).

II. Description of the Proposed Rule Change

NSCC provides clearing, settlement, risk management, central counterparty services, and a guarantee of completion for virtually all broker-to-broker trades involving equity securities, corporate and municipal debt securities, and unit investment trust transactions in the U.S. markets. A key tool that NSCC uses to manage its credit exposure to its members is collecting an appropriate Required Fund Deposit ( i.e., margin) from each member. A member's margin is designed to mitigate potential losses to NSCC associated with liquidation of the member's portfolio in the event of that member's default. The aggregate of all NSCC members' margin deposits (together with certain other deposits required under the Rules) constitutes NSCC's Clearing Fund, which NSCC would access should a member default and that member's margin, upon liquidation, be insufficient to satisfy NSCC's losses.

A member's margin consists of a number of applicable components, each of which addresses specific risks faced by NSCC. Many of those components are designed to measure risks presented by the net unsettled positions a member submits to NSCC to be cleared and settled; however, certain components, often referred to as margin “add-ons,” measure and mitigate other risks that NSCC may face, such as credit risks.

NSCC's excess capital premium (“ECP”) is one such add-on that makes up part of the margin that a member must pay to NSCC. The purpose of this charge is to mitigate the heightened default risk a member could pose to NSCC if it operates with lower capital levels relative to its margin requirements. Put another way, the ECP charge operates to collect additional margin if a member's exposure to NSCC based on its clearing activity is out of proportion to its capital.

As described in more detail below, the ECP charge applies when a specified portion of a member's required margin exceeds its capital by a ratio of more than 1.0 (defined in the Rules as the “Excess Capital Ratio”). When the charge applies, NSCC determines its amount by multiplying the member's capital by this ratio, with the resulting amount serving as the add-on charge.

NSCC's proposal would change both the calculation methodology and governance of the ECP charge in its Rules. With respect to the calculation of the charge, NSCC proposes to: (1) use the volatility charge of a member's margin requirement to compare a member's applicable capital amounts, as opposed to the current methodology which uses a specific “calculated amount” identified in the Rules; (2) when calculating the ECP charge, for members that are broker-dealers, use net capital amounts rather than excess net capital, and for all other members, use equity capital in the calculation of the ECP charge; and (3) establish a cap of 2.0 for the Excess Capital Ratio that is used in calculating a member's ECP charge. With respect to governance, NSCC proposes to: (1) identify the particular circumstances in which NSCC has the ability to waive the charge, including the information that NSCC would review in deciding whether to waive the ECP charge as well as the governance around the application of such waiver; and (2) provide that NSCC may calculate the charge based on updated capital information.

NSCC has estimated the potential impacts of the proposal during the period of June 1, 2020 through December 31, 2021. The study showed that the proposal would have had no impact to NSCC's overall or member-level margin coverage, that is, that NSCC would continue to collect margin that would cover its credit exposures to its members under the proposal. Further, the study showed that the proposal would have reduced the number of ECP charges that would have been triggered by the calculation by 65 percent, from 347 ECP charges triggered for 19 members to 122 ECP charges triggered for 14 members. The total aggregate amount that would have been triggered by the proposed calculation if the proposal was effective during that time would have been reduced from $51.31 billion (the actual total amount of ECP charges triggered by the current calculation during that period) to approximately $17.44 billion (the total amount of ECP charges that would have been triggered during that time by the proposed calculation), with the average amount per member reducing from $147.9 million to approximately $143.0 million.

A. Current Calculation and Governance of the ECP Charge

NSCC's current methodology for determining applicability of the ECP charge is as follows. First, NSCC determines the member's “Calculated Amount,” pursuant to the Rules. The Calculated Amount is designed to represent the member's margin requirements to NSCC resulting from its unsettled positions, and it is made up of a number of the components of a member's margin. NSCC then divides the member's Calculated Amount by its current capital amount, which is the amount reported to NSCC pursuant to its ongoing membership standards.

Next, if the member's Calculated Amount divided by the applicable capital amount (referred to as the member's Excess Capital Ratio) is greater than 1.0, NSCC may require that member to make an ECP charge. The applicable ECP charge is the product of (1) the amount by which a member's Calculated Amount exceeds its applicable capital amount, multiplied by (2) the member's Excess Capital Ratio. However, NSCC has the authority to collect a lower ECP charge than the amount calculated pursuant to the Rules or to determine not to collect the ECP charge from a member at all, and it may return all or a portion of a collected ECP charge if it believes the imposition or maintenance of the ECP charge is not necessary or appropriate.

The Rules describe some circumstances when NSCC may determine not to collect an ECP charge from a member, which includes, for example, when an ECP charge results from trading activity for which the member submits later offsetting activity that lowers its Required Fund Deposit. The discretion to adjust, waive or return an ECP charge was designed to allow NSCC to determine when a calculated ECP charge may not be necessary or appropriate to mitigate the risks it was designed to address.

B. Amendments to the Calculation of the ECP Charge

Use Members' Volatility Component Instead of the Calculated Amount. NSCC proposes to replace the Calculated Amount with the amount collected as that member's volatility component of its margin for purposes of determining the applicability of the ECP charge. The volatility component measures the market price volatility of a member's portfolio, and it usually comprises the largest portion of a member's margin.

Currently, determining a member's Calculated Amount requires a more complicated calculation, as it uses a member's margin, but excludes certain components and includes other deposits. The proposal would simplify this calculation by using only the volatility component. NSCC states that one of the tools it provides to its members is a calculator that allows them to determine their potential volatility charge based on trading activity, and that, therefore, this proposed change would make the calculation of the ECP charge both clearer and more predictable for members.

Use Net Capital for Broker-Dealer Members and Equity Capital for All Other Members in the Calculation of the ECP Charge. NSCC is proposing to use net capital, rather than excess net capital, for broker-dealer members when calculating the ECP charge. NSCC states that this revision would align the capital measures used for broker-dealer members and other members, which would result in more consistent calculations of the ECP charge across different types of members. NSCC also states that using net capital rather than excess net capital would provide NSCC with a better measure of the increased default risks presented when a broker-dealer member operates at low net capital levels relative to its margin requirements.

In addition, NSCC is proposing to provide that, for all members that are not broker-dealers, it would use equity capital in calculating the ECP charge, rather than the capital amount set forth in NSCC's membership standards. Currently, for all members that are not banks, non-bank trusts or broker-dealers (which generally include, for example, exchanges and registered clearing agencies), NSCC uses those members' reported equity capital in the calculation of the ECP charge. Therefore, in practice, the ECP charge is calculated for the majority of members that are not broker-dealers using their equity capital, and this proposed change is not expected to have a material impact on the collection of ECP charges. NSCC states that the proposal would simplify the calculation of the ECP charge for members that are not broker-dealers by providing that NSCC would use equity capital rather than use different measures that are based on other membership requirements, and that it would also create consistency across members.

Establish a Cap for the Excess Capital Ratio. NSCC is proposing to set a maximum amount of the Excess Capital Ratio that is used in calculating members' ECP charge of 2.0. Specifically, the Excess Capital Ratio is the multiplier that is applied to the difference between a member's volatility charge and its applicable capital measure. Currently, the Rules do not include any cap on the Excess Capital Ratio.

NSCC states that capping the multiplier would allow it to address the risks it faces without imposing an overly burdensome ECP charge. NSCC further states that, historically, the Excess Capital Ratio has rarely exceeded 2.0 in the calculation of members' ECP charges, and in cases when 2.0 was exceeded NSCC typically exercised the discretion provided to it in the Rules to reduce the applicable charge, which was appropriate because NSCC believes it is able to mitigate the risks presented to it by a member's lower capital levels by collecting an ECP charge calculated with an Excess Capital Ratio that is at or below 2.0. NSCC also states that this proposed change would provide members with more clarity and transparency, by allowing them to predict and estimate the maximum amount of their potential ECP charge.

C. Changes Regarding Governance of the ECP Charge

NSCC's Ability to Waive the ECP Charge. NSCC would also revise its Rules to specify particular circumstances in which NSCC retains the ability to waive the ECP charge. NSCC states that the proposed changes to the calculation of the ECP charge would, taken together, eliminate most circumstances in which NSCC would have exercised this discretion. For example, the proposal to cap the Excess Capital Ratio at 2.0 and the proposal to specify that NSCC may calculate an ECP charge based on updated capital amounts (as described below), both address the most common circumstances when NSCC has either waived or reduced the ECP charge in the past.

However, NSCC believes that there may still be circumstances when it may not be necessary or appropriate to collect an ECP charge from a member, for example, in certain exigent circumstances when NSCC observes unexpected changes in market volatility or trading volumes. Therefore, NSCC is proposing to retain discretion to waive an ECP charge in certain defined circumstances and to specify the approval required to apply such discretion.

As proposed, NSCC's Rules would describe the exigent circumstances in which NSCC would retain the ability to waive an ECP charge as those when NSCC, in its sole discretion, observes extreme market conditions or other unexpected changes in factors such as market volatility, trading volumes or other similar factors. As noted above, NSCC states that, based on a review of past data, the proposed changes to the calculation of the ECP charge would otherwise eliminate most prior instances when an ECP charge was waived.

NSCC also states that there have been instances, particularly in recent years, when NSCC has waived the ECP charge in circumstances that would fall within the proposed identification of exigent circumstances, and that the ECP charge would have been triggered in such circumstances, even as amended by this proposed rule change. Such instances occurred multiple times in recent years, including, for example, during the extreme market volatility experienced in early 2020 related to the global outbreak of the COVID-19 coronavirus and the meme stock market event in early 2021. Further, NSCC believes there remains some ongoing possibility that an unexpected increase in market volatility, for example, could cause a relative increase in a member's volatility charge, which may, in turn, trigger an ECP charge, even under the proposal.

In such circumstances, under the proposal, NSCC would determine if the ECP charge being triggered at that time is not primarily caused by the risk presented by a member's capital levels and whether NSCC can effectively address the risk exposure presented by that member without the collection of the ECP charge. Alternatively, NSCC may determine, based on its review of the information available to it, that the ECP charge was appropriately triggered by a member's capital position or trading activity and was not driven primarily by the prevailing market conditions or other exigent circumstances. Therefore, NSCC believes it is appropriate to retain a certain amount of discretion to review an ECP charge that is triggered in such circumstances to determine whether a waiver of the ECP charge may be appropriate.

In addition to defining the circumstances in which NSCC may waive the ECP charge, the proposed changes would also describe the review NSCC would conduct in deciding to waive the charge in the exigent circumstances, the information NSCC would consider in such review, and the approval required to waive the ECP charge. More specifically, the proposed rule change provides that NSCC would review all relevant facts and other information available to it at the time of its decision, including the degree to which a member's capital position and trading activity compare or correlate to the prevailing exigent circumstances and whether NSCC can effectively address the risk exposure presented by a member without the collection of the ECP charge from that member. For example, as noted above, if NSCC believes, based on its review of the relevant circumstances, that the risk exposure presented by a member is driven by the unexpected increase in market volatility and not by a member's capital levels, NSCC may determine that it is appropriate to address such risk through the collection of a special charge from that member rather than an ECP charge.

Finally, the proposed rule change would specify the governance around a decision to waive an ECP charge, by identifying the level of NSCC officer who would be authorized to apply a waiver and by requiring that the decision be documented in a written report that is made available upon request to the affected member.

NSCC's Ability to Consider Updated Capital Information. Under the proposal, NSCC would provide that it may calculate the ECP charge based on updated capital information. As described above, NSCC would use the net capital or equity capital amounts that are reported on members' most recent financial reporting or financial statements delivered to NSCC in connection with the ongoing membership reporting requirements. Under the proposal, if a member's capital amounts change between the dates when it submits these financial reports, it may provide NSCC with updated capital information for purposes of calculating the ECP charge.

NSCC is proposing to retain some discretion in when it would accept updated capital information for this purpose. For example, NSCC may require a member to provide documentation of the circumstances that caused a change in capital information, and if adequate evidence is not available or NSCC does not believe the evidence sufficiently verifies that the member's capital position has changed, NSCC would continue to calculate the ECP charge for that member based on the prior capital information available to NSCC until the next financial reporting or financial statements are delivered. NSCC believes it is appropriate to retain some discretion to allow NSCC to determine if updated capital information is adequately verified before it agrees to rely on that information for this calculation.

III. Discussion and Commission Findings

Section 19(b)(2)(C) of the Act directs the Commission to approve a proposed rule change of a self-regulatory organization if it finds that such proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to such organization. After carefully considering the proposed rule change, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to NSCC. In particular, the Commission finds that the proposed rule change is consistent with Section 17A(b)(3)(F) of the Act and Rules 17Ad-22(e)(6)(i) and (e)(23)(ii) thereunder.

A. Consistency With Section 17(A)(b)(3)(F) of the Act

Section 17A(b)(3)(F) of the Act requires, among other things, that the rules of a clearing agency be designed to, among other things, promote the prompt and accurate clearance and settlement of securities transactions, assure the safeguarding of securities and funds which are in the custody or control of the clearing agency or for which it is responsible, and protect investors and promote the public interest.

The Commission believes that the proposed changes to the calculation of the ECP charge described in section II.B above should allow NSCC to ensure that it continues to collect margin sufficient to address the heightened default risk presented by a member operating with lower capital levels relative to its margin requirements. Based on its review of the proposed rule change, including the detailed impact analysis submitted as a confidential exhibit, the Commission understands that NSCC's margin coverage would not be impacted by this change and that NSCC would continue to collect sufficient margin to manage its potential exposure to its members.

In addition, the Commission believes that the proposed changes to the calculation of the ECP charge described in section II.B should result in a simplified and more straight-forward method for calculating the ECP charge, based on understandable metrics with which NSCC's members are familiar. For example, using a member's volatility charge, which is an established aspect of the overall margin requirements identified in NSCC's Rules, as opposed to the Calculated Amount that involves both including and excluding various margin components, is clearer and more predictable while still consistent with the purpose of the ECP charge. Similarly, using net capital and equity capital for broker-dealer members and all other members, respectively, in the calculation of the ECP charge would result in a more consistent calculation across different types of members. Moreover, capping the Excess Capital Ratio at 2.0 would be an appropriate balance between addressing the heightened default risk without imposing overly burdensome ECP charges.

Together, by improving the consistency and predictability of the ECP charge, the proposed enhancements would also improve NSCC's ability to collect margin amounts that reflect the risks posed by its members such that, in the event of member default, NSCC's operations would not be disrupted, and non-defaulting members would not be exposed to losses they cannot anticipate or control. In this way, the proposed rule change is designed to promote the prompt and accurate clearance and settlement of securities transactions and to assure the safeguarding of securities and funds which are in the custody or control of NSCC or for which it is responsible, consistent with Section 17A(b)(3)(F) of the Act.

The Commission believes that the proposed changes set forth in both sections II.B and II.C should improve transparency and understanding of the NSCC's governance and application of the ECP charge. For example, NSCC's proposal would describe the exigent circumstances in which NSCC may waive the ECP charge, describe what information NSCC would consider when determining whether to waive the charge, and specify the approval necessary to waive the charge. Moreover, using commonly understood inputs as the determinants of the ECP charge ( i.e., using the volatility charge instead of the Calculated Amount and using net capital and equity capital instead of the current standards) and capping the Excess Capital Ratio at 2.0 should help members better anticipate and plan for a potential ECP charge. Through its client portal, NSCC provides regularly updated information to members about their volatility charges, such that a member should be able to better calculate and understand its potential ECP charge by using that information in conjunction with their capital, while also considering how the proposed cap on the Excess Capital Ratio would affect any eventual charge.

Taken together, these proposed changes should help NSCC's members better anticipate their required margin because of the use of simplified inputs to the calculation of the ECP charge and the imposition of a cap on the applicable Excess Capital Ratio. This improved understanding of the potential margin requirements should, in turn, facilitate prompt and accurate clearance and settlement by removing potential ambiguity or confusion about a member's obligations to NSCC. Similarly, the Commission believes that the improved transparency provided by this proposed rule change both with respect to a member's margin obligations and the process by which NSCC would consider waiver of an ECP charge should provide members and the public with more clarity about the nature and application of the ECP charge and resolve potential ambiguity about when the ECP charge would or would not apply, which is consistent with promoting the public interest.

For these reasons, the Commission therefore believes that the proposed changes are consistent with Section 17A(b)(3)(F) of the Act.

B. Consistency With Rule 17Ad-22(e)(6)(i)

Rule 17Ad-22(e)(6)(i) under the Act requires that NSCC establish, implement, maintain and enforce written policies and procedures reasonably designed to cover its credit exposures to its participants by establishing a risk-based margin system that, at a minimum, considers, and produces margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market.

The Required Fund Deposits are made up of risk-based components (as margin) that are calculated and assessed daily to limit NSCC's exposures to members. NSCC's proposed changes to use the volatility charge rather than the Calculated Amount, and to use net capital and equity capital, as appropriate, in the calculation of the ECP charge would collectively make the calculation clearer and more predictable to members, while continuing to apply an appropriate risk-based charge designed to mitigate the risks presented to NSCC. Similarly, the proposal to cap the Excess Capital Ratio at 2.0 would allow NSCC to appropriately address the risks it faces without imposing an overly burdensome ECP charge and would reduce the circumstances in which NSCC may waive the charge, resulting in a more transparent margining methodology. Finally, the proposed rule change would clarify the exigent circumstances when NSCC may determine that it is appropriate to waive the ECP charge. Overall, these proposed changes would improve the effectiveness of the calculation of the ECP charge and, therefore, allow NSCC to more effectively address the increased default risks presented by members that operate with lower capital levels relative to their margin requirements.

Taken together, the proposed changes enhance the ability of the ECP charge to produce margin levels commensurate with the risks NSCC faces related to its members' operating capital levels. Therefore, the Commission believes that the proposed rule change is consistent with Rule 17Ad-22(e)(6)(i) under the Act.

C. Consistency With Rule 17Ad-22(e)(23)(ii)

Rule 17Ad-22(e)(23)(ii) under the Act requires that NSCC establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for providing sufficient information to enable participants to identify and evaluate the risks, fees, and other material costs they incur by participating in NSCC.

As discussed above in section III.A, the Commission believes that the proposed changes set forth in both sections II.B and II.C should improve NSCC's members' ability to understand and estimate the potential magnitude of any ECP charge and to better anticipate when such a charge would apply and in what exigent circumstances NSCC would be able to waive the charge. The proposal would do this in several ways, including by simplifying and clarifying the inputs to the calculation of the ECP charge, capping the Excess Capital Ratio at 2.0, and by providing additional information regarding NSCC's ability to waive the charge.

Therefore, the Commission believes that these changes are consistent with Rule 17Ad-22(e)(23)(ii) under the Act.

IV. Conclusion

On the basis of the foregoing, the Commission finds that the proposed rule change, as modified by Amendment Nos. 1, 2, and 3, is consistent with the requirements of the Act, and in particular, the requirements of Section 17A of the Act and the rules and regulations thereunder.

It is therefore ordered , pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-NSCC-2022-005), as modified by Amendment Nos. 1, 2, and 3, be, and hereby is, approved.