Regarding the text and substance of the amendment, I request that the NSCC modify Rules 4, 18, and 22 of the NSCC’s Rules and Procedures to address the aforementioned issues by:
(a) codifying strict procedures for completing settlement of guaranteed transactions,
(b) removing ambiguity and discretion,
(c) enhancing the liquidity and strengthening the resilience of SIFMUs, particularly registered Clearing agencies such as the NSCC and OCC,
(d) supporting the overall stability of our financial markets and financial system, and
(e) incentivizing appropriate risk management practices of financial market participants.
With respect to the text of the proposed changes itemized below (blue and
strikethrough, where applicable), additions are identified by square brackets (i.e., “[“ and “]”) and double-dashes (i.e., “--”) indicate deletions.
NSCC Rule 4 Proposed Change
SEC. 4. Loss Allocation Waterfall, Off-the-Market Transactions.
Each Member[, including its executives,] shall be obligated to the Corporation for the entire amount of any loss or liability incurred by the Corporation arising out of or relating to any Defaulting Member Event with respect to such Member. [To the extent that such loss or liability is not satisfied by the Member, all executives of the Member (past or present) shall be obligated to the Corporation for an amount equivalent to the preceding 5 years of compensation from the Member.] To the extent that such loss or liability is not satisfied pursuant to Section 3 of this Rule 4, the Corporation shall apply a Corporate Contribution thereto and charge the remaining amount of such loss or liability ratably to other Members, as further provided below.
NSCC Rule 18 Proposed Change
SEC. 6. (a) Promptly after the Corporation has given notice that it has ceased to act for the Member, and in a manner consistent with the provisions of Section 3, the Net Close Out Position with respect to each CNS Security shall be closed out (whether it
be by buying in, selling out or otherwise liquidating the position) by the Corporation--; provided however, if, in the opinion of the Corporation, the close out of a position in a specific security would create a disorderly market in that security,
then the completion of such close-out shall be in the discretion of the Corporation--.
NSCC Rule 22 Proposed Change (Option A – Public Notice)
RULE 22. SUSPENSION OF RULES
The time fixed by these Rules, the Procedures or any regulations issued by the Corporation for the doing of any act or acts may be extended or the doing of any act or acts required by these Rules, the Procedures or any regulations issued by the Corporation may be waived or any provision of these Rules, the Procedures or any regulations issued by the Corporation may be suspended by the Board of Directors or by the Chairman of the Board, the President, the General Counsel or such other officers of the Corporation having a rank of Managing Director or higher whenever, in its or his judgment, such extension, waiver or suspension is necessary or expedient.
A written report of any such extension, waiver or suspension (other than an extension of time of less than eight hours), stating the pertinent facts, the identity of the person or persons who authorized such extension, waiver or suspension and the reason such extension, waiver or suspension was deemed necessary or expedient, shall be promptly made [and published on the Corporation’s website for access by the general public within 1 business day] and filed with the Corporation’s records and shall be available for inspection by any [person,] Member, Mutual Fund/Insurance Services Member, Municipal Comparison Only Member, Insurance Carrier/Retirement Services Member, TPA Member, TPP Member, Investment Manager/Agent Member, Fund Member, Data Services Only Member or AIP Member during regular business hours on Business Days. Any such extension or waiver may continue in effect after the event or events giving rise thereto but shall not continue in effect for more than 60 calendar days after the date thereof unless it shall be approved [by] the Board of Directors within such period of 60 calendar days [with a written report made and published as described by this paragraph].
NSCC Rule 22 Proposed Change (Option B – No Exceptions)
RULE 22. --SUSPENSION OF RULES--[NO EXCEPTIONS]
--The time fixed by these Rules, the Procedures or any regulations issued by the Corporation for the doing of any act or acts may be extended or the doing of any act or acts required by these Rules, the Procedures or any regulations issued by the
Corporation may be waived or any provision of these Rules, the Procedures or any regulations issued by the Corporation may be suspended by the Board of Directors or by the Chairman of the Board, the President, the General Counsel or such other officers of
the Corporation having a rank of Managing Director or higher whenever, in its or his judgment, such extension, waiver or suspension is necessary or expedient. A written report of any such extension, waiver or suspension (other than an extension of time of
less than eight hours), stating the pertinent facts, the identity of the person or persons who authorized such extension, waiver or suspension and the reason such extension, waiver or suspension was deemed necessary or expedient, shall be promptly made and
filed with the Corporation’s records and shall be available for inspection by any Member, Mutual Fund/Insurance Services Member, Municipal Comparison Only Member, Insurance Carrier/Retirement Services Member, TPA Member, TPP Member, Investment Manager/Agent
Member, Fund Member, Data Services Only Member or AIP Member during regular business hours on Business Days. Any such extension or waiver may continue in effect after the event or events giving rise thereto but shall not continue in effect for more than 60
calendar days after the date thereof unless it shall be approved the Board of Directors within such period of 60 calendar days.--
[The time fixed by these Rules, the Procedures or any regulations issued by the Corporation for the doing of any act or acts may not be extended. The doing of any act or acts required by these Rules, the Procedures or any regulations issued by the Corporation may not be waived and any provision of these Rules, the Procedures or any regulations issued by the Corporation may not be suspended.
A written report of any deviation from these Rules, Procedures or any regulations issued by the Corporation (including extension, waiver or suspension), stating the pertinent facts, the identity of the person or persons who authorized such extension, waiver or suspension and the reason such extension, waiver or suspension was deemed necessary or expedient, shall be promptly made and published on the Corporation’s website for access by the general public within 1 business day and filed with the Corporation’s records and shall be available for inspection by any person, Member, Mutual Fund/Insurance Services Member, Municipal Comparison Only Member, Insurance Carrier/Retirement Services Member, TPA Member, TPP Member, Investment Manager/Agent Member, Fund Member, Data Services Only Member or AIP Member during regular business hours on Business Days.]
As a retail investor, I believe these enhancements to NSCC Rules 4, 18 and 22 will protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation in accordance with the SEC’s mission. Removing ambiguity and discretion by codifying strict procedures for completing settlement of guaranteed transactions at our CCPs ensures consistent clearance and settlement procedures are well defined for all market participants fostering a level playing field for everyone. Of the two options proposed for NSCC Rule 22, Option B “No Exceptions” is preferable to Option A in ensuring consistent application of Rules, Procedures, and regulations issued by the CCP. Option A is proposed with the acknowledgement that flexibility in managing situations can be helpful, but NSCC Rule 22 would need to mandate full disclosure to the public to avoid distorting markets as reducing information asymmetries leads to more efficient and fair markets.
These enhancements to NSCC Rules foster a “you broke it, you bought it” environment where costs for closing out positions, including those which may be disruptive, are first paid by the defaulting Member(s) and its executives with defined and consistent application of clearance and settlement procedures. Including clawbacks for executive compensation in the loss allocation waterfall introduces another loss absorbing resource and incentivizes proactive risk management practices over the short, medium, and long term which simultaneously discourages socializing losses for privatized profits. Thus, the proposed enhancements to the loss allocation waterfall enhances the liquidity and strengthens the resilience of registered Clearing agencies, such as the NSCC, which supports the overall stability of our financial markets and financial system. [13]
Retail investors like myself appreciate the opportunity to submit this petition for rulemaking and respectfully request that the Commission act on it promptly for the NSCC with similar conforming changes for the DTC (e.g., Rules 4 and 18), FICC Government Securities Division (e.g., Rules 4 and 42), FICC Mortgage Backed Securities Division (e.g., Rules 4 and 33), and elsewhere as applicable (e.g., Options Clearing Corporation which describes their loss allocation waterfall in “OCC’s Clearing Member Default Rules and Procedures” [15]).
Sincerely,
A Concerned Retail Investor
[2] NSCC Rules & Procedures are currently available at https://www.dtcc.com/~/media/Files/Downloads/legal/rules/nscc_rules.pdf
[3] https://www.sec.gov/rules-regulations/petitions-rulemaking-submitted-to-sec
[5] For a publicly available description of this issue, see “This is how Wall St ensures heads they win and tails you lose” at https://www.reddit.com/r/Superstonk/comments/yhx48w/this_is_how_wall_st_ensures_heads_they_win_and/ which describes the moral hazard problem created by Too Big To Fail based on a 1996 paper titled "Banks with Something to Lose: The Disciplinary Role of Franchise Value" [https://www.newyorkfed.org/research/epr/96v02n2/9610dems.html] available from the Federal Reserve Bank of NY.
[6] Decades after the Global Financial Crisis, options for resolving large financial institutions remain limited with bail-ins potentially replacing the unpopular bail outs. See, e.g, Investopedia (https://www.investopedia.com/terms/b/bailin.asp) and the Federal Reserve Bank of New York’s “Why Bail-In? And How!” (https://www.newyorkfed.org/medialibrary/media/research/epr/2014/1412somm.pdf/1000). While bail-ins are theoretically more palatable with creditors absorbing losses instead of taxpayers, self serving profit motivated financial institutions remain committed to shifting losses to others as exemplified by the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) which proposed to have new bond investors absorb losses first [2022 Proposed Rule Federal Reserve Docket R-1786 RIN 7100-AG4 and FDIC RIN 3064-AF86 available on the Federal Register at https://www.federalregister.gov/documents/2022/10/24/2022-23003/resolution-related-resource-requirements-for-large-banking-organizations]. Additional discussion regarding this proposed rule may be found on Reddit (https://www.reddit.com/r/Superstonk/comments/zdebh6/comment_against_the_federal_reserve_fdic_proposal/ and https://www.reddit.com/r/Superstonk/comments/163ztcz/federal_reserve_fdic_seeking_bag_holders/) which note that this strategy was successfully implemented with the failure of Credit Suisse where AT1 “bonds were created precisely for such situations” to “be fully written off in the event of a trigger event”.
[7] See, e.g., https://www.federalregister.gov/documents/2023/08/30/2023-18670/self-regulatory-organizations-national-securities-clearing-corporation-notice-of-filing-of-proposed which discusses the Existing Accord for the transfer between OCC and NSCC of responsibility for settlement obligations including the time when OCC’s settlement guarantee ends and NSCC’s settlement guarantee begins.
[8] https://www.dtcc.com/about/businesses-and-subsidiaries/nscc
[9] While a naked short position is used as an example here, it is only chosen as an example due to its inherent risk of unlimited loss. Any type of position could become risky as an extremely large long position could also lead to a disorderly market on close out even with limited loss potential. A large short position (whether naked or borrowed) is of particular relevance as the SEC’s Staff Release GameStop Report [https://www.sec.gov/page/sec-staff-release-gamestop-report] noted that GameStop (GME) had significant short interest (as a percent of float) in January 2021 of 122.97% with “short interest of more than shares outstanding in January 2021” [Id. pg 21].
[10] Per the current NSCC Rule 22, only certain parties have access to records of any extension, waiver, or suspension of rules related to not closing out a position. A much smaller subset of those parties with access are actively made aware of the situation. One option to mitigate market distortions would be to timely (i.e., immediately) make the written reports of Rule 22, including the pertinent facts, available to the SEC and to the general public as proposed for NSCC Rule 22 as Option A - Public Notice.
[11] For example, naked shorts and failures to deliver were documented in Dr. Susanne Trimbath’s book “Naked, Short and Greedy: Wall Street’s Failure to Deliver” and in 2008 the SEC halted short selling of financial stocks (and only financial stocks) in an emergency action “to combat market manipulation” and “restore equilibrium to markets”. [See, e.g., https://www.sec.gov/news/press/2008/2008-211.htm]
[12] NSCC’s Loss Allocation Waterfall may be found in, for example, NSCC’s Rules Rule 4 SEC 4 “Loss Allocation Waterfall, Off-the-Market Transactions”. OCC’s Loss Allocation Waterfall is described in OCC’s Clearing Member Default Rules and Procedures [https://www.theocc.com/getmedia/e8792e3c-8802-4f5d-bef2-ada408ed1d96/default-rules-and-procedures.pdf] publicly linked to from the OCC’s website on Default Rules & Procedures [https://www.theocc.com/risk-management/default-rules-and-procedures].
[13] The SEC has supported adoption of rules which “helps foster more resilient clearinghouses” [https://www.sec.gov/newsroom/press-releases/2023-236] where the need for more resilient clearinghouses is discussed in more detail on Reddit [https://www.reddit.com/r/Superstonk/comments/17wzqc4/clearinghouses_busted_confirmation_bias_from_the/].
[14] See, e.g., DTC Rules [https://www.dtcc.com/-/media/Files/Downloads/legal/rules/dtc_rules.pdf], FICC Government Securities Division Rules [https://www.dtcc.com/~/media/Files/Downloads/legal/rules/ficc_gov_rules.pdf], and FICC Mortgage Backed Securities Division Rules [https://www.dtcc.com/~/media/Files/Downloads/legal/rules/ficc_mbsd_rules.pdf] where DTC Rule 18 “WAIVER OR SUSPENSION OF RULES AND PROCEDURES”, FICC Government Securities Division Rule 42 “SUSPENSION OF RULES”, and FICC Mortgage Backed Securities Division Rule 33 “SUSPENSION OF RULES IN EMERGENCY CIRCUMSTANCES” are similar to NSCC Rule 22 “SUSPENSION OF RULES” while DTC Rule 4 Section 5 “Loss Allocation Waterfall” and FICC’s Rule 4 “CLEARING FUND AND LOSS ALLOCATION” are similar to NSCC Rule 4 in defining their loss allocation waterfalls.
[15] See, e.g., https://www.theocc.com/getmedia/e8792e3c-8802-4f5d-bef2-ada408ed1d96/default-rules-and-procedures.pdf which is linked to from https://www.theocc.com/risk-management/default-rules-and-procedures.