Self-Regulatory Organizations; International Securities Clearing Corporation; Order Temporarily Approving on an Accelerated Basis a Proposed Rule Change Amending ISCC's Clearing Fund Formula

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34392; International Series Release No. 687; File No.

SR-ISCC-94-1]

Self-Regulatory Organizations; International Securities Clearing

Corporation; Order Temporarily Approving on an Accelerated Basis a

Proposed Rule Change Amending ISCC's Clearing Fund Formula

July 15, 1994.

On June 9, 1994, International Securities Clearing Corporation

(``ISCC'') filed with the Securities and Exchange Commission

(``Commission'') a proposed rule change pursuant to Section 19(b)(1) of

the Securities Exchange Act of 1934 (``Act'').\1\ The Commission

published notice of the proposed rule change in the Federal Register on

June 22, 1994.\2\ No comments were received on the notice. As discussed

below, the Commission is temporarily approving the proposed rule change

on an accelerated basis through July 18, 1995.

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\1\15 U.S.C. 78s (b)(1) (1988).

\2\Securities Exchange Act Release No. 34222, International

Series Release No. 674 (June 16, 1994), 59 FR 32254.

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I. Description

In 1986, ISCC and the London Stock Exchange (``LSE'') entered into

a linkage agreement which allows ISCC to obtain comparison and

settlement services in the United Kingdom from the LSE on behalf of

ISCC members. Pursuant to this linkage agreement, ISCC is responsible

for paying for all securities believed. ISCC has no requirement to

complete open pending trades.\3\ On July 18, 1994, the LSE is moving to

a ten day rolling settlement cycle with trades settling ten days after

trade date.\4\ In response to this change, ISCC is adjusting its method

of calculating its clearing fund requirements.\5\

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\3\ISCC is not responsible for trades that are scheduled to

settle after the day of default of an ISCC member. Agreement, dated

December 22, 1988, between ISCC and LSE.

\4\Currently, the LSE settles trades on a fortnightly basis with

all trades that occur during a two-week period settling on the same

day.

\5\Currently, ISCC collects three percent of member's average

gross settlement value over two account periods on a biweekly basis.

This figure represents both market risk and foreign exchange risk.

As of July 18, 1994, the clearing fund deposit will be calculated

and collected on a weekly basis. The calculation will be made on

Tuesday and collected within three days. Therefore, ISCC will

collect clearing fund deposits prior to the settlement day.

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ISCC bases its clearing fund calculations on the assumption that it

will take one day to sell all of a defaulting participant's positions.

This results in an eleven day exposure for market risk with ten days

between trade date and settlement date and one day between settlement

date and close out of positions. There also will be a one day exposure

for foreign exchange risk. (ISCC will convert U.S. dollars into British

pounds on settlement day and will convert the proceeds from the close

out of positions into U.S. dollars the next day.) The formula,

therefore, is the sum of two components--the amount collected to cover

market risk and the foreign exchange factor.

To calculate the amount of clearing fund deposit attributable to

market risk, ISCC establishes a market risk factor which is the largest

percentage change over eleven days in the Financial Times Index over a

minimum of 365 days. Initially, the market risk factor will be set at

seven percent.\6\ The market risk factor is multiplied by the largest

single daily gross debit value for the applicable week less 15% of the

Institutional Net Settlement (``INS'') receive value for that day based

on debit values for the calendar week following the week in which the

calculation is performed (``adjusted gross debit value'').\7\

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\6\ISCC will review annually the market risk factor.

\7\Under the INS system, redeliveries of securities from the

ISCC member to institutional participants can occur automatically

through the LSE. Therefore, ISCC generally is not required to pay

the LSE for these securities. These debits are offset only partially

because these items may be reclaimed by the receiver, and in such

circumstance, ISCC is liable to the LSE for the full value of the

reclamation.

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The foreign exchange factor is calculated by multiplying the

adjusted gross debit value by the largest one day percentage change in

the U.S. Dollar-British Pound foreign exchange rate over a minimum of

365 days (``estimated foreign exchange volatility'').\8\ The product is

then reduced by the product of the adjusted gross debit value times the

estimated foreign exchange volatility times the market risk factor. The

reduction is made because the risk of foreign exchange is on the amount

of money converted into U.S. dollars after sale of the securities not

on the entire amount of dollars ISCC originally converted into British

pounds.

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\8\During the period from 1989 to 1992, the maximum fluctuation

in the U.S. Dollar-British Pound exchange rate was 4.445%.

Initially, this number will be used in calculating the foreign

exchange factor. ISCC will review annually the foreign exchange risk

factor.

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Previously for ISCC members on surveillance status, the market risk

factor and the foreign exchange factor of the clearing fund formula

were increased, in the discretion of ISCC, by requiring up to an

additional 3%, 5%, and 7% of average daily debits for members on

Advisory, Class A, and Class B surveillance, respectively. Under the

new formula, both the market risk factor and the foreign exchange

factor may be increased by a maximum of 3%, a maximum of 5%, and a

maximum of 7% for members on Advisory, Class A, and Class B

surveillance, respectively.

II. Discussion

The Commission believes the proposed rule change is consistent with

Section 17A of the Act and, therefore, is approving the proposal.

Specifically, the Commission believes the proposal is consistent with

Section 17A(b)(3)(F)\9\ of the Act in that it better enables ISCC to

safeguard securities and funds for which it is responsible. ISCC's

adjustments to its clearing fund formula will result in a more accurate

reflections of its risks. Instead of basing the formula on past

obligations of the ISCC member, the formula is now based on the actual

obligations of such member during the relevant time period. This should

provide ISCC increased protection when an ISCC member has unusually

heavy trading activity. In addition, the previous ISCC clearing fund

formula relied on a calculation of market risk factor and of foreign

exchange risk factor that is now outdated. ISCC's increase in the size

of these factors provides ISCC with greater protection consistent with

likely movements in securities prices and in foreign exchange rates.

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\9\15 U.S.C. 78q-1(b)(3)(F) (1988).

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On June 17, 1980, the Commission issued a release announcing the

standards to be used by the Division of Market Regulation in connection

with the registration of clearing agencies.\10\ In that release, the

Commission stated that it is appropriate for a clearing agency to

establish an appropriate level of clearing fund contributions based,

among other things, on its assessment of the risks to which it is

subject. In addition, contributions to the clearing fund should be

based on a formula that applies to users on a uniform,

nondiscriminatory basis. The Commission believes that ISCC's proposal

is consistent with these guidelines. The new clearing fund formula is

based on the risks (i.e., time, market, and foreign exchange risks)

created by the LSE's method of settlement. In addition, the formula is

applied uniformly to all ISCC members in accordance with their usage of

the LSE link.

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\10\Securities Exchange Act Release No. 16900 (June 17, 1980),

45 FR 41920.

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The Commission preliminarily finds that the proposal is consistent

with Section 17A of the Act. The Commission believes that in light of

its significance to ISCC and its members, the proposed revisions to

ISCC's clearing fund formula should be carefully monitored before they

become a permanent feature. For this reason, the Commission is

approving the proposal on a temporary basis through July 18, 1995.

The Commission finds good cause for approving the proposed rule

change prior to the thirtieth day after the date of publication of the

notice of filing. The LSE is scheduled to move to its new settlement

cycle on July 18, 1994. ISCC needs to have its new clearing fund

formula in place at the same time in order to sufficiently cover its

new risks. The Commission therefore believes that it is appropriate to

accelerate approval of the proposal.

III. Conclusion

It is therefore ordered pursuant to section 19(b)(2) of the Act

that the proposed rule change (File No. SR-ISCC-94-01) be, and hereby

is, temporarily approved through July 18, 1955.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.

Margaret H. McFarland,

Deputy Director.

[FR Doc. 94-18026 Filed 7-22-94; 8:45 am]

BILLING CODE 8010-01-M