Self-Regulatory Organizations; International Securities Clearing Corporation; Notice of Filing and Order Granting Accelerated Approval on a Temporary Basis of Proposed Rule Change Relating to Modification of the Calculation of Its Clearing Fund Formula

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-35970; International Securities Release No. 828; File

No. SR-ISCC-95-03]

Self-Regulatory Organizations; International Securities Clearing

Corporation; Notice of Filing and Order Granting Accelerated Approval

on a Temporary Basis of Proposed Rule Change Relating to Modification

of the Calculation of Its Clearing Fund Formula

July 13, 1995.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''),\1\ notice is hereby given that on July 5, 1995, the

International Securities Clearing Corporation (``ISCC'') filed with the

Securities and Exchange Commission (``Commission'') the proposed rule

change (File No. SR-ISCC-95-03) as described in Items I and II below,

which items have been prepared primarily by ISCC. The Commission is

publishing this notice and order to solicit comments on the proposed

rule change from interested persons and to grant accelerated approval

of the proposed rule change through August 1, 1996.

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

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I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Changes

ISCC proposes to modify some of the factors used in the calculation

of its clearing fund formula. The modification is being made to

accommodate the five day rolling settlement cycle recently instituted

by the London Stock Exchange (``LSE'').

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Changes

In its filing with the Commission, ISCC 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 IV below. The self-regulatory organization has prepared summaries,

set forth in sections (A), (B), and (C) below, of the most significant

aspects of such statements.\2\

\2\ The Commission has modified the text of the summaries

prepared by ISCC.

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(A) Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

On June 26, 1995, the LSE moved from a ten day rolling settlement

period to a five day rolling settlement period.\3\ In response to this

change in the standard settlement cycle, ISCC is adjusting its method

of calculating its clearing fund requirements.\4\ ISCC's clearing fund

formula requires ISCC members to deposit an amount based upon the

following weekly calculation: (Gross Debit Value) x (Market Risk

Factor) + (Foreign Exchange Factor). Under the proposal, ISCC is not

modifying its clearing fund formula but is modifying the calculations

used to derive factors used in the clearing fund formula. ISCC is

modifying the calculation of the Gross Debit Value and Market Risk

Factor because the determination of these factors relies in part upon

the applicable settlement period. ISCC also is adding to its clearing

fund formula procedures a requirement that each member must deposit the

greater of (a) the largest clearing fund deposit requirement imposed

over the previous fifty-two week period or (b) the current weekly

calculated clearing fund requirement.\5\

\3\ In 1986, ISCC and the 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 delivered. ISCC has no requirement to complete open

pending trades. On July 18, 1994, the LSE moved to a ten day rolling

settlement cycle with trades settling ten days after trade date.

Previously, the LSE settled trades on a fortnightly basis with all

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

day. In response to the change to a rolling settlement cycle, ISCCA

adjusted its method of calculating its clearing fund requirements.

Securities Exchange Act Release Act Release No. 34392, International

Series Release No. 687 (July 15, 1994), 50 FE 37798.

\4\ When ISCC amended its clearing fund formula rule last year

to accommodate the change from a fortnightly system to a ten day

rolling settlement system, the rule filing was approved on a

temporary basis until July 18, 1995. Securities Exchange Act Release

No. 34392, International Series Release No. 687 (July 15, 1995), 59

FR 37798. ISCC cannot request an extension of the approval because

the current formula is not appropriate for a five day settling

system. ISCC therefore is seeking approval of the proposed change on

an expedited basis.

\5\ Members will continue to be required to contribute a minimum

of $50,000 to the clearing fund.

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The Gross Debit Value currently is the largest single daily gross

debit value, based on debit values for the calendar week following the

week in which the calculation is performed,\6\ less 15% of the

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

day.\7\ Under a five day settlement standard, it is no longer feasible

for ISCC to calculate the required deposit using the existing formula

because at the time of the calculation ISCC only will know of the

trades settling on one day of the following week.\8\ Accordingly, ISCC

will now base the Gross Debit Value on the largest single daily gross

debit value, based on debit values for five consecutive business days

including the day on which the calculation is performed, less 15% of

the INS receive value for that day.

\6\ Currently, ISCC calculates the Gross Debit Value each

Tuesday.

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

members to institutional participants can occur automatically

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

the LSE for these securities. The debits arising from these

redeliveries may be offset only partially because these securities

may be reclaimed (i.e., returned) by the receiver, and in such

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

reclamation.

\8\ ISCC calculates and collects the required deposit on a

weekly basis. If ISCC calculates a member's clearing fund

requirement on Tuesday, August 2, only the settlements for trades

conducted on Monday, August 1, and settling on Monday, August 8,

will be available for consideration. An ISCC member has three

business days after notice of an increase in its clearing fund

contribution to pay such increase. Under the prior ten day rolling

settlement system, the clearing fund formula was based on the actual

largest daily obligation of a member during the relevant time

period, and the clearing fund deposit could be calculated and

collected prior to the settlement day. However, under the five day

rolling settlement cycle, because an ISCC member has three business

days after the calculation to make additional deposits, ISCC will be

calculating and collecting clearing fund contributions generally

based on the prior week's trades which already have settled.

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The five day settlement standard also requires modification to the

Market Risk Factor component of the formula. The formula currently uses

a Market Risk Factor based on the largest calculated percentage change

in the Financial Times Index over an eleven day period over a minimum

of 365 days. This calculation was based on the premise that there could

be eleven days from the day a member executed a trade until ISCC

liquidated the position.\9\ Applying the same reasoning to the five day

settlement environment, the Market

[[Page 37699]]

Risk Factor is being amended to reflect that it will be based on the

largest percentage change in the Financial Times Index over a six day

period over a minimum of 365 days. Initially, the Market Risk Factor

will continue to be set at 7%.

\9\ ISCC bases its clearing fund calculations on the assumption

that it will take one day to sell all of a defaulting participant's

positions. Under a ten day settlement period, this resulted 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 is a one day exposure for foreign

exchange risk because ISCC converts U.S. dollars to British pounds

on the settlement date and converts the proceeds from the sale of

the positions to U.S. dollars the following day.

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No change is required to be made to the formula used to derive the

Foreign Exchange Factor. This factor is based in part on the Estimated

Foreign Exchange Volatility, an amount that is equal to the largest one

day percentage change in the U.S. dollar/British pound foreign exchange

rate over a minimum of 365 days and that is unaffected by the change in

the standard settlement period.\10\ The Estimated Foreign Exchange

Volatility will continue to be set at 4%.\11\

\10\ The Foreign Exchange Factor is the product of the Gross

Debit Value and the Estimated Foreign Exchange Volatility less the

product of the Gross Debit Value times the Market Risk Factor times

the Estimated Foreign Exchange Volatility.

\11\ During the period from 1989 to 1992, the maximum

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

4.445%. ISCC will continue to review annually the foreign exchange

risk factor.

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ISCC believes that the proposed rule change is consistent with the

requirements of Section 17A of the Act and the rules and regulations

thereunder because the rule proposal will facilitate ISCC's ability to

safeguard securities and funds in its custody or control.

(B) Self-Regulatory Organization's Statement on Burden on Competition

ISCC does not believe that the proposed rule changes will have an

impact on or impose a burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the

Proposed Rule Change Received from Members, Participants, or Others

ISCC will notify the Commission of any written comments it

receives.

III. Date of Effectiveness of the Proposed Rule Change and Timing for

Commission Action

Section 17A(b)(3)(F) \12\ of the Act requires that the rules of a

clearing agency be designed to assure the safeguarding of securities

and funds which are in the custody or control of the clearing agency or

for which it is responsible. The Commission believes that ISCC's

proposal to amend certain factors used in its clearing fund formula

should enhance the safeguarding of securities and funds which are in

the custody or control of ISCC or for which it is responsible because

the modifications will result in a more feasible means of determining

ISCC's risks under the shorter standard settlement cycle. Because of

the effect of a five day settlement cycle on the calculation of the

clearing fund requirements, the proposal will enable ISCC to require

members to deposit the greater of (a) the current calculation amount or

(b) the largest calculation amount over the prior fifty-two weeks.

Collection of the larger amount for deposit to the clearing fund should

provide additional protection to compensate for the change in the

calculations of the Gross Debit Value and Market Risk Factor which

generally will be based upon previously settled trades rather than

outstanding obligations.

\12\ 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.\13\ 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.\14\ The clearing fund formula

continues to be based upon the risk factors created by LSE's method of

settlement (i.e., time, market, and foreign exchange risks).

Furthermore, ISCC's proposed changes do not alter the uniform

application of the clearing fund formula to all ISCC members in

accordance with their usage of the LSE link established by the linkage

agreement between ISCC and LSE.\15\

\13\ Securities Exchange Act Release No. 16900 (June 17, 1980),

45 FR 41920.

\14\ ISCC has agreed that prior to the expiration of this order

it will report to the Commission the average level of clearing fund

deposits for each participant under the ten day settlement cycle and

the five day settlement cycle. In addition, ISCC has agreed to

report to the Commission how frequently it required each participant

to deposit the largest clearing fund deposit over the prior fifty-

two weeks rather than the current calculation amount.

\15\ The linkage agreement between ISCC and LSE, dated December

22, 1988, allows ISCC to obtain comparison and settlement services

in the United Kingdom from the LSE on behalf of ISCC members.

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ISCC has requested that the Commission find good cause for

approving the proposed rule change prior to the thirtieth day after the

date of publication of notice of the filing. The Commission finds good

cause for so approving the proposed rule change because (i) approval of

the current clearing fund formula will expire on July 18, 1995, (ii)

the LSE already has implemented the five day rolling settlement system,

and (iii) application of an amended clearing fund formula is critical

to the clearance and settlement of transactions under the shorter T+5

settlement time frame.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and

arguments concerning the foregoing. Persons making written submission

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, N.W., Washington D.C. 20549.

Copies of the submissions, all subsequent amendments, all written

statements with respect to the proposed rule change that are filed with

the Commission, and all written communications relating to the proposed

rule change between the Commission and any person, other than those

that may be withheld from the public in accordance with the provisions

of 5 U.S.C. 552, will be available for inspection and copying in the

Commission's Public Reference Section, 450 5th Street, N.W.,

Washington, D.C. 20549. Copies of such filings will also be available

for inspection and copying at the principal office of ISCC. All

submissions should refer to the file number SR-ISCC-95-03 and should be

submitted by August 11, 1995.

It Is Therefore Ordered, pursuant to section 19(b)(2) of the Act,

that the proposed rule change (File No. SR-ISCC-95-03) be, and hereby

is, temporarily approved through August 1, 1996.

For the Commission by the Division of Market Regulation,

pursuant to delegated authority.\16\

\16\ 17 CFR 200.30-3(a)(12) (1994).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 95-17940 Filed 7-20-95; 8:45 am]

BILLING CODE 8010-01-M