Self-Regulatory Organizations; Government Securities Clearing Corporation; Order Approving Proposed Rule Change Regarding Off-The- Market Transactions

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[Release No. 38847; File No. SR-GSCC-97-01]

Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Order Approving Proposed Rule Change Regarding Off-The-
Market Transactions

July 17, 1997.
    On March 11, 1997, the Government Securities Clearing Corporation 
(``GSCC'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change (File No. SR-GSCC-97-01) 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'').\1\ Notice of the proposal was published in the Federal 
Register on May 16, 1997.\2\ No comment letters were received. For the 
reasons discussed below, the Commission is approving the proposed rule 

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 38601 (May 9, 1997), 62 
FR 27089.

I. Description

    The modifications to GSCC's rules revise the loss allocation 
provisions and margining process relating to the netting and guaranteed 
settlement of transactions that have a price that differs significantly 
from the prevailing market price for the underlying security (``off-
the-market transactions''). More specifically, GSCC is defining an off-
the-market transaction as any of the following: (1) An options 
exercise; (2) a single transaction that is (i) greater than $1 million 
in par value and (ii) either one percentage point higher than the highest price or one percentage point lower than the lowest price for 
the underlying security on the day of the submission of data on the 
transaction to GSCC (with such prices being obtained by GSCC from a 
third-party source selected by GSCC for such purpose); or (3) a pattern 
of transactions submitted by two members that if looked at as a single 
transaction would constitute an off-the-market transaction.
    If a member submits data on a trade day before settlement. GSCC 
will not be able to collect margin before it has guaranteed the trade. 
Thus, if one side defaults, GSCC could be exposed to a significant loss 
if the transaction has a price significantly different from the market 
price. Pursuant to this rule change, GSCC will continue to allow off-
the-market transactions to the insolvent's counterparty.
    This rule change also amends GSCC's rules on payments of credits 
resulting from an increase in the value of a member's positions. Every 
day, GSCC collects from its members any debit and pays to its members 
any credit from the difference between the contract price of such 
member's positions at GSCC and GSCC's system price (i.e., a mark-to-
market payment). If the failed member's counterparty also defaults on 
its settlement obligations to GSCC after that member has received the 
benefit of the mark-to-market relating to an off-the-market 
transaction. GSCC is exposed to significant loss. Pursuant to the rule 
change, if the debit side has not paid the mark-to-market amount 
associated with an off-the-market transaction to GSCC on the morning of 
the business day following the submission of the trade (i.e., the debit 
side fails before it has satisfied its funds settlement obligation), 
GSCC will not pay the credit to the other side.

II. Discussion

    Section 17A(b)(3)(F) \3\ of the Act requires that the rules of a 
clearing agency assure the safeguarding of securities and funds which 
are in the custody or control of the clearing agency or for which it is 
responsible. GSCC's risk management system is designed to margin and to 
allocate loss for transactions based on the current market price. 
GSCC's margining system through the mark-to-market process reprices 
transactions every day to the current market price and thus assures 
that GSCC's loss is limited to a one day price movement. GSCC maintains 
a clearing fund designed to cover the remaining loss. Because off-the-
market transactions have a price significantly different from the 
current market price, GSCC's margining system is not designed to cover 
losses resulting from these trades.

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

    The proposal adopts loss allocation and margin rules that take into 
account off-the-market transactions. Such rules should limit the loss 
that GSCC could incur upon a member default. Without the proposal, GSCC 
could be exposed to a loss that could effect its ability to meet its 
settlement obligations to its participants. By limiting GSCC's exposure 
to these trades, the proposal is consistent with GSCC's obligation to 
safeguard securities and funds.

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act and in 
particular with 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 (File No. SR-GSCC-97-01) be and hereby is 

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\4\

    \4\ 17 CFR 200.30-3(a)(12).

Jonathan G. Katz,
[FR Doc. 97-19628 Filed 7-24-97; 8:45 am]
BILLING CODE 8010-01-M  

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