Material Amendments to CDS Procedures - DTC Direct Link and New York Link Services: Changes to Participant Collateral and Funding Requirements - Request for Comments

Market Regulation Document Type
Canadian Depository for Securities Limited (CDS) rule review

CDS CLEARING AND DEPOSITORY SERVICES INC. (CDS®)

MATERIAL AMENDMENTS TO CDS PROCEDURES

DTC DIRECT LINK AND NEW YORK LINK SERVICES:

CHANGES TO PARTICIPANT COLLATERAL AND FUNDING REQUIREMENTS

REQUEST FOR COMMENTS

A. DESCRIPTION OF THE PROPOSED CDS PROCEDURE AMENDMENTS

Effective November 1, 2009, CDS sponsored participants of the New York Link ("NYL") service will be required to meet expanded collateral requirements resulting from changes introduced by the National Securities Clearing Corporation ("NSCC"). Such changes will require NYL participants to pledge all risk based margin ("RBM") related collateral directly with NSCC. In the current process, all RBM related collateral posted by NYL participants is held by CDS.

Since NSCC will be holding all the RBM related collateral from NYL participants starting November 1, 2009, CDS will no longer have access to the collateral needed to protect the remaining NYL participants from the default of a single NYL participant. Therefore, CDS will require NYL participants to pledge additional collateral to CDS, with a value similar to the RBM collateral pledged directly with NSCC, effectively doubling the RBM collateral requirement for each NYL participant.

CDS will also establish a NYL participant fund ("NYL Fund") and a DTC Direct Link ("DDL") participant fund ("DDL Fund"), requiring both DDL participants and NYL participants to post collateral to support those fund requirements. The NYL Fund and the DDL Fund will be established with a total value equal to the largest debit cap allocated to any participant using the related service, currently 60 million USD for NYL participants and 40 million USD for DDL participants. Both funds will be calculated in the same manner as the "Receiver's Collateral Pool" (RCP) in CDSX and will cover the default of the single largest participant. The intent of the NYL Fund and the DDL Fund is to provide collateral to meet day to day liquidity requirements resulting from the default of a participant.

As mentioned, the changes described above will take effect November 1, 2009. It is important to note that this is a deadline imposed on CDS by DTC and cannot be changed.

B. NATURE AND PURPOSE OF THE PROPOSED CDS PROCEDURE AMENDMENTS

The proposed amendments to the New York Link Participant Procedures and to the DTC Direct Link Participant Procedures are intended to clarify the process by which NYL and DDL participants can comply with the new collateral and funding requirements.

C. IMPACT OF THE PROPOSED CDS PROCEDURE AMENDMENTS

CDS Participant Fund for DTC Direct Link (administered by CDS)

A DTC Direct Link Participant Fund ("DDL Fund") will be established with a total value equal to the largest net debit cap allocated to any participant using the service, currently USD 40 million. The fund will be calculated in the same manner as the existing Receivers' Collateral Pools in CDSX and would cover the default of the single largest participant. The intent of this fund is to provide the collateral necessary to meet the day-of-default liquidity requirement resulting from the default of a DDL participant. The amount of collateral required for the DDL Fund will be adjusted on a quarterly basis.

New York Link Participant Funds

A New York Link Participant Fund ("NYL Fund") will be established and will be made up of two components. The first component will have a total value equal to the largest net debit cap allocated to any participant using the service, currently USD 60 million. This component will be calculated in the same manner as the DDL Fund and will provide the collateral necessary to cover the DTC payment obligation of a defaulting NYL participant. The second component will be calculated to cover the vast majority of NSCC payment obligations. The amount of collateral required for this second component will be adjusted on a quarterly basis.

Impact of Changes

CDS and participants of both the NYL and DDL services will need to implement processes and procedures to meet the new collateral requirements. The impact to both CDS and its participants will be additional cost of implementing and maintaining processes and procedures. In addition participants may incur added cost for acquiring new collateral in order to meet their new collateral obligations required by NSCC and CDS.

C.1 Competition

CDS is the only provider of sponsored membership in DTC and NSCC for CDS participants.

C.2 Risks and Compliance Costs

There is a cost to participants for having to provide additional collateral to CDS. Moreover, if CDS participants are not willing to provide additional collateral to CDS, they will not be able to continue as a CDS sponsored participant in NSCC and DTC.

C.3 Comparison to International Standards -- (a) Committee on Payment and Settlement Systems of the Bank for International Settlements, (b) Technical Committee of the International Organization of Securities Commissions, and (c) the Group of Thirty

CDS's proposed amendments are consistent with IOSCO's recommendation 11 for central counterparties; that being "CCPs that establish links either cross border or domestically to clear trades should evaluate the potential sources of risks that can arise, and ensure that the risks are managed prudently on an ongoing basis. There should be a framework for cooperation and coordination between the relevant regulators and overseers".

D. DESCRIPTION OF THE PROCEDURE DRAFTING PROCESS

D.1 Development Context

The proposed amendments were prepared by CDS's staff to define and document the manner by which participants would be required to meet the new collateral requirements.

D.2 Procedure Drafting Process

CDS Procedure Amendments are reviewed and approved by CDS's Strategic Development Review Committee ("SDRC"). The SDRC determines or reviews, prioritizes and oversees CDS-related systems development and other changes proposed by participants and CDS. The SRDC's membership includes representatives from the CDS Participant community and it meets on a monthly basis.

These amendments were reviewed and approved by the SDRC on July 30, 2009

D.3 Issues Considered

Liquidity risk in the case of a participant default was the primary consideration in CDS's evaluation of the new requirements.

D.4 Consultation

CDS consulted with the Risk Advisory Committee, the Audit/Risk Committee of the Board, as well as the CDS Board of Directors and obtained their feedback. CDS also kept its regulators informed on an ongoing basis of the events surrounding these changes. In addition, CDS held meetings with all impacted participants via conference calls and via the FAS working committee sponsored by IIROC and provided them with information relative to the proposed changes.

D.5 Alternatives Considered

CDS considered a number of options including asking participants to provide twice as much the collateral RBM collateral calculated by NSCC. These were not viable as they would not have addressed the liquidity risk inherent in these services.

D.6 Implementation Plan

CDS is recognized as a clearing agency by the Ontario Securities Commission pursuant to section 21.2 of the Ontario Securities Act. The Autorité des marchés financiers has authorized CDS to carry on clearing activities in Québec pursuant to sections 169 and 170 of the Québec Securities Act. In addition CDS is deemed to be the clearing house for CDSX®, a clearing and settlement system designated by the Bank of Canada pursuant to section 4 of the Payment Clearing and Settlement Act. The Ontario Securities Commission, the Autorité des marchés financiers and the Bank of Canada will hereafter be collectively referred to as the "Recognizing Regulators".

The amendments to Participant Procedures may become effective upon approval of the amendments by the Recognizing Regulators following public notice and comment. Implementation of these changes is planned for November 1, 2009.

E. TECHNOLOGICAL SYSTEMS CHANGES

E.1 CDS

CDS will modify its "risk model" to incorporate the new collateral requirement calculations and will develop supporting reports in order to communicate collateral and funding obligations to participants.

E.2 CDS Participants

Participants will be required to amend their processes and procedures to comply with the new collateral and funding requirements.

E.3 Other Market Participants

There is no anticipated impact to other market participants.

F. COMPARISON TO OTHER CLEARING AGENCIES

No comparable or similar procedures were available for other depository or clearing agencies.

G. PUBLIC INTEREST ASSESSMENT

CDS has determined that the proposed amendments are not contrary to the public interest.

H. COMMENTS

Comments on the proposed amendments should be in writing and submitted within 30 calendar days following the date of publication of this notice in the Ontario Securities Commission Bulletin to:

Kris Sanker

Director, Product Development

CDS Clearing and Depository Services Inc.

85 Richmond Street West

Toronto, Ontario M5H 2C9

Phone: 416-365-8395

Fax: 416-365-0842

Email: [email protected]

Copies should also be provided to the Autorité des marchés financiers and the Ontario Securities Commission by forwarding a copy to each of the following individuals:

Me Anne-Marie Beaudoin

Manager, Market Regulation

Secrétaire del'Autorité

Capital Markets Branch

Autorité des marchés financiers

Ontario Securities Commission

800, square Victoria, 22e étage

Suite 1903, Box 55,

C.P. 246, tour de la Bourse

20 Queen Street West

Montréal, Québec, H4Z 1G3

Toronto, Ontario, M5H 3S8

 

Télécopieur: (514) 864-6381

Fax: 416-595-8940

Courrier électronique: [email protected]

e-mail: [email protected]

CDS will make available to the public, upon request, all comments received during the comment period.

I. PROPOSED CDS PROCEDURE AMENDMENTS

Due to table restrictions and formatting issues the text of current CDS Participant Procedures marked to reflect proposed amendments as well as text of these procedures reflecting the adoption of the proposed amendments can be accessed by clicking on the following link.

Please refer to http://www.cds.ca/cdsclearinghome.nsf/Pages/-EN-blacklined?Open to review the affected procedure amendments and the acceptable collateral table marked to reflect the proposed amendments. Once the link is accessed, please click on "Changes to the New York Link and DTC Direct Link services".