Hey Ms. Countryman,
I hope this message finds you well! I’m writing as a retail investor to share some thoughts and request a change regarding the SEC's rules. I’d love to see some updates to NSCC Rules 18 and 22 to help us all feel more confident about the settlement of guaranteed transactions. My goal is to make sure we have clearer guidelines and to help strengthen the role of clearing agencies like the NSCC as central counterparties. This, in turn, would support the stability of our financial markets and encourage better risk management practices.
According to the SEC’s guidelines for rulemaking petitions, anyone can ask the Commission to change or repeal a rule, and I’m following those guidelines here. My petition includes the substance of the proposed changes and outlines why I believe this is important.
I’ve noticed that the NSCC's rules don’t have clear procedures for closing out positions if a member defaults. As stated in NSCC’s Disclosure Framework, when a member defaults, the NSCC has to complete the settlement for guaranteed transactions on their behalf. But NSCC Rule 18 mentions that if closing out a position might disrupt the market, it’s up to the NSCC to decide whether to proceed.
This kind of discretion raises some concerns among retail investors like me. We worry that this could lead to market distortions and manipulation based solely on the NSCC’s internal judgment. Here are a few questions that come to mind:
Looking at NSCC Rule 18, it seems like the problem starts when a member builds up a position that could cause market chaos if they need to close it out. Members with risky positions might end up being “Too Big To Fail,” as their failure could create significant systemic risks.
As a member’s risk of default rises, they might feel pressured to increase their risky positions, knowing they could rely on a bailout later. If they default, CCPs like the NSCC end up covering the associated risks and costs, which puts a strain on our financial system.
Misaligned incentives are at play here. Members might choose to build up risky positions that could disrupt the market, especially if they’re reaping short-term profits. For instance, a naked short position can inflate the supply of a security without being closed out, creating a hidden market distortion.
CCPs, worried about maintaining stability, might hesitate to close out these problematic positions, leading to further distortions. When guaranteed transactions pile up, it can overwhelm a CCP’s risk management capabilities.
It’s clear that members creating these risky positions bear some responsibility. For example, those with naked short positions face significant losses if things go south. The problem arises when these losses get transferred to a CCP, essentially socializing the risks while some members privatize their profits.
To fix this misalignment, we need to ensure that members are held accountable for the costs of closing out their risky positions. This might involve changes to how we allocate costs during a default. We should prioritize accountability by potentially clawing back compensation from executives of defaulting members to cover closing costs.
It’s essential that CCPs have clear procedures for handling guaranteed transactions and closing out positions. This would eliminate bias and ensure fairness for all market participants. If executives know they’re responsible for the costs of their risky decisions, it will encourage better risk management.
I propose that we modify NSCC Rules 4, 18, and 22 to address these concerns by:
Here’s a quick look at my proposed changes for NSCC Rule 4:
NSCC Rule 4 Proposed Change
Each Member shall be obligated to the Corporation for any losses incurred due to a Defaulting Member Event. If a Member can’t cover those losses, all executives (past or present) should be responsible for up to their last 5 years of compensation.
NSCC Rule 18 Proposed Change
The closing out process for any position should be prompt and straightforward, even if it might cause market disruption.
Thank you for considering my petition! I’m hopeful that with some updates to these rules, we can create a fairer and more stable financial environment for everyone involved.
Best,
A Concerned Retail Investor