February 9, 2022
Proposed rule change SR-NSCC-2021-803 should be disapproved under Section 19(b)(2) of the Exchange Act.
Proposed rule change SR-NSCC-2021-803 fails to accurately fulfil the requirements of Title VIII of the Dodd- Frank Wall Street Reform and Consumer Protection Act Sections 806(e)(1)(C)(i), 806(e)(1)(C)(ii), and 806(e)(1)(D).
SR-NSCC-2021-803 Section I entirely omits the purpose of the proposed rule change. The exact language from Section I, is repeated under Section II(A)(1) titled purpose. Items (i), (ii), (iii), and (iv) in the referenced section are falsely represented as the purpose of the rule change. Rather, these are the privileges that will be granted to the NSCC and NSCC Members as a result of approval of the proposed rule change. The purpose of the rule change should be described as the reason(s) that the listed privileges have been proposed and the equally distributed benefit that all market participants would gain from implementation of the rule change.
Section II(A)(1)(i) paragraph 2 sentence 1 is a false statement. SFTs largely do not involve the owner of securities. The lender of the securities may have the rights from the owner of the securities to lend the securities, but the lender is not typically the owner. This introduces an additional level of risk that is omitted in entirety from SR-NSCC-2021-803. In the case that the lender has legal rights to lend the securities but does not own them, the lender takes no risk in the risk-situation that they have just facilitated, the risk-situations NSCC describes in the rule change. The lender has directly contributed to devaluing their customers asset by lending it to short sellers. The lender has no risk in their own assets being devalued in this transaction.
Section II(A)(1)(i) paragraph 2 sentence 4 SFTs are only needed to provide liquidity if Market Makers have failed to operate as required. SFTS should not be justified in the name of market liquidity. SFTs should not be used to make DELIVERY on short-sales, and thereby avoid FTDs. SFTs should be used to ENTER a short sale if the short seller does not own the security (however, this itself presents risk to the market, the only way to adequately manage that risk is to require that the short-seller actually own the security. The argument that, the short-seller is betting that the security value will decrease, so they should not need to own the security as an investment, is not a valid rebuttal, as short-selling should be exactly as that statement indicates, not what it has become which is driving the value of a security to be worthless, and unnaturally forcing massive market risk. This point is beyond the scope of this comment response). If SFTs are used to deliver short-sales, that means that the initial short-sale was already a naked-short, which violates SEC REG SHO. Before even entering the description of the proposed rule change, NSCC here has acknowledged the market corruption that the rule is attempting hide, and even further increase if implemented.
Capital Efficiency Opportunities
Section II(A)(1)(i) paragraph 3 sentence 1 NSCC believes that Basel III capital and leverage requirements enacted to protect the market, hinder NSCC Members from entering SFTs. NSCC here has highlighted the inherent risk any SFTs have on capital and leverage requirements.
Section II(A)(1)(i) paragraph 3 sentence 2 NSCC believes that the rule change will further increase the ability of NSCC Members to enter SFTs. This indicates that the rule change will make the inherent risks SFTs have on the market more available and accessible.
Section II(A)(1)(i) paragraph 4 sentence 4 NSCC indicates that the proposed netted balance sheet method helps NSCC Members to reduce the amount of regulatory capital required by regulatory capital requirements. This indicates that the rule change will increase the risk that NSCC Members exert of the overall market, by lowering the capital requirements to make lofty bets.
Section II(A)(1)(i) paragraph 5 ALL NSCC continues their profound desire to maximize the risk in financial markets by facilitating ways for their Members to dodge regulatory capital requirements. There is no reason a securities regulation should be proposed to absolve any select participants from established capital requirements that are used to mitigate risk. These participants are the ones involved in creating the greatest market risk in the first place.
Fire Sale Risk Mitigation
Section II(A)(1)(i) paragraph 10 and 11 NSCC elaborates how their Members already utilize SFTs and create great market risk. If the borrower defaults, there is a potential fire sale scenario where all owners of affected securities suffer loss. The rule change will increase the availability of SFTs to NSCC Members, even though SFTs are already a significant contributor to the underlying reason of Member defaults. This indicates that the rule change will potentially increase the level of negligent risk behavior of NSCC Members.
Section II(A)(1)(i) paragraph 12 NSCC explains that in the event of a NSCC Member default, the NSCC will only liquidate the Net positions, and not the Gross positions of the participant. The justification is that less positions will be closed, and therefore less price impact to the affected securities. NSCC indicates that NSCC Members take such negligent risks on such a high volume of securities, that action must be taken so that in the event of a default, the market impact is minimized. The rule change indicates no proposal to prevent the negligent risk of Members in the first place, such as increasing capital requirements. Instead, the rule proposes to protect the negligent NSCC Member activity by making sure that the Member does not go bankrupt in the event of default, and has a high change to recover. Meaning, the defaulting Member will re-emerge in the market to perpetuate their negligent risk behavior. The proposed rule directly stimulates increased risk behavior by minimizing the downside to the risk-taker. In the event of a Member default, the defaulter should in no case be protected from full default, and everything should be done to maintain the investments of unaffiliated parties of the defaulter. Per NSCC requirements, NSCC and remaining Members are responsible for the open portfolio positions of the defaulting Member. The only reason for a fire sale as a result of liquidation of the Members positions would be a directly from NSCCs actions to close the positions. The rule not only further facilitates NSCC Member negligence, but it also facilitates the negligence of the NSCC itself. The rule enables the NSCC to limit their own loss as a result of Member negligence, which removes responsibility and accountability from the NSCC to ensure that NSCC Members are following securities laws and not engaging in high risk behavior.
Liquidity Drain Risk Mitigation
Section II(A)(1)(i) paragraph 13 generally the paragraph does not warrant comment, it only re-describes that NSCC Members over exert their holdings and create high risk situations, which can have far reaching impact beyond the Member itself and cause market wide downturn. Section II(A)(1)(i) paragraph 13 sentence 4 if a borrower needs to re-borrow a security to deliver it to a counterparty, that means that the borrower did not own the security or have the security borrowed for the short sale. This is naked shorting and is illegal under SEC REG SHO. Illegal naked shorting activity has been referenced again in the rule proposal as normal market activity. As for the last part of the sentence, yes naked shorting should result in significant loss, and no rule should be implemented to prevent that loss the contract was entered under those conditions.
The remainder of the proposed rule change does not warrant comment as it only provides the details of the system NSCC would like to implement to further perpetuate illegal, negligent, high-risk behavior of its Members. As described up to this point, there is significant reason to disapprove this rule change. The proposal itself should be replaced with a new NSCC rule change proposal as to how NSCC will reduce the vast market risk imposed by NSCC Members, possibly considerations such as: increase capital requirements, NSCC defaulting Member portfolio unwinding procedures, NSCC obligations to make market participants whole from negligent NSCC Member actions, etc.