[Federal Register Volume 83, Number 146 (Monday, July 30, 2018)]
[Notices]
[Pages 36635-36638]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-16168]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83691; File No. SR-LCH SA-2018-003]


Self-Regulatory Organizations; LCH SA; Order Approving Proposed 
Rule Change Relating to Liquidity Risk Management

July 24, 2018.

I. Introduction

    On June 4, 2018, Banque Centrale de Compensation, which conducts 
business under the name LCH SA (``LCH SA''), filed with the Securities 
and Exchange Commission (``Commission''), pursuant to Section 19(b)(1) 
of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change (the ``Proposed Rule Change'') to 
amend its Risk Management Procedures (the ``Procedures'') to adopt a 
Liquidity Risk Modelling Framework (the ``Framework''). The proposed 
rule change was published for comment in the Federal Register on June 
22, 2018.\3\ The Commission has not received any comments on the 
proposed rule change. For the reasons discussed below, the Commission 
is approving the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 34-83456 (June 18, 
2018), 83 FR 29146 (June 22, 2018) (SR-LCH-2018-003) (``Notice'').
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II. Description of the Proposed Rule Change

    The Framework \4\ describes the Liquidity Stress Testing framework 
by which the Collateral and Liquidity Risk Management department 
(``CaLRM'') of LCH Group Holdings Limited (``LCH Group'') assures that 
LCH SA has enough cash available to meet any financial obligations, 
both expected and unexpected, that may arise over the liquidation 
period for each of the clearing services that LCH SA offers.\5\ The 
Framework compliments other policies and procedures LCH uses to

[[Page 36636]]

manage its liquidity risk, i.e., the risk that LCH SA will not have 
enough cash available, in extreme but plausible circumstances, to 
settle margin payments or delivery obligations when they become due, in 
particular upon the default of a clearing member.\6\ Such policies and 
procedures include, among others: (i) The Group Liquidity Risk Policy; 
(ii) the Group Liquidity Plan; (iii) the Group Financial Resource 
Adequacy Plan; (iv) the Group Collateral Risk Policy; (v) the Group 
Investment Risk Policy; and (vi) the LCH SA Collateral Control 
Framework.\7\ The Framework complements these existing policies and 
procedures and develops further the Group Liquidity Risk Policy.\8\
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    \4\ Capitalized terms used herein but not otherwise defined have 
the meaning set forth in the Framework and LCH SA rulebook, which is 
available at https://www.lch.com/system/files/media_root/CDSClear_Rule_Book_04.01.2018.pdf.
    \5\ Notice, 83 FR at 29146.
    LCH SA, a wholly owned subsidiary of LCH Group, manages its 
liquidity risk pursuant to, among other policies and procedures, the 
Group Liquidity Risk Policy and the Group Liquidity Plan applicable 
to each entity within LCH Group.
     In addition to its CDSClear service, LCH SA provides clearing 
services in connection with cash equities and derivatives listed for 
trading on Euronext (EquityClear), commodity derivatives listed for 
trading on Euronext (CommodityClear), and tri-party Repo 
transactions (RepoClear).
    \6\ Notice, 83 FR 29146-29147.
    \7\ Notice, 83 FR 29147.
    \8\ Id.
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    The Framework: (i) Identifies LCH SA's sources of liquidity and 
corresponding liquidity risks; (ii) identifies LCH SA's liquidity 
requirements with respect to its members and its interoperable central 
counterparty (``CCP''), Cassa di Compensazione e Garanzia (``CC&G''); 
\9\ (iii) describes the metrics and limits that LCH SA monitors 
regarding liquidity risk; and (iv) describes the scenarios under which 
these metrics are computed.\10\
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    \9\ LCH SA has an interoperability agreement with CC&G, an 
Italian CCP, pursuant to which LCH SA's clearing members and CC&G's 
clearing members are able to benefit from common clearing services 
without having to join the other CCP. Each CCP is a clearing member 
of the other one with a particular status when accessing the 
clearing system of the other counterparty.
    \10\ Notice, 83 FR 29147.
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    The proposed Framework identifies the main sources of liquidity 
available to LCH SA, including cash and non-cash collateral, and 
assigns non-cash collateral to one of three tiers.\11\ Tier 1 assets 
are limited to those securities that are deemed to be of sufficient 
quality and demand to generate liquidity at little or no loss in the 
event of a default of a clearing member or a major market stress.\12\ 
LCH SA is able to pledge these securities to the Banque de France to 
generate cash on the same day.\13\ Only Tier 1 assets are included as 
liquidity resources in liquidity stress testing.\14\ Tier 2 assets are 
those securities that have a market and may be financed but are of 
lesser quality than Tier 1 assets.\15\ Tier 3 assets are deemed to have 
little or no liquidity value in the event of a default or major market 
stress or are deemed to be too illiquid to be converted in the 
timeframe that a CCP would require.\16\
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    \11\ Id. Securities comprising non-cash collateral are comprised 
of the following components: (i) Margin collateral, i.e., non-cash 
collateral pledged by clearing members for margin cover; (ii) 
Collateral and Liquidity Management (``CaLM'') collateral, i.e., 
direct securities holdings that are part of the CaLRM's investment 
activities; and (iii) clearing settlement collateral, i.e., 
collateral resulting from the physical settlement of contracts on 
behalf of a defaulting clearing member.
    \12\ Notice, 83 FR 29147.
    \13\ Id.
    \14\ Id.
    \15\ Notice, 83 FR 29147, n.6.
    \16\ Notice, 83 FR 29147, n.6.
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    The Framework highlights the three principal categories under which 
LCH SA would require liquidity: (i) The default of one or more clearing 
members; (ii) the default of CC&G and (iii) operational liquidity 
needs.\17\
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    \17\ Notice, 83 FR 29147.
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    Liquidity needs arising from clearing members' defaults are those 
needs arising from fulfilment of the settlement of the securities of 
the defaulted clearing member(s); posting of variation margin to non-
defaulting members on the positions held by the defaulted clearing 
member(s); the value of bonds pledged at the Banque de France; haircuts 
by the European Central Bank on securities posted by the defaulting 
Clearing Member; and investment losses.\18\
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    \18\ Id.
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    Liquidity needs arising from the default of CC&G are those needs 
arising from the service closure of the Italian clearing activity, 
including reimbursement of the margins and default funds related to the 
Italian clearing activity and cash settlement of the Italian repo 
positions.\19\
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    \19\ Id.
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    Operational liquidity needs relate to the operational management of 
LCH SA in a stressed environment that does not lead to a member's 
default. Such a liquidity requirement may arise from a number of 
factors, including the need to repay excess cash posted by members, the 
need to repay margin when margin requirements are reduced, and the 
substitution of cash collateral and European Central Bank eligible 
securities.\20\
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    \20\ Notice, 83 FR 29147.
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    The proposed Framework describes the metrics used to determine LCH 
SA's liquidity needs, which are calculated each day over a five-day 
period. These metrics include: (i) The liquidity coverage ratio; (ii) a 
monthly rolling average liquidity buffer; (iii) a daily minimum 
liquidity buffer; and (iv) required cash collateral.\21\ Moreover, the 
Framework describes how the liquidity coverage ratio, monthly rolling 
average liquidity buffer, and daily minimum liquidity buffer are 
reported to LCH SA senior management daily.
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    \21\ Id.
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    With respect to the liquidity coverage ratio, the Framework 
explains how the liquidity coverage ratio is determined for each of the 
clearing services that LCH SA offers in a Cover 2 scenario, i.e., the 
liquidity risk arising from the default of at least two clearing group 
members to which LCH SA has the largest exposures during the 5 days 
following default.\22\ The Cover 2 amount is computed by aggregating 
the liquidity risks related to clearing members within the same group 
across all of LCH SA's services.\23\ The two largest group members are 
chosen according to the liquidity needs related to these members.\24\ 
These liquidity requirements are generated by settlement risk, market 
risk, and ECB haircuts.\25\ For the CDSClear service, LCH SA determines 
the liquidity risk by considering variation margin modelled at member 
level by applying the most punitive CDS spread widening stress scenario 
for both ITraxx Main and CrossOver (currently the historical scenario 
considering the 2007 crisis).\26\ The liquidity coverage ratio also 
considers the provision of liquidity to facilitate settlement including 
fails, such as delays in posting securities by members. The Framework 
focuses on the principal risks for which LCH SA must assure that it has 
sufficient liquidity.\27\
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    \22\ Id.
    \23\ Id.
    \24\ Id.
    \25\ Notice, 83 FR 29147.
    \26\ Id.
    \27\ Id.
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    Finally, the Framework describes the reverse stress test that LCH 
SA runs at least quarterly. The reverse stress test is designed to help 
determine the limits of LCH SA's liquidity models and of the Framework 
by modelling extreme market conditions that go beyond what are 
considered plausible market conditions over a 5-day time horizon.\28\ 
The Framework stresses seven risk factors independently, and also 
considers these risk factors together in two combined reverse stress 
test scenarios, the Behavioural and Macro-economic.\29\
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    \28\ Id.
    \29\ Id.
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III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and the

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rules and regulations thereunder applicable to such organization.\30\ 
For the reasons given below, the Commission finds that the proposed 
rule change is consistent with Section 17A(b)(3)(F) of the Act \31\ and 
Rules 17Ad-22(e)(7)(i) and (vi) thereunder.\32\
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    \30\ 15 U.S.C. 78s(b)(2)(C).
    \31\ 15 U.S.C. 78q-1(b)(3)(F).
    \32\ 17 CFR 240.17Ad-22(e)(7)(i), (vi).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of LCH SA be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and, to the extent 
applicable, derivative agreements, contracts, and transactions, as well 
as to assure the safeguarding of securities and funds which are in the 
custody or control of LCH SA or for which it is responsible, and, in 
general, to protect investors and the public interest.\33\
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    \33\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Framework would assess the sources of LCH SA's liquidity needs, 
including the liquidity needs arising from the default of one or more 
clearing members and liquidity needs arising from LCH SA operating in a 
stressed environment that does not lead to a member's default. The 
Framework would also identify the sources of liquidity that LCH SA may 
use to satisfy those needs, describe the metrics LCH SA would use to 
quantify those liquidity needs, and the tests and reports LCH SA would 
use to confirm that its sources of liquidity can satisfy those 
liquidity needs.
    The Commission believes that by setting out in advance the 
liquidity needs of LCH SA in stressed market conditions, including 
member defaults and stressed environments not leading to member 
defaults and identifying sources of liquidity to meet those needs, the 
Framework would increase the likelihood that LCH SA would have the 
liquid resources necessary to continue operations in such stressed 
market conditions. Specifically, the Commission believes that by 
enabling LCH SA to quantify its liquidity needs and confirm that its 
sources of liquidity can satisfy those liquidity needs, the Framework 
would allow LCH SA to determine whether it has sufficient resources to 
meet all of its current and future liquidity needs. The Commission 
believes that this would, in turn, enhance LCH SA's ability to avoid 
any potential disruptions to its operations caused by unmet liquidity 
needs, especially in stressed market conditions, including member 
defaults and stressed environments not leading to member defaults.
    The Commission therefore believes that the Framework would increase 
the likelihood that LCH SA can continue to provide clearing services 
without disruption in times of member default or other stressed market 
conditions not leading to member default. The Commission finds that 
this, in turn, would promote the prompt and accurate clearance and 
settlement of securities transactions by reducing the likelihood of a 
disruption to LCH SA's operations arising from a liquidity need. 
Similarly, the Commission believes the Framework would help assure the 
safeguarding of securities and funds which are in the custody or 
control of LCH SA or for which it is responsible by increasing the 
likelihood that LCH SA can avoid disruptions to its operations which 
could impede access to such securities and funds. For both of these 
reasons, the Commission also believes that the Framework would, in 
general, protect investors and the public interest.
    Therefore, the Commission finds that the proposed rule change would 
promote the prompt and accurate clearance and settlement of securities 
transactions, assure the safeguarding of securities and funds in LCH 
SA's custody and control, and, in general, protect investors and the 
public interest, consistent with the Section 17A(b)(3)(F) of the 
Act.\34\
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    \34\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(7)(i) of the Act

    Rule 17Ad-22(e)(7)(i) requires that LCH SA establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to effectively measure, monitor, and manage the liquidity risk 
that arises in or is borne by LCH SA, including measuring, monitoring, 
and managing its settlement and funding flows on an ongoing and timely 
basis, and its use of intraday liquidity by maintaining sufficient 
liquid resources at the minimum in all relevant currencies to effect 
same-day and, where appropriate, intraday and multiday settlement of 
payment obligations with a high degree of confidence under a wide range 
of foreseeable stress scenarios that includes, but is not limited to, 
the default of the participant family that would generate the largest 
aggregate payment obligation for LCH SA in extreme but plausible market 
conditions.\35\
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    \35\ 17 CFR 240.17Ad-22(e)(7)(i).
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    As discussed above, the Framework would assess the sources of LCH 
SA's liquidity needs, including the liquidity needs arising from the 
default of one or more clearing members and liquidity needs arising 
from LCH SA operating in a stressed environment that does not lead to a 
member's default. The Framework would also identify the sources of 
liquidity that LCH SA would use to satisfy those needs, describe the 
metrics LCH SA would use to quantify its liquidity needs, and the tests 
and reports LCH SA would use to confirm that its sources of liquidity 
can satisfy those liquidity needs. These metrics would include: (i) The 
liquidity coverage ratio; (ii) a monthly rolling average liquidity 
buffer; (iii) a daily minimum liquidity buffer; and (iv) required cash 
collateral. With respect to the liquidity coverage ratio, the Framework 
would explain how the liquidity coverage ratio is determined for each 
of the clearing services that LCH SA offers in a Cover 2 scenario, 
i.e., the liquidity risk arising from the default of at least two 
clearing group members to which LCH SA has the largest exposures during 
the 5 days following default. Finally, the Framework would describe how 
these metrics are calculated for each day over a maximum 5 day 
liquidity period and how the liquidity coverage ratio, monthly rolling 
average liquidity buffer, and daily minimum liquidity buffer would be 
reported to LCH SA senior management daily.
    The Commission believes that the metrics provided by the Framework 
would enhance LCH SA's ability to measure, monitor, and manage the 
liquidity risk that arises in or is borne by LCH SA. The Commission 
believes that, for example, by reviewing its liquidity coverage ratio, 
monthly rolling average liquidity buffer, and daily minimum liquidity 
buffer on a daily basis, LCH SA would be able to anticipate future 
liquidity needs and potential shortfalls. Moreover, because the 
liquidity coverage ratio considers the provision of liquidity to 
facilitate settlement, including fails as delays in posting securities 
by members, the Commission believes that review of the ratio would 
improve LCH SA's ability to manage the liquidity needs arising from the 
settlement of transactions. The Commission therefore believes that the 
Framework would facilitate LCH SA's ability to measure, monitor, and 
manage the liquidity risk that arises in or is borne by LCH SA, 
including measuring, monitoring, and managing its settlement and 
funding flows on an ongoing and

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timely basis, and its use of intraday liquidity.
    Moreover, by using the liquidity ratio to determine in advance the 
liquidity needs of LCH SA arising from the default of at least two 
clearing group members to which LCH SA has the largest exposures during 
the 5 days following default, the Commission believes the Framework 
would enhance LCH SA's ability to determine whether it has sufficient 
resources to meet its liquidity needs should such a default occur. The 
Commission believes that this would, in turn, enable LCH SA to avoid 
any potential disruptions to its operations caused by such liquidity 
needs arising from such a default. The Commission therefore believes 
that the Framework would enable LCH SA to maintain sufficient liquid 
resources to effect settlement of its payment obligations under a wide 
range of foreseeable stress scenarios, including the default of the 
participant family that would generate the largest aggregate payment 
obligation for LCH SA in extreme but plausible market conditions.
    Therefore, for the above reasons the Commission finds that the 
proposed rule change is consistent with Rule 17Ad-22(e)(7)(i).\36\
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    \36\ 17 CFR 240.17Ad-22(e)(7)(i).
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C. Consistency With Rule 17Ad-22(e)(7)(vi) of the Act

    Rule 17Ad-22(e)(7)(vi) requires that LCH SA establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to effectively measure, monitor, and manage the liquidity risk 
that arises in or is borne by LCH SA, including measuring, monitoring, 
and managing its settlement and funding flows on an ongoing and timely 
basis, and its use of intraday liquidity by determining the amount and 
regularly testing the sufficiency of the liquid resources held for 
purposes of meeting the minimum liquid resource requirement under Rule 
17Ad-22(e)(7)(i) \37\ by, among other things, conducting stress testing 
of its liquidity resources at least once each day using standard and 
predetermined parameters and assumptions.\38\
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    \37\ 17 CFR 240.17Ad-22(e)(7)(i).
    \38\ 17 CFR 240.17Ad-22(e)(7)(vi).
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    As discussed above, the Framework would describe the metrics LCH SA 
would use to quantify its liquidity needs, and the tests and reports 
LCH SA would use to confirm that its sources of liquidity can satisfy 
those liquidity needs. These metrics would include: (i) The liquidity 
coverage ratio; (ii) a monthly rolling average liquidity buffer; (iii) 
a daily minimum liquidity buffer; and (iv) required cash collateral. 
The Framework would describe how these metrics would be calculated for 
each day over a maximum of a 5 day liquidity period and how the 
liquidity coverage ratio, monthly rolling average liquidity buffer, and 
daily minimum liquidity buffer would be reported to LCH SA senior 
management daily.
    The Commission believes that the metrics provided by the Framework 
would help LCH SA determine the amount and regularly test the 
sufficiency of LCH SA's liquid resources. The Commission believes that 
the liquidity coverage ratio, for example, would provide LCH SA senior 
management a view to LCH SA's liquidity needs in stressed conditions 
arising from a default of at least two clearing group members to which 
LCH SA has the largest exposures. As discussed above, the Framework 
would require the calculation and reporting of the liquidity coverage 
ratio daily. The Commission believes the other metrics described above 
would similarly test, and provide LCH SA senior management insight 
regarding, the sufficiency of LCH SA's liquid resources.
    For the above reasons, the Commission therefore finds that the 
proposed rule change is consistent with Rule 17Ad-22(e)(7)(vi).\39\
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    \39\ 17 CFR 240.17Ad-22(e)(7)(vi).
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III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act, 
and in particular, Section 17A(b)(3)(F) of the Act \40\ and Rules 17Ad-
22(e)(7)(i) and (vi) thereunder.\41\
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    \40\ 15 U.S.C. 78q-1(b)(3)(F).
    \41\ 17 CFR 240.17Ad-22(e)(7)(i), (vi).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
that the proposed rule change (SR-LCH SA-2018-003) be, and hereby is, 
approved.\42\
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    \42\ In approving the proposed rule change, the Commission 
considered the proposal's impacts on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\43\
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    \43\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-16168 Filed 7-27-18; 8:45 am]
 BILLING CODE 8011-01-P