[Federal Register Volume 84, Number 34 (Wednesday, February 20, 2019)]
[Notices]
[Pages 5137-5140]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-02733]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-85128; File No. SR-ICEEU-2018-024]
Self-Regulatory Organizations; ICE Clear Europe Limited; Order
Approving Proposed Rule Change, as Modified by Amendment No. 1,
Relating to the ICE Clear Europe Model Risk Governance Framework
February 13, 2019.
I. Introduction
On November 21, 2018, ICE Clear Europe Limited (``ICE Clear
Europe'') 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 to adopt a Model Risk Governance Framework
(``MRGF'') and related Independent Validator Selection Guidelines
(``Guidelines''). On December 21, 2018, ICE Clear Europe filed
Amendment No. 1 to the proposed rule change.\3\ The proposed rule
change, as modified by Amendment No. 1, was published for comment in
the Federal Register on December 31, 2018.\4\ The Commission did not
receive 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\ The amendment clarified Items 1(a) and 2(a) in the Form 19b-
4 but did not change any other items in Form 19b-4, any exhibits to
the filing, or the text of the proposed rule change.
\4\ Securities Exchange Act Release No. 84933 (Dec. 21, 2018),
83 FR 67810 (Dec. 31, 2018) (SR-ICEEU-2018-024) (``Notice'').
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II. Description of the Proposed Rule Change
The proposed rule change would adopt a new MRGF and related
Guidelines. The MRGF would establish overall standards and principles
for managing and mitigating model risk for all product categories that
ICE Clear Europe clears.\5\ Specifically, the MRGF would (1) establish
a definition of model and model risk; (2) establish and define criteria
for assessing the materiality and significance of models and model
changes; (3) establish procedures for oversight and validation of
models and model changes; and (4) establish related governance
structures. The MRGF would apply to models developed internally, third-
party models, and models shared with other group entities (but not to
models in research and development or that are already retired), and
would apply throughout the life cycle of all such models used by the
Clearing House. In addition, the Guidelines would establish standards
for the independence and competence of the persons that validate models
pursuant to the MRGF.
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\5\ Capitalized terms not otherwise defined herein have the
meaning given to them in the MRGF or the ICE Clear Europe rulebook.
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A. Definition of Model and Model Changes
The MRGF would define a ``model'' as a quantitative method, system
or approach that applies statistical, economic, financial or
mathematical theories, techniques and assumptions to process input data
into quantitative estimates.\6\ The MRGF would also define ``model
risk'' as the risk that a model does not perform as it was designed,
either due to error or failure in the model specification or
inappropriate use.\7\
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\6\ Notice, 84 FR at 67811.
\7\ Notice, 84 FR at 67811.
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The MRGF would assess the materiality of models based on the
potential impact the related model risk may have on ICE Clear Europe
and its clearing members. In particular, the MRGF would treat a model
as material where the output of the model is the primary factor
affecting risk management decisions relating to counterparty and
liquidity risk.\8\ The MRGF may also treat a model as material if it
has a high error potential with sizeable impact resulting from: (1)
Complexities in the data model and inputs (like complex manipulation of
input data); (2) the modelling approach (such as reliance on a large
number of assumptions); (3) the model output (such as a large number of
other models dependent on the output); or (4) model users and
operations (such as a large number of independent systems that use the
model).\9\
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\8\ Notice, 84 FR at 67811.
\9\ Notice, 84 FR at 67811, n.5.
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With respect to model changes, the MRGF would categorize changes as
significant and not significant. In determining whether a model change
is significant, the MRGF would consider the size of resulting changes
in risk requirements calculated by the model, alterations in the scope
of model use and the risk profile of products covered, and the
development of new model features.\10\
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\10\ Notice, 84 FR at 67811.
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[[Page 5138]]
B. Oversight and Validation of Models and Model Changes
The MRGF would set out a general oversight process for models
throughout their life cycle, including development of new models, model
changes, review of existing models, and model retirements. For new
models, the MRGF would require that they be subject to validation
before being approved and introduced into use.\11\ For model changes,
the MRGF would require that significant changes be validated before
being approved using the same process as for new models.\12\ The MRGF
would validate model changes that are not significant in accordance
with ICE Clear Europe's periodic re-validation pipeline, as discussed
below.\13\
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\11\ Notice, 84 FR at 67811.
\12\ Notice, 84 FR at 67811.
\13\ Notice, 84 FR at 67811.
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The MRGF would re-validate and assess the performance of models to
determine whether they continue to be fit for use. The Risk Oversight
Department (``ROD'') would establish a validation pipeline, meaning a
periodic cycle for re-validation of existing models.\14\ The ROD would
establish the frequency of re-validation based on applicable regulatory
requirements, which may be annually where required or more frequently
as needed.\15\ Similarly, the MRGF would require that performance
assessments be conducted on a periodic basis at least annually, in
accordance with applicable regulatory requirements.\16\
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\14\ Notice, 84 FR at 67811.
\15\ Notice, 84 FR at 67811.
\16\ Notice, 84 FR at 67811.
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The MRGF would make the ROD responsible for conducting the
independent validation (if done internally) at the appropriate
frequency and coordinating an external independent validation when
appropriate.\17\ The Guidelines would establish both technical
expertise and independence requirements for model validations.\18\ The
Guidelines would provide that the Clearing House may engage an external
independent model validator when (1) there are insufficient internal
resources to meet both the technical expertise and independence
requirements for the model undergoing independent validation; (2)
internal resources do not have the operational capacity to perform the
validation within the required timeframe; or (3) otherwise at the
discretion of the ROD.\19\
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\17\ Notice, 84 FR at 67811.
\18\ Notice, 84 FR at 67811.
\19\ Notice, 84 FR at 67811.
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Under the MRGF and the Guidelines, ICE Clear Europe's Model
Oversight Committee (``MOC'') would be required to review and approve
the use of external independent model validators.\20\ The ROD would
maintain a list of external validators approved by the MOC.\21\ The
Guidelines would provide that the MOC may decide, for models deemed
complex and material, to perform a competitive selection process for
external independent validators. Similarly, the ROD may, with the
consent of the MOC, split components of the independent model
validation scope across one or more external independent validators.
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\20\ Notice, 84 FR at 67812.
\21\ Notice, 84 FR at 67812.
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The MRGF would also provide a process for model retirements and
deactivations (retirement would permanently discontinue a model while
deactivation would be a temporary discontinuation).\22\ Prior to
retiring or deactivating a model, the MRGF would require an impact
assessment of the risks and consequences of such retirement or
deactivation.
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\22\ Notice, 84 FR at 67811.
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C. Governance
The MRGF would establish the roles of the MOC and ICEEU Board in
controlling overall model risk, including reviewing and approving
models and changes. Under the MRGF, the MOC would be responsible for
model risk governance at an executive level and for advising the Board
on material model risk.\23\ Under the MRGF, the MOC also would be
responsible for approving new models, model changes, retirement of
models, the periodic validation cycle, remediation actions, external
validators, and reviewing model performance assessments.\24\ The MRGF
would assign the ICE Clear Europe Board ultimate responsibility for
model risk governance, approving material new models and significant
model changes for material models, reviewing the actions of the MOC,
reviewing performance of material models outside of acceptable levels
for model risk, and reviewing impact assessments for the retirement of
material models.\25\
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\23\ Notice, 84 FR at 67811.
\24\ Notice, 84 FR at 67811.
\25\ Notice, 84 FR at 67811.
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The MRGF would further apply a three-tiered approach to the
development and validation of models and changes. Specifically, the
MRGF would: (1) Designate the owner of the models as the First Line;
(2) designate the ROD as the Second Line; and (3) designate the
Internal Audit Department as the Third Line. The First Line (owners of
the models) would be responsible for ensuring that models are properly
developed, implemented and used, establishing a model inventory,
proposing new models, proposing model changes, proposing model
retirements, conducting performance and impact assessments, and
proposing and implementing remediation actions as needed. The Second
Line (ROD) would be responsible for performing or overseeing
independent validations, reviewing and performing performance
assessments, establishing risk appetite metrics for model performance,
establishing guidelines for validations and external validators, and
reporting results of validations and assessments. The Third Line
(Internal Audit Department) would be responsible for assessing the
overall effectiveness of the MRGF and related governance policies and
assessing independent validation work.\26\
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\26\ Notice, 84 FR at 67811.
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III. 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 rules and regulations thereunder applicable to such
organization.\27\ For the reasons given below, the Commission finds
that the proposed rule change is consistent with Section 17A(b)(3)(F)
of the Act \28\ and Rules 17Ad-22(e)(2)(i) and (v), (e)(3),
(e)(4)(vii), (e)(6)(vii), and (e)(7)(vii) thereunder.\29\
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\27\ 15 U.S.C. 78s(b)(2)(C).
\28\ 15 U.S.C. 78q-1(b)(3)(F).
\29\ 17 CFR 240.17Ad-22(e)(2)(i) and (v), (e)(3), (e)(4)(vii),
(e)(6)(vii), and (e)(7)(vii).
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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 ICE Clear Europe 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 ICC or for which it is
responsible, and, in general, to protect investors and the public
interest.\30\
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\30\ 15 U.S.C. 78q-1(b)(3)(F).
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As discussed above, the proposed rule change would adopt the MRGF
and Guidelines. The MRGF would establish overall standards and
principles for managing and mitigating model risk for all product
categories that ICE Clear Europe clears. The MRGF would do so
[[Page 5139]]
by establishing processes for the oversight and validation of models
and changes to models and defining related governance responsibilities.
Finally, the Guidelines would help ensure the independence and
competence of validations by establishing standards for model
validators regarding independence and technical proficiency.
The Commission believes that these changes, taken as a whole, would
help ICE Clear Europe establish and maintain effective and functioning
models. For example, in requiring the validation of new models and
significant model changes, the Commission believes that the MRGF would
help ICE Clear Europe to identify and remediate possible errors in
models and changes thereto before such models or changes are put into
effect. Doing so may help ICE Clear Europe avoid the potential harm
that could result from models that do not function properly, such as
margin requirements that are not effective at mitigating risk.
Similarly, the Commission believes that the Guidelines, in establishing
standards for independence and technical proficiency of validators,
would help ensure that validations are completed objectively and
competently. Because biased or ineffective validations could miss
potential errors in models and model changes, the Commission believes
that the Guidelines may also help ICE Clear Europe avoid the potential
harm that could result from models that do not function properly.
Given that ICE Clear Europe uses its models, such as its margin
models, to manage and mitigate ICE Clear Europe's credit exposures to
its Clearing Members and the risks associated with clearing security
based swap-related portfolios, the Commission believes that the
proposed rule change would enhance ICE Clear Europe's ability to avoid
losses that could result from the mismanagement of such credit
exposures and risks. Because such losses could disrupt ICE Clear
Europe's ability to promptly and accurately clear security based swap
transactions, by adopting the MRGF and the Guidelines, the Commission
believes that the proposed rule change would enhance ICE Clear Europe's
ability to promote the prompt and accurate clearance and settlement of
securities transactions.
Similarly, appropriate management of ICE Clear Europe's credit
exposures to its Clearing Members and the risks associated with
clearing security based swap-related portfolios is critical to avoiding
the realization of losses on such portfolios that could threaten ICE
Clear Europe's ability to operate, thereby threatening access to
securities and funds in ICE Clear Europe's control. Because the
proposed rule change would improve the processes to review and maintain
the models that ICE Clear Europe uses to manage and mitigate such
exposures, the Commission believes that the proposed rule change would
help assure the safeguarding of securities and funds which are in the
custody or control of ICE Clear Europe or for which it is responsible.
Finally, for both of these reasons, the Commission believes the
proposed rule change is consistent with protecting 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 ICE
Clear Europe's custody and control, and, in general, protect investors
and the public interest, consistent with the Section 17A(b)(3)(F) of
the Act.\31\
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\31\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rules 17Ad-22(e)(2)(i) and (v)
Rules 17Ad-22(e)(2)(i) and (v) require that ICE Clear Europe
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for governance arrangements
that are clear and transparent and specify clear and direct lines of
responsibility.\32\
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\32\ 17 CFR 240.17Ad-22(e)(2)(i) and (v).
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As discussed above, the MRGF would define the responsibilities of
the MOC and ICEEU Board in model review and approval. For example,
under the MRGF, the MOC would be responsible for approving new models,
model changes, and retirement of models, while the Board ultimately
would be responsible for model risk governance, and approving material
new models and significant model changes for material models, among
other things. In doing so, the Commission believes that the MRGF would
clearly and transparently define who is responsible for which aspect of
oversight of the MRGF (i.e., the MOC or the Board) and specify the
responsibilities of the MOC and the Board under the MRGF.
Moreover, the proposed rule change would establish the
responsibilities of the first line model owners, ROD, and ICE Clear
Europe Internal Audit Department in performing certain functions under,
and assessing the effectiveness of, the MRGF. For example, the MRGF
would make the First Line responsible for developing models, the ROD,
as the Second Line, responsible for validating models, and the Internal
Audit Department, as the Third Line, responsible for assessing the
effectiveness of the MRGF and validations. In doing so, the Commission
believes the proposed rule change would improve the transparency of the
governance related to the MRGF by defining the relevant
responsibilities for the development and validation of models and the
review of the overall effectiveness of the MRGF. The Commission
believes these aspects of the MRGF would also clearly define the
responsibilities of the first line model owners, ROD, and ICE Clear
Europe Internal Audit Department with respect to the MRGF.
Therefore, for the above reasons the Commission finds that the
proposed rule change is consistent with Rules 17Ad-22(e)(2)(i) and
(v).\33\
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\33\ 17 CFR 240.17Ad-22(e)(2)(i) and (v).
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C. Consistency With Rule 17Ad-22(e)(3)
Rule 17Ad-22(e)(3) requires that ICE Clear Europe establish,
implement, maintain and enforce written policies and procedures
reasonably designed to maintain a sound risk management framework for
comprehensively managing legal, credit, liquidity, operational, general
business, investment, custody, and other risks that arise in or are
borne by ICE Clear Europe which includes risk management policies,
procedures, and systems designed to identify, measure, monitor, and
manage the range of risks that arise in or are borne by ICE Clear
Europe, that are subject to review on a specified periodic basis and
approved by the board of directors annually.\34\
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\34\ 17 CFR 240.17Ad-22(e)(3).
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As discussed above, the MRGF would require the review and
validation of new models, existing models, and model changes, which the
Commission believes would identify and remediate possible errors in
models and changes thereto before such models or changes are put into
effect. In this way, the Commission believes the MRGF would help reduce
model risk at ICE Clear Europe. Moreover, the Commission believes the
Guidelines would help ensure the objectivity and competence of
validations by establishing standards for model validators regarding
independence and technical proficiency. The Commission believes that
competent and objective validations would, in turn, help to reduce
model risk. Finally, the Commission believes that the governance
aspects of the MRGF discussed above would help ensure that the MRGF and
its processes are effectively reviewed and
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maintained. Thus, the Commission believes that the proposed rule change
would enable ICE Clear Europe to maintain a sound risk management
framework for comprehensively managing its model risk.
Therefore, the Commission finds that the proposed rule change is
consistent with Rule 17Ad-22(e)(3).\35\
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\35\ 17 CFR 240.17Ad-22(e)(3).
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D. Consistency With Rules 17Ad-22(e)(4)(vii), (e)(6)(vii), and
(e)(7)(vii)
Rule 17Ad-22(e)(4)(vii) requires that ICE Clear Europe establish,
implement, maintain and enforce written policies and procedures
reasonably designed to effectively identify, measure, monitor, and
manage its credit exposures to participants and those arising from its
payment, clearing, and settlement processes, including by performing a
model validation for its credit risk models not less than annually or
more frequently as may be required by its risk management
framework.\36\ Rule 17Ad-22(e)(6)(vii) requires that ICE Clear Europe
establish, implement, maintain and enforce written policies and
procedures reasonably designed to cover its credit exposures to its
participants by establishing a risk-based margin system that, among
other things, requires a model validation for its margin system and
related models to be performed not less than annually, or more
frequently as may be contemplated by its risk management framework.\37\
Rule 17Ad-22(e)(7)(vii) requires that ICE Clear Europe 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 ICE Clear Europe,
including measuring, monitoring, and managing its settlement and
funding flows on an ongoing and timely basis, and its use of intraday
liquidity by, among other things, performing a model validation of its
liquidity risk models not less than annually or more frequently as may
be contemplated by its risk management framework.\38\
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\36\ 17 CFR 240.17Ad-22(e)(4)(vii).
\37\ 17 CFR 240.17Ad-22(e)(6)(vii).
\38\ 17 CFR 240.17Ad-22(e)(7)(vii).
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As discussed above, the MRGF would specify the frequency of model
validations. Specifically, the MRGF would provide that model
validations shall comply with applicable regulatory requirements, in
particular in regards to annual validation cycles, and that model
performance assessments shall also be conducted on a periodic basis,
with cycles no greater than one year.
The Commission believes that these aspects of the MRGF would help
ensure that ICE Clear Europe complies with the aspects of Rules 17Ad-
22(e)(4)(vii), (e)(6)(vii), and (e)(7)(vii) \39\ that require annual
model validations by providing that the frequency of model validations
shall comply with applicable regulatory requirements, in particular in
regards to annual validation cycles, and that model performance
assessments shall also be conducted on cycles no greater than one year.
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\39\ 17 CFR 240.17Ad-22(e)(4)(vii), (e)(6)(vii), and
(e)(7)(vii).
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Therefore, the Commission finds that the proposed rule change is
consistent with Rules 17Ad-22(e)(4)(vii), (e)(6)(vii), and
(e)(7)(vii).\40\
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\40\ 17 CFR 240.17Ad-22(e)(4)(vii), (e)(6)(vii), and
(e)(7)(vii).
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IV. 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, with the requirements of Section 17A(b)(3)(F) of the
Act \41\ and Rules 17Ad-22(e)(2)(i) and (v), (e)(3), (e)(4)(vii),
(e)(6)(vii), and (e)(7)(vii) thereunder.\42\
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\41\ 15 U.S.C. 78q-1(b)(3)(F).
\42\ 17 CFR 240.17Ad-22(e)(2)(i) and (v), (e)(3), (e)(4)(vii),
(e)(6)(vii), and (e)(7)(vii).
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It is therefore ordered pursuant to Section 19(b)(2) of the Act
\43\ that the proposed rule change, as modified by Amendment No. 1 (SR-
ICEEU-2018-024), be, and hereby is, approved.\44\
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\43\ 15 U.S.C. 78s(b)(2).
\44\ In approving the proposed rule change, the Commission
considered the proposal's impact 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.\45\
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\45\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-02733 Filed 2-19-19; 8:45 am]
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