[Federal Register Volume 84, Number 57 (Monday, March 25, 2019)]
[Notices]
[Pages 11146-11148]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-05572]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-85357; File No. SR-ICC-2019-001]
Self-Regulatory Organizations; ICE Clear Credit LLC; Order
Approving Proposed Rule Change Relating to the ICE CDS Clearing: Back-
Testing Framework
March 19, 2019.
I. Introduction
On January 28, 2019, ICE Clear Credit LLC (``ICC'') 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 (SR-ICC-2019-001)
to update and formalize the ICE CDS Clearing: Back-Testing Framework
(``Back-Testing Framework'').\3\ The proposed rule change was published
in the Federal Register on February 8, 2019.\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\ Capitalized terms used herein but not otherwise defined have
the meaning set forth in the ICC Rules or the Back-Testing
Framework. Available at https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Rules.pdf.
\4\ Securities Exchange Act Release No. 34-85047 (Feb. 4, 2019),
84 FR 2938 (Feb. 8, 2019) (SR-ICC-2019-001) (``Notice'').
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II. Description of the Proposed Rule Change
The proposed rule change would update and formalize the Back-
Testing Framework. The Back-Testing Framework would describe ICC's
back-testing process, reporting of back-testing results, and procedures
for remediating poor back-testing results.
A. Back-Testing Process
Generally, ICC's back-testing process would count the number of
occurrences, also referred to as exceedances, when the observed loss
for a Clearing Participant's (``CP'') portfolio over a given time
horizon is greater than the risk measure projected by ICC's Risk
Management Model (the ``Model'').\5\ ICC would then evaluate the total
number of exceedances against the number of exceedances acceptable at
the 99.5% risk quantile.\6\ Under the Framework, the ICC Risk
Management Department (``ICC Risk'') would perform daily, weekly,
monthly, and quarterly portfolio-level back-testing analyses.\7\
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\5\ Notice, 84 FR at 2938.
\6\ Notice, 84 FR at 2939.
\7\ Notice, 84 FR at 2938.
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The Back-Testing Framework would calculate the observed loss for a
CP's portfolio as the worst unrealized profit/loss (``P/L'') over the
Margin Period of Risk (``MPOR''), using the changes in net asset values
(``NAVs'').\8\ The Back-Testing Framework would use the greatest MPOR
for all of the instruments in the considered portfolio, rounded up to
the nearest integer.\9\ For example, if an instrument is subject to
5.5-day MPOR estimations and no other instrument in the portfolio has a
longer MPOR, then ICC would perform the back-testing analysis by
comparing the N-day worst unrealized P/L against the model projected
risk measure with N=6.\10\
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\8\ Id.
\9\ Id.
\10\ Id.
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The Back-Testing Framework would define the model projected risk
measure as the sum of the following selected initial margin components:
Integrated spread response, basis risk, and interest rate sensitivity
(collectively, the ``Back-Tested Components'').\11\ The Back-Testing
Framework would not test the other components of initial margin (Jump-
To-Default, Wrong-Way-Risk, Concentration Charge, and Liquidity Charge)
because those components are not always market observed and
statistically modeled.\12\
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\11\ Notice, 84 FR at 2938.
\12\ Notice, 84 FR at 2939.
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For multi-currency portfolios, the Back-Testing Framework would
require that the back-testing analysis be performed in the
clearinghouse base currency (U.S. Dollar) and would account for the
foreign exchange risk exposure.\13\
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\13\ Notice, 84 FR at 2938.
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Under the Back-Testing Framework, ICC would utilize the Basel
Traffic Light System (``BTLS'') to assess the soundness of the
Model.\14\ The BTLS would be based on three zones: Green, yellow, and
red, with each zone defined by the maximum number of acceptable
exceedances.\15\ Under the Back-Testing Framework, ICC would consider
the model well calibrated if the number of exceedances across all CP-
related portfolios is consistent with the 99.5% risk quantile.\16\
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\14\ Id.
\15\ Id.
\16\ Id.
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In addition to analyzing all CP-related portfolios, the Back-
Testing Framework would also analyze a range of hypothetical
portfolios. The Back-Testing Framework would refer to these portfolios
as special strategy portfolios.\17\ ICC would use the back-testing
results for the special strategy portfolios to identify and assess
potential weaknesses in the Model's assumptions.\18\
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\17\ Notice, 84 FR at 2939.
\18\ Id.
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Finally, in addition to assessing the Model's performance by back-
testing, the Back-Testing Framework would direct ICC Risk to assess the
Model by conducting monthly parameter reviews and parameter sensitivity
analyses.
B. Reporting of Results
The Back-Testing Framework would require a number of reports
regarding the back-testing analysis of CP portfolios. First, daily
portfolio back-testing results would be reported for each CP based on
the appropriate MPOR.\19\ For each day in the back-testing period, the
report would provide all components of initial margin and
[[Page 11147]]
identify the back-tested components and non-back-tested components.\20\
The report would also provide the sum of the back-tested components
alongside the unrealized P/L and the associated shortfall.\21\ Second,
the Back-Testing Framework would require a report of the back-testing
results for the full period of the MPOR.\22\ Third and finally, with
each set of back-testing results (daily and full period), the Back-
Testing Framework would require an exceedance summary showing the total
number of exceedances in the back-testing period and the maximum number
of exceedances that satisfy each zone in the BTLS.\23\ This report
would show the back-tested components and the N-day P/L results for
every back-tested day for each portfolio associated with a given
CP.\24\
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\19\ Id.
\20\ Id.
\21\ Id.
\22\ Id.
\23\ Notice, 84 FR at 2939.
\24\ Id.
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In addition to reporting results per a given CP, the Back-Testing
Framework would also require that ICC Risk report, periodically and as
appropriate depending on market conditions, instrument and Risk Factor
(``RF'') \25\ level results.\26\ Specifically, with this report, ICC
Risk would compute the unrealized worst P/Ls over the appropriate time
period, projected risk measures and exceedances for each RF and present
the results as an average over all SN RFs for five groups of benchmark
tenors.
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\25\ ICC deems each index, sub-index, or underlying single name
(``SN'') reference entity a separate RF.
\26\ Id.
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C. Remediation of Poor Results
The Back-Testing Framework would provide guidelines for remediating
poor back-testing results. The Back-Testing Framework would identify
back-testing results as poor if the number of observed exceedances
falls in the red zone of the BTLS.\27\ The Back-Testing Framework would
also note that red-zone results coming from overlapping back-testing
periods should not be automatically classified as poor back-testing
results if the effects of one adverse observation are responsible for a
cluster of exceedances.\28\ In that case, the Back-Testing Framework
would make the Chief Risk Officer and Risk Oversight Officer
responsible for determining whether the number of exceedances is
indicative of poor back-testing results, basing their determination in
part on an additional back-testing analysis without overlapping
periods.\29\
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\27\ Notice, 84 FR at 2939.
\28\ Id.
\29\ Notice, 84 FR at 2939.
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The Back-Testing Framework would describe various actions to be
taken upon the identification of poor back-testing results, including
seeking feedback from the Risk Working Group and consulting with the
Risk Committee on any necessary remedial action.\30\ Moreover, if poor
back-testing results are identified and confirmed at the portfolio
level, the Back-Testing Framework would require an analysis of
individual RF back-testing results.\31\ Finally, the Back-Testing
Framework would empower ICC Risk to recommend enhancements to the Risk
Committee and the Board.\32\
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\30\ Id.
\31\ Id.
\32\ Id.
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The Back-Testing Framework would also describe the actions to take
if the number of exceedances falls in the yellow zone, including a
review by ICC Risk to determine the cause of the Model's performance
and, if necessary, a complimentary back-testing analysis without
overlapping back-testing periods.\33\
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\33\ 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 rules and regulations thereunder applicable to such
organization.\34\ For the reasons given below, the Commission finds
that the proposal is consistent with Section 17A(b)(3)(F) of the Act
\35\ and Rules 17Ad-22(b)(2), 17Ad-22(b)(3), and 17Ad-22(d)(8)
thereunder.\36\
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\34\ 15 U.S.C. 78s(b)(2)(C).
\35\ 15 U.S.C. 78q-1(b)(3)(F).
\36\ 17 CFR 240.17Ad-22(b)(2), (b)(3), and (d)(8).
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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 ICC 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.\37\
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\37\ 15 U.S.C. 78q-1(b)(3)(F).
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As discussed above, the proposed rule change would update and
formalize ICC's Back-Testing Framework. The Commission believes that,
in general, the Back-Testing Framework would help ensure the sound
operation of ICC's Model. Specifically, the Commission believes that
the Back-Testing Framework, in describing in detail ICC's process for
conducting back-testing of the Model, would help assure the soundness
of the Model by ensuring that ICC has a means for determining whether
the Model's margin requirements cover possible losses under CP
portfolios at the 99.5% risk quantile. The Commission further believes
that the Back-Testing Framework, in setting out the requirements for
reporting the results of the back-testing process, would help assure
that ICC personnel are informed of the results and therefore able to
take action to correct the Model if necessary. Finally, the Commission
believes that the Back-Testing Framework, in mandating action to
remediate poor back-testing results, would assure that ICC corrects
deficiencies in the Model.
By helping to assure the sound operation of the Model and ICC's
margin requirements, which ICC uses to manage the credit exposures
associated with clearing security based swap transactions, the
Commission believes that the proposed rule change would help improve
ICC's ability to avoid the losses that could result from the
miscalculation of ICC's credit exposures. Because such losses could
disrupt ICC's ability to operate and thus clear and settle security
based swap transactions, the Commission finds the proposed rule change
would promote the prompt and accurate clearance and settlement of
securities transactions. Because such losses could also threaten access
to securities and funds in ICC's control, the Commission finds the
proposed rule change would help assure the safeguarding of securities
and funds that are in the custody or control of ICC or for which it is
responsible. Likewise, for both of these reasons, the Commission finds
the proposed rule change would, in general, help 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 ICC's
custody and control, and, in general, protect investors and the public
interest,
[[Page 11148]]
consistent with the Section 17A(b)(3)(F) of the Act.\38\
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\38\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rules 17Ad-22(b)(2) and 17Ad-22(b)(3)
Rule 17Ad-22(b)(2) requires that ICC establish, implement, maintain
and enforce written policies and procedures reasonably designed to use
margin requirements to limit its credit exposures to participants under
normal market conditions and use risk-based models and parameters to
set margin requirements and review such margin requirements and the
related risk-based models and parameters at least monthly.\39\ Rule
17Ad-22(b)(3) requires that ICC establish, implement, maintain and
enforce written policies and procedures reasonably designed to maintain
sufficient financial resources to withstand, at a minimum, a default by
the two participant families to which it has the largest exposures in
extreme but plausible market conditions.\40\
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\39\ 17 CFR 240.17Ad-22(b)(2).
\40\ 17 CFR 240.17Ad-22(b)(3).
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As discussed above, the Commission believes that the proposed rule
change would help ensure the soundness of the Model by formalizing
ICC's process for conducting back-testing, reporting the results of
back-testing, and remediating poor results. The Commission believes
that the proposed rule change would therefore help ICC to maintain
margin requirements to limit its credit exposures to participants under
normal market conditions. Moreover, as discussed above, the Back-
Testing Framework would also require that ICC Risk conduct monthly
parameter reviews and parameter sensitivity analyses. The Commission
believes that this aspect of the Back-Testing Framework would help ICC
to review margin requirements and the related risk-based models and
parameters at least monthly. Finally, as discussed above, the Back-
Testing Framework would also require reporting the results of the back-
testing process. The Commission believes that this aspect of the
proposed rule change would help ICC to use risk-based models and
parameters to set margin requirements by helping assure that ICC
personnel are informed of the results of back-testing and therefore
able to take action to improve the Model if necessary. The Commission
therefore finds that the proposed rule is consistent with is consistent
with Rule 17Ad-22(b)(2).\41\
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\41\ 17 CFR 240.17Ad-22(b)(2).
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Moreover, the amount a CP must contribute to ICC's Guaranty Fund is
equal to the expected losses to ICC associated with the default of that
CP, calculated using ICC's stress test methodology, and taking into
account, among other things, the loss after application of initial
margin.\42\ Thus, ICC's guaranty fund is based on the initial margin
requirements. The Commission therefore believes that, in helping to
maintain the soundness of ICC's Model and therefore margin
requirements, the proposed rule change would also help ICC to maintain
sufficient financial resources to withstand, at a minimum, a default by
the two participant families to which it has the largest exposures in
extreme but plausible market conditions. The Commission therefore finds
that the proposed rule is consistent with is consistent with Rule 17Ad-
22(b)(3).\43\
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\42\ See ICC Rule 801(a).
\43\ 17 CFR 240.17Ad-22(b)(3).
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Therefore, for these reasons, the Commission finds that the
proposed rule change is consistent with Rules 17Ad-22(b)(2) and 17Ad-
22(b)(3).\44\
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\44\ 17 CFR 240.17Ad-22(b)(2), (b)(3).
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C. Consistency with Rule 17Ad-22(d)(8)
Rule 17Ad-22(d)(8) requires that ICC establish, implement, maintain
and enforce written policies and procedures reasonably designed to have
governance arrangements that are clear and transparent to fulfill the
public interest requirements in Section 17A of the Act and to promote
the effectiveness of ICC's risk management procedures.\45\
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\45\ 17 CFR 240.17Ad-22(d)(8).
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As described above, the proposed rule change would make a number of
ICC personnel responsible for reporting and remediating back-testing
results. Specifically, the Back-Testing Framework would require that
ICC Risk periodically report results in terms of each CDS instrument,
depending on market conditions. If red-zone results appear from
overlapping back-testing periods, the Back-Testing Framework would make
the Chief Risk Officer and Risk Oversight Officer responsible for
determining whether the number of exceedances is indicative of poor
back-testing results. Moreover, if the number of exceedances falls in
the yellow zone, the Back-Testing Framework would require ICC Risk to
determine the cause of the Model's performance. Finally, as discussed
above, the Back-Testing Framework would also require that ICC Risk
conduct monthly parameter reviews and parameter sensitivity analyses.
The Commission believes that in assigning these responsibilities,
the proposed rule change would establish governance arrangements
relating to the Back-Testing Framework that are clear and transparent
to fulfill the public interest requirements in Section 17A of the Act
by clearly assigning and documenting responsibilities for reporting and
acting on the results of back-testing. Moreover, the Commission
believes that in setting out specific actions to remediate poor back-
testing results the proposed rule change would promote the
effectiveness of ICC's risk management procedures by requiring specific
actions to correct deficiencies in the Model.
Therefore, for this reason, the Commission finds that the proposed
rule change is consistent with Rule 17Ad-22(d)(8).\46\
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\46\ 17 CFR 240.17Ad-22(d)(8).
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
proposal is consistent with the requirements of the Act, and in
particular, with the requirements of Section 17A(b)(3)(F) of the Act
\47\ and Rules 17Ad-22(b)(2), 17Ad-22(b)(3), and 17Ad-22(d)(8)
thereunder.\48\
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\47\ 15 U.S.C. 78q-1(b)(3)(F).
\48\ 17 CFR 240.17Ad-22(b)(2), (b)(3), and (d)(8).
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It is therefore ordered pursuant to Section 19(b)(2) of the Act
\49\ that the proposed rule change (SR-ICC-2019-001) be, and hereby is,
approved.\50\
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\49\ 15 U.S.C. 78s(b)(2).
\50\ 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.\51\
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\51\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-05572 Filed 3-22-19; 8:45 am]
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