[Federal Register Volume 84, Number 112 (Tuesday, June 11, 2019)]
[Notices]
[Pages 27167-27169]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-12193]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-86039; File No. SR-ICC-2019-004]
Self-Regulatory Organizations; ICE Clear Credit LLC; Order
Approving Proposed Rule Change Relating to the ICC Model Validation
Framework
June 5, 2019.
I. Introduction
On April 5, 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 to revise the ICC
Model Validation Framework. The proposed rule change was published in
the Federal Register on April 23, 2019.\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. 34-85673 (April 17,
2019), 84 FR 16900 (April 23, 2019) (SR-ICC-2019-004) (``Notice'').
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II. Description of the Proposed Rule Change
The proposed rule change would revise the ICC Model Validation
Framework (``Framework''), which sets forth ICC's model validation
procedures.\4\ Through the model validation procedures, ICC determines
the appropriateness of changes to the risk modeling components (``Model
Components'') of ICC's risk management system and the appropriateness
of the configuration and calibration of ICC's risk management system.
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\4\ Notice, 84 FR at 16900. Capitalized terms used herein but
not otherwise defined have the meaning set forth in the Framework
and ICE Clear Credit rulebook, which is available at https://www.theice.com/clear-credit/regulation.
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The proposed rule change would update the Framework's
classification of Model Components, categorization of model changes,
documentation requirements relating to model inventory, the priority
scale used by independent validators, and the annual validation of
Model Components and related practices.
The proposed rule change would revise the `Risk Management System
Models' section to account for Model Components that are no longer
utilized.\5\ Currently, the Framework classifies Model Components as
new Model Components, which consider risk drivers that are not
currently included in the risk management system, and enhancements to
Model Components, which improve upon the methodologies used by the risk
management system to consider a given risk driver or drivers (these
are, collectively, ``Model Change''). The proposed rule change would
amend the Framework to add a category for retired Model Components,
which are Model Components that are no longer utilized in the risk
management system.
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\5\ Notice, 84 FR at 16901.
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In the `Model Change Qualification and Materiality' section, the
proposed rule change would add a quantitative measure to define certain
Model Changes.\6\ Currently, the Framework classifies a Model Change as
either Materiality A or Materiality B, depending on how substantially
the Model Change affects the risk management system's assessment of
risk for the related risk driver or drivers. Materiality B model
changes do not substantially affect the risk management system's
assessment of risk for the related risk driver or drivers. The proposed
rule change would characterize any Model Change that leads to a
decrease/increase of the total pre-funded financial resources over a
certain percentage as a Materiality A Model Change.
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\6\ Notice, 84 FR at 16901.
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The proposed revisions to the `Documentation Requirements' section
of the Framework would relate to the Model Inventory.\7\ The Model
Inventory is maintained by the ICC Risk Department and contains key
information about all Model Components and Model Changes. The Framework
currently specifies documentation requirements for the information
maintained in the Model Inventory. The proposed rule change would
update the documentation requirements to require documentation related
to retired Model Components and to remove information related to design
and development resources and the location of filenames of certain
documents, which ICC no longer
[[Page 27168]]
considers relevant for purposes of the Model Inventory.
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\7\ Notice, 84 FR at 16901.
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The proposed updates to the `Independent Initial Validation'
section would relate to the priority scale used by independent
validators in completing initial validations.\8\ The Framework
currently directs independent validators conducting initial validations
to classify their findings based on a priority scale, consisting of
high, medium, and low priority ratings, and an observation only rating.
The Framework currently describes low priority findings as those where
the likely deficiencies or impact to any process is not material. The
Framework currently requires that ICC document all low priority items
and address them within a reasonable timescale. The proposed rule
change would modify this requirement to provide that ICC, in
consultation with the Risk Committee, may determine that a low priority
item does not reflect a potential deficiency and take no action. The
proposed rule change would make an identical change with respect to low
priority items found by independent validators conducting periodic
reviews.
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\8\ Notice, 84 FR at 16901.
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The proposed rule change would make clarifying changes to the
`Independent Periodic Review' section.\9\ Specifically, the proposed
rule change would add information regarding how ICC tracks the annual
validation of Model Components and related practices. Currently, the
Framework only provides that independent validators perform periodic
reviews of Model Components and related practices once in every
calendar year. The proposed rule change would further specify that
independent validators perform periodic reviews of Model Components and
related practices at least every twelve months and that ICC relies on
the date of the engagement letter to track this twelve month
requirement. The proposed rule change would also make a clarifying
change to the `Independent Periodic Review' section to refer to a
twelve month cycle of reviews, rather than reviews each year.
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\9\ Notice, 84 FR at 16901.
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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.\10\ For the reasons given below, the Commission finds
that the proposed rule change is consistent with Section 17A(b)(3)(F)
of the Act \11\ and Rules 17Ad-22(b)(2), 17Ad-22(b)(3), and 17Ad-
22(b)(4) thereunder.\12\
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\10\ 15 U.S.C. 78s(b)(2)(C).
\11\ 15 U.S.C. 78q-1(b)(3)(F).
\12\ 17 CFR 240.17Ad-22(b)(2)-(4).
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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.\13\
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\13\ 15 U.S.C. 78q-1(b)(3)(F).
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The Commission believes that the proposed rule change would enhance
the operation of the Framework. Specifically, the Commission believes
that in adding a category for retired Model Components the proposed
rule change would distinguish Model Components that are no longer used,
avoiding potential confusion regarding which Model Components are
currently effective.
The Commission also believes that by adding a quantitative measure
to define Materiality A Model Changes, the proposed rule change would
provide greater certainty and objectivity regarding Materiality A Model
Changes, which is important given that Materiality A Model Changes are
subject to internal initial validation and an independent initial
validation.
The Commission further believes that in adding retired Model
Components to the Model Inventory the proposed rule change would help
ensure that ICC has information on retired Model Components in case it
ever needs to employ those Model Components again or needs to use those
retired Model Components in developing new Model Components. Moreover,
the Commission believes that in removing information no longer
considered relevant to the Model Inventory, the proposed rule change
would help to ensure that the Model Inventory focuses only on the
information needed to carry out the purposes of the Framework.
In specifying that ICC, in consultation with the Risk Committee,
may determine that a low priority item found by an independent
validator during an initial validation or periodic review does not
reflect a potential deficiency and take no action in response to the
item, the Commission believes that the proposed rule change would allow
ICC to efficiently close findings by independent validators that may
have no material impact on ICC's risk management system. Doing so could
also free up resources within ICC and the Risk Committee to respond to
other, higher priority findings by independent validators.
Finally, by specifying that independent validators perform periodic
reviews of Model Components and related practices at least every twelve
months and that ICC relies on the date of the engagement letter to
track this twelve month requirement, the Commission believes that the
proposed rule change would help to ensure that all Model Components and
related practices are reviewed annually by providing a uniform and
objective means of tracking the date of the validation through the date
of the engagement letter.
For these reasons, the Commission believes these proposed revisions
to the Framework would help improve the functioning of the Framework.
The Commission further believes that because the Framework allows ICC
to determine the appropriateness of Model Change and Model Components,
a well-functioning Framework is necessary for an effective risk
management system. Moreover, the Commission believes that ICC's risk
mismanagement system enables ICC to manage the risks associated with
clearing security based swap-related portfolios, and that such risks,
if not properly managed, could cause ICC to realize losses on such
portfolios and disrupt ICC's ability to promptly and accurately clear
security based swap transactions. The Commission therefore believes
that the proposed rule change, in improving the Framework and thereby
improving the functioning of ICC's risk management system, would
promote the prompt and accurate clearance and settlement of securities
transactions. Similarly, given that mismanagement of the risks
associated with clearing security based swap-related portfolios could
cause ICC to realize losses on such portfolios and threaten ICC's
ability to operate, thereby threatening access to securities and funds
in ICC's control, the Commission believes that the proposed rule
change, in improving the Framework, would help assure the safeguarding
of securities and funds which are in the custody or control of the ICC
or for which it is responsible. Finally, for both
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of these reasons, the Commission believes 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 ICC's
custody and control, and, in general, protect investors and the public
interest, consistent with the Section 17A(b)(3)(F) of the Act.\14\
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\14\ 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.\15\ 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, in its capacity as a central
counterparty for security-based swaps.\16\
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\15\ 17 CFR 240.17Ad-22(b)(2).
\16\ 17 CFR 240.17Ad-22(b)(3).
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As described above, the proposed rule change would enhance the
operation of the Framework. In doing so, the Commission believes that
the proposed rule change would help ensure that ICC's risk management
system is appropriate and effective for dealing with the risks
associated with clearing security based swap-related portfolios. The
Commission further believes that the proposed improvements to the
Framework would also improve ICC's review and maintenance of the models
that generate margin requirements. The Commission believes that the
proposed rule change would therefore improve ICC's use of initial
margin requirements to limit its credit exposures to participants under
normal market conditions and ICC's use of risk-based models and
parameters to set margin requirements. The Commission therefore finds
that the proposed rule change is consistent with Rule 17Ad-
22(b)(2).\17\
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\17\ 17 CFR 240.17Ad-22(b)(2).
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Moreover, the amount a clearing member must contribute to ICC's
Guaranty Fund is equal to the expected losses to ICC associated with
the default of that clearing member, calculated using ICC's stress test
methodology, and taking into account, among other things, the loss
after application of initial margin.\18\ Thus, ICC's guaranty fund is
based on the initial margin requirements. The Commission therefore
believes that, in improving the operation of the Framework, which would
in turn improve the operation of ICC's margin model and 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 change is consistent with Rule 17Ad-
22(b)(3).\19\
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\18\ See ICC Rule 801(a).
\19\ 17 CFR 240.17Ad-22(b)(3).
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Therefore, for the above reasons the Commission finds that the
proposed rule change is consistent with Rules 17Ad-22(b)(2) and 17Ad-
22(b)(3).\20\
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\20\ 17 CFR 240.17Ad-22(b)(2), (b)(3).
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C. Consistency With Rule 17Ad-22(b)(4)
Rule 17Ad-22(b)(4) requires that ICC establish, implement, maintain
and enforce written policies and procedures reasonably designed to
provide for an annual model validation consisting of evaluating the
performance of its margin models and the related parameters and
assumptions associated with such models by a qualified person who is
free from influence from the persons responsible for the development or
operation of the models being validated.\21\
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\21\ 17 CFR 240.17Ad-22(b)(4).
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As discussed above, the proposed rule change would revise the
Framework to specify that independent validators perform periodic
reviews of Model Components and related practices at least every twelve
months and that ICC relies on the date of the engagement letter to
track this twelve month requirement. The Commission believes that the
proposed rule change would therefore help to ensure that all Model
Components and related practices are reviewed annually by providing a
uniform and objective means of tracking the date of the validation
through the date of the engagement letter. Therefore, the Commission
finds that the proposed rule change is consistent with Rule 17Ad-
22(b)(4).\22\
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\22\ 17 CFR 240.17Ad-22(b)(4).
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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 \23\ and Rules 17Ad-22(b)(2), 17Ad-22(b)(3), and 17Ad-22(b)(4)
thereunder.\24\
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\23\ 15 U.S.C. 78q-1(b)(3)(F).
\24\ 17 CFR 240.17Ad-22(b)(2)-(4).
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It is therefore ordered pursuant to Section 19(b)(2) of the Act
\25\ that the proposed rule change (SR-ICC-2019-004) be, and hereby is,
approved.\26\
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\25\ 15 U.S.C. 78s(b)(2).
\26\ 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.\27\
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\27\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-12193 Filed 6-10-19; 8:45 am]
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