[Federal Register Volume 84, Number 154 (Friday, August 9, 2019)]
[Notices]
[Pages 39386-39391]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-17108]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-86576; File No. SR-LCH SA-2019-005]
Self-Regulatory Organizations; LCH SA; Notice of Filing of
Proposed Rule Change Relating to Introduction of Clearing of the New
Markit iTraxx Subordinated Financials Index CDS and the Related Single
Name CDS Constituents and Enhancements to Wrong Way Risk Margin
August 6, 2019.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder \2\ notice is hereby given that
on August 2, 2019, Banque Centrale de Compensation, which conducts
business under the name LCH SA (``LCH SA''), filed with the Securities
and Exchange Commission (``Commission'') the proposed rule change
described in Items I, II and III below, which Items have been prepared
primarily by LCH SA. The Commission is publishing this notice to
solicit comments on the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change
Banque Centrale de Compensation, which conducts business under the
name LCH SA (``LCH SA''), is proposing to amend its (i) Reference
Guide: CDSClear Margin Framework and (ii) CDSClear Default Fund
Methodology (together the ``CDSClear Risk Methodology'') and (iii) CDS
Clearing Supplement (``Supplement'') and (iv) CDS Clearing Procedures
(``Procedures'') to incorporate new terms and to make conforming,
clarifying and changes [sic] to allow clearing of the new Markit iTraxx
Subordinated Financials Index CDS and the related single name CDS
constituents.
LCH SA is also amending its CDSClear Margin Framework to
incorporate changes to the Wrong Way Risk margin in order to address
some recommendations in respect of the risk model validation.
The text of the proposed rule change has been annexed as Exhibit
5.\3\
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\3\ All capitalized terms not defined herein have the same
definition as the Rule Book, Supplement or Procedures, as
applicable.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
In its filing with the Commission, LCH SA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. LCH SA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of these statements.
A. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
1. Purpose
LCH SA is proposing to introduce clearing of the Markit iTraxx
Subordinated Financials Index CDS and the related single name CDS
constituents (``SubFins'') which is the natural next step following the
recent changes in financial entities' issuance patterns that are being
rolled out in the wider industry.
In August 2016, IHSMarkit initiated the Markit iTraxx Europe rule
review which prescribes how bank entities are included in the Markit
iTraxx Europe Indices. At the time, the iTraxx Europe Index Advisory
Committee identified that three differing regulatory approaches to
TLAC/MREL regulations (Total Loss Absorbing Capacity/Minimum
Requirements and Eligible Liabilities) eligible debt were driving new
bank debt issuance patterns:
Structural Subordination
[cir] Operating Company versus Holding Company (referred to as
OpCoHoldCo)
Contractual Subordination
[cir] Senior Non-Preferred Tier 3 Bonds, adopted by Danish, French and
Spanish banks, (Seniority tier is SNRLAC: Senior Loss Absorbing
Capacity)
Statutory Subordination
[cir] All senior unsecured debt made eligible, adopted by German banks
Structural subordination was introduced in September 2017 and
Contractual subordination in March 2018.
As a result of these different approaches, LCH SA now manages
different levels of debt seniorities in its product scope and risk
framework.
The proposed change will naturally extend the product scope
eligible for clearing by completing the set of seniority with
subordinated debt for financial entities.
For the purpose of introducing clearing of SubFins, LCH SA proposes
to modify its CDS Clearing Supplement and Procedures to include the
relevant language to allow the clearing of the SubFins.
LCH SA is also taking this opportunity to introduce a few changes
to the Wrong Way Risk (``WWR'') margin in order to address some of the
open model validation recommendations meant to improve the stability of
the WWR margin and to include positions on the iTraxx Main index in the
scope of products subject to the WWR margin.
Finally, a clarification to the Default Fund Additional Margin
(``DFAM''), independent from the SubFins initiative, is also added to
the CDSClear Default Fund Methodology to reflect an adjustment
requested by LCH SA's Risk Department for any clearing service in order
to cap the DFAM to the Stress Test Loss Over Additional Margin
(``STLOAM'').
(1) CDSClear Risk Methodology
The introduction of CDS with subordinated debt as an underlier is
akin to introducing Senior Non Preferred debt, therefore the same
margins need to be adapted, namely spread margin, wrong way risk,
liquidity charge and jump-to-default risk margins (Short Charge and
Self-Referencing Margin).
The Senior Non Preferred CDS differ from Subordinated financial CDS
with respect to the availability of the historical market data and the
recovery rate which for Subordinated debt is conventionally 20% (versus
40% for Senior debt).
The spread margin will use the historical data available for
SubFins, and consider Subordinated and Senior debt as different
financial instruments with regards to portfolio margining.\4\
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\4\ See Article 27 of Commission Delegated Regulation (EU) No
153/2013).
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Similarly, the WWR margin is extended to cover SubFins in addition
to Senior CDS, as if they were different names from an offset
perspective, and with shocks defined specifically for SubFins
calibrated from the historical data available.
The Liquidity Charge will consider Markit iTraxx Subordinated
Financials index to be a new hedging instrument,
[[Page 39387]]
thus extending the existing framework. Then, similarly to the change
introduced for Senior Non Preferred CDS, Senior and Subordinated
financial CDS will be considered jointly from a concentration
perspective. This leads to the need to define a common concentration
threshold, linearly interpolated between the thresholds that would be
determined by our existing framework for each seniority.
The Short Charge margin is modified in two ways:
(i) The recovery rates used in the calculation of exposures are
shocked to capture any adverse move, hence increasing the exposure.
(ii) The number of expected credit events in the 5 days following
the default of a member has been decreased from 2 to 1, meaning we only
retain the top exposure and no longer consider one of the riskiest
entities.
Considering shocks in the recovery rates is necessary to ensure the
difference between Senior and Subordinated CDS recovery rates is
covered. Doing this without modifying the number of defaults would have
led to overly conservative margins, with jump-to-default risk far
outweighing the other risks. The second credit event has therefore been
reclassified to being under the ``extreme market conditions'' category
as opposed to the ``normal market conditions'' category.
In addition to moving from covering the default of two entities to
one a floor to the short charge will be introduced. This floor is
calculated as the 99.7% quantile of a loss distribution based on a
single factor model. In other words, having calculated the exposure the
portfolio has to each underlying reference entity, the probability of
each combination of defaults is calculated (up to all entities in the
portfolio defaulting at the same time) to define the maximum amount
that could be lost with a 99.7% confidence due to default events. The
greater of this calculated amount and the top exposure with a shifted
recovery rate will be retained as being the Short Charge margin.
Consequently, the Stressed Short Charge has been revised with a
similar calculation for exposures, with a recovery of 10% for senior
debt and 0% for subordinated debt. The global short charge will now
consider the top exposure plus the average of the riskiest entities
(for an improved stability), while the financial short charge will
consider the top two exposures on financial entities. For CDX.HY names
specifically, the sum of the top two exposures and the average across
the ten riskiest entities will be retained. The Stressed Short Charge
would then be the max across those three components.
Separately, the model validation recommendations will lead to two
changes to the WWR margin:
(i) The calculation will be done as if the WWR margin was
calculated inside the expected shortfall, leading to (a) the starting
spread for the WWR P&L reflecting the spread level simulated in the
scenarios selected as part of the spread margin and (b) the cap on the
offset formula considering the maximum between the portfolio
calculation and 20% of the sum of the instrument level calculations
will now be applied to the sum of the spread margin and WWR margin (as
opposed to the spread margin alone).
(ii) The iTraxx Main index will now be included in the WWR margin
calculation, with a dedicated shock defined, separately from the iTraxx
Senior Financials and iTraxx Subordinated Financials indices.
Finally, the DFAM is updated and capped to the STLOAM to ensure
that the sum of all resources called from a Clearing Member do not
exceed the stress tested loss measured for that member. LCH SA's risk
framework demands that the stress risk of a given Clearing Member above
and beyond a certain threshold (defined as a percentage of the size of
the default fund and dependent on the internal credit score (ICS) of
such member) be demutualised gradually through the DFAM.
On the other hand, as a CCP, LCH SA doesn't require its Clearing
Members to deposit a total amount of resources for a given clearing
service higher than their worst stress loss for that service. That is
why the DFAM needs to be capped at the STLOAM as it is now defined in
the CDSClear Default Fund Methodology.
(2) CDS Clearing Supplement
The Supplement will be amended in order to include the relevant
language to allow the clearing of the new Markit iTraxx Subordinated
Financials Index CDS and related single name CDS.
In Part A of the Supplement, only Section 8.1. `Creation of Matched
Pairs' will be modified to correct inaccurate references to the CCM
Client account structure in the current version of the Supplement. This
change is not related to the SubFins initiative.
In Part B of the Supplement, the various references to
'Restructuring Credit Event' will be changed to 'M(M)R Restructuring'
or new references to `M(M)R Restructuring' will be created. Indeed,
these provisions apply to transactions for which either `Mod R' or `Mod
Mod R' is applicable. This change is required as clearing SubFins will
introduce transactions for which Restructuring is an applicable Credit
Event but where neither `Mod R' nor `Mod Mod R' are applicable. This is
usually referred to as ``Old R'' (these terms are, for example,
applicable to transactions under the Standard Subordinated European
Insurance Corporate Transaction Type).
Such change will be reflected in Section 1.2. for the term `CEN
Triggering Period', `Compression Cut-off Date', `DC Restructuring
Announcement Date', `DTCC Notice Facility', `First Novation Date',
`NEMO Triggering Period', `Novation Cut-off Date', `Restructuring
Matched Pair', `Spin-off Single Name Cleared Transaction', and also in
Section 2.4 `Amendments to 2014 ISDA Credit Derivatives Definitions',
Section 4.1 ``Determination of Credit Events and Successions Events',
Section 4.3 `Novation and Compression following Credit Events', Section
4.4. `Re-couponing of Restructuring Cleared Transactions', Section 5.1.
`Creation and Notification of Restructuring Matched Pairs', Section 5.2
`Creation of Restructuring Cleared Transactions', Section 5.3
`Triggering of Restructuring Cleared Transaction', Section 5.5
`Reversal of DC Credit Event Announcements', Section 7.4 `Notification
of DTCC Failure and Resolution', Section 7.6 `Clearing Member
Communications Failure Event, Section 8.1 `Creation of Matched Pairs',
Section 9.1 `Occurrence of Clearing Member Self Referencing
Transaction', Section 9.2 `Occurrence of Client Self Referencing
Transactions' and Sections 4.4 `Communications Failure Event'; 5
`Determination of Credit Events and Succession Events' and 8.2
`Notification of Self Referencing Transactions' of the `Appendix XIII:
CCM Client Transaction requirements'.
There is also currently a number of provisions which are stated to
apply to all Cleared Transactions which reference a Reference Entity.
Clearing SubFins will introduce transactions which have the same
underlying Reference Entity, but which have different seniorities (e.g.
Senior Transactions and Subordinated Transactions) and in certain cases
different Transactions Types. The treatment of transactions in case of
credit event or succession event with respect to the relevant Reference
Entity may vary depending upon these terms, as it is possible for
certain events only to apply to certain Transaction Types, or only to a
certain seniority. Therefore, the current references to Reference
Entity will no longer be sufficiently
[[Page 39388]]
granular. As a result, we will add wording (predominantly in the
relevant defined terms) which will enable a different treatment
depending upon the Transaction Type and/or Reference Obligation. It is
to be noted that the Reference Obligation is used to determine the
seniority of a transaction.
Accordingly, in Section 1.2., the term `Affected Cleared
Transaction' will be amended in order to take into account the case
where credit events or succession events apply to a Cleared Transaction
(or, in the case of an Index Cleared Transaction, there [sic] relevant
portion of such transaction defined as a Component Transaction) based
on the Reference Entity but also on the applicable Transaction Type
and/or Reference Obligation.
In addition, the term `Component Transaction' will be created as it
is currently mentioned in different Sections of the Supplement. The
terms `Index Cleared Transaction', `Index CCM Client Transaction', and
`Spin-off Single Name Cleared Transaction' will be modified
accordingly.
The terms `First Novation Date', `Novation Cut-off Date', and
`Spin-off Single Name Cleared Transaction' will be amended to provide
for the correct treatment of transactions based on the combination of
the Reference Entity, Transaction Type and Reference Obligation, and
not only in respect of a Reference Entity.
Section 2.3. `Single Name Cleared Transaction Confirmation' will be
modified in order to take into account the fact that the form of
confirmation for use with the Physical Settlement Matrix that
incorporates the 2014 ISDA Credit Derivatives Definitions only requires
the election with respect to Restructuring to be included for the North
American Corporate and the Standard North American Corporate
Transaction Types, and that it be specified as ``Not Applicable''. The
proposed changes will simplify the wording and also enable the correct
treatment of new Transaction Types introduced by the clearing of
SubFins initiative.
Section 2.5. `Physical Settlement Matrix Updates' will be modified
to ensure the assessment of fungibility between terms of a Revised
Matrix and an Existing Matrix is conducted for the relevant combination
of Reference Entity, Transaction Type and Reference Obligation, and no
longer only in respect of a Reference Entity.
In addition, for clarification/consistency purposes, in Section
1.2. the term ``Relevant Physical Settlement Matrix'' has been added,
with a reference to Section 4.3 of the Procedures.
Furthermore, in line with the changes proposed under Part A of the
Supplement, Section 8.1 `Creation of Matched Pairs' will be modified to
correct inaccurate references to the CCM Client account structure in
the current version of the Supplement. This change is not related to
the SubFins initiative.
In Part C of the Supplement, the term `M(M)R Restructuring Credit
Event' will be changed to `M(M)R Restructuring' in order to align with
the wording mentioned in Part B of the Supplement and with the 2014
ISDA Credit Derivatives Definitions.
Accordingly, in Section 1.2 the term `CEN Triggering Period',
`Compression Cut-off Date', `DC Restructuring Announcement Date',
`First Novation Date', `NEMO Triggering Period', `Novation Cut-off
Date', `SRMP Triggerable Amount' and Section `2.3 `Amendments to 2014
ISDA Credit Derivatives Definitions', Section 4.1 `Determination of
Credit Events and Succession Events', Section 4.2 `M(M)R Restructuring
Credit Event Timeline', Section 5.1 `Creation and Notification of
Swaption Restructuring Matched Pairs', Section 5.3 `Triggering of
Swaption Restructuring Cleared Transactions, Section 5.8 `Effect of
Credit Event Notices and Notices to Exercise Movement Option', Section
5.9 `Reversal of DC Credit Event Announcements', Section 5.11 `Expiry
of CEN Triggering Period', Section 6.1 `Creation and Notification of
Exercise Matched Pairs', Section 7.1 `Creation of Index Cleared
Transactions', Section 7.2 `Creation of Initial Single Name Cleared
Transactions for Settlement purposes in respect of Credit Events other
than M(M)R Restructuring', Section 7.3 `Creation of Restructuring
Cleared Transactions for Triggering and/or Settlement purposes',
Section 7.4 `Creation of Initial Single Name Cleared Transactions in
respect of untriggered M(M)R Restructuring Credit Events', Appendix III
`Form of Credit Event Notice' and Section 8.2 `Creation of
Restructuring Single Name Transaction' of Appendix VIII `CCM Client
Transaction Requirements', will be modified.
Further, as mentioned supra, additional granularity is required to
provide for appropriate treatment in case of a credit or succession
event with respect to a Reference Entity, as such treatment will also
be dependent upon the applicable Transaction Type and seniority. As a
result, we will add wording (predominantly in the relevant defined
terms) which will enable a different treatment depending upon the
Transaction Type and/or seniority of a transaction. Accordingly,
Section 4.2 `M(M)R Restructuring Credit Event Timeline' will be
modified in order to take into account the case where a M(M)R
Restructuring is applicable to a combination of Reference Entity,
Transaction Type and Reference Obligation, and not only in respect of a
Reference Entity.
Furthermore, the term `Component Transaction' will be created for
consistency purposes, as it is currently mentioned in different
Sections of the Supplement and will be created in Part B of the
Supplement. The terms `First Novation Date', `Novation Cut-off Date'
and Section 4.2 `M(M)R Restructuring Credit Event Timeline, Section 5.1
`Creation and Notification of Swaption Restructuring Matched Pairs',
Section 7.2 `Creation of Initial Single Name Cleared Transactions for
Settlement purposes in respect of Credit Events other than M(M)R
Restructuring', Section 7.3 `Creation of Restructuring Cleared
Transactions for Triggering and/or Settlement purposes' and Section 7.4
`Creation of Initial Single Name Cleared Transactions in respect of
untriggered M(M)R Restructuring Credit Events' will be modified
accordingly.
In addition, the cross-references mentioned in Section 1.2
`Swaption Clearing Member Notice', `Swaption Clearing Member Notice
Deadline', Section 5.1 `Creation and Notification of Swaption
Restructuring Matched Pairs', Section 5.3 `Triggering of Swaption
Restructuring Cleared Transactions', Section 5.9 (e) `Reversal of DC
Credit Event Announcements', Section 6.1 `Creation and Notification of
Exercise Matched Pairs', Section 6.3 `Exercise and Abandonment by way
of EEP', Section 6.5 `EEP failure and resolution', Section 6.7
`Termination of Exercise Cleared Transactions', Section 6.8
`Consequences of no Swaption Clearing Member Notice or Swaption CCM
Client Notice being received by LCH SA', Section 8.1 `General Rules
relating to Notices', Section 8.2 `Failure to notify Matched Pairs',
Section 8.4 `Disputes as to Notices', Section 9.1 `Creation of Matched
Pairs', Section 9.6 `Clearing Member matched with Itself', Section 12
`Forms of Notices' and Section 5.4 `Consequences of EEP Failure' and
5.8 `Confidentiality Waiver' of, Appendix VIII `CCM Client Transaction
Requirements' will be updated as they are not correct. These
corrections are not related to the SubFins initiative but are due to an
error in the cross references system.
Finally, in line with the proposed changes under Parts A and B of
the Supplement, Section 9.1 `Creation of Matched Pairs' will be
modified to correct inaccurate references to the CCM
[[Page 39389]]
Client account structure in the current version of the Supplement. This
change is not related to the SubFins initiative.
The amendments to the CDS Clearing Supplement also contain
typographical amendments and similar technical corrections.
(3) CDS Clearing Procedures
LCH SA also proposes to modify Section 4 of the Procedures in order
to take into account the changes to the CDS Clearing Supplement and
therefore to enable different treatments depending upon the Transaction
Type and/or seniority of a transaction.
In Procedure 4.3. `Eligible Reference Entities', a reference to the
Seniority Level of the Reference Obligation will be added, and the
wording will also be modified in order to take into account a
combination of Reference Entity, Transaction Type and Reference
Obligation.
2. Statutory Basis
LCH SA believes that the proposed rule change in connection with
the clearing of SubFins is consistent with the requirements of Section
17A of the Securities Exchange Act of 1934 \5\ (the ``Act'') and the
regulations thereunder, including the standards under Rule 17Ad-22.\6\
In particular, Section 17(A)(b)(3)(F) \7\ of the Act requires, among
other things, that the rules of a clearing agency be designed to
promote the prompt and accurate clearance and settlement of securities
transactions and derivative agreements, contracts, and transactions and
to assure the safeguarding of securities and funds which are in the
custody or control of the clearing agency or for which it is
responsible.
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\5\ 15 U.S.C. 78q-1.
\6\ 17 CFR 240.17Ad-22.
\7\ 15 U.S.C. 78q-1(b)(3)(F).
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As noted above, the proposed rule change is designed:
--To manage the risk arising from the clearing of SubFins indices and
single name CDS constituents, including collecting and maintaining
financial resources intended to cover the risks to which LCH SA is
exposed in connection with offering clearing services for SubFins. As
such LCH SA will be able to minimize the risk that the losses
associated with the default of a participant (or participants) in the
clearing service will extend to other participants in the service.
--To streamline the description of the existing margin framework and
default fund methodology for CDS to take into account SubFins and
improve the organization and clarity of the CDSClear Margin Framework
and Default Fund Methodology. The proposed changes to the Methodology
guide provide additional clarity regarding LCH SA's risk methodology
and enhance readability to further ensure that the documentation
remains up-to-date, clear, and transparent. LCH SA believes that having
policies and procedures that clearly and accurately document LCH SA's
risk methodology and practices are an important component to the
effectiveness of LCH SA's risk management systems, which promotes the
prompt and accurate clearance and settlement of securities
transactions, derivatives agreements, contracts and transactions and
contributes to the safeguarding of securities and funds associated with
security-based swap transactions in LCH SA's custody or control, or for
which LCH SA is responsible.
--To address the independent model validation recommendations on the
WWR margin framework which LCH SA believes will enhance the WWR margin
model by improving its ability to determine the total amount of margin
that should be called and therefore collected to mitigate the spread
risk on financial instruments, including on iTraxx Main indices for
which circa 24% of the constituents reference Financial single names.
This in turn would improve LCH SA's ability to manage financial risk
exposures that may arise in the course of its ongoing clearance and
settlement activities and thus better allow LCH SA to complete the
clearance and settlement process in the event of a member default.
For these reasons, LCH SA believes that the proposed rule change
should help promote the prompt and accurate clearance and settlement of
securities transactions, derivatives agreements, contracts and
transactions. Similarly, it should enhance LCH SA's ability to help
assure the safeguarding of securities and funds which are in the
custody or control of LCH SA or for which it is responsible.
LCH SA believes that the proposed changes to the CDSClear Margin
Framework and the Default Fund Methodology satisfy the requirements of
Rule 17Ad-22(e).\8\
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\8\ 17 CFR 240.17Ad-22(e).
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Rule 17Ad-22(b)(2) requires a clearing agency to use margin
requirements to limit its credit exposures to participants under normal
market conditions and to use risk-based models and parameters to set
margin requirements.\9\ Rule 17Ad-22(b)(3) requires each clearing
agency acting as a central counterparty for security-based swaps to
maintain sufficient financial resources to withstand, at a minimum, a
default by the two participant families to which it has the largest
exposure in extreme but plausible market conditions (the ``cover two
standard''). Rule 17Ad-22(e)(4) requires a covered clearing agency to
effectively identify, measure, monitor, and manage its credit exposures
to participants and those arising from its payment, clearing and
settlement processes by maintaining sufficient financial resources,\10\
and Rule 17Ad-22(e)(6) requires a covered clearing agency that provides
central counterparty services to cover its credit exposures to its
participants by establishing a risk-based margin system that meets
certain minimum requirements.\11\
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\9\ 17 CFR 240.17Ad-22(b)(22).
\10\ 17 CFR 240.17Ad-22(e)(4)(i).
\11\ 17 CFR 240.17Ad-22(e)(6)(i).
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As described above, LCH SA proposes to amend its CDSClear
Methodology Framework to manage the risks associated with clearing
SubFins. Specifically, the proposed rule change amends the Short Charge
margin by shocking the recovery rates used in the calculation of the
jump to default exposure as a function of the seniority of the
underlying single name as well as by only considering the largest
exposure and not the largest and the largest amongst the 3 riskiest
anymore. It also amends the Liquidity Charge margin by setting the
Markit iTraxx Subordinated Financial Index as an additional hedging
pillar as well as by commingling exposures on all seniorities of a
given single name underlying reference to capture concentration risk
appropriately. Finally, it updates all the other margin components of
the total initial margin to incorporate SubFins. These changes are
designed to use a risk-based model to set margin requirements and use
such margin requirements to limit LCH SA's credit exposures to
participants in clearing SubFins CDS and/or other CDS and CDS Options
under normal market conditions, consistent with Rule 17Ad-22(b)(2). LCH
SA also believes that its risk-based margin methodology takes into
account, and generates margin levels commensurate with, the risks and
particular attributes of each of the SubFins and other CDS as well as
CDS Options at the product and portfolio levels, appropriate to the
relevant market it serves, consistent with Rule 17Ad-22(e)(6)(i) and
(v). In addition, LCH SA believes that the margin
[[Page 39390]]
calculation under the revised CDSClear Margin Framework would
sufficiently account for the 5-day liquidation period for house account
portfolio and 7-day liquidation period for client portfolio and
therefore, is reasonably designed to cover LCH SA's potential future
exposure to participants in the interval between the last margin
collection and the close out of positions following a participant
default, consistent with Rule 17Ad-22(e)(6)(iii). LCH SA also believes
that the current pricing methodology with respect to CDS, based on
widely accepted ISDA Model with appropriate adjustments for SubFins, as
supplemented by methodology for circumstances in which pricing data are
not readily available, would generate reliable data set to enable LCH
SA to calculate spread margin, consistent with Rule 17Ad-22(e)(6)(iv).
Further, Rule 17Ad-22(b)(3) requires a clearing agency acting as a
central counterparty for security-based swaps to establish policies and
procedures reasonably designed to maintain the cover two standard.\12\
Similarly, Rule 17Ad-22(e)(4)(ii) requires a covered clearing agency
that provides central counterparty services for security-based swaps to
maintain financial resources additional to margin to enable it to cover
a wide range of foreseeable stress scenarios that include, but are not
limited to, meeting the cover two standard.\13\ LCH SA believes that
its Default Fund Methodology, with the modifications described herein,
will appropriately incorporate the risk of clearing SubFins CDS, which,
together with the proposed changes to the CDSClear Margin Framework,
will be reasonably designed to ensure that LCH SA maintains sufficient
financial resources to meet the cover two standard, in accordance with
Rule 17Ad-22(b)(3) and (e)(4)(ii).\14\
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\12\ 17 CFR 240.17Ad-22(b)(3).
\13\ 17 CFR 240.17Ad-22(e)(4)(ii).
\14\ 17 CFR 240.17Ad-22(b)(3) and (e)(4)(ii).
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LCH SA also believes that the proposed rule changes are consistent
with the requirements of Rule 17Ad-22.\15\ Rule 17Ad-22(e)(17) requires
a covered clearing agency to manage operational risks by (i)
identifying the plausible sources of operational risk, both internal
and external, and mitigating their impact through the use of
appropriate systems, policies, procedures, and controls; (ii) ensuring
that systems have a high degree of security, resiliency, operational
reliability, and adequate, scalable capacity; and (iii) establishing
and maintaining a business continuity plan that addresses events posing
a significant risk of disrupting operations.\16\
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\15\ 17 CFR 240.17Ad-22.
\16\ 17 CFR 240.17Ad-22(e)(17).
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As described above, the proposed rule change will enable LCH SA to
extend its CDSClear product offering to SubFins as CDSClear has been
clearing Senior Financials Indices and Single Names since June 2015.
The process and controls already in place to manage Senior Financials
will apply to SubFins and no additional operational risk is created in
relation to SubFins.
In accordance with the model validation recommendations, the
proposed changes on WWR would also improve the stability and accuracy
of the WWR margin so that LCH SA can better determine the full margin
amount to be collected by the CCP that LCH SA believes is consistent
with the relevant requirements of Rule 17Ad-22.\17\ Rule 17Ad-
22(e)(6)(i) \18\ requires LCH SA to establish, implement, maintain and
enforce written policies and procedures reasonably designed to result
in a margin system that, at a minimum, considers and produces margin
levels commensurate with, the risks and particular attributes of each
relevant product, portfolio, and market.
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\17\ 17 CFR 240. 17Ad-22.
\18\ 17 CFR 240. 17Ad-22(e)(6).
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Rule 17Ad-22(e)(2) \19\ requires LCH SA to have governance
arrangements that are clear and transparent to fulfill the public
interest requirements in Section 17A of the Act.\20\
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\19\ 17 CFR 240. 17Ad-22(e)(2).
\20\ 15 U.S.C. 78q-1.
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LCH SA's governance arrangements clearly assign and document
responsibility for risk decisions and require consultation with or
approval from the LCH SA Board, Risk committees, or management.
CDSClear's proposed rule changes were decided in accordance with the
LCH SA governance process, which included review of the changes to the
CDSClear Margin Framework and related risk management considerations by
the LCH SA Risk Committee and approval by the Board. These governance
arrangements continue to be clear and transparent, such that
information relating to the assignment of responsibilities for risk
decisions and the requisite involvement of the LCH SA Board,
committees, and management is clearly documented, consistent with the
requirements of Rule 17Ad-22(e)(2).\21\
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\21\ 17 CFR 240.17Ad-22(e)(2).
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For the reasons stated above, LCH SA believes that the proposed
rule change with respect to the CDSClear Margin Framework, the CDSClear
Default Fund Methodology, as well as the Supplement and Procedures in
connection with the clearing of SubFins are consistent with the
requirements of prompt and accurate clearance and settlement of
securities transactions and derivative agreements, contracts and
transactions, and assuring the safeguarding of securities and funds in
the custody or control of the clearing agency or for which it is
responsible, in accordance with Section 17(A)(b)(3)(F) \22\ of the Act,
with the requirements of operational risk management in Rule 17Ad-
22(e)(17),\23\ and with clear and transparent governance arrangements
in Rule 17Ad-22(e)(2).\24\
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\22\ 15 U.S.C. 78q-1(b)(3)(F).
\23\ 17 CFR 240.17Ad-22(e)(17).
\24\ 17 CFR 240.17Ad-22(e)(2).
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B. Clearing Agency's Statement on Burden on Competition
Section 17A(b)(3)(I) of the Act requires that the rules of a
clearing agency not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Act.\25\ LCH SA does
not believe that the proposed rule change would impose burdens on
competition that are not necessary or appropriate in furtherance of the
purposes of the Act. Specifically, the proposed changes to the CDSClear
Margin Framework, Default Fund Methodology, Supplement and Procedures
would apply equally to all Clearing Members whose portfolios includes
SubFins and other CDS and CDS Options. Because the margin methodology
and default fund sizing methodology are risk-based, consistent with the
requirements in Rule 17Ad-22(b)(2) and (e)(6), depending on a Clearing
Member's portfolio, each Clearing Member would be subject to a margin
requirement and default fund contribution commensurate with the risk
particular to its portfolio. Such margin requirement and default fund
contribution impose burdens on a Clearing Member but such burdens would
be necessary and appropriate to manage LCH SA's credit exposures to its
CDSClear participants and to maintain sufficient financial resources to
withstand a default of two participant families to which LCH SA has the
largest exposures in extreme but plausible market conditions,
consistent with the requirements under the Act as described above.
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\25\ 15 U.S.C. 78q-1(b)(3)(I).
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Therefore, LCH SA does not believe that the proposed rule change
would impose a burden on competition not necessary or appropriate in
furtherance of the purposes of the Act.
[[Page 39391]]
C. Clearing Agency's Statement on Comments on the Proposed Rule Change
Received From Members, Participants or Others
Written comments relating to the proposed rule change have not been
solicited or received. LCH SA will notify the Commission of any written
comments received by LCH SA.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-LCH SA-2019-005 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-LCH SA-2019-005. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (http://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of LCH SA and on LCH SA's website
at: https://www.lch.com/resources/rules-and-regulations/proposed-rule-changes-0.
All comments received will be posted without change. Persons
submitting comments are cautioned that we do not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make available publicly. All
submissions should refer to File Number SR-LCH SA-2019-005 and should
be submitted on or before August 30, 2019.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\26\
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\26\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-17108 Filed 8-8-19; 8:45 am]
BILLING CODE 8011-01-P