[Federal Register Volume 84, Number 209 (Tuesday, October 29, 2019)]
[Notices]
[Pages 57897-57903]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-23552]
[[Page 57897]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-87388; File No. SR-LCH SA-2019-008]
Self-Regulatory Organizations; LCH SA; Notice of Filing of a
Proposed Rule Change Relating to the Updated 2018 Version of the
Recovery Plan
October 23, 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 October 8, 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
LCH SA is proposing to adopt an updated recovery plan (the ``RP'')
in accordance with Rule 17Ad-22(e)(3)(ii). The text of the proposed
rule change has been annexed as Exhibit 5. LCH SA has requested
confidential treatment of the material submitted as Exhibit 5.
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
On September 28, 2016, the Securities and Exchange Commission (the
``Commission'') adopted amendments to Rule 17Ad-22 \3\ pursuant to
Section 17A of the Securities Exchange Act of 1934 (the ``Act'') \4\
and the Payment, Clearing and Settlement Supervision Act of 2010
(``Clearing Supervision Act'') \5\ to establish enhanced standards for
the operation and governance of those clearing agencies registered with
the Commission that meet the definition of a ``covered clearing
agency,'' as defined by Rule 17Ad-22(a)(5) \6\ (collectively, the new
and amended rules are herein referred to as ``CCA rules'').
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\3\ 17 CFR 240.17Ad-22.
\4\ 15 U.S.C. 78q.
\5\ 12 U.S.C. 5461 et seq.
\6\ 17 CFR 240.17Ad-22(a)(5).
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LCH SA is a covered clearing agency under the CCA rules and
therefore is subject to the requirements of the CCA rules, including
Rule 17Ad-22(e)(3). The CCA rules require that covered clearing
agencies, among other things, ``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 the covered
clearing agency, which . . . includes plans for the recovery and
orderly wind-down of the covered clearing agency necessitated by credit
losses, liquidity shortfalls, losses from general business risk, or any
other losses''.\7\ As a central counterparty recognized under the
European Market Infrastructure Regulation (``EMIR''),\8\ LCH SA is also
subject to prudential requirements, as well as requirements regarding
its operations and oversight. As a credit institution based in the
European Union, LCH SA is also subject to Directive 2014/59/EU, as
supplemented, requiring institutions to draw up and maintain recovery
plans setting forth options for measures to be taken by the institution
to restore its financial position following a significant deterioration
of its financial position.
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\7\ 17 CFR 240.17Ad-22(e)(3)(ii).
\8\ Regulation (EU) No 648/2012 of the European Parliament and
of the Council of 4 July 2012 on OTC derivatives, central
counterparties and trade repositories.
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Specific guidance has been given on Recovery for CCP by CPMI IOSCO.
Within the CPMI IOSCO principles for financial market infrastructures
(PFMI) it is outlined that all systemically important FMIs should have
a comprehensive and effective recovery plan. For this purpose, it has
issued the report ``recovery of financial market infrastructures''
containing guidance on recovery plans, content of a recovery plan in
October 2014 and a guidance relating resilience and recovery in 2017.
Furthermore, regulations are under preparation on a European level
outlining the Recovery and Resolution measures for CCPs.
As described in more detail below, the purpose of the RP is to
maintain the continuity of critical services in times of extreme stress
and to facilitate the recovery of LCH SA agency. Among other things,
the RP seeks to: (i) Identify if and to what level LCH SA's service are
critical for the market and what internal or external services/systems
are critical for the continuity of LCH SA's activity; (ii) outline the
scenario under which recovery of the LCH SA might be necessary; (iii)
define the early warning indicators and triggers for initiating the
recovery measures under the RP, including the market conditions or
events that could trigger it; (iv) define the governance framework to
trigger these recovery measures; (v) identify the available recovery
tools to manage crisis situations and to restore business as usual; and
(vi) perform a quantitative and qualitative assessment if the recover
tools meet the CPMI IOSCO criteria for recovery instruments.
The RP also includes a detailed summary of the overall business and
regulatory framework that LCH SA operates in, including identification
of applicable regulations, company structure, detail regarding the LCH
SA business lines and geographical spread, and information regarding
the interaction between LCH SA and its parent entity (the ``Parent'').
The RP also contains an FMI analysis, which analyses LCH SA
relationship with other financial market infrastructure (e.g.
settlement platforms, trade repositories, etc) and institutions used by
LCH SA or its clearing members such a payment and settlement agents.
The RP covers all scenarios, which may potentially prevent LCH SA
from providing its critical services:
--The default of one or multiple Clearing Member(s) on one or several
of its markets, where LCH SA has to re-establish the matched book and
may have allocate any uncovered credit losses to its own capital or to
surviving clearing members.
--Potential and actual liquidity shortfalls as result of a clearing
member or allied clearing house default.
--The default of an investment counterparty of LCH SA or any other
investment losses resulting from changes in the market value on the
investments.
--A loss resulting from an operational risk event or any other event
which impacts the critical services provided by LCH SA and particularly
legal and operational risk (including Fraud) which finally would erode
LCH SA's capital.
[[Page 57898]]
--Failure of a critical IT service provider. A special focus has been
made on LCH Ltd as a provider of critical services to LCH SA given the
fact that LCH Ltd is also a CCP and part of the same group.
--Poor business performance or loss of critical contracts with
Exchanges.
--Operational or financial failure of an FMI (e.g. allied clearing
house/(I) CSD/Trades Repository).
The updated 2018 version of the RP includes the following main
improvements:
--CC&G Rulebook changes: Consultation with clearing members and
National Competent Authorities have been completed and LCH SA has
implemented the rules relating to CC&G service closure during 2018.
This has resolved a potential liquidity risk relating to a CC&G
default.
--Critical service providers: LCH SA has implemented a new framework to
manage critical service providers, this framework has been approved in
the LCH SA Board and a new list of critical service providers has been
put together which is part of this RP.
--Cyber scenario: The RP includes now more details on the management of
a cyber-scenario and the Cyber Crisis Management Plan has been added as
a new recovery tool. The purpose of this document is to provide a
framework of procedures allowing LCH SA to respond to cyber incidents
in case of cyber crisis. As such, the process defined is to be
activated in case of detection of a cyber incident that could
potentially cause a significant impact on LCH SA business objectives.
--Capital related recovery tools: The quantitative assessment section
of the recovery plan now includes more details on the monitoring of
capital related recovery tools like surplus capital, variable payments
and dividend payments.
--Recovery tools for non-Euro transactions and collateral: LCH SA has
to its disposal GMRA's to raise liquidity on USD and GBP, access to FX
markets and can perform payments in alternative currency (EUR) as a
last resort.
--LCH Ltd exit plan: LCH Ltd provides IT services to LCH SA and a
practical approach on how LCH SA will manage a potential wind down of
LCH Ltd is now included in the RP.
1. Identification of Critical Services and Operations
With respect to the critical services that might impact the
continuity of LCH SA's operations, the proposed RP provides that an
assessment has been done in accordance with guidance by the Financial
Stability Board (``FSB'') on identification of critical functions and
shared services. LCH SA has assessed that the clearing services LCH SA
provides to participants with respect to the markets identified in the
RP are deemed critical for purposes of the RP. Overall the services
provided in respect of all markets are critical because: (1) The volume
of the activity on certain markets may be very significant, (2) most of
the business on the relevant market is cleared through LCH SA or (3)
the suspension of the clearing service could impact materially the
functioning of the market; the level of global market share with
respect to certain products is high; and LCH SA's service are used by
significant clearing firms. Moreover, a transfer of the clearing
activity to another CCP is technically and organizationally complex to
perform on short notice.
The RP also identifies those shared operations which LCH SA depends
on to perform critical services to members, including those critical
departments and services and systems within its corporate group and
those provided by others. The RP identifies the main operating units
within LCH SA that play a critical role in providing services as well
as those enterprise systems that are critical for LCH SA's ongoing
operations. Such systems are categorized as (i) Tier 1 Enterprise
Critical (which is the most important category and where a failure may
have direct impact on the continued functioning of LCH SA); (ii) Tier 2
Business Critical (which is a category of systems where business may
not be able to proceed as usual in the event of a failure); and (iii)
Tier 3 Business Support (which are non-critical systems). In addition,
the RP identifies those services provided by its affiliates (including
its Parent) and third-party service providers through a comprehensive
framework that are essential to LCH SA's operations as well as the
agreements governing such relationships.
The RP describes that LCH SA maintains comprehensive exit
management plans should LCH Ltd initiate its own recovery and wind-down
plan, cease to operate following a Business continuity or Cyber event,
or notify LCH SA of its termination of services. as well as the
corresponding recovery tools in each case.
The RP also describes the business continuity procedures and exit
management plans that LCH SA would initiate upon the failure of a
critical third-party service provider including LCH Ltd. This is
managed under relevant services agreement between LCH Ltd and LCH SA so
that LCH SA can continue to offer its services in case of a potential
failure.
2. Identification of Possible Stress and Recovery Scenarios
The RP categorizes potential stress scenarios in two ways as a
result of either: (i) Clearing member defaults and (ii) non-clearing
member events. Clearing member defaults are identified as those losses
that threaten LCH SA's ability to operate as a going concern through
either uncovered credit losses or liquidity shortfalls created as a
result of a default by one or more members. Non-clearing member
defaults are defined as losses impacting capital adequacy arising from
risks, including, without limitation, general business risks,
operational events, custody and investment risks, or risks on the
interoperability link.
The RP then identifies, prior to implementing any of the recovery
strategies described therein, the day-to-day risk measures in place to
assure provision of the critical services performed where these are
insufficient the recovery plan will be triggered.
With respect to clearing member defaults, the LCH SA risk framework
provides mitigations for uncovered credit losses due to a member
default. LCH SA follows high standards to assess financial resources
against member portfolios, including initial margin model covering the
potential loss from any member default to a 99.7% confidence level over
the applicable holding period, margin add-ons to deal with specific
member portfolios risks such as concentration, liquidity risk and
sovereign risk, and default fund sizing to cover simultaneous default
of the 2 members having the largest stress testing losses beyond the
99.7% confidence level. Stress tests are applied by LCH SA in order to
assess whether financial resources are calibrated to handle systemic
risks. In addition, a reverse stress resting procedure is used to
ascertain adequacy of financial resources held against member
positions. The stress testing framework is reviewed on an annual basis.
Further, reverse stress testing exercise is conducted at least
quarterly for each default fund and is subject to review by LCH
Executive Risk Committee. Risk monitoring mechanisms have been
established in order to anticipate and identify any credit or market
risks with respect to a clearing member, including daily monitoring of
credit watch lists by LCH SA's credit risk department.
[[Page 57899]]
The RP covers the default of one or multiple Clearing Member(s) on
one or several of its markets, where LCH SA has to re-establish the
matched book and may have allocate any uncovered credit losses to its
own capital or to surviving clearing members.
With respect to liquidity shortfalls as a result of the clearing
member default, the existing liquidity risk management framework seeks
to manage liquidity risk by requiring certain minimum liquidity
coverage ratio and using reserve stress testing to identify plausible
scenarios where the liquidity coverage ratio falls below 100%, as well
as considering the liquidity impact as a result of the default of its
liquidity line provider.
LCH SA would leverage on the reserve stress testing scenarios and
the liquidity line provider's default to define the liquidity recovery
scenarios.
In addition, the RP provides that LCH SA uses a set of early
warning indicators and management actions to mitigate liquidity risk
prior to implementing RP. To the extent a clearing member default has
occurred, LCH SA would perform increased risk monitoring, including
preparation of liquidity risk reports that would be produced several
times a day.
The RP covers the potential and actual liquidity shortfalls as
result of a clearing member or allied clearing house default.
For operational risks, the RP provides that on a monthly basis,
control assessments, incident and audit recommendations are reviewed
and adjusted as appropriate. On a yearly basis, a risk and control
self-assessment is performed whereby all risks are reassessed. The
operational risk department performs second line challenge on all these
activities. In addition, all ``major'' or ``high'' incidents are
processed through a detailed incident review to identify actions to
further improve the control environment.
LCH SA performs a business impact analysis where it identifies all
critical systems and departments and has in place a global business
continuity strategy which outlines the strategy to maintain critical
services in case of a disaster. The RP further identifies events,
including cyber-attacks, failure of a critical service provider,
failure of data providers and exchanges, failure of LCH SA's Parent,
and reputational events as potential operational risks that could
threaten its continued functioning.
The RP covers both a loss resulting from an operational risk event
(for example resulting from a fraud) or any other event which impacts
the critical services provided by LCH SA (e.g. failure in the provision
of service by a third party, unavailability of primary place of work,
Staff unavailability to a point where the continuity of operations may
be compromised or the occurrence of a cyber-event).
The most important operational exposures within SA relates to Cyber
risk:
--Third party liability, associated damages and defense costs arising
from the following, amongst others: Privacy and confidentiality,
Network security, Media liability, Regulatory costs and fines, Internal
investigation; cover combines the Civil Liability and Crime policy only
for Third Party related Liabilities and the Cyber policy;
--Business Interruption, caused by a Cyber incident or a software
malfunction.
The definition of a cyber crisis involves several notions which,
according to the ISO 27000 standard, can be described as follows:
--A security event is an identified occurrence of a system, service or
network state indicating a possible breach of information security
policy or failure of controls, or a previously unknown situation that
can be security relevant
--A security incident is a single or a series of unwanted or unexpected
information security events that have a significant probability of
compromising business operations and threatening information security.
The following scenarios are possible for a cyber attack:
--Attempts (either failed or successful) to gain unauthorized access to
a system or its data
--Security breach or potential security breach
--Unauthorized scan or probe
--Unwanted disruption or denial of service
--Malicious code or virus
--Unauthorized processing or storage of data
--Networking system failure (widespread)
--Application or database failure (widespread)
--Etc.
A crisis management plan has been developed to manage the risks
listed above. It comprises:
--The procedure to identify the priority of an incident and decide
whether to activate the Crisis Management Plan (Triaging Procedure);
--The procedure to notify the hierarchy (Escalation Procedure) and
activate the Crisis Management Team (Crisis Management Team Activation
Plan);
--The Tactical Procedures used to fuel the decision-making process,
depending on the crisis scenario;
--The Communication Procedures used to dress the guidelines of the
notification of the incident;
--The several contact registries necessary to swiftly notify the
relevant contacts.
A specific change in the plan has been to detail the case of a
failure of LCH Ltd which provides critical IT service to LCH SA. The
following scenarios have been identified:
1. A Business continuity event affecting LCH Ltd. This is mitigated
through highly resilient systems described in the business continuity
plan.
2. A sale of LCH SA. In this case, LCH Ltd would continue to
provide the service over the period required to exit and described in
detail in the exit plan. The plan states the main steps that would be
followed.
3. A Wind-down of LCH Ltd. In this case, LCH Ltd will have
insufficient resources to continue as a CCP but will continue to
provide the service for 6 months supported by its wind down capital.
The plan describes the steps that would be followed to replicate the
exact IT service provided by LCH Ltd on short notice.
Business risk is managed by the relevant individual business lines
and requires frequent monitoring of results against budget and
financial plans, with a second line challenge performed by the risk and
finance departments to verify if sufficient capital buffers are
available for applicable business risks. In addition, LCH SA conducts a
yearly review of business risk scenarios to define potential loss
scenarios under foreseeable conditions and the LCH SA finance
department monitors key metrics, including revenues and quarterly
financial information. Investment risk and second line monitoring is
also conducted with respect to interest rate risk, aggregate credit
risk exposure, daily mark-to-market limits, and internal credit scores
for investment counterparties.
The RP also considers that LCH SA is connected to a broad range of
financial market infrastructures, including central securities
depositories, settlement platforms and interoperating central
counterparties and identifies the types of operational or financial
failures that could restrict LCH SA's ability to operate.
Finally, the RP identifies a series of scenarios which, taken
together, could
[[Page 57900]]
also impact the continued functioning of critical services.
3. Triggers for RP
The RP includes a detailed list of events, which if they were to
occur would trigger the implementation of a specific action identified
in the RP.
The RP provides that a clearing member default will be identified
through credit risk monitoring and review of external information
indicating a default. Each LCH SA business line then applies its own
default management process under which a default management group
identifies and manages the phases of the default management process and
the application of the default waterfall. The possible triggers for the
RP include: (i) A clearing member default, in which case the default
procedures will be initiated to reestablish the matched book; (ii)
several default events may lead to more than one replenishment of Skin
in the Game (iii) mutualized default fund contributions per specific
default have been consumed, in which case unfunded resources will be
used to keep LCH SA appropriately funded.
Each LCH SA business lines maintain its own default management
process and waterfall, but, in general, the RP describes the tools used
in the event of a clearing member default. The default management
process is used to re-establish the matched book of LCH SA and return
back to business as usual and therefore considered as a recovery tool.
The relevant governance for the management of a default is followed as
described in the paragraph 5.
When covering the relevant credit losses related to a default
event, first, LCH SA looks to the defaulting clearing member's margin.
These amounts are already held by LCH SA and are available to manage
the default of a clearing member and, as such, are not considered to be
a trigger of the RP. Second, LCH SA looks to the defaulting clearing
member's default fund contribution, which may be allocated to the
defaulting clearing member's shortfalls. Again, this action is within
the control of LCH SA and does not impact the capital adequacy of LCH
SA, so is also not considered a trigger for the RP. Third, in line with
requirements under EMIR, LCH SA is required to hold capital equivalent
to 25 percent of LCH SA's minimum net capital requirement against which
default losses can be applied against liquid available capital. In
addition, excess capital is held to replenish such amount within the
relevant EMIR deadline. Where multiple defaults occur over a longer
time period and lead to multiple replenishments of Skin in the Game,
this may lead to start up of the recovery plan and application of
capital conservation measures. Fourth, should losses arising from a
clearing member default be consumed by the defaulter's margin and
default fund contribution and subsequently LCH SA's contribution from
capital, LCH SA may look to non-defaulting member default fund
contributions. Those amounts are pre-funded by members and held and
controlled by LCH SA for the purposes of managing a default and, thus,
the utilization of those amounts is not considered an application of
the RP. However, LCH SA has the right to trigger an assessment of the
defaults as to reestablish the fund to its original size, and such an
assessment is considered to be a recovery measure under the RP.
Finally, when it is no longer possible for LCH SA to make assessments
and all pre-funded default fund contributions have been used, recovery
measures under the RP, as described below, will be implemented.
With respect to liquidity shortfall triggers, LCH SA runs a daily
liquidity assessment and monitors key liquidity drivers. In the event
that these fall below a specific level, the RP will be triggered. In
addition, the occurrence of a clearing member default or the failure of
a third-party providing settlement and payment services to clearing
member may also result in increased monitoring, and in the event that
LCH SA does not have sufficient liquid resources to meet liquidity
needs, the RP would be triggered.
With respect to non-clearing member default events, the RP
identifies those events with more particularity and identifies the
specific triggers for the RP with respect to such events:
For investment losses, which are defined as losses related to the
default of an investment counterparty or losses incurred as a result of
extreme market conditions, the RP is triggered if losses are greater
than the maximum regulatory capital allocated to this activity. For
operational risk events, the RP is triggered upon any operational
losses that consume the regulatory capital LCH SA holds against the
relevant risks; failure of a third party which impacts the provision of
LCH SA's services; and reputational events impacting LCH SA's
reputation with clearing members and partners. With respect to business
risks, the RP is triggered upon a loss that consumes the regulatory
capital LCH SA holds against the relevant risks. The RP may also be
triggered upon the failure of other financial market infrastructures or
a failure in the delivery of services including a cyber-event.
4. Identification and Assessment of Recovery Tools
The RP identifies the various recovery tools that may be applied by
LCH SA upon the triggering of the RP, using again the same distinction
between clearing member default events and non-clearing member events.
For clearing member default scenarios, the existing stages of the
LCH SA default management process have been used as the framework for
identifying and confirming the appropriate tools to use in the event of
a clearing member default. The RP describes the default management
process in detail and summarizes the actions to be taken at each phase,
including, as mentioned above, (i) reestablishing the matched book,
(ii) default fund assessments, (iii) service continuity charges, and
(iv) voluntary payments. To the extent that the default fund and
assessments cannot manage the losses accumulated from the clearing
member default and any service continuity or voluntary service
continuity contributions received are not sufficient to cover the
relevant losses, the service closure phase of the default management
process is triggered and all outstanding contracts will be closed out
as of the clearing day following such determination and all relevant
losses are allocated to the clearing members. If the RP is triggered as
a result of a liquidity shortfall, the RP provides that LCH SA may use
its central bank credit line to deposited securities received on behalf
of defaulting clearing member(s). The amounts of non-Euro liquidity are
very low and LCH SA has appropriate liquidity lines but also has
recovery tools in place for this for example the possibility to pay in
alternative currency (Euro).
Other potential tools to manage liquidity stress situation are
limits with respect to illiquid collateral or, if necessary apply
increased haircuts on certain types of collateral to incentivize the
use of more liquid collateral as well or apply specific liquidity
margins.
The measures should assure that LCH SA has sufficient liquid
resources at all times. As a last resort, under its rulebook, LCH SA
could defer funding for the settlement platform for a limited period of
time.
As to non-clearing member events, the tool that is used under the
RP will depend on the nature of the event, but for most investment,
business, and operational risks, LCH SA has its capital surplus that it
can allocate losses against. Further, LCH SA can put in place several
measures for capital
[[Page 57901]]
conservation and LCH SA also maintains insurance coverage for specific
operational risk events. As a last resort, LCH SA may also initiate a
capital raising strategy in order to obtain an injection of capital to
replenish any consumed capital.
In order to cope with a liquidity stress situation, LCH SA has the
possibility to use non-Euro collateral to raise liquidity. The
repurchase agreements will then realise the required currency liquidity
requirements needed to satisfy the outgoings resulting from the member
default. Non-euro bonds deposited as non cash collateral by surviving
members can be used for repo transactions and CALM should perform repo
transactions with Gilt/T-bills as collateral in order to raise
liquidity. CaLM has multi-currency GMRA signed with a number of
investment banks, which will allow CaLM to do bilateral transactions.
If liquidity is received in non-euro currencies through bilateral repo
transaction this can be transformed into Euro through the recovery tool
``FX markets''. CALM also has its disposal some Triparty repo agreement
signed to do cross currency repo transactions, where liquidity is
received directly in Euro from Gilt or USD securities.
For any shortfall in a particular currency SA has the ability to
enter into a FX Transaction with a range of counterparties. LCH SA also
has the possibility to transform liquidity received through bilateral
repo transaction of collateral in USD and GBP into Euro.
Article 4.4.3.2 of CDSClear rulebook and instruction I.V.4-2 of the
SA Rulebook allows LCH to convert amounts owed to members into such
other currency or currencies, using a reasonable/prevailing rate of
exchange. In the application of this regulation, LCH SA is therefore
able to resolve a specific currency liquidity shortfall by completing
the required transaction in an alternate currency than the original
obligation.
A ``Cyber Crisis Management Plan'' has been developed which provide
a framework of procedures allowing LCH SA to respond to cyber incidents
in case of cyber crisis. As such, the process defined is to be
activated in case of detection of a cyber incident that could
potentially cause a significant impact on LCH SA business objectives.
Cyber incidents can develop rapidly and business impact can quickly
escalate. The objective of this framework is to manage cyber events or
incident in a way that:
Limits the damage, increases the confidence in
stakeholders and reduces recovery time and costs,
facilitate systematic and efficient response,
empowered decision making,
all response activities are recognised and coordinated.
LCH SA monitors on a monthly basis if it meets the EMIR capital
requirements and in addition it monitors sufficient ``surplus/buffers
capital'' is available to assure recovery of the CCP from both CMD and
non-CMD losses under single scenarios (e.g. default of a clearing
member on one or several services, default on an investment
counterpart) and combined scenarios (e.g. Failure of a clearing member
which is also acting as an investment counterparty). Associated to each
scenario is attached one or several indicators and the capital coverage
tools available in each case. In addition to the capital requirements
and available headroom, LCH SA follows indicators such as the Liquidity
Coverage Ratio, the aggregate credit risk and market risk exposure on
its investment portfolio, operational risk and business risks
indicators. Capital coverage instruments include prefunded capital
surplus and buffers, limitation of credit and market risks and
therefore of potential losses and insurance coverage. The capital and
buffers are monitored in order to allow LCH SA to always be in a
situation to replenish the SIG within one month, if the CCP was to face
multiple defaults. The liquidity coverage ratio indicator ensures that
LCH SA will always be in a situation to have access to sufficient
liquidity provided either from its own cash or by the ECB even in very
extreme cases as no capital coverage is possible in a liquidity stress
scenario. The Aggregate Risk Exposure and Market Risk limits on the
investment portfolio are in place to ensure that capital will be
sufficient to cover any reasonable losses. Operational risk is followed
to ensure that operational risk capital can be replenished if the
insurance policy does not cover the loss event. Finally, business risk
scenarios are monitored to ensure LCH SA has sufficient capital for
replenishment if required.
Next to the surplus capital, the LCH Board may decide to withhold
Dividend payment and Variable bonus payment to be used as additional
buffers.
If an event resulted in a major disruption of its activities, LCH
SA would initiate its business continuity strategy, which establishes
an enterprise wide RP and response proportionate to the event which
aims to minimize the impact of a major disruption on LCH SA's critical
business and resources, or in case of a cyber-event LCH will trigger
the cyber crisis management plan. For any disruption or loss of key
third-party service provider, LCH SA would be able to exercise several
contractual rights and maintains exit plans which are intended to
safeguard the continuity of services. LCH SA also maintains back up
procedures and protocols that would be initiated if there is an impact
on critical services of FMIs, for example its ability to collect margin
within T2 under an emergency platform. Finally, LCH SA maintains a
crisis communication plan, which outlines the procedure for
communicating with clearing members and partners in the event of a
disruption.
With respect to each recovery tool identified, the RP also seeks to
assess that each tool possesses the following characteristics:
Comprehensive; effective, including as to reliability, timeliness;
transparent, provides appropriate incentives, and results in a minimum
negative impact. To confirm that each recovery tool does, in fact, have
these characteristics, the RP considers as to each: The barriers or
constraints within the tool itself; the steps and time to implement (if
not already available as a tool); the likely effectiveness of the tool;
any risk of execution; the potential impacts on participants and
markets generally; the sequencing of the use of the tools where
multiple tools may be required; and the legal basis of the tool. The RP
also includes a qualitative and quantitative assessment to provide an
indication of the likelihood and severity of a potential recovery
situation and whether the tools included in the RP are adequate.
5. Governance Requirements
The creation of the RP and its approval is subject to a number of
layers of governance approval. At a high level, the LCH SA Management
Committee is responsible for the preparation of the RP and
implementation of the monitoring and the recovery tools set forth in
the RP. Before submission to the LCH SA Risk Committee, the RP is
reviewed and validated by the Executive Risk Committee of LCH Group.
The LCH SA Risk committee, which includes independent directors, then
reviews, challenges (if needed), and recommends the RP for approval by
the LCH SA board. Final approval of the RP rests with the LCH SA Board.
At a more granular level, the RP identifies the groups and
individuals within LCH SA that are responsible for the various aspects
of the RP.
A clearing member default will be managed in accordance with the
relevant procedures. The Default Management Group (``DMG'') is
responsible for the management of the default while all critical
decisions are
[[Page 57902]]
escalated and submitted to the LCH SA Default Crisis Management Team
(``DCMT''). All decision which may lead to the triggering of recovery
measures are subject to discussion in the DCMT and approval of the LCH
SA CEO.
With respect to non-clearing member events, the management of those
events will depend on the nature of the event. For example, investment
losses and liquidity shortfalls are managed from a first line of
defense, which attempts to control risks within the risk appetite
parameters set by the Board, and then are escalated as appropriate.
Operational risks are managed in accordance with the operational risk
policy approved by the Board and reporting and second line challenges
are performed by the operational risk department. Business risk is
managed by individual business lines and requires frequent monitoring
of results against budget and financial plans, with a second line
challenge performed by the risk and finance departments to verify if
sufficient capital buffers are available for the applicable business
risks.
Upon the occurrence of a clearing member default, the recovery
measures that will apply are clearly set forth in LCH SA's rulebook and
LCH SA's CEO has the authority to trigger the different stages in the
waterfall process, but will consult with DCMT and regulators prior to
taking any action. In addition, the RP provides that the LCH SA will
also activate an emergency board meeting for approval (if reasonably
possible). Upon receipt of information relevant to a scenario causing
non-default losses, the LCH SA management committee will consider
whether a recommendation to formally invoke the RP should be made to
the LCH SA Board. Upon receipt of a recommendation for action, the LCH
SA Board will consider the information presented to determine if the RP
should be formally invoked.
6. Plan Testing and Maintenance
The RP requires that LCH SA conduct testing and review of member
default rules and associated procedures through the running of periodic
``fire drills'' which simulate member default scenarios. According to
the RP, the fire drills are intended to simulate all aspects of a
member default, including the auctioning of the defaulting members
portfolio to non-defaulting members (where appropriate) and involves
the participation of members and relevant functions within the LCH SA
organization. Further, because one of the main scenarios contemplated
under the RP is a clearing member default, the testing of this element
(i.e. the tools to recover from uncovered credit losses or liquidity
shortfalls arising from a member default) will be incorporated into
each relevant fire drill cycle. As noted in the RP, LCH SA performs an
annual multi-service fire drill and service specific fire drills are
performed at least annually and testing for non-default events are
incorporated into the fire drill regime as well. Should either the
periodic testing or other change within LCH SA result in the need to
amend the RP, the RP will be revised in accordance with the governance
requirements identified above.
(b) Statutory Basis
LCH SA believes that the proposed rule change is consistent with
the requirements of Section 17A of the Act and the regulations
thereunder, including the standards under Rule 17Ad-22.\9\
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\9\ 17 CFR 240.17Ad-22.
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Section 17A(b)(3)(F) of the Act \10\ 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 to
assure safeguarding of securities and funds which are in the custody or
control of the clearing agency or for which it is responsible, and in
general to protect investors and the public interest. LCH SA believes
that the RP will permit it to initiate recovery upon the occurrence of
certain trigger events to maintain continuity of critical services or
orderly wind down in accordance with the applicable requirements of
Rule 17Ad-22 \11\ and LCH SA's rules. The RP is designed to formalize
and set out the risk framework and measures that LCH SA will use to
ensure its stability and recovery in the event of a crisis in order to
be able to maintain its critical business processes and operations.
Specifically, the RP would describe the LCH SA risk framework and
process applicable to identify measure, monitor and manage the risks
faced by LCH SA in the provision of clearing, settlement and risk
management services when a crisis event occurs. The RP would serve as a
means of addressing, credit risk, market risk, general business risk,
operational risk, and other risks that may otherwise threaten the
viability of LCH SA. The RP would also support the stability of LCH SA
as a clearing house that is part of the broader financial markets and
seeks to promote the protection of market participants from the risk of
default by a clearing member of LCH SA or an unforeseen operational or
business event that impacts LCH SA's continued functioning. The RP also
facilitates the prompt clearance and settlement of the securities as it
will enable LCH to levy additional resources to match the positions,
limit the volume of fails and more generally avoid the market
disruption that would be caused by the default of the CCP. The
objective of the RP is to maintain the viability of the CCP and bring
back the company to normal business, thereby ensuring that the
securities and funds that the members have deposited as guarantees be
fully returned to the market participants. In that regard, LCH SA
believes that the RP supports the public interest, in line with Section
17A(b)(3)(F) \12\ of the Act.
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\10\ 15 U.S.C. 78q-1(b)(3)(F).
\11\ 17 CFR 240.17Ad-22.
\12\ 15 U.S.C. 78q-1(b)(3)(F).
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The RP would also be consistent with the specific relevant
requirements of Rule 17Ad-22, including under 17Ad-22(e)(2) and (3)
\13\. Rule 17Ad-22(e)(2) \14\ provides that a covered clearing agency
shall have governance arrangements that are clear and transparent and
clearly prioritize the safety and efficiency of the covered clearing
agency, to support the public interest requirements in Section 17A of
the Act applicable to clearing agencies, and the objectives of owners
and participants. LCH SA believes that the RP is consistent with these
requirements. The RP includes extensive governance requirements that
clearly identify the lines of responsibility with respect to the RP. As
described above, at a high level, the LCH SA Management Committee is
responsible for the preparation of the RP and implementation of the
monitoring and the recovery tools set forth in the RP. The LCH SA Risk
committee, which includes clearing member representatives, then
reviews, challenges (if needed), and recommends the RP for approval by
the LCH SA board. Final approval of the RP rests with the LCH SA Board,
which includes, among other categories, non-executive Chair,
independent directors and user directors. At a more granular level, the
RP identifies the groups and individuals within LCH SA that are
responsible for the various aspects of the RP. Therefore, LCH SA
believes that the RP contains governance arrangements that are clear
and transparent and clearly prioritize the safety and efficiency of the
covered clearing agency, to support the public interest requirements
and the objectives of owners and participants, and is,
[[Page 57903]]
therefore, consistent with the requirements of Rule 17Ad-22(e)(2).
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\13\ 17 CFR 240.17Ad-22(e)(2) and (3).
\14\ 17 CFR 240.17Ad-22(e)(2).
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Rule 17Ad-22(e)(3) \15\ requires that a covered clearing agency
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 the covered
clearing agency, which must include plans for the recovery and orderly
wind-down of the covered clearing agency necessitated by credit losses,
liquidity shortfalls, losses from general business risk, or any other
losses. The RP is designed to maintain the continuity of critical
services in times of extreme stress and to facilitate the recovery of
LCH SA in the event of extreme (loss) scenarios, as part of LCH SA's
comprehensive risk management framework. As described above, the RP
seeks to identify those services which could impact the continuity of
LCH SA's operations, implement early warning indicators to identify
potential recovery scenarios and define the triggers for initiating the
RP, and clearly identify the recovery tools available under the RP.
Accordingly, LCH SA believes the RP is consistent with Rule 17Ad-
22(e)(3).\16\
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\15\ 17 CFR 240.17Ad-22(e)(3).
\16\ 17 CFR 240.17Ad-22(e)(3).
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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.\17\ LCH SA does
not believe the proposed rule change would impact or impose any burden
on competition. The proposed rule change would establish and maintain
LCH SA's RP in accordance with the CCA rules. The RP would not affect
clearing member's access to services offered by LCH SA or impose any
direct burden on clearing members. To the contrary, the RP seeks to
identify the key risks and to establish appropriate recovery measures
to ensure LCH SA's ability to operate in the event of an extreme loss.
Accordingly, the proposed rule change would not unfairly inhibit market
participants' access to LCH SA's services or disadvantage or favor any
particular user in relationship to another user. Therefore, LCH SA does
not believe that the proposed rule change imposes any burden on
competition that is not necessary or appropriate in furtherance of the
purposes of the Act.
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\17\ 15 U.S.C. 78q-1(b)(3)(I).
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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.
D. Extension of Time Period for Commission Action
LCH SA does not consent to the extension of the time period listed
in Section 19(b)(2) of the Securities Exchange Act of 1934 for
Commission action.
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-2019-008 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-2019-008. 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 arecautioned 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-2019-008 and should
be submitted on or before November 19, 2019.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\18\
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\18\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-23552 Filed 10-28-19; 8:45 am]
BILLING CODE 8011-01-P