[Federal Register Volume 84, Number 223 (Tuesday, November 19, 2019)]
[Notices]
[Pages 63912-63915]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-24980]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87522; File No. SR-LCH SA-2019-009]


Self-Regulatory Organizations; LCH SA; Notice of Filing of 
Proposed Rule Change Relating to Amendments to CDSClear Reference Guide 
To Allow Index Basis Packages Margining

November 13, 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 29, 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 (the ``CDSClear Risk Methodology'') in 
order to allow Index Basis Packages margining as a single instrument.
    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 CDSClear is proposing to amend its CDSClear Risk Methodology 
in order to consider any relevant and identified Index Basis Packages 
identified as a single instrument.
(a) Index Basis Package Principles
    LCH SA CDSClear currently clears CDS on a number of indices such as 
iTraxx Main, iTraxx Cross-over, iTraxx Senior Financials as well as all 
the Single Name constituents of these indices. The iTraxx Subordinated 
Financials indices will soon be made eligible for clearing as well. 
Indices and their constituents are currently managed and margined as 
independent instruments. However, market participants may execute Index 
Basis Packages consisting of an Index CDS trade and individual Single 
Name CDS trades on each of the reference entities constituents of such 
Index perfectly offsetting the index.
    The following criteria would need to be required to constitute an 
Index Basis Package:

 The package is constituted of an Index CDS and Single Names 
CDS on all the entities constituting the index
 The position (Long/Short) on the Index offsets the positions 
on the Single Names (Short/Long).
 The notional of the Index and across all the Singles Names 
match exactly
 All the Single Names CDS trades to have the same currency, 
coupon and maturity as the Index CDS
 All the Single Name CDS trades to have the same Seniority, 
ISDA Definition and Restructuring Clause than as constituents of the 
Index

    Clearing Members and/or Clients will be required to identify all 
trades being part of an Index Basis Package and to notify LCH SA 
CDSClear. CDSClear would then perform controls to ensure all principles 
and requirements stated above for qualifying the trades as an Index 
Basis Package are satisfied and would flag them with a common ID 
number. These trades will continue to be margined as different trades 
until these tasks and controls have been fully completed and the 
qualification as an Index Basis Package confirmed.
    Once an Index Basis Package is validated as complete, the margin 
enhancement proposed in the current rule change would then be applied 
as part of the overnight margin calculation.
    In order to ensure that the trades continue to meet the criteria of 
an Index Basis Package, controls will be performed every day at the 
start of the overnight batch process.
    Index Basis Packages identified and flagged as such will be 
excluded from compression runs with the rest of the portfolio in order 
to avoid breaking any packages.
    Index Basis Packages can be un-flagged as such at the Clearing 
Member and/or Client's request. The Index CDS and the Single Name CDS 
would then be treated and margined separately as per the current 
framework.
    In case of a Clearing Member's default, CDSClear will have the 
ability to liquidate Index Basis Packages in a dedicated auction should 
it be advised to do so by the Default Management Group in order to 
minimize the liquidation costs.
(b) Proposed Changes to CDSClear Risk Methodology
    In order to take into account the specific risk created by Index 
Basis Packages positions, LCH SA proposes to amend the calculation of 
the Spread Margin and the calculation of the Liquidity Charge Margin as 
described in its Reference Guide, CDSClear Margin Framework.
    LCH SA CDSClear currently considers an Index Basis Package as 
multiple instruments in the calculation of its Spread Margin. In 
accordance with the portfolio margining requirements under Article 27 
of Commission Delegated

[[Page 63913]]

Regulation (EU) No 153/2013 \4\ (the ``RTS''), LCH SA CDSClear applies 
a cap of 80% to the possible margin offsets reduction. Therefore the 
Spread Margin of an Index Basis Package is calculated as the maximum 
between the expected shortfall of the package and 20% of the sum of the 
expected shortfalls calculated for each components of the package.
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    \4\ https://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2013:052:0041:0074:EN:PDF.
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    Considering that this does not appropriately reflect the actual 
risk of an Index Basis Package meeting the criteria stated above, 
CDSClear is proposing to amend its CDSClear Risk Methodology in order 
to consider Index Basis Packages identified as such as a single 
instrument when calculating the amount of margins required. In 
particular, the 80% cap on offsets between the components of the Index 
Basis Package would not be applied in the calculation of the Spread 
Margin, but would be maintained between an Index Basis Package and all 
the other positions in the portfolio.
    In the opinion published in April 2017 \5\ and clarifying the 
application of Article 27 of the RTS, the European Securities and 
Market Authority (``ESMA''), acknowledges the low level of risk 
presented by a package consisting in a future on an index and futures 
on each of the constituents of the index and allows a CCP to 
acknowledge margin reduction in excess of 80% in this specific case.
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    \5\ https://www.esma.europa.eu/sites/default/files/library/esma70-708036281-18_opinion_on_portfolio_margining.pdf.
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    Considering that an Index Basis Package would likely be sold off in 
a dedicated auction in case of default of a Clearing Member, LCH SA 
also proposes to amend the calculation of the Liquidity Charge Margin 
described in the CDSClear Risk Methodology in order to better reflect 
the actual cost it would incur when liquidating an Index Basis Package. 
CDSClear proposes to charge a specific bid/ask spread for each Index 
family underlying an Index Basis Package identified as such rather than 
use the current Liquidity Charge Margin algorithm based on charging 
bid/ask spreads for each individual component in the package taken 
independently. The current Liquidity Charge Margin methodology will 
nevertheless remain in the calculation specific to Index Basis Packages 
identified as such by acting as a cap to the new calculation method.
    Finally, Index Basis Packages flagged as such would be excluded 
from the Recovery Risk, Interest Risk, or Wrong Way Risk Margin 
calculations as by construction Index Basis Packages are immune to the 
risks these margins aim at capturing.
    No other changes are made to the CDSClear Risk Methodology.
(c) Proposed Changes to CDSClear Risk Methodology
    The CDS Clearing Rulebook, Supplement and Procedures will not need 
to be amended for the IBP initiative purposes. Only one new Clearing 
Notice is expected to be published, this notice defines what an IBP is 
and the procedure to be followed to request a set of Cleared Trades to 
be identified as an IBP.
2. Statutory Basis
    LCH SA believes that the proposed rule change in connection with 
the specific margin calculations for Index Basis Packages identified as 
such is consistent with the requirements of Section 17A of the 
Securities Exchange Act of 1934 \6\ (the ``Act'') and the regulations 
thereunder, including the standards under Rule 17Ad-22.\7\ In 
particular, Section 17(A)(b)(3)(F) \8\ 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 derivatives 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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    \6\ 15 U.S.C. 78q-1.
    \7\ 17 CFR 240.17Ad-22.
    \8\ 15 U.S.C. 78q-1(b)(3)(F).
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    As noted above, the proposed rule change is designed to apply 
specific margin calculations for Index Basis Packages flagged as such 
in order:
    --To appropriately collect and maintain financial resources 
intended to cover the risks to which LCH SA is exposed in connection 
with offering clearing services for Index Basis Packages. As such, LCH 
SA will be able to minimize the risk that losses associated with the 
default of a participant (or participants) in the clearing service will 
extend to other participants in the service.
    --To reflect the specific features of Index Basis Packages, notably 
the way that these are executed by market participants, which in turn 
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.
    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).\9\
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    \9\ 17 CFR 240.17Ad-22(e).
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    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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    \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 the clearing 
of Index Basis Packages identified as such. Specifically, the proposed 
rule change amends the Spread Margin calculation for Index Basis 
Packages by not applying the 80% cap on offsets between the various 
instruments constituting the package. It also amends the Liquidity 
Charge Margin by applying a specific bid-ask spread per Index family 
underlying of an Index Basis Package identified as such in order to 
reflect the way that those packages trade in the market and would 
likely be auctioned off in the case of a default of a Clearing Member, 
as well as by capping the new Liquidity Charge Margin calculation by 
the amount calculated using the current Liquidity Charge framework 
based on an individual bid-ask spread per component of the Index Basis 
Package. Finally, all the other margins part of the CDSClear Risk 
Methodology will not be calculated on Index Basis Packages flagged as 
such as immune to those risks due to the complete offsets between the 
components of the package.
    These changes are designed to use an appropriate risk-based model 
to set

[[Page 63914]]

margin requirements and use such margin requirements to limit LCH SA's 
credit exposures to participants in clearing Index Basis Packages and/
or other CDS and CDS Options under normal market conditions, consistent 
with Rule 17Ad-22(e)(3).\12\ 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 Index 
Basis Packages, 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).\13\ In addition, LCH SA 
believes that the margin calculation under the revised CDSClear Margin 
Framework would sufficiently account for the 5-day liquidation period 
for house account portfolios and 7-day liquidation period for client 
portfolios 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).\14\
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    \12\ 17 CFR 240.17Ad-22(e)(3).
    \13\ 17 CFR 240.17Ad-22(e)(6)(i) and (v).
    \14\ 17 CFR 240.17Ad-22(e)(6)(iii).
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    Further, Rule 17Ad-22(e)(4)(ii) \15\ 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. LCH SA believes 
that its Default Fund Methodology, not being impacted by the proposed 
rule change, will therefore still appropriately incorporate the risk of 
clearing Index Basis Packages, CDS, and CDS Options 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(e)(4)(ii).\16\
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    \15\ 17 CFR 240.17Ad-22(e)(4)(ii).
    \16\ 17 CFR 240.17Ad-22(e)(4)(ii).
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    LCH SA also believes that the proposed rule changes are consistent 
with the provisions of Rule 17Ad-22(e)(17) \17\ requiring 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.\18\
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    \17\ 17 CFR 240.17Ad-22(e)(17).
    \18\ 17 CFR 240.17Ad-22(e)(17).
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    As stated above LCH SA will flag each component of an Index Basis 
Package using a common ID number to ensure complete identification of 
the package and perform checks to ensure all principles and 
requirements for qualifying as an Index Basis Package are satisfied. No 
margin enhancement will be given until the full Index Basis Package is 
complete. Once an Index Basis Package is validated as complete, the 
specific margin calculations will then be applied as part of the 
overnight margin calculation.
    LCH SA will also implement additional automated controls in its 
systems performed daily to ensure all the requirements are met on a 
continuous basis.
    Index Basis Packages will be excluded from compressions with the 
rest of the portfolio in order to avoid being broken up.
    LCH SA will update its operational procedures and IT systems to 
ensure all the above is adequately implemented and operational risk 
reduced to a very minimum.
    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. LCH 
SA's proposed rule change was 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 Executive Risk Committee. 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 is consistent with the requirements of prompt and accurate 
clearance and settlement of securities 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 17A(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, would apply equally to all Clearing Members and 
Clients whose portfolios include Index Basis Packages as long as a 
request to identify them as such was received by LCH SA and the 
controls performed confirmed the completeness of the package. Because 
the margin methodology is 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 commensurate with the risk particular to its portfolio. 
Such margin requirement 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 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.

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.

[[Page 63915]]

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-2019-009 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-2019-009. 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-2019-009 and should 
be submitted on or before December 10, 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. 2019-24980 Filed 11-18-19; 8:45 am]
 BILLING CODE 8011-01-P