[Federal Register Volume 85, Number 20 (Thursday, January 30, 2020)]
[Notices]
[Pages 5489-5491]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-01649]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88039; File No. SR-LCH SA-2019-007]


Self-Regulatory Organizations; LCH SA; Order Approving Proposed 
Rule Change Relating to Amendments to LCH SA's Liquidity Risk Modelling 
Framework

January 24, 2020.

I. Introduction

    On December 3, 2019, Banque Centrale de Compensation, which 
conducts business under the name LCH SA (``LCH SA''), filed with the 
Securities and Exchange Commission (``Commission''), pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ 
and Rule 19b-4 thereunder \2\ a proposed rule change (``Proposed Rule 
Change'') to amend its Liquidity Risk Modeling Framework (the 
``Framework''). The Proposed Rule Change was published for comment in 
the Federal Register on December 10, 2019.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 87655 (Dec. 4, 2019), 84 
FR 67488 (Dec. 10, 2019) (SR-LCH-SA-2019-007) (``Notice'').
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II. Description of the Proposed Rule Change

    LCH SA is proposing to amend its Framework, which describes the 
Liquidity Stress Testing framework by which the Collateral and 
Liquidity Risk Management department of LCH Group Holdings Limited 
(``LCH Group'') assures that LCH SA has enough cash available to meet 
any financial obligations, both expected and unexpected, that may arise 
over the liquidation period for each of the clearing services that LCH 
SA offers.\4\ The Framework identifies LCH SA's sources of liquidity 
and corresponding liquidity risks; identifies LCH SA's liquidity 
requirements with respect to its members and its interoperable central 
counterparty; describes the metrics and limits that LCH SA monitors; 
and describes the scenarios under which these metrics are computed.\5\ 
The proposed rule change would make revisions to three aspects of the 
Framework related to physically-settled options, Fixed Income Clearing 
System, and stress tests.
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    \4\ The following description is substantially excerpted from 
the Notice.
    \5\ Notice, 84 FR at 67488.
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A. Physically-Settled Options

    LCH SA is proposing to amend the Framework in order to address more 
accurately its liquidity requirements in the event of the assignment 
and exercise of physically-settled options involving a defaulting 
clearing member during the liquidation period of such clearing 
member.\6\ Specifically, the amended Framework will address LCH SA's 
liquidity requirements in the event options that are in the money are 
exercised either on the day (``T''), or on the business day immediately 
following the day (``T+1''), on which the clearing member that is a 
seller of the options defaults.\7\
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    \6\ Id.
    \7\ Notice, 84 FR at 67488-67489.
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    If a defaulting clearing member is a seller of a Call option that 
is in the money, LCH SA would have to purchase the underlying 
securities in the market at a stressed price and await payment at the 
strike price from the non-defaulting purchaser of the Call option at 
settlement.\8\ If such defaulting clearing member is a seller of a Put 
option that is in the money, LCH SA would have to purchase the 
underlying securities at the strike price from the non-defaulting 
purchaser of the Put option.\9\ Although margins should cover any 
potential loss, liquidity outflows as a result of the sales' proceeds 
are included as liquidity requirements, in each case.\10\
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    \8\ Notice, 84 FR at 67489.
    \9\ Id.
    \10\ Id.
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    In the current Framework, there is no liquidity provision related 
to the risk of assignment and exercise of options at expiration.\11\ In 
order to address this concern, the amended Framework will anticipate, 
prior to the expiration dates, the amount of liquidity funding that may 
arise from options that may be exercised, in the event of the default 
of LCH SA's two largest members (``Cover 2'').\12\ On a daily basis, 
LCH's liquidity coverage ratio (``LCR'') calculation will identify all 
of the potential positions that are in the money or at the money on 
that day and the next business day.\13\ Given the potential option 
exercise, the LCR calculation will generate a liquidity need.\14\ The 
additional liquidity amount that LCH SA could potentially need will be 
equal to the sum of the equities to source following the option 
assignments at expiration and/or the difference between the underlying 
securities and the strike price or the strike price minus the asset in 
the event of a cash settlement.\15\
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    \11\ Id.
    \12\ Id.
    \13\ Id.
    \14\ Id.
    \15\ Id.
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    In practice, the process would work as follows on a daily basis:
     The liquidity needs arising from the options that are in 
the money or at the money, having their expiries on T or T+1, will be 
computed by applying no market stress to the equities.
     The liquidity needs arising from the options that are in 
the money or at the money, having their expiries on T or T+1, will be 
computed by applying a stress scenario to the equities.
     LCH SA will select the positions consistent with the Cover 
2 for both modes described above and will retain the most punitive one.
    This amount would be added to the current cash equity amount in the 
LCR calculation, which LCH would then retain through qualified liquid 
resources.\16\
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    \16\ Id.
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B. Fixed Income Clearing System

    LCH SA is proposing to amend the Framework to take into account the 
expansion of sovereign debt for which LCH SA provides clearing services 
through its Fixed Income Clearing System.\17\ LCH SA initially provided 
clearing services only with respect to French sovereign debt.\18\ The 
Fixed Income Clearing service subsequently added the sovereign debt of 
Italy, Spain, Germany, and Belgium.\19\ More recently, the Fixed Income 
Clearing System has been extended to eight additional Euro markets: 
Austria, Netherlands, Finland, Ireland, Portugal, Slovakia, Slovenia 
and Supranationals.\20\
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    \17\ Id.
    \18\ Id.
    \19\ Id.
    \20\ Id.
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    In this regard, therefore, the Framework would be revised to 
provide that all securities resulting from the settlement of all 
repurchase contracts (``repos'') on behalf of a defaulting clearing 
member, not just repos on the sovereign debt of France, Italy and 
Spain, may be used to generate liquidity

[[Page 5490]]

at the Banque de France.\21\ The amended Framework would also clarify 
that, in the event that a Central Bank Guarantee (``CBG'') is triggered 
by the default of a clearing member posting the CBG, the relevant 
Central Bank will pay the liabilities of the defaulting clearing member 
in cash.\22\
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    \21\ Id.
    \22\ Id.
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    Further, the Framework would be revised to (i) identify the 
relevant central securities depository (``CSD'') through which 
transactions in the sovereign debt of the different jurisdictions may 
settle, (ii) describe the manner by which LCH SA injects liquidity into 
each settlement platform, in particular, Euroclear Bank and Clearstream 
Luxembourg, and (iii) modify the limits by settlement platform on the 
main liquidity drivers (i.e., cash injected into the platforms, auto-
collateralization and gross fails).\23\
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    \23\ Id.
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C. Stress Tests

    The proposed rule change would make clarifications with respect to 
certain aspects of its stress tests.\24\ With respect to the 
operational liquidity target, which is a metric allowing LCH SA to 
confirm that the business as usual liquidity sources are sufficient for 
a five day period in stressed situations, consistent with the LCR time 
horizon, the Framework would note that LCH SA uses a three-day window 
with regard to margin reduction.\25\ The Framework would further 
clarify that, in calculating liquidity resources, LCH SA deducts funds 
required to facilitate settlements, cover end of day fails at Euroclear 
Bank and Clearstream Luxembourg, and avoid Target 2 Securities 
fails.\26\ In addition, the Framework assumes that members allowed to 
post CBGs will switch from cash or ECB-eligible non-cash collateral to 
CBGs (although the Framework does not currently take such switches into 
account, since all eligible members, i.e., Dutch and Belgian members, 
have already done so).\27\ Moreover, the amended Framework would 
confirm that, in calculating required variation margin payments to 
CC&G, LCH SA assumes a theoretical 5-day holding period.\28\
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    \24\ Id.
    \25\ Id.
    \26\ Id. Target 2 Securities is a Eurosystem technical platform 
to which CSDs assign the management of securities settlement in 
central bank money.
    \27\ Id.
    \28\ Id.
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    The amended Framework would also clarify how stressed liquidity 
requirements and impact are calculated for each clearing member, in 
particular with respect to the cash equity settlement requirement for 
options.\29\ These calculations are used to determine the two clearing 
members that would potentially cause the largest aggregate liquidity 
exposure for the CCP in extreme but plausible market conditions.\30\
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    \29\ Id.
    \30\ Id.
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    Finally, the Framework would clarify how LCH SA conducts reverse 
stress tests in order to determine if there is a combination of changes 
in LCH SA's liquidity that could lead to a liquidity shortfall.\31\ In 
particular, the amended Framework would consider whether there is a 
combination of changes in LCH SA's liquidity resources that could lead 
to a liquidity shortfall, even in the absence of stress in the 
market.\32\
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    \31\ Id.
    \32\ Id.
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III. Commission Findings

    Section 19(b)(2)(C) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
the proposed rule change is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to the 
organization.\33\ For the reasons given below, the Commission finds 
that the proposed rule change is consistent with Section 17A(b)(3)(F) 
of the Act \34\ and Rule 17Ad-22(e)(4)(ii) thereunder.\35\
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    \33\ 15 U.S.C. 78s(b)(2)(C).
    \34\ 15 U.S.C. 78q-1(b)(3)(F).
    \35\ 17 CFR 240.17Ad-22(e)(4)(ii).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of LCH SA be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and, to the extent 
applicable, derivative agreements, contracts, and transactions, to 
assure the safeguarding of securities and funds which are in the 
custody or control of LCH SA or for which it is responsible, and, in 
general, to protect investors and the public interest.\36\
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    \36\ 15 U.S.C. 78q-1(b)(3)(F).
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    As described above, the proposed rule change would amend the 
Framework to anticipate, prior to expiration dates, the need for LCH SA 
to step in and meet a defaulter's obligation in the event of the 
assignment or exercise of physically-settled options involving a 
defaulting clearing member by utilizing the LCR calculation, on a daily 
basis, to identify all of the potential positions that are in the money 
or at the money on that day and the next business day. LCH SA will then 
be able to calculate the additional need and ensure it holds sufficient 
qualified liquid resources to meet that need. The Commission believes 
that, by anticipating and ensuring that it meets its liquidity needs in 
this manner, the proposed rule change would help ensure that LCH SA is 
able to meet its financial obligations in stressed situations, which in 
turn would allow LCH SA to continue to meet its obligation to promptly 
and accurately clear and settle securities transactions in such 
situations.
    Further, as noted above, the proposed rule change would amend the 
Framework to take into account the expansion of sovereign debt for 
which LCH SA provides clearing services through its Fixed Income 
Clearing System. Specifically, LCH SA would revise the Framework to 
provide that all securities resulting from the settlement of all repos 
on behalf of a defaulting clearing member, not just repos on the 
sovereign debt of France, Italy and Spain, may be used to generate 
liquidity at the Banque de France, and clarify that, in the event that 
a CBG is triggered by the default of a clearing member posting the CBG, 
the relevant Central Bank will pay the liabilities of the defaulting 
clearing member in cash. The Commission believes that, through these 
changes, the proposed rule change would enhance LCH SA's sources of 
liquidity and thus LCH SA's financial condition, which in turn would 
support LCH SA's ability to continue to promptly and accurately clear 
and settle securities transactions. Additionally, the Commission 
believes that by specifying the CSD through which transactions in the 
identified foreign sovereign debt may settle and describing the manner 
by which LCH SA injects liquidity into each settlement platform, the 
proposed rule change would strengthen LCH SA's procedures for 
safeguarding securities and funds for which it is responsible and 
facilitate prompt and accurate clearance and settlement by clarifying 
procedures for interacting with such platforms.
    For the reasons stated above, the Commission believes that the 
proposed rule change is consistent with Section 17A(b)(3)(F) of the 
Act.\37\
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    \37\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(4)(ii)

    Rule 17Ad-22(e)(4)(ii) requires that, among other things, LCH SA 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to, as applicable, effectively identify, 
measure, monitor, and manage its credit exposures to

[[Page 5491]]

participants and those arising from its payment, clearing, and 
settlement processes, including by maintaining additional financial 
resources at the minimum to enable it to cover a wide range of 
foreseeable stress scenarios that include, but are not limited to, the 
default of the two participant families that would potentially cause 
the largest aggregate credit exposure for the covered clearing agency 
in extreme but plausible market conditions.\38\
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    \38\ 17 CFR 240.17Ad-22(e)(4)(ii).
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    As described above, the proposed rule change would amend the 
Framework to clarify certain aspects of LCH SA's stress tests. 
Specifically, the proposed rule change would clarify how stressed 
liquidity requirements and impact are calculated for each clearing 
member. Because these calculations would then be used by LCH SA to 
determine the two clearing members that would potentially cause the 
largest aggregate liquidity exposure for LCH SA in extreme but 
plausible market conditions, the Commission believes that the proposed 
rule change would support LCH SA's ability to effectively identify, 
measure, monitor, and manage its credit exposures to participants, and 
ultimately maintain additional financial resources at the minimum to 
enable it to cover a wide range of foreseeable stress scenarios that 
include, but are not limited to, the default of the two participant 
families. Further, by clarifying how LCH SA conducts reverse stress 
tests in order to determine if there is a combination of changes in LCH 
SA's liquidity that could lead to a liquidity shortfall even in the 
absence of stress in the market, the Commission believes that the 
proposed rule change would enhance LCH SA's ability to manage its 
credit exposures and maintain additional resources.
    Finally, as discussed above, under the proposed rule change the 
Framework would anticipate, prior to expiration dates, the need for LCH 
SA to step in and meet a defaulter's obligation in the event of the 
assignment or exercise of physically-settled options involving a 
defaulting clearing member. The Commission believes that this change as 
well would enhance LCH SA's ability to manage its credit exposures and 
maintain additional financial resources to cover foreseeable stress 
scenarios involving Cover 2 by identifying the liquidity need ahead of 
time and then retaining the amounts through qualified liquid resources.
    For the reasons stated above, the Commission believes that the 
proposed rule changes are consistent with Rule 17Ad-22(e)(4)(ii).\39\
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    \39\ 17 CFR 240.17Ad-22(e)(4)(ii).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act, 
and in particular, with the requirements of Section 17A(b)(3)(F) of the 
Act \40\ and Rule 17Ad-22(e)(4)(ii) thereunder.\41\
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    \40\ 15 U.S.C. 78q-1(b)(3)(F).
    \41\ 17 CFR 240.17Ad-22(e)(4)(ii).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
\42\ that the proposed rule change (SR-LCH SA-2019-007) be, and hereby 
is, approved.\43\
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    \42\ 15 U.S.C. 78s(b)(2).
    \43\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\44\
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    \44\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-01649 Filed 1-29-20; 8:45 am]
 BILLING CODE 8011-01-P