[Federal Register Volume 85, Number 38 (Wednesday, February 26, 2020)]
[Notices]
[Pages 11129-11136]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-03775]
=======================================================================
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88253; File No. SR-ICC-2019-010]
Self-Regulatory Organizations; ICE Clear Credit LLC; Order
Approving Proposed Rule Change, as Modified by Partial Amendment No. 1
and Partial Amendment No. 2, Relating to Amendments to the ICC Clearing
Rules To Address Non-Default Losses, on an Accelerated Basis
February 20, 2020.
I. Introduction
On August 8, 2019, ICE Clear Credit LLC (``ICC'') filed with the
Securities and Exchange Commission (``Commission''), pursuant to
Section 19(b)(1) of the Securities Exchange Act of 1934 (the
``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to
amend ICC's Clearing Rules (the ``Rules'') \3\ to address treatment of
losses not related to a Clearing Participant default. The proposed rule
change was published for comment in the Federal Register on August 28,
2019.\4\ The Commission received comments regarding the proposed rule
change.\5\
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Capitalized terms used but not defined herein have the
meanings specified in the Rules.
\4\ Self-Regulatory Organizations; ICE Clear Credit LLC;
Proposed Rule Change, Security-Based Swap Submission, or Advance
Notice Relating to the ICC Clearing Rules; Exchange Act Release No.
86729 (Aug. 22, 2019); 84 FR 45191 (Aug. 28, 2019) (SR-ICC-2019-010)
(``Notice'').
\5\ Comments are available at https://www.sec.gov/comments/sr-icc-2019-010/sricc2019010.htm.
---------------------------------------------------------------------------
On October 4, 2019, the Commission designated a longer period of
time for Commission action on the proposed rule change until November
26, 2019.\6\ On October 7, 2019, ICC filed a partial amendment
(``Partial Amendment No. 1'') to modify the proposed rule
[[Page 11130]]
change.\7\ On November 25, 2019, the Commission published notice of
Partial Amendment No. 1, solicited comments from interested persons on
the proposed rule change as modified by Partial Amendment No. 1, and
instituted proceedings under Section 19(b)(2)(B) of the Act \8\ to
determine whether to approve or disapprove the proposed rule change as
modified by Partial Amendment No. 1.\9\ On January 24, 2020, ICC filed
Partial Amendment No. 2 to the proposed rule change.\10\ Notice of
Partial Amendment No. 2 was published in the Federal Register on
February 3, 2020, and in that notice the Commission requested comments
on the proposed rule change, as modified by Partial Amendments No. 1
and No. 2.\11\ The Commission did not receive any comments in response
to the Notice of Partial of Amendment No. 2.
---------------------------------------------------------------------------
\6\ Self-Regulatory Organizations; ICE Clear Credit LLC; Notice
of Designation of Longer Period for Commission Action on Proposed
Rule Change Relating to Amendments to the ICC Clearing Rules To
Address Non-Default Losses; Exchange Act Release No. 87225 (Oct. 4,
2019); 84 FR 54712 (Oct. 10, 2019) (SR-ICC-2019-010).
\7\ In Partial Amendment No. 1 to the proposed rule change, ICC
provided additional details and analyses surrounding the proposed
rule change in the form of a confidential Exhibit 3.
\8\ 15 U.S.C. 78s(b)(2)(B).
\9\ Self-Regulatory Organizations; ICE Clear Credit LLC; Notice
of Filing of Partial Amendment No. 1 and Order Instituting
Proceedings To Determine Whether To Approve or Disapprove Proposed
Rule Change, as Modified by Partial Amendment No. 1, Relating to
Amendments to the ICC Clearing Rules To Address Non-Default Losses;
Exchange Act Release No. 87622 (Nov. 25, 2019); 84 FR 66041 (Dec. 2,
2019) (SR-ICC-2019-010).
\10\ In Partial Amendment No. 2 to the proposed rule change, ICC
modified the initial filing to (1) differentiate the treatment of
investment losses in the Client Origin Account from the treatment of
investment losses in the House Origin Account and (2) limit the
allocation of investment losses to those Clearing Participants that
have instructed, or are deemed to have instructed, ICC to invest the
cash Initial Margin in the Client Origin Account.
\11\ Self-Regulatory Organizations; ICE Clear Credit LLC; Notice
of Filing of Partial Amendment No. 2 to Proposed Rule Change
Relating to Amendments to the ICC Clearing Rules to Address Non-
Default Losses; Exchange Act Release No. 88064 (Jan. 28, 2020); 85
FR 6007 (Feb. 3, 2020).
---------------------------------------------------------------------------
For the reasons discussed below, the Commission is approving the
proposed rule change, as modified by Partial Amendment No. 1 and
Partial Amendment No. 2 (hereinafter, ``proposed rule change'') on an
accelerated basis.
II. Background
The proposed rule change is principally designed to address and
manage the risks posed to ICC by potential non-default loss events,
including investment losses, custodial losses with respect to margin
and General Guaranty Fund contributions, and other losses resulting
from general business risk, operational risk, or other non-default
scenarios, to ensure that ICC has a mechanism to fully allocate any
such losses and thereby enhance its ability to continue orderly
clearing operations or otherwise maintain its viability as a going
concern in the event that such losses are realized.\12\ To that end,
the proposed rule change would define three exclusive categories of
losses not related to a Clearing Participant default: (i) Investment
Losses, (ii) Custodial Losses, and (iii) Non-Default Losses. In
addition, with respect to the treatment of such losses, the proposed
rule change would: (i) Define the resources of ICC that ICC would apply
to cover each such category of losses; (ii) assign responsibility to
Clearing Participants, in certain circumstances, to make contributions
with respect to Investment Losses and Custodial Losses (but not Non-
Default Losses); and (iii) in the event that ICC recovers funds related
to Investment Losses or Custodial Losses, address the treatment of
recoveries by ICC with respect to such losses. The proposed rule change
would also make additional changes related to all three categories of
losses, including changes to take into account the effect of the
proposed rule change on other ICC rules.
---------------------------------------------------------------------------
\12\ See Notice, 84 FR at 45193.
---------------------------------------------------------------------------
A. Loss Categories
The proposed rule change would add to Rule 102 new definitions for
``Investment Losses'' and ``Non-Default Losses'' and revise the
definition of ``Custodial Losses.''
Under the proposed rule change, Investment Losses would be defined
as losses incurred or suffered by ICC in connection with the default of
the issuer of any investment of Margin or General Guaranty Fund assets
by ICC, or the default of the counterparty to any repurchase, reverse
repurchase contract, or similar transaction used to invest or reinvest
such Margin or General Guaranty Fund assets. The proposed rule change
would also include as an Investment Loss change in value of investments
due to market movements, but would exclude a Custodial Loss, a negative
yield or interest rate on an investment, and a loss on a security or
non-cash asset posted by a Clearing Participant as a Margin or Guaranty
Fund contribution.
Currently, Rule 406(g) defines Custodial Losses as those arising
out of or relating to the holding, investment, or use of the Client
Omnibus Margin Account or assets credited thereto from time to time,
and specifies that ICC shall not be liable for any such losses except
to the extent that they result from the gross negligence or willful
misconduct of ICC, or from the investment of such assets by ICC in its
discretion within the meaning of CFTC Rule 1.29(b). The proposed rule
change would move the definition of Custodial Losses to Section 102 of
ICC's Rules (Definitions) and revise it to mean losses of Margin or
General Guaranty Fund assets (including declines in the value thereof)
as a result of (i) the insolvency or failure of a Custodian or (ii) the
embezzlement or theft of such assets by any person (other than ICC or
its employees or representatives). The proposed rule change would
define a Custodian for this purpose as a bank or trust company, central
bank, central securities depository or other third party settlement
system used by ICC for the deposit, holding, custody or transfer of
cash or securities. Additionally, because the proposed rule change
would create a stand-alone definition of Investment Losses, as
described above, the revised definition of Custodial Losses would
specify that Custodial Losses would not include Investment Losses.
The proposed rule change would define Non-Default Losses to include
losses incurred or suffered by ICC that are neither Investment Losses
nor Custodial Losses and arise in connection with an event other than a
Clearing Participant's default. The definition thus would capture
losses from general business or operational risk that do not constitute
Custodial Losses or Investment Losses.
B. Treatment of Losses
i. ICC Resources
The proposed rule change would require that, with respect to an
Investment Loss or Custodial Loss, ICC would first apply any available
Investment Loss Resources or Custodial Loss Resources, as applicable.
ICC would determine the amount of such resources based on its
assessment of its potential exposure to investment losses under its
investment policies and procedures, and the ICC Board would
periodically conduct a risk-based assessment of the appropriate level
of Investment Loss Resources.\13\ As an initial measure of its
potential exposure to investment losses, ICC has taken into account
components of the European Union capital requirements applicable to
central counterparties (which are not directly applicable to ICC), in
particular the capital requirements for credit, counterparty and market
risks and operational and legal risks.\14\ Based on its initial
assessment of ICC's potential Investment Losses utilizing this
methodology, ICC determined that its
[[Page 11131]]
potential exposure to Investment Losses is $20 million, and therefore
the proposed rule change would initially define Investment Loss
Resources as $20 million of ICC's own assets designated by ICC as
available to be applied to Investment Losses. Similarly, based on ICC's
initial assessment of its potential Custodial Losses utilizing this
methodology, ICC determined that its potential exposure to Custodial
Losses is $32 million, and therefore the proposed rule change would
initially define Custodial Loss Resources as $32 million of ICC's own
assets designated by ICC as available to be applied to Custodial
Losses. In either case, as noted, the ICC Board could modify the amount
from time to time, and such determination would be risk-based in light
of ICC's potential exposure to such losses.
---------------------------------------------------------------------------
\13\ See Notice, 84 FR at 45194.
\14\ See id.
---------------------------------------------------------------------------
Unlike Investment Losses and Custodial Losses, the proposed rule
change would not define or place a cap on the specific ICC resources
available to satisfy Non-Default Losses. Rather, proposed Rule 811(b)
would require that Non-Default Losses, whatever the amount, be met from
available ICC capital and other ICC assets (including available
retained earnings, Investment Loss Resources, and Custodial Loss
Resources). Thus, the proposed rule change would make ICC solely
responsible for Non-Default Losses and would not allocate Non-Default
Losses to Participants. Similarly, proposed Rule 811(b) would prohibit
ICC from covering Non-Default Losses with ICC contributions to default
resources or with Clearing Participant contributions to Margin, General
Guaranty Fund, or Assessments.
ii. Responsibility of Clearing Participants
Unlike Non-Default Losses, for which ICC would be solely
responsible, in the event Investment Loss Resources are insufficient to
cover an Investment Loss (an ``Investment Loss Shortfall''), ICC would
have the right, under proposed Rule 811(d), to allocate the Investment
Loss Shortfall to Clearing Participants (including any Defaulting
Participants). In that event, the Clearing Participants would be
obligated to make a contribution (an ``Investment Loss Contribution''),
based on their pro rata share of the Investment Loss Shortfall,
determined based on the methodology described below. Investment Loss
Contributions could only be applied to Investment Loss Shortfalls (and
not Custodial Loss Shortfalls). Under proposed Rule 811(e), a Clearing
Participant's pro rata Investment Loss Contribution in respect of any
event giving rise to an Investment Loss could not exceed its aggregate
Initial Margin (both house and customer) and General Guaranty Fund
contributions (its ``Participant IM/GF Contribution'').
The method for determining a Clearing Participant's Investment Loss
Contribution would depend on whether the Investment Loss occurred with
respect to the House Origin Account or Client Origin Account. In the
case of an Investment Loss in the House Origin Account, a Clearing
Participant's Investment Loss Contribution would be based on the
proportion of its Participant IM/GF Contribution as compared to the
aggregate Participant IM/GF Contributions for all Participants. In the
case of an Investment Loss in the Client Origin Account, only those
Clearing Participants that are ``Investing Participants'' (as defined
below) would be obligated to make an Investment Loss Contribution.
Specifically, each Investing Participant would be obligated to pay an
Investment Loss Contribution equal to its pro rata share of the
Investment Loss Shortfall, determined based on the proportion of its
Participant IM/GF Contribution to the aggregate Participant IM/GF
Contributions of all Investing Participants, rather than the aggregate
Participant IM/GF Contributions of all Clearing Participants (as would
be the case in the House Origin Account). In the event of simultaneous
Investment Losses for the House Origin Account and Client Origin
Account, ICC would apply available Investment Loss Resources pro rata
based on the amount of such Investment Losses. Thus, with respect to an
Investment Loss Shortfall in the Client Origin Account, only those
Clearing Participants that are Investing Participants would be required
to contribute to the shortfall, rather than all Clearing Participants,
and, moreover, each Investing Participant's pro rata share of the
shortfall would be determined by the ratio of its Participant IM/GF
Contribution to the aggregate Participant IM/GF Contributions of all
Investing Participants.
Proposed Rule 402(k) would define ``Investing Participant'' as any
Clearing Participant that (1) has instructed ICC to invest the cash
Initial Margin in its Client Origin Account or (2) is deemed to have
instructed ICC to invest the cash Initial Margin in its Client Origin
Account. As provided in proposed Rule 402(k), a Clearing Participant
would be required to instruct ICC whether ICC should invest cash
Initial Margin. If instructed to invest, ICC would invest the cash in
accordance with its Rules and investment policies procedures and
applicable law. If instructed not to invest, ICC would hold the cash in
a deposit account with a Custodian in accordance with ICC's policies
and procedures. If a Clearing Participant does not provide an
instruction, then (i) for U.S. dollar cash, the Clearing Participant
would be deemed to have instructed ICC not to invest such cash, and
(ii) for cash in other (non U.S. dollar) currencies, the Clearing
Participant would be deemed to have instructed ICC to invest such cash.
Thus, the term Investing Participant and therefore responsibility for
an Investment Loss Shortfall in the Client Origin Account would apply
to any Clearing Participant that instructs ICC to invest cash Initial
Margin or that makes no instruction with respect to cash Initial Margin
in currencies other than U.S. dollars.
Likewise, in the event that Custodial Loss Resources are
insufficient to cover a Custodial Loss (a ``Custodial Loss
Shortfall''), ICC would have the right, under proposed Rule 811(f), to
allocate the Custodial Loss Shortfall to all Clearing Participants
(including any Defaulting Participants). The proposed rule change would
give ICC the right to allocate Custodial Loss Shortfalls to Clearing
Participants in the same fashion as ICC would allocate Investment Loss
Shortfalls in the House Origin Account. In other words, each Clearing
Participant would be obligated to make a contribution based on its pro
rata share of the Custodial Loss Shortfall, determined based on the
proportion of its Participant IM/GF Contribution as compared to the
aggregate Participant IM/GF Contributions for all Participants. In the
event of a Custodial Loss where the Custodian is a central bank,
however, proposed Rule 811(f) would make the entire Custodial Loss as a
Custodial Loss Shortfall subject to allocation to Clearing Participants
(as opposed to first applying Custodial Loss Resources). As discussed
in the Notice, ICC believes such an approach is justified by the remote
nature of such a failure by a central bank and the preference among
regulators and Clearing Participants for central bank custody.\15\
Finally, as with Investment Losses, a Clearing Participant's pro rata
contribution in respect of any event giving rise to a Custodial Loss
could not exceed its Participant IM/GF Contribution.
---------------------------------------------------------------------------
\15\ Notice, 84 FR at 45195.
---------------------------------------------------------------------------
iii. Recoveries by ICC
Proposed Rule 811(l) would provide a ``reverse waterfall'' for
allocation of any recoveries ICC obtains with respect to an Investment
Loss or Custodial Loss
[[Page 11132]]
allocated to Clearing Participants. Under the proposed rule, after
deduction of expenses of ICC, ICC would provide the recoveries to the
parties that bore the loss (whether ICC, Clearing Participants, or
both) in the reverse order from which they were initially applied. The
proposed rule change would also set out ICC's obligations to seek
recoveries in respect of Investment Losses and Custodial Losses,
generally using the same degree of care as it exercises with respect to
its own assets that are not subject to allocation under proposed Rule
811.
C. Additional Changes
Proposed Rule 811(u) would contain a general disclaimer by ICC of
losses resulting from the holding, deposit, custody, transfer, or
investment of Margin, General Guaranty Fund contributions and
Assessment Contributions, except as otherwise provided in Rule 811, and
provided that Rule 811 would not limit any liability of ICC for its own
gross negligence or willful misconduct. The proposed rule change would
relatedly amend Rule 406 to remove an existing disclaimer for custodial
losses, which would be superseded by the new provisions in the proposed
rule change.
Proposed Rule 811 would also address certain procedures for notices
to Participants of the use of Investment Loss Resources and Custodial
Loss Resources and of required Loss Contributions in respect of
Investment Losses and Custodial Losses. The proposed rule would also
define the timing and manner of collection of Loss Contributions
(including through offset against obligations of ICC to return margin
or other assets), and for currency conversions as necessary. The
proposed rule would specify that the requirement to make Loss
Contributions would not reduce or otherwise affect other obligations of
a Clearing Participant to make payments or deliveries to ICC under the
Rules, or otherwise limit ICC's netting, setoff and other rights under
the Rules. In particular, the proposed rule would separate obligations
to make Loss Contributions from any obligation to make an Assessment
Contribution and would specify that the limitations on Assessments
under the Rules would not apply to liabilities for Loss Contributions.
The proposed rule would similarly explain that use of the Loss
Contribution procedures would also not be deemed to constitute an ICE
Clear Credit Default under the Rules.
Finally, proposed Rule 811 would require ICC to disclose to
Clearing Participants the amount of Custodial Loss Resources and
Investment Loss Resources at least annually, and to notify Clearing
Participants promptly following any changes in such amounts. Proposed
Rule 811 would further specify that if such loss resources are applied
as a result of a loss event, any replenishment of such resources by ICC
would not reduce the amount of any Custodian Loss Shortfall or
Investment Loss Shortfall (or resulting Loss Contributions) for that
loss event. Finally, proposed Rule 811 would explicitly limit ICC's
liability for Custodial Losses or Investment Losses to the amount of
designated Custodial Loss Resources or Investment Loss Resources, as
applicable, from time to time.
III. Statutory Standards
Section 19(b)(2)(C) of the Act directs the Commission to approve a
proposed rule change of a self-regulatory organization if it finds that
such proposed rule change is consistent with the requirements of the
Act and the rules and regulations thereunder applicable to such
organization.\16\ The Commission addresses in its review of the
proposed rule change the following relevant provisions of the Exchange
Act and the rules and regulations thereunder applicable to registered
clearing agencies:
---------------------------------------------------------------------------
\16\ 15 U.S.C. 78s(b)(2)(C).
---------------------------------------------------------------------------
Section 17A(b)(3)(D) of the Exchange Act requires, in
part, that the rules of ICC provide for the equitable allocation of
reasonable dues, fees, and other charges among its participants.\17\
---------------------------------------------------------------------------
\17\ 15 U.S.C. 78q-1(b)(3)(D).
---------------------------------------------------------------------------
Section 17A(b)(3)(F) of the Exchange Act requires, in
part, that the rules of ICC be designed to promote the prompt and
accurate clearance and settlement of securities transactions, to assure
the safeguarding of securities and funds which are in the custody or
control of ICC or for which it is responsible, and to protect investors
and the public interest.\18\
---------------------------------------------------------------------------
\18\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
Rule 17Ad-22(d)(3) under the Exchange Act requires that
ICC establish, implement, maintain and enforce written policies and
procedures reasonably designed to hold assets in a way that minimizes
risk of loss or of delay in its access to them.\19\
---------------------------------------------------------------------------
\19\ 15 U.S.C. 17Ad-22(d)(3).
---------------------------------------------------------------------------
Rule 17Ad-22(d)(8) under the Exchange act requires that
ICC establish, implement, maintain and enforce written policies and
procedures reasonably designed to have governance arrangements that are
clear and transparent to fulfill the public interest requirements in
Section 17A of the Act applicable to clearing agencies, to support the
objectives of owners and participants, and to promote the effectiveness
of ICC's risk management procedures.\20\
---------------------------------------------------------------------------
\20\ 15 U.S.C. 17Ad-22(d)(8).
---------------------------------------------------------------------------
IV. Discussion and Commission Findings
After considering the entire record, and for the reasons given
below, the Commission finds that the proposed rule change is consistent
with Section 17A(b)(3)(F) and (D) of the Act \21\ and Rules 17Ad-
22(d)(3) and 17Ad-22(d)(8) thereunder.\22\
---------------------------------------------------------------------------
\21\ 15 U.S.C. 78q-1(b)(3)(F), (D).
\22\ 17 CFR 240.17Ad-22(d)(3) and (d)(8).
---------------------------------------------------------------------------
A. Consistency With Section 17A(b)(3)(F) of the Act
Section 17A(b)(3)(F) of the Act requires, among other things, that
the rules of ICC be designed to promote the prompt and accurate
clearance and settlement of securities transactions and, to the extent
applicable, derivative agreements, contracts, and transactions, as well
as to assure the safeguarding of securities and funds which are in the
custody or control of ICC or for which it is responsible, and, in
general, to protect investors and the public interest.\23\ Based on its
review of the record, the Commission finds the proposal is consistent
with Section 17A(b)(3)(F) of the Exchange Act.
---------------------------------------------------------------------------
\23\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
The Commission believes that the proposed rule change as a whole
would help enhance ICC's ability to manage non-default losses
generally, and more specifically to continue operating as a going
concern in the event that it incurs potential operational, general
business risk, or other non-default losses by, among other things,
ensuring that ICC's Rules clearly and transparently identify, define
and address specific categories of potential non-default risks that ICC
will attempt to assess and cover. For example, ICC has assessed its
potential exposure to Investment, Custodial, and Non-Default Losses--
taking into account relevant components of the European Union capital
requirements applicable to central counterparties, including the
capital requirements for credit, counterparty, market, operational, and
legal risks--to determine an initial measure of ICC's exposure to such
risks, and has selected and set its level of Investment Loss Resources
and Custodial Loss Resources to be commensurate with those
measures.\24\ At the same time, ICC
[[Page 11133]]
proposes to designate the specific ICC resources that would be used to
cover such losses and the process for replenishing such resources
should such losses materialize. Similarly, with respect to Non-Default
Losses, ICC proposes to designate that such losses be met from
available ICC capital and other ICC assets and to prohibit the use of
ICC contributions to default resources or Clearing Participant
contributions to Margin, General Guaranty Fund, or Assessments to cover
such losses. In addition, ICC also proposes to periodically conduct
risk-based assessments of the appropriate level of ICC resources
designed to fully cover such potential losses and to reserve the
ability to adjust such resources as needed.\25\ Correspondingly, ICC
proposes to create new definitions for Investment Losses and Non-
Default Losses and the term Custodian, and modify the existing
definition of Custodial Losses to ensure consistency with the above
descriptions. The Commission did not receive any comments on these
aspects of the proposal.
---------------------------------------------------------------------------
\24\ See Notice, 84 FR at 45194.
\25\ See Id.
---------------------------------------------------------------------------
The proposed rule change would also limit ICC's liability for
Custodial Losses or Investment Losses in various ways. For example, the
proposed rule change would specify that ICC's liability for Custodial
and Investment Losses would be limited to the amount of the designated
Custodial Loss Resources or Investment Loss Resources, respectively,
and would clarify that ICC would not be liable for losses resulting
from the holding, deposit, custody, transfer, or investment of Margin,
General Guaranty Fund contributions, and Assessment Contributions,
absent ICC's own gross negligence or willful misconduct. As such, the
proposed rule change is designed to align the limitation of ICC's
liability for Custodial and Investment Losses with the amount that ICC
has determined is sufficient to fully cover its potential exposure to
such losses.
As discussed in more detail in the Notice, ICC views potential loss
scenarios where Investment or Custodial Losses could exceed applicable
ICC resources (i.e., an Investment Loss Shortfall or Custodial Loss
Shortfall), as extreme and therefore remote.\26\ Nevertheless, by
stipulating that ICC may only allocate Investment Loss Shortfalls in
the House Origin Account and Custodial Loss Shortfalls to Clearing
Participants and Investment Loss Shortfalls in the Client Origin
Account to Investing Participants (up to their Participant IM/GF
Contribution), the proposed rule change is designed to allow ICC to
plan for, and fully allocate Investment Losses and Custodial Losses
that materialize as a result of, remote and unprecedented, but
potentially extreme, loss events that could exceed ICC's designated
Investment Loss and Custodial Loss Resources.\27\ The Commission
believes that this aspect of the proposed rule change also would
enhance ICC's ability to fully cover its potential exposure to
potential Investment and Custodial Losses, including such losses that
could exceed ICC's available Investment Loss and Custodial Loss
Resources.
---------------------------------------------------------------------------
\26\ Notice, 84 FR at 45195.
\27\ Notice, 84 FR at 45193-45194. As discussed in more detail
below, one commenter expressed the belief that ICC's Clearing
Participants should not be responsible for Investment Losses and
Custodial Losses but rather ICC should ensure adequate
capitalization to address all non-default losses, including
Investment Losses and Custodial Losses. The Commission discusses and
addresses this comment below in Section 0.
---------------------------------------------------------------------------
Relatedly, the proposed rule change would enhance ICC's ability to
replenish the resources available to satisfy Investment Losses and
Custodial Losses in the event that such Losses materialize by putting
in place a process for collecting and using Loss Contributions,
defining the timing and manner of notices to Participants on the amount
and use Loss Contributions, and defining the timing and manner of
collection of Loss Contributions, which ICC could, in turn, use to
satisfy Investment Loss Shortfalls and Custodial Loss Shortfalls. The
proposed rule change also would define ICC's responsibility for, and
the standard of care it would be required to utilize in, seeking
recoveries from Investment Losses and Custodial Losses, and how ICC
would allocate such recoveries.
Finally, the Commission believes that various aspects of the
proposed rule change would help to ensure that Non-Default Losses,
Investment Losses, and Custodial Losses would not affect ICC's ability
to cover losses arising from the default of a Clearing Participant. In
particular, the proposed rule change would: (i) Specify that Loss
Contributions would not reduce or otherwise affect other obligations of
a Clearing Participant to make payments or deliveries to ICC under the
Rules, or otherwise limit ICC's netting, setoff and other rights under
the Rules; (ii) separate a Clearing Participant's obligation to make
Loss Contributions from any obligation to make an Assessment
Contribution; (iii) specify that the limitations on Assessments under
the Rules would not apply to liabilities for Loss Contributions; and
(iv) clarify that action by ICC under proposed Rule 811 (specifying
ICC's treatment of Non-Default Losses, Investment Losses, and Custodial
Losses) would not be deemed to constitute an ICE Clear Credit Default
under the Rules. The Commission believes that these provisions will
help ensure that ICC's treatment and allocation of losses not arising
from the default of a Clearing Participant do not hinder ICC's ability
to cover and fully allocate losses arising from the default of one or
more Clearing Participants.
Taken together, the Commission believes that the various components
of the proposed rule change discussed above would enhance ICC's ability
to manage the specific categories of general business risk, operational
risk, and other non-default scenarios that ICC has identified and
assessed, which in turn would reduce the risk that ICC would be
unavailable to clear and settle security-based swap transactions and
therefore is consistent with promoting prompt and accurate clearance
and settlement of such transactions. Accordingly, the Commission finds
that the proposed rule change is consistent with the requirements of
Section 17A(b)(3)(F) of the Act.\28\
---------------------------------------------------------------------------
\28\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
B. Consistency With Section 17A(b)(3)(D) of the Act
Section 17A(b)(3)(D) of the Act requires that the rules of ICC
provide for the equitable allocation of reasonable dues, fees, and
other charges among its participants.\29\ As discussed below, based on
its review of the record, the Commission finds that ICC's proposed rule
change--as relevant here, the proposal to allocate Investment Losses
and Custodial Losses to Clearing Participants in the event that such
Losses exceed ICC's Investment Loss and Custodial Loss Resources--is
consistent with Section 17A(b)(3)(D) of the Exchange Act.\30\
---------------------------------------------------------------------------
\29\ 15 U.S.C. 78q-1(b)(3)(D).
\30\ Id.
---------------------------------------------------------------------------
As noted, the purpose of the proposed rule change as a whole is to
ensure that ICC has resources sufficient to recover operations and
continue as a going concern in the vent that it incurs non-default
losses. To that end, as discussed above, ICC has assessed its potential
exposure to Investment, Custodial, and Non-Default Losses--taking into
account relevant components of the European Union capital requirements
applicable to central counterparties, including the capital
requirements for credit, counterparty, market,
[[Page 11134]]
operational, and legal risks \31\--and designated specific ICC
resources in the form of $20 million in Investment Loss Resources and
$32 million in Custodial Loss Resources that ICC believes should be
sufficient to cover such potential Losses. The Commission did not
receive any comments on this aspect of the proposed rule change. Based
on our review of the record, the Commission believes that ICC's efforts
to determine its reasonable potential exposure to Investment and
Custodial Losses are reasonable.
---------------------------------------------------------------------------
\31\ See Notice, 84 FR at 45194.
---------------------------------------------------------------------------
As discussed above, the proposed rule change would make ICC's
Clearing Participants responsible for any amount of Investment Losses
and Custodial Losses beyond ICC's contributions of $20 million and $32
million respectively, and solely responsible for any amount of
Custodial Loss where the Custodian is a central bank. ICC views the
potential risk of such Losses as remote, but intends this aspect of the
proposed rule change as necessary to allow it to ``plan for remote and
unprecedented, but potentially extreme, types of loss event[s] . . . .
'' \32\
---------------------------------------------------------------------------
\32\ Notice, 84 FR at 45194.
---------------------------------------------------------------------------
One commenter, the Futures Industry Association (``FIA''),
submitted a comment letter generally expressing the belief that ICC's
Clearing Participants should not be responsible for Investment Losses
and Custodial Losses but rather ICC should ensure adequate
capitalization to address all non-default losses, including Investment
Losses and Custodial Losses.\33\ The FIA suggests this is appropriate
because it believes that Investment Losses and Custodial Losses are
under the exclusive control and governance of ICC.\34\ As evidence, the
FIA points to ICC's investment policy and its relationships with, and
oversight of, Custodians, which the FIA maintains are determined and
approved by ICC without the involvement of Clearing Participants.\35\
In support of its argument the FIA also contends that ``participants
are provided with a specified return on collateral posted and do not
directly receive the gain from ICC's investment of funds.'' \36\
---------------------------------------------------------------------------
\33\ See letter from Jacqueline Mesa, Chief Operating Officer &
Senior Vice President of Global Policy, Futures Industry
Association, dated September 18, 2019, to Vanessa Countryman,
Secretary, Commission (``FIA Letter'') at 2.
\34\ FIA Letter at 2.
\35\ FIA Letter at 1, 2.
\36\ FIA Letter at 1.
---------------------------------------------------------------------------
ICC disputes the FIA's characterization and offers, as evidence,
the regulations applicable to ICC as a registered clearing agency.\37\
ICC maintains that these regulations dictate how ICC may invest Margin
and Guaranty Fund assets, by requiring that ICC hold such assets in a
manner that minimizes the risk of loss or delay in access and only
invest in instruments and counterparties with minimal credit, market
and liquidity risk.\38\ ICC further explains that its investment and
custodial policies are reviewed and approved by ICC's Risk Committee,
which is made up predominantly of representatives of ICC's Clearing
Participants, and ICC's Board of Managers, which includes
representatives of Clearing Participants.\39\ Similarly, ICC represents
that ICC's procedures for the monitoring of ICC's Custodians,
investment counterparties and depositories, are subject to review by
ICC's Risk Committee.\40\ In response to the FIA's contention that
participants are provided with a specified return on collateral posted,
ICC asserts that the majority of the investment yield and depository
interest received related to such custodial and investment activity is
credited to Clearing Participants and therefore ICC effectively acts as
an agent for the Clearing Participants and their clients.\41\ Thus, ICC
maintains that, in taking custody and investing Margin and Guaranty
Fund assets, ICC essentially is acting on behalf of Clearing
Participants.\42\
---------------------------------------------------------------------------
\37\ See letter from Stanislav Ivanov, President, ICC, dated
October 15, 2019, to Vanessa Countryman, Secretary, Commission
(``ICC Letter'') at 1.
\38\ ICC Letter at 1.
\39\ ICC Letter at 2.
\40\ ICC Letter at 2.
\41\ ICC Letter at 2.
\42\ ICC Letter at 2.
---------------------------------------------------------------------------
Based on our review of the record, the Commission does not agree
with the FIA's characterization of Investment Losses and Custodial
Losses as under the exclusive control and governance of ICC. As an
initial matter, the Commission notes that ICC's ability to invest
Margin and Guaranty Fund assets is subject to the requirements of
Exchange Act Rule 17Ad-22(d)(3), which requires that ICC``[h]old assets
in a manner that minimizes risk of loss or of delay in its access to
them; and invest assets in instruments with minimal credit, market and
liquidity risks.'' \43\ Moreover, ICC invests pursuant to its policies
and procedures, which must be filed with and approved by the Commission
pursuant to Section 19(b)(1) of the Exchange Act \44\ and Rule 19b-4
thereunder,\45\ and which, once approved, ICC must comply with under
Section 19(g) \46\ of the Exchange Act.\47\ Specifically, under ICC
Rule 502, ICC may not modify its policies and procedures regarding
investment of Initial Margin and Guaranty Fund assets without
consulting the Risk Committee,\48\ and under ICC Rule 503, a majority
of the Risk Committee consists of representatives of Clearing
Participants.\49\ Taken together, in the Commission's view, these
factors limit how and where ICC may invest its Clearing Participants'
Initial Margin and Guaranty Fund assets.
---------------------------------------------------------------------------
\43\ 17 CFR 240.17Ad-22(d)(3).
\44\ 15 U.S.C. 78s(b)(1).
\45\ 17 CFR 240.19b-4.
\46\ 15 U.S.C. 78s(g).
\47\ See, e.g., Exchange Act Release No. 87859 (Dec. 26, 2019);
85 FR 157 (Jan. 2, 2020) (SR-ICC-2019-012); Exchange Act Release No.
84312 (Sep. 28, 2018); 83 FR 50124 (Oct. 4, 2018) (SR-ICC-2018-009);
Exchange Act Release No. 78566 (Aug. 12, 2016); 81 FR 55254 (Aug.
18, 2016) (SR-ICC-2016-009); Exchange Act Release No. 76733 (Dec.
22, 2015); 80 FR 81384 (Dec. 29, 2015) (SR-ICC-2015-017); Exchange
Act Release No. 74456 (Mar. 6, 2015); 80 FR 13055 (Mar. 12, 2015)
(SR-ICC-2015-002); Exchange Act Release No. 72762 (Aug. 5, 2014); 79
FR 46896 (Aug. 11, 2014) (SR-ICC-2014-12).
\48\ See ICC Rule 502(b) and (c) (``ICE Clear Credit shall not
take nor permit to be taken any of the following actions without
prior consultation with the Risk Committee . . . Modify the ICE
Provisions that relate to . . . the application, or the use,
rehypothecation or investment, of Margin and . . . Modify the ICE
Provisions that relate to . . . the use, rehypothecation or
investment of Collateral on deposit in the General Guaranty Fund . .
. .'').
\49\ See ICC Rule 503(a) regarding appointment of nine
Participant Appointees.
---------------------------------------------------------------------------
The FIA also states its belief that ICC has a duty of care to its
clearing members and that ICC should not be able to pass through losses
that are within the sole control of ICC.\50\ As an initial matter, with
respect to the FIA's assertion that ICC owes Clearing Participants a
duty of care, the Commission notes that ICC is subject to the
requirements of Section 17A(b)(3)(F) of the Act, which requires that
ICC's Rules be designed to, among other things, assure the safeguarding
of securities and funds which are in ICC's custody or control or for
which it is responsible,\51\ as well as the requirements of Rule 17Ad-
22(d)(3), which requires ICC to establish, implement, maintain, and
enforce written policies and procedures reasonably designed to hold
assets, including Clearing Participants' securities and funds, in a way
that minimizes risk of loss or of delay in its access to them, and to
invest assets in instruments with minimal credit, market, and liquidity
risks.\52\ As discussed in more detail below, the Commission believes
that ICC's proposal is consistent with these
[[Page 11135]]
requirements. Further, as discussed above, in the Commission's view,
where and how ICC may invest Margin and Guaranty Fund assets is subject
to applicable Exchange Act requirements and Rules and ICC's own Rules,
and therefore the Commission does not agree with the FIA's
characterization of Investment Losses and Custodial Losses as under the
exclusive control and governance of ICC.
---------------------------------------------------------------------------
\50\ FIA Letter at 2.
\51\ 15 U.S.C. 78q-1(b)(3)(F).
\52\ 17 CFR 240.17Ad-22(d)(3).
---------------------------------------------------------------------------
Finally, the FIA states that it ``is unclear . . . why ICC's own
funds would not be used first'' in case of a Custodial Loss resulting
from a central bank acting as Custodian.\53\ In response, ICC points to
international standards, which encourage clearing houses to fully
utilize central bank services.\54\ Moreover, as ICC explained in the
Notice, ``[w]ith respect to Custodial Losses arising from a central
bank custodial failure, ICC believes that such a scenario is extremely
remote, and entirely outside of its control.'' \55\ The Commission
recognizes ICC's point that clearing agencies may be encouraged in
various ways to utilize central bank services when available and
believes that ICC's position that a scenario involving Custodial Losses
arising from a central bank custodial failure could be extremely remote
is reasonable, and on that basis finds ICC's view on this point
compelling.\56\ Accordingly, the Commission believes that ICC's
proposal to allocate to Clearing Participants all Custodial Losses
arising from a central bank acting as custodian without first utilizing
ICC's Loss Resources is reasonable.
---------------------------------------------------------------------------
\53\ FIA Letter at 2.
\54\ ICC Letter at 1.
\55\ Notice, 84 FR at 45195.
\56\ ICC Letter at 1.
---------------------------------------------------------------------------
In the Commission's view, because ICC uses Initial Margin and
Guaranty Fund assets to manage the risks associated with clearing
security-based swap transactions, it is vital to the ongoing operation
of ICC that ICC have the ability to quickly replenish any Margin and
Guaranty Fund assets depleted by Investment Losses and Custodial
Losses. Based on its review of the record, the Commission finds the
specific allocation of the Investment Losses and Custodial Losses that
could potentially result from the investment of such assets between ICC
and its Clearing Participants to be reasonable because ICC would be
assuming liability commensurate with the risks associated to it with
investment of the Margin and Guaranty Fund assets. As discussed above,
ICC has assessed its potential exposure to Investment, Custodial, and
Non-Default Losses--taking into account relevant components of the
European Union capital requirements applicable to central
counterparties, including the capital requirements for credit,
counterparty, market, operational, and legal risks--to determine an
initial measure of ICC's exposure to such risks, and has selected and
set its level of Investment Loss, Custodial Loss, and Non-Default Loss
Resources to be commensurate with those measures.\57\ As noted above,
based on its review of the record, the Commission believes that ICC's
efforts to determine its reasonable potential exposure to Investment
and Custodial Losses are reasonable. At the same time, ICC proposes to
designate the specific ICC resources that would be used to cover such
losses and the process for replenishing such resources should such
losses materialize. In addition, ICC also proposes to periodically
conduct risk-based assessments of the appropriate level of ICC
resources designed to fully cover such potential losses and to reserve
the ability to adjust such resources as needed.\58\ It would only be in
the event that ICC incurred Investment or Custodial Losses that exceed
ICC's Investment Loss or Custodial Loss Resources--an eventuality that
ICC views as remote--that ICC would have the discretion to require
Clearing Participants to make an Investment Loss Contribution or
Custodial Loss Contribution. And, as noted above, in that event each
Clearing Participant's Loss Contribution could not exceed that Clearing
Participant's IM/GF Contribution. In the Commission's view, ICC's
proposal to use its own resources to absorb Investment and Custodial
Losses up to the amounts that ICC has determined represent reasonable
assessments of such potential Losses, and to allocate Investment and
Custodial Losses to Clearing Participants on a pro rata basis based on
relevant Initial Margin and Guaranty Fund assets only in the event that
such Losses exceed ICC's Resources, represents an appropriate and
reasonable allocation of potential contingent non-default losses to
Clearing Participants.
---------------------------------------------------------------------------
\57\ See Notice, 84 FR at 45194.
\58\ See Id.
---------------------------------------------------------------------------
Finally, as discussed above, the proposed rule change would
allocate Investment Losses and Custodial Losses to Clearing
Participants based on their participation in the investment of cash
Initial Margin and their share of the total Initial Margin and Guaranty
Fund assets. Moreover, each Clearing Participant's liability for an
Investment Loss or Custodial Loss exceeding ICC's initial contributions
could not exceed that Participant's aggregate contributions to the
Guaranty Fund and the Initial Margin provided by the Participant, for
both the House Origin Account and Client Origin Account. The Commission
believes this allocation is equitable because it would distribute the
losses based on each Clearing Participant's share of the Margin and
Guaranty Fund assets that were depleted by the Investment Losses and
Custodial Losses, and each Clearing Participant's liability could not
exceed the total amount it contributed to Margin and the Guaranty Fund.
Thus, the Commission believes this should help to ensure that Clearing
Participants only contribute to the recovery from such losses in
amounts commensurate with their contribution to Margin and Guaranty
Fund assets in the first instance. Finally, in limiting the allocation
of Investment Losses in the Client Origin Account to those Clearing
Participants that have instructed, or are deemed to have instructed,
ICC to invest cash Initial Margin, the Commission believes that the
proposed rule change would help to ensure that only those Clearing
Participants that have participated in an investment would contribute
to the recovery of losses suffered on that investment.
For the reasons discussed above, the Commission believes that the
proposed rule change is consistent with the requirement that ICC's
rules provide for the equitable allocation of fees. Accordingly, the
Commission finds that the proposed rule change is consistent with the
requirements of Section 17A(b)(3)(D) of the Act.\59\
---------------------------------------------------------------------------
\59\ 15 U.S.C. 78q-1(b)(3)(D).
---------------------------------------------------------------------------
C. Consistency With Rule 17Ad-22(d)(3)
Rule 17Ad-22(d)(3) requires that ICC establish, implement, maintain
and enforce written policies and procedures reasonably designed to hold
assets in a way that minimizes risk of loss or of delay in its access
to them.\60\ The Commission believes that, in specifying that Clearing
Participants must instruct ICC whether to invest cash Initial Margin in
a Client Origin Account and that without an instruction to invest, ICC
would (i) not invest US dollar cash and (ii) invest cash in other
currencies in accordance with its rules and procedures, the proposed
rule change would provide a procedure reasonably designed for ICC to
hold cash Initial Margin in a Client Origin Account that minimizes risk
of loss and of delay in access to such cash Initial Margin.
---------------------------------------------------------------------------
\60\ 15 U.S.C. 17Ad-22(d)(3).
---------------------------------------------------------------------------
[[Page 11136]]
Further, in limiting the allocation of Investment Losses in the
Client Origin Account to those Clearing Participants that have
instructed, or are deemed to have instructed, ICC to invest cash
Initial Margin in the Client Origin Account, the Commission believes
that the proposed rule change would help to minimize risk of loss and
of delay in access to cash Initial Margin by providing a means for
Clearing Participants to opt out responsibility for Investment Losses
with respect to the Client Origin Account.
Accordingly, the Commission finds that the proposed rule change is
consistent with the requirements of Rule 17Ad-22(d)(3).\61\
---------------------------------------------------------------------------
\61\ 15 U.S.C. 17Ad-22(d)(3).
---------------------------------------------------------------------------
D. Consistency With Rule 17Ad-22(d)(8)
Rule 17Ad-22(d)(8) requires that ICC establish, implement, maintain
and enforce written policies and procedures reasonably designed to have
governance arrangements that are clear and transparent to fulfill the
public interest requirements in Section 17A of the Act applicable to
clearing agencies, to support the objectives of owners and
participants, and to promote the effectiveness of ICC's risk management
procedures.\62\
---------------------------------------------------------------------------
\62\ 15 U.S.C. 17Ad-22(d)(8).
---------------------------------------------------------------------------
The Commission believes that the proposed rule change, in providing
that the ICC Board could modify the amount of Investment Loss Resources
and Custodial Loss Resources from time to time, and specifying that
such determination would be risk-based in light of ICC's potential
exposure to such losses, would establish clear and transparent
governance arrangements for determining the amount of such resources.
Accordingly, the Commission finds that the proposed rule change is
consistent with the requirements of Rule 17Ad-22(d)(8).\63\
---------------------------------------------------------------------------
\63\ 15 U.S.C. 17Ad-22(d)(8).
---------------------------------------------------------------------------
V. Accelerated Approval of the Proposed Rule Change, as Modified by
Partial Amendment No. 1 and Partial Amendment No. 2
The Commission finds good cause, pursuant to Section 19(b)(2) of
the Act,\64\ to approve the proposed rule change prior to the 30th day
after the date of publication of Partial Amendment No. 2 in the Federal
Register. As discussed above, Partial Amendment No. 2 modifies the
initial proposed rule change to (1) differentiate the treatment of
Investment Losses in the Client Origin Account from the treatment of
Investment Losses in the House Origin Account and (2) limit the
allocation of Investment Losses to those Clearing Participants that
have instructed, or are deemed to have instructed, ICC to invest cash
Initial Margin in the Client Origin Account. In so doing, Partial
Amendment No. 2 provides for a more clear and comprehensive
understanding of the treatment of Investment Losses and the impact of
the proposed rule change on Clearing Participants, which helps to
improve the Commission's review of the proposed rule change for
consistency with the Act.
---------------------------------------------------------------------------
\64\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------
For similar reasons as discussed above, the Commission finds that
Partial Amendment No. 2 is designed to help assure the prompt and
accurate clearance and settlement of securities transactions and the
safeguarding of securities and funds which are in the custody or
control of ICC, consistent with Section 17A(b)(3)(F) of the Act,\65\
and the equitable allocation of reasonable dues, fees, and other
charges among ICC's Clearing Participants, consistent with the Section
17A(b)(3)(D) of the Act.\66\ Accordingly, the Commission finds good
cause for approving the proposed rule change, as modified by Partial
Amendment No. 2, on an accelerated basis, pursuant to Section 19(b)(2)
of the Exchange Act.\67\
---------------------------------------------------------------------------
\65\ 15 U.S.C. 78q-1(b)(3)(F).
\66\ 15 U.S.C. 78q-1(b)(3)(D).
\67\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------
VI. Conclusion
On the basis of the foregoing, the Commission finds that the
proposed rule change, as modified by Partial Amendment No. 1 and
Partial Amendment No. 2, is consistent with the requirements of the
Act, and in particular, with the requirements of Section 17A(b)(3)(F)
and (D) of the Act \68\ and Rules 17Ad-22(d)(3) and (d)(8)
thereunder.\69\
---------------------------------------------------------------------------
\68\ 15 U.S.C. 78q-1(b)(3)(F), (D).
\69\ 17 CFR 240.17Ad-22(d)(3) and (d)(8).
---------------------------------------------------------------------------
It is therefore ordered pursuant to Section 19(b)(2) of the Act
\70\ that the proposed rule change, as modified by Partial Amendment
No. 1 and Partial Amendment No. 2 (SR-ICC-2019-010), be, and hereby is,
approved on an accelerated basis.\71\
---------------------------------------------------------------------------
\70\ 15 U.S.C. 78s(b)(2).
\71\ 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.\72\
---------------------------------------------------------------------------
\72\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2020-03775 Filed 2-25-20; 8:45 am]
BILLING CODE 8011-01-P