[Federal Register Volume 88, Number 50 (Wednesday, March 15, 2023)]
[Notices]
[Pages 16040-16042]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-05271]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-97100; File No. SR-LCH SA-2023-001]


Self-Regulatory Organizations; LCH SA; Order Approving Proposed 
Rule Change Relating to the Liquidity Risk Model Framework

March 9, 2023.

I. Introduction

    On January 4, 2023, 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 (the ``Proposed Rule Change'') to 
amend its Liquidity Risk Modelling Framework (the ``Framework''). The 
Proposed Rule Change was published for comment in the Federal Register 
on January 24, 2023.\3\ The Commission has not received any comments on 
the Proposed Rule Change. For the reasons discussed below, the 
Commission is approving the Proposed Rule Change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 96694 (Jan. 18, 2023), 
88 FR 4227 (Jan. 24, 2023) (File No. SR-LCH-2023-001) (``Notice'').
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II. Description of the Proposed Rule Change

    LCH SA is a clearing agency registered with the Commission for the 
purpose of clearing security-based swaps (also known as credit-default 
swaps or ``CDS''). LCH SA provides clearing services for eligible CDS 
contracts, including both European and US Indices and Single Names 
Index constituents, and clearing services for eligible options on 
European Index CDS. In offering clearing services for these CDS 
contracts, LCH SA acts as a central counterparty (``CCP''). Being a CCP 
means that LCH SA, in clearing a trade, becomes a counterparty to, and 
responsible for, the corresponding trade obligations arising from the 
original bilateral trade between its clearing members. In other words, 
as a CCP, LCH SA acts functionally as the buyer to every seller and the 
seller to every buyer.
    As a CCP providing clearing services, LCH SA is subject to 
liquidity risk in that it may not have enough cash in the relevant 
currency to meet its payment obligations when they become due, in 
particular upon the default of a clearing member. For example, LCH SA 
would be unable to make a payment in United States Dollars (``USD'') 
if, at the time the payment were due, all of LCH SA's resources were 
held in securities or British Pounds Sterling. To comprehensively 
measure, monitor, and manage its liquidity risk, LCH SA has 
established, among other policies and procedures, \4\ the Framework.
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    \4\ For example, as described in the Notice, LCH SA, as a 
subsidiary of LCH Group, manages its liquidity risk pursuant to, 
among other policies and procedures, the LCH Group Liquidity Risk 
Policy and the LCH Group Liquidity Plan. Id. at 4228.
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    The Framework supports LCH SA's management of liquidity risk by 
identifying LCH SA's sources of liquidity and corresponding liquidity 
risks, identifying LCH SA's liquidity requirements with respect to its 
members and its interoperable central counterparty,\5\ describing the 
metrics and limits that LCH SA monitors, and describing the scenarios 
under which these metrics are computed.\6\
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    \5\ LCH SA has an interoperability agreement with Cassa di 
Compensazione e Garanzia (``CC&G''), an Italian CCP, pursuant to 
which LCH SA's clearing members and CC&G's clearing members are able 
to benefit from common clearing services without having to join the 
other CCP. Each CCP is a clearing member of the other one with a 
particular status when accessing the clearing system of the other 
counterparty.
    \6\ For additional information regarding the Framework, see 
Self-Regulatory Organizations; LCH SA; Order Approving Proposed Rule 
Change Relating to Liquidity Risk Management, Exchange Act Release 
No. 83691 (July 24, 2018), 83 FR 36635 (July 30, 2018) (SR-LCH SA-
2018-003).
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    Broadly, the Proposed Rule Change seeks to amend the Framework in 
four ways: (1) more accurately describe how LCH SA currently manages 
its liquidity requirements and operational target \7\ calculation when 
there is a scheduled reduction to LCH SA's Default Fund \8\ or when LCH 
SA needs to provide an extraordinary liquidity injection to facilitate 
settlement of transactions during a business day; (2) reflect changes 
to two of LCH SA's committed credit lines; (3) add a list of LCH SA's 
existing options to address default situations in which there is a 
liquidity shortfall in a currency different from EUR; \9\ and (4) make 
two changes relating to LCH SA's existing processes for injecting 
liquidity in the settlement system to ease settlement flow at 
International Central Securities Depositories (``ICSDs''). Each of 
these proposed changes is discussed in turn below.
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    \7\ The operational target ``represents the amount of liquidity 
to be held to satisfy the liquidity needs related to the operational 
management of the CCP in a stressed environment that does not lead 
to a member's default.'' Notice, 88 FR at 4228, n.6.
    \8\ LCH SA maintains a Default Fund for its CDS clearing 
service. The Default Fund consists of financial resources that LCH 
SA can use to cover losses in the event of a default by a clearing 
member, in accordance with its rules and procedures. LCH SA requires 
clearing members to contribute to the Default Fund, and Article 
4.4.1.3 of the LCH SA CDS Clearing Rulebook explains how LCH SA 
determines the amount of each clearing member's contribution. 
Generally, LCH SA calculates the amount of the Default Fund and each 
clearing member's contribution thereto each month. If a clearing 
member's contribution decreases for a given month, LCH SA could be 
obligated to return cash to that clearing member in the amount of 
the reduction in its contribution. Such a return of cash to a 
clearing member would decrease the amount of liquidity available to 
LCH SA.
    \9\ As described below, LCH SA did not propose adopting new 
authorities, but rather, specified existing options to conform the 
Framework to the LCH SA Liquidity Plan and the LCH SA CDS Clearing 
Rulebook. See LCH SA CDS Clearing Rule Book Chapter 3 Article 
1.3.1.7, Appendix 1 Article 8.2, Appendix 1 Article 8.10.
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A. Liquidity Requirements and Operational Target

    Based on a recommendation from its independent risk model 
validation department, LCH SA proposes to amend the Framework to 
address more fully its liquidity requirements in the event of a Default 
Fund scheduled reduction or an extraordinary intraday liquidity 
injection in the settlement platform.
    A Default Fund scheduled reduction refers to an instance where LCH 
SA returns Default Fund contributions to its clearing members. As 
background, at the start of each month, LCH SA determines the amount of 
its Default Fund according to its internal procedures.\10\ If the new 
amount for a given clearing member is lower than the current amount, 
then LCH SA will return the appropriate difference to that clearing 
member. Before a Default Fund

[[Page 16041]]

reduction takes place, a latency period occurs between the final 
approval of the new Default Fund amount and the settlement of the new 
contributions. LCH SA is proposing changes to the Framework in order to 
properly reflect the Default Fund reduction in the operational target 
calculation until the settlement of the new contributions occurs.\11\
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    \10\ Notice, 88 FR at 4228, n.8.
    \11\ Id. at 4228.
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    In the Framework, LCH SA proposes additional text to describe 
enhancements to the operational target calculation. The additional 
content includes (1) a statement that the Default Fund recomputed is 
compared to the Default Fund actually paid and in the account of LCH 
SA, (2) a description of the reported amount of the Default Fund, 
including adjustments made to the calculation of the operational 
target, and (3) a detailed description of the operational steps in the 
calculation.
    Moreover, LCH SA proposes to make conforming changes to another 
section of the Framework to reflect the significance of a Default Fund 
reduction. The Framework currently lists five different reasons for LCH 
SA's operational liquidity needs, including repayment of excess cash 
and non-cash collateral to members, the substitution of cash collateral 
upon members' request, and LCH SA's provision of liquidity to 
facilitate settlement, among others. LCH SA proposes to add the planned 
reduction of Default Fund amounts as another reason for its operational 
liquidity needs.
    LCH SA also proposes various Framework changes to more fully 
address the impact of intraday liquidity injections into the settlement 
platform. According to LCH SA, when volumes in the settlement platform 
are particularly high, additional liquidity may need to be injected 
during the day to ensure the smooth function of the settlement 
flows.\12\
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    \12\ Id. at 4228, n.9.
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    The Proposed Rule Change would add governance details regarding the 
provision of intraday liquidity injections. In particular, the Proposed 
Rule Change would add language to note that LCH SA has delegated to its 
Fixed Income Operations team authority to provide up to one billion 
euros in additional liquidity intraday for settlement. LCH SA's Chief 
Risk Officer and Head of Collateral and Liquidity Management, or their 
delegates, would need to approve any intraday amounts greater than one 
billion euros.\13\
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    \13\ An injection of more than $1 billion euro would also 
trigger certain internal reporting requirements.
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    LCH SA proposes changes to the Framework that would require the 
recalculation of LCH SA's operational liquidity target in response to 
an intraday injection of more than 1 billion euros. The Framework does 
not currently take into consideration extraordinary liquidity 
injections in the settlement system in the daily operational target 
calculation.
    In addition, LCH SA proposes to add a footnote to provide 
additional context for LCH SA's provision of liquidity in order to 
facilitate settlement.\14\ The proposed footnote would indicate that 
the provision of liquidity to facilitate settlement includes both 
beginning-of-day liquidity injections as well as intraday injections 
above one billion euros.
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    \14\ See Article 1.3.3.5 of LCH SA's rules (stating that ``LCH 
SA ensures the delivery of Securities or the payment of cash, in 
accordance with the Clearing Rule Book . . .''). Further, LCH SA 
injects liquidity in the settlement platforms or lodges non-cash 
collateral at ICSDs to facilitate settlement, including fails. LCH 
SA handles these injections since they represent one of the main 
intraday liquidity needs for the CCP. See LCH SA Liquidity Risk 
Modelling Framework Section 4.2.1.4.
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B. Committed Credit Lines

    As part of its liquidity resources, LCH SA maintains different 
credit lines that it can draw upon as needed to obtain liquid financial 
resources.\15\ LCH SA proposes changes to the Framework to reflect that 
(1) one such credit line, with KAS Bank to cover non-euro variation 
margin payments for listed derivatives activity, is no longer active, 
and (2) LCH SA has established a flexible, intraday credit line with 
Norges Bank to cover non-euro variation margin payments for listed 
derivatives activity. Specifically, LCH SA proposes to update the 
Framework to delete outdated references to the KAS Bank credit line and 
add references to the Norges Bank credit line.
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    \15\ For example, LCH SA has a multi-currency overdraft facility 
of [euro]10 million with an international bank and a secured, 
committed, intraday credit line with a different bank. Notice, 88 FR 
at 4229.
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C. Liquidity Shortfall Options

    LCH SA's Liquidity Plan and CDS Clearing Rulebook identify and 
define a set of tools, or options, that LCH SA can utilize to address a 
Clearing Member default that leads to a liquidity shortfall in a 
currency different from EUR, including the following:
     Non-euro cash deposited as collateral;
     The sale of the non-euro securities of the defaulting 
member;
     Bilateral repo transactions (non-euro cash taker and non-
euro collateral giver);
     Cross-currency bilateral repo (non-euro cash taker and 
euro collateral giver);
     Cross-currency triparty repo (non-euro cash taker and euro 
collateral giver);
     LCH SA's multicurrency overdraft facility with an 
International Bank;
     FX spot market transactions;
     ECB weekly tender in USD (last resort); and
     Replacing LCH SA's liabilities in non-euros by euros as 
per clearing rulebook.\16\
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    \16\ See LCH SA CDS Clearing Rule Book Chapter 3 Article 
1.3.1.7, Appendix 1 Article 8.2, Appendix 1 Article 8.10; see LCH SA 
Liquidity Plan Section 6.2.2.2.
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    Currently, the Framework does not identify these tools as the 
options LCH SA has to address default situations in which there is a 
liquidity shortfall in a currency different from EUR. The Proposed Rule 
Change would update the Framework to include the list of tools that LCH 
SA may use.

D. Injection of Liquidity To Ease Settlement Flow

    The current Framework describes LCH SA's requirements and process 
for injecting liquidity into settlement platforms of various ICSDs to 
facilitate settlement related to certain sovereign debt, such as 
French, Spanish, German, Belgian, and Italian debt. It includes a table 
that describes the settlement platforms, the debt activities covered by 
those settlement platforms, and an associated maximum level of 
liquidity. LCH SA is proposing two specific changes to this portion of 
the Framework. First, LCH SA proposes to reduce the maximum level of 
liquidity to be injected daily in the settlement system to ease 
settlement flow at an Italian ICSD. This change is being proposed to 
ensure the maximum level of liquidity specifically related to Italian 
debt is appropriate given actual settlement activity related to Italian 
debt observed by LCH SA's Operations Team. Second, LCH SA proposes to 
include additional text to specify the dates of its most recent tests 
to successfully transfer securities related to settlement for Italy, 
Spain, Germany, and Belgium transactions.

III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act requires 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

[[Page 16042]]

the organization.\17\ For the reasons given below, the Commission finds 
that the Proposed Rule Change is consistent with Section 17A(b)(3)(F) 
of the Act \18\ and Rule 17Ad-22(e)(7) thereunder.\19\
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    \17\ 15 U.S.C. 78s(b)(2)(C).
    \18\ 15 U.S.C. 78q-1(b)(3)(F).
    \19\ 17 CFR 240.17Ad-22(e)(7).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Under Section 17A(b)(3)(F) of the Act, LCH SA's rules, among other 
things, must be ``designed to promote the prompt and accurate clearance 
and settlement of . . . derivative agreements, contracts, and 
transactions . . . .'' \20\ Based on its review of the record, and for 
the reasons discussed below, the Commission believes that LCH SA's 
changes are consistent with Section 17A(b)(3)(F) of the Act because 
they contribute to LCH SA's management of its liquidity risk.
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    \20\ 15 U.S.C. 78q-1(b)(3)(F).
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    LCH SA relies on the Framework to support its management of 
liquidity risk arising from a potential member default, default of 
CC&G, and operational liquidity requirements. Managing such risks, such 
as through the maintenance of liquid resources sufficient to meet 
payment obligations, reduces the likelihood that LCH would fail to make 
payments when due, thereby avoiding disruptions to the settlement of 
transactions for which such payments are due. Thus, the Framework, as a 
rule of LCH SA, supports the prompt and accurate clearance and 
settlement of the derivatives transactions LCH SA clears, including 
security-based swaps.
    Certain of the changes LCH SA proposes would update and clarify 
existing aspects of the Framework. These include changes meant to 
accurately portray LCH SA's banking relationships, changes describing 
the options LCH SA has to address default situations in which there is 
a liquidity shortfall in a currency different from EUR, and changes 
reflecting that LCH SA has successfully tested the transfer of 
securities coming from settlement for Italy, Spain, Germany, and 
Belgium transactions. These updates and clarifications contribute to 
the effectiveness of the Framework as a tool supporting LCH SA's 
management of liquidity risk arising from a potential member default, 
default of CC&G, and operational liquidity requirements, which 
facilitates prompt and accurate clearance and settlement.
    LCH SA proposes changes designed to control and more accurately 
quantify LCH SA's liquidity risk with regard to its operational 
liquidity needs, including changes to the Framework that would take 
into account decreases in the Default Fund, adding arrangements 
governing how extraordinary intraday liquidity injections are approved 
and considered in the operational target, and updating the maximum 
level of liquidity to be injected daily in the settlement system to 
ease settlement flow for ICSDs. Control over and accurate measurement 
of liquidity risk is necessary to ensure that LCH SA's exposure does 
not exceed its resource so that LCH SA can meet its payment obligations 
on time without disrupting settlement. Thus, these changes promote 
prompt and accurate clearance and settlement.
    The Commission believes, therefore, that the Proposed Rule Change 
is consistent with the requirements of Section 17A(b)(3)(F) of the 
Act.\21\
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    \21\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(7) Under the Act

    Rule 17Ad-22(e)(7) requires covered clearing agencies to establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to measure, monitor, and manage the liquidity risk 
that arises in or is borne by the covered clearing agency.\22\ In 
adopting Rule 17Ad-22(e)(7), the Commission provided guidance that a 
covered clearing agency should consider in establishing and maintaining 
policies and procedures that address liquidity risk. Specifically, the 
Commission stated that a covered clearing agency should generally 
consider whether it has a robust framework to manage its liquidity 
risks from its participants and other entities.\23\
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    \22\ 17 CFR 240.17Ad-22(e)(7).
    \23\ Securities Exchange Act Release No. 78961 (Sept. 28, 2016), 
81 FR 70786, 70823 (Oct. 13, 2016) (File No. S7-03-14).
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    LCH SA proposes changes that would make the Framework more robust 
by broadening the description of potential sources of liquidity risk 
and describing internal processes governing when prior approval must be 
obtained for an intraday liquidity injection. For example, LCH SA 
proposes to expand the list of actions that may cause liquidity needs 
to arise, and would adjust how LCH SA considers decreases in the 
Default Fund and intraday liquidity injections with regard to its 
operational target. These proposed changes would provide LCH SA with a 
more accurate understanding of both its liquidity needs and its 
operational target. LCH SA's increased ability to measure its liquidity 
risk due to these changes makes the Framework more robust. 
Additionally, as noted above, LCH SA proposes changes that would 
describe internal processes governing when prior approval must be 
obtained for an intraday liquidity injection. These changes provide for 
stronger internal controls regarding liquidity risk management. The 
Commission believes that the proposed changes to LCH SA's Framework 
described in Section II A above are consistent with Rule 17Ad-22(e)(7) 
because they are strengthening changes to the Framework and thus 
support LCH SA's ability to measure, monitor, and manage its liquidity 
risk.
    The Commission believes, therefore, that the Proposed Rule Change 
is consistent with the requirements of Rule 17Ad-22(e)(7) under the 
Act.\24\
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    \24\ 17 CFR 240.17Ad-22(e)(7).
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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, Section 17A(b)(3)(F) of the Act \25\ and Rule 17Ad-
22(e)(7) thereunder.\26\
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    \25\ 15 U.S.C. 78q-1(b)(3)(F).
    \26\ 17 CFR 240.17Ad-22(e)(7).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
that the Proposed Rule Change (SR-LCH SA-2023-001) be, and hereby is, 
approved.\27\
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    \27\ In approving the Proposed Rule Change, the Commission 
considered the proposal's impacts 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.\28\
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    \28\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2023-05271 Filed 3-14-23; 8:45 am]
BILLING CODE 8011-01-P