Self-Regulatory Organizations; Chicago Mercantile Exchange Inc.; Notice of Filing of Proposed Rule Change Related to Enhancements to Its Risk Model for Credit Default Swaps, 48805-48809 [2014-19527]

Download as PDF Federal Register / Vol. 79, No. 159 / Monday, August 18, 2014 / Notices SECURITIES AND EXCHANGE COMMISSION [Release No. 34–72834; File No. SR–CME– 2014–28] Self-Regulatory Organizations; Chicago Mercantile Exchange Inc.; Notice of Filing of Proposed Rule Change Related to Enhancements to Its Risk Model for Credit Default Swaps August 13, 2014. mstockstill on DSK4VPTVN1PROD with NOTICES Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’ or ‘‘Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that on August 8, 2014, Chicago Mercantile Exchange Inc. (‘‘CME’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change described in Items I, II and III below, which Items have been prepared primarily by CME. The Commission is publishing this notice to solicit comments on the proposed rule change for interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The proposed change relating to the Risk Model for Credit Default Swaps (‘‘CDS’’) (the ‘‘CDS Risk Model’’) (such enhanced model, the ‘‘Proposed CDS Risk Model’’) will apply only to broadbased index CDS products cleared by CME and will not apply to securitybased swaps. CME will file separate proposed rule changes with the Commission in the future to implement any CDS risk model applicable to the clearing of security-based swaps. CME is proposing to change its current CDS Margin Model as follows (such new model, the ‘‘Proposed CDS Margin Model’’): • Replacing the current multiple market risk factors with a single market risk component calculated by reference to scenarios obtained within a statistical framework that addresses relevant market risk factors affecting a given CDS portfolio; • Enhancing the Idiosyncratic Risk Component with a more systematic approach that avoids double counting of risk with other elements of the Proposed CDS Margin Model; • Enhancing the Liquidity/ Concentration Risk Component to incorporate reference entity or index series and maturity-specific liquidity features and to address liquidation risk for highly concentrated positions with a progressively increasing margin requirement; 1 15 2 17 U.S.C. 78s(b)(1). CFR 240.19b–4. VerDate Mar<15>2010 16:57 Aug 15, 2014 Jkt 232001 • Adding a risk component for interest rate/discount curve risk; and • Addressing foreign exchange (‘‘F/ X’’) related risk that may result from CDS portfolios that include CDS positions denominated in multiple currencies. CME is additionally proposing to add a new CDS Guaranty Fund charge to CDS Clearing Members that clear CDS Products that reference themselves or their affiliates and delete the current threshold based approach. Further, CME proposes to amend its CDS Stress Test Methodology to align with the Proposed CDS Margin Model framework. The CDS Guaranty Fund will continue to be sized so that CME’s financial resources are sufficient to meet its financial obligations to its CDS Clearing Members notwithstanding a default by the two CDS Clearing Members creating the largest loss in extreme but plausible market conditions based upon the results of the new CDS Stress Test Methodology. In addition, CME proposes to add a new risk component to its CDS Stress Test Methodology to capture self-referencing risk arising from contracts that include component transactions for which the reference entity is a clearing member or one of its affiliates. In addition, CME proposes to add a new stress exposure calculation to size the self-referencing risk discussed above. The text of the proposed change is also available at the CME’s Web site at http://www.cmegroup.com, at the principal office of CME, and at the Commission’s Public Reference Room. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, CME included statements concerning the purpose and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. CME has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change a. Purpose 1. Description of the Proposed Changes to the CDS Margin Model CME is proposing to make changes to the existing CDS Margin Model by changing the current Market Risk PO 00000 Frm 00086 Fmt 4703 Sfmt 4703 48805 Factor, the Idiosyncratic Risk Factor and the Liquidity/Concentration Risk Factor as well as adding a new Interest Rate Sensitivity Component, and a methodology for addressing new F/X related risks for CDS portfolios denominated in multiple currencies. The Proposed CDS Margin Model aims to holistically model the risk of a CDS portfolio comprised of a variety of index and single-name CDS products using statistically derived scenarios. 1.1 Proposed Changes for Market Risk Component To reflect the variations in market value of a CDS portfolio, which may be comprised of positions in different index and single-name CDS products with different maturities, CME is proposing to use a scenario-based approach which relies on a statistical model, for the Market Risk Component. The statistical model is designed to generate scenarios that aim to reproduce the salient characteristics of marginal and joint movement of credit spreads across different index series or reference entity and maturity combinations. The scenarios used for the modeling of the Market Risk Component are based on the log changes in: • Par-spreads for ‘‘run-rank’’ (on-therun (‘‘OTR’’), OTR–1, OTR–2, . . .) index CDS at standard maturities (1, 3, 5, 7 and 10 years); and • Par-spreads for single-name CDS at standard maturities (1, 3, 5, 7 and 10 years). A joint probability distribution for the 5-day log changes in par spreads is estimated using historical data on daily log changes in par spreads, which are the driving risk factors of the Proposed CDS Margin Model. The distributional characteristics of these risk factors are represented through time-varying autocorrelations, volatilities and tail risk parameters. The volatility of each risk factor is an exponentially weighted moving average floored at an equal-weighted long-run average. The dependence across risk factors is modeled by historical and stressed correlation matrices combined with a copula function to model tail-risk dependence. The new statistical model allows CME to generate extreme but plausible spread scenarios across different index series and/or reference entities and maturities. Both the volatility floor and stressed correlation matrices add counter-cyclical features to the Market Risk Component. CME will employ a Monte Carlo simulation approach to generate spread scenarios for computing the Market Risk Component as further described below. The proposed Market Risk Component E:\FR\FM\18AUN1.SGM 18AUN1 48806 Federal Register / Vol. 79, No. 159 / Monday, August 18, 2014 / Notices (‘‘MR’’) is represented by the following formula: MR = BMR + DR mstockstill on DSK4VPTVN1PROD with NOTICES Where • the Base Market Risk Component (‘‘BMR’’) is determined as the Value-at-Risk (‘‘VaR’’) at a 99% confidence level for the CDS portfolio’s theoretical changes in value over 5 days. This corresponds to the 1% greatest negative change in the CDS portfolio value based on spread scenarios generated by Monte Carlo simulation by reference to historical correlation matrix estimate; and • the Dependence Risk Component (‘‘DR’’) is determined by computing the VaR at a 99% confidence level under stressed correlation scenarios for the CDS portfolio’s theoretical changes in value over 5 days. A low and high correlation VaR is estimated through the 1% greatest negative change in the CDS portfolio value based on spread scenarios generated by Monte Carlo simulation by reference to stressed low and high correlation matrices, respectively. DR is computed as the excess of the greater of the low and high correlation VaR over BMR, multiplied by a risk-aversion coefficient.3 The proposed Market Risk Component aims to more accurately capture different sources of market risk through a holistic and theoretically coherent scenario-based approach that is driven by conservative statistical assumptions. CME notes that the current CDS Margin Model relies on separate add-on factors which are modeled and calibrated in isolation and gives rise to the potential for double counting. Varying degrees of volatility and tail risks across par spreads of different index series or reference entities at different maturities are not represented in the current CDS Margin Model. Historical correlations, tail dependence and correlation risk are not explicitly and consistently accounted for within the current CDS Margin Model. In contrast, spread volatility and tail risks are modeled precisely and consistently in the Proposed CDS Margin Model. The effects of historical correlations, tail dependence and correlation risk on the co-movement of spreads of CDS products are explicitly addressed in the Proposed CDS Margin Model. The risk factors of the current CDS Margin Model such as curve, sector and convergence/divergence are replaced by a scenario-based approach which incorporates historical correlation matrices into the market risk computation. The Market Risk Component also aims to capture correlation risk that might arise from relying exclusively on historicallyestimated correlations which can change under extreme market 3 The risk-aversion coefficient was determined by back testing a collection of theoretical and production portfolios. VerDate Mar<15>2010 17:50 Aug 15, 2014 Jkt 232001 conditions. The correlation risk is addressed by employing two extreme correlation scenarios (high correlations and low correlations) to compute DR which addresses the risk of long-short or diversified portfolios driven by correlation uncertainty. Additionally, the proposed Market Risk Component incorporates countercyclical features for calibration and modeling of volatilities, autocorrelations and correlations. In comparison to the existing model, the proposed change to the manner in which the market risk is assessed may, in isolation, result in a reduction in the margin requirement for market risk. CME believes that this margin reduction does not come at the expense of adding more risk to the CME Clearing House since the statistical model and its different components were shown to appropriately cover the risk of a wide range of theoretical and production portfolios under extreme but plausible market conditions and in historical back testing, going back to 2008. 1.2 Proposed Idiosyncratic Risk Component The Idiosyncratic Risk Component is intended to address CME’s potential exposure to possible ‘‘jump-to-default’’ (‘‘JTD’’) risk due to default of a reference entity as well as ‘‘jump to health’’ (‘‘JTH’’) risk where a reference entity benefits from an extreme drop in credit spreads (due to an improvement in credit quality) (in each case, beyond what is covered by the Market Risk Component). JTD risk of a reference entity is driven by the exposure to a scenario which reduces the price of the reference entity to a stressed recovery rate. JTH risk of a reference entity is driven by the exposure to a scenario which is a drastic improvement in credit quality of the entity. In addition to the price differential under current market and idiosyncratic scenarios, both JTD and JTH margin requirements take into account the risk concentration to a reference entity through dependence on position size. Within the Proposed CDS Margin Model, only the marginal risk contribution of idiosyncratic events will be reflected in the risk component. This is accomplished by coherent modeling of the associated market and idiosyncratic risks. Both JTD and JTH margin requirements are estimated by the difference between the pure market risk of the portfolio and the sum of the idiosyncratic risk and the market risk of the portfolio, excluding positions in the reference entity which drives the Idiosyncratic Risk Component. PO 00000 Frm 00087 Fmt 4703 Sfmt 4703 1.3 New Interest Rate Sensitivity Component CME is proposing to introduce a new Interest Rate Sensitivity Component to capture the effect of changes in interest rates (relevant to the underlying discount curve) on the market value of CDS portfolios. The calculation of the Interest Rate Sensitivity Component relies on applying parallel up and down shocks to the discount curve relevant to the index series or reference entity. 1.4 Proposed Change to the Liquidity/ Concentration Risk Component The Liquidity/Concentration Risk Component is designed to reflect CME’s costs during the liquidation of a CDS portfolio following a CDS Clearing Member default, resulting from widening bid/ask spreads and/or increasing liquidation times due to the size of the CDS portfolio and/or eventdriven liquidity squeezes. The proposed changes to the Liquidity/Concentration Risk Component are intended to add granularity to the modeling of liquidity/ concentration risk by taking into account varying liquidity profiles across index series or reference entities and relevant maturities. The different liquidity characteristics of various index families/series and reference entities are modeled using trading volume data on the specific index series or reference entities. The dependence on trading volume data enables the model to more sensitively react to changes in trading activity. The modeling of relative liquidity of instruments at different maturities relies on an analysis of bid/ ask spreads across maturities for both index and single-name CDS products. Concentration risk is addressed by a progressively increasing super-linear dependence on position size relative to the trading volume of the underlying reference entity or index series and relevant maturity. The enhancements in the proposed Liquidity/Concentration Risk Component result in higher liquidity risk margin requirements for off-the-run indices, which are generally in line with the change in observed trading activity when a series becomes off-the-run. For single-name CDS, the proposed Liquidity/Concentration Risk Component results in higher liquidity risk margin requirements for reference entities with relatively low trading volume. Furthermore, the proposed Liquidity/Concentration Risk Component generally yields higher liquidity risk margin requirements for short and long dated contracts. An analysis of proposed Liquidity/ Concentration Risk Component on an E:\FR\FM\18AUN1.SGM 18AUN1 Federal Register / Vol. 79, No. 159 / Monday, August 18, 2014 / Notices mstockstill on DSK4VPTVN1PROD with NOTICES indicative set of CDS portfolios reveals that the proposed Liquidity/ Concentration Risk Component responds as expected to concentration, diversification and hedging. The overall effect of the enhancements made to the Liquidity/Concentration Risk Component is to reduce risk to the CME Clearing House by conservatively increasing margin requirements for positions which are expected to be more difficult to close out. 1.5 New F/X Related Risk Component CME is proposing to address F/X related risks associated with the inclusion of non-USD denominated CDS positions in CDS portfolios (each a ‘‘Non-USD CDS Positions’’). As proposed above, CME will allow for correlation based risk offsets with respect to both Market Risk Components and Idiosyncratic Risk Components of the Proposed CDS Margin Model. The calculation of such risk offsets will require that the Market Risk Components and Idiosyncratic Risk Components be calculated in USD (or other such common/base currency as may be chosen from time to time). In order to calculate the USD requirements, profit and loss due to market and idiosyncratic factors (‘‘P&L’’) will be converted into their USD equivalents based on conservative F/X rates. The USD equivalent requirements for the Market Risk Component and the Idiosyncratic Risk Component will then be apportioned into each currency specific sub-portfolio based on its Market Risk Component and Idiosyncratic Risk Component requirements. With respect to the Interest Rate Sensitivity Component and the Liquidity Risk/Concentration Component of the Proposed CDS Margin Model, where CME does not propose to offer risk or diversification offsets, only currency specific margin requirements are computed. The overall risk requirement for each specific currency is then calculated as the sum of (a) the currency specific Liquidity/Concentration Risk Component requirement, (b) the currency specific Interest Rate Sensitivity Component requirement, and (c) the sum of the Market Risk Component and the Idiosyncratic Risk Component requirement (apportioned to each specific currency). Under the Proposed CDS Margin Model, CME will inform clearing members of their margin requirements with respect to their multi-currency CDS positions in amounts that are required to be posted for each denominated currency in their portfolios. VerDate Mar<15>2010 16:57 Aug 15, 2014 Jkt 232001 2. Description of the Proposed Changes to Stress Test Methodology 2.1 Proposed Changes to CDS Stress Test Methodology for Sizing and Allocation of CDS Financial Resources CME currently utilizes a stressed extension of its margin model to size the CDS Guaranty Fund and CDS Assessments (as defined in the CME Rules). The ‘‘potential residual loss’’ used to size and allocate the CDS Guaranty Fund and CDS Assessments is determined as the excess of the stressed exposure for CDS products over the margin deposited for CDS products. CME is proposing changes to the CDS Stress Test Methodology in order to align it with the Proposed CDS Margin Model. The proposed CDS Stress Test Methodology will rely on more extreme and counter-cyclical scenarios for the calculation of the different risk components compared to the scenarios used in the Proposed CDS Margin Model. 2.2 New Self-Referencing Risk Component Although CME does not permit a CDS Clearing Member or a customer to enter into or maintain a single-name CDS position referencing the clearing member or an affiliate, a self-referencing CDS position may arise where the CDS Clearing Member or its affiliate is the Reference Entity in respect of a component transaction within the index referenced in a CDS position. For example, such a situation may arise in the context of index CDS contracts which reference CDS Clearing Members or their affiliates. In such cases, the CDS Clearing Member (a ‘‘CDS SR Clearing Member’’), either through its own account or that of a customer, has exposure to a CDS Product that references itself or its affiliate (each an ‘‘SR Transaction’’). CME proposes to address this potential exposure to selfreferencing risk by allocating an additional JTD risk for each CDS SR Clearing Member under its Stress Test Methodology. CME considers a CDS Clearing Member default to be an extreme tail risk event which is subject to the CDS financial safeguards, including mutualization across all other CDS Clearing Members via the CDS Guaranty Fund. Currently, CDS SR Clearing Members, clearing self-referencing indices for itself or its customers, are required to collateralize the self-referencing exposure in an amount specified in the CME Rules. CME is now proposing to adopt a risk based approach without reference to any preset threshold, to capture this self-referencing risk. The PO 00000 Frm 00088 Fmt 4703 Sfmt 4703 48807 additional risk associated with CDS SR Clearing Members will be added to the stress scenarios used to size the CDS Guaranty Fund and CME will require each CDS SR Clearing Member to make an additional CDS Guaranty Fund Deposit to address this risk (such additional deposit, the ‘‘CDS SR Deposit’’). The net theoretical selfreferencing exposure of each CDS Clearing Member is computed as the additional theoretical self-referencing ‘‘potential residual loss’’ to CME in extreme but plausible market conditions using the stress testing methodology determined by the CDS Risk Committee. The aggregate amount of CDS SR Deposits will be sized to cover the sum of the net theoretical self-referencing exposures of two CDS SR Clearing Members which would create the two largest net theoretical self-referencing exposures.4 The required CDS SR Deposit will then be allocated to each CDS SR Clearing Member in proportion to each such CDS SR Clearing Member’s net self-referencing exposure. A new CME Rule 8H06 (CDS SR Deposit) has been added to accurately reflect these proposed changes to the CDS Guaranty Fund in the CME Rules, and CME Rule 8H802.B (Satisfaction of Clearing House Obligations) has been amended to reflect the introduction of the CDS SR Deposit. In addition, provisions in CME Rule 80104.A (Clearing Through Clearing Member’s House (or Proprietary) Account) and CME Rule 80104.B (Clearing Through Clearing Members Customer Account) that relate to the requirement by clearing members that clear selfreferencing indices for themselves or their customers to collateralize the selfreferencing exposure in an amount specified in the CME Rules have been deleted. A CDS Clearing Member default may result in contagion among financial institutions, widening spreads and exposing portfolios consisting of index CDS that reference financial entities to potential wrong-way risk. For example, the default of a CDS Clearing Member based in the United States, which is not referenced in an index referencing European names, could lead to overall widening of the credit spreads among financial institutions worldwide, leading to widening of spreads in nonUS indices. This may lead to variations in correlations between such non-US indices and other North American indices, potentially adversely impacting 4 For purposes of determining the two largest potential residual losses, the self-referencing exposure of a CDS SR Clearing Member will be aggregated with that of any affiliated CDS SR Clearing Member. E:\FR\FM\18AUN1.SGM 18AUN1 48808 Federal Register / Vol. 79, No. 159 / Monday, August 18, 2014 / Notices mstockstill on DSK4VPTVN1PROD with NOTICES certain portfolios which are sensitive to such correlations. This increase in potential exposure caused by contagion is addressed in the CME Proposed CDS Risk Model and Stress Test Methodology via incorporation of stressed correlation scenarios. 2.3 Portfolio Margining Implications The Proposed CDS Margin Model relies on a statistical model to support a scenario-based approach in line with the joint probability distribution characteristics of par spreads of index series or reference entities across standard maturities. The Market Risk Component of the Proposed CDS Margin Model provides risk offsets between single-name CDS positions and index CDS positions. Such risk offsets are driven by the dependence structure across spread scenarios imposed by historical and counter-cyclical stressed correlations. The Interest Rate Sensitivity Component for a portfolio containing index and single-name CDS products is designed as an aggregate risk component across index and single-name CDS positions. Under the Proposed CDS Margin Model, the JTD component of the margin is computed by aggregating the exposure to the default of a reference entity in both single-name CDS positions and index CDS positions. CME relies on a decomposition model to compute the JTD component of the margin requirement for a CDS portfolio containing index and single-name CDS products. The Liquidity/Concentration Risk Component of the Proposed CDS Margin Model is driven by an expected liquidation process in which the market risk exposure of the portfolio is first hedged with the most liquid CDS instrument and then the resulting basis (hedged) portfolio is liquidated. The margin requirements of the Liquidity/ Concentration Risk Component that are driven by market risk hedging costs are calculated by aggregating the market risk exposure of the index and singlename CDS positions. Index and singlename CDS positions are handled separately for the calculation of the basis risk margin requirement (due to unwinding of hedged positions) of the Liquidity/Concentration Risk Component and also for the modeling of the concentration margin requirement as a function of position size. b. Statutory Basis CME believes the proposed rule change is consistent with the requirements of the Exchange Act, including Section 17A of the Exchange VerDate Mar<15>2010 16:57 Aug 15, 2014 Jkt 232001 Act,5 and the applicable regulations thereunder. The proposed rule change is designed to promote the prompt and accurate clearance and settlement of securities transactions and, to the extent applicable, derivatives agreements, contracts, and transactions, to assure the safeguarding of securities and funds which are in the custody or control of the clearing agency or for which it is responsible, and, in general, to protect investors and the public interest consistent with Section 17A(b)(3)(F) of the Exchange Act.6 The proposed rule change accomplishes these objectives because it is intended to more accurately capture different sources of risk through a holistic and theoretically coherent scenario-based approach that is driven by conservative statistical assumptions, which in turn allows CME to appropriately cover the risk of a wide range of theoretical and production portfolios under extreme but plausible market conditions and in historical back testing, going back to 2008. In particular, the amendments will enhance CME’s margin methodology by more accurately addressing F/X risk and self-referencing risk presented by clearing index CDS contracts. CME will also promote the efficient use of margin for the clearinghouse and its Clearing Members and their customers by enabling CME to provide appropriate portfolio margining treatment between index and singlename CDS positions and as such contribute to the safeguarding of securities and funds in CME’s custody or control or for which CME is responsible and the protection of investors.7 CME also believes the proposed rule change is consistent with the requirements of Rule 17Ad-22 of the Exchange Act.8 In particular, in terms of financial resources, CME believes that the proposed rule change will continue to ensure sufficient margin to cover its credit exposure to its clearing members, consistent with the requirements of Rule 17Ad–22(b)(2) 9 and Rule 17Ad– 22(d)(14) 10 and that the CDS Guaranty Fund contributions and required margin, both as modified by the proposed rule change, will provide sufficient financial resources to withstand a default by the two participant families to which it has the largest exposures in extreme but 5 15 6 15 U.S.C. 78q–1. U.S.C. 78q–1(b)(3)(F). plausible market conditions consistent with the requirements of Rule 17Ad– 22(b)(3).11 In addition, CME believes that the proposed rule change is consistent with CME’s requirement to limit its exposures to potential losses from defaults by its participants under normal market conditions pursuant to 17Ad–22(b)(1).12 CME also believes that the proposed rule change will continue to allow for it to take timely action to contain losses and liquidity pressures and to continue meeting its obligations in the event of clearing member insolvencies or defaults, in accordance with Rule 17Ad–22(d)(11).13 B. Self-Regulatory Organization’s Statement on Burden on Competition CME does not believe that the proposed rule change will have any impact, or impose any burden, on competition. The proposed rule change reflects enhancements to CME’s CDS Risk Model. CME does not believe that any increase in margin or CDS Guaranty Fund contributions, would significantly affect the ability of Clearing Members or other market participants to continue to clear CDS, consistent with the risk management requirements of CME, or otherwise limit market participants’ choices for selecting clearing services. For the foregoing reasons, the Proposed CDS Risk Model does not, in CME’s view, impose any unnecessary or inappropriate burden on competition. C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others Written comments relating to the Proposed CDS Risk Model have not been solicited or received. CME will notify the Commission of any written comments received by CME. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 45 days of the date of publication of this notice in the Federal Register or within such longer period up to 90 days (i) as the Commission may designate if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will: (A) by order approve or disapprove such proposed rule change, or (B) institute proceedings to determine whether the proposed rule change should be disapproved. 7 Id. 8 17 11 17 9 17 CFR 240.19b–4. CFR 240.17Ad–22(b)(2). 10 17 CFR 240.17Ad–22(d)(14). 12 17 PO 00000 Frm 00089 Fmt 4703 Sfmt 4703 CFR 240.17Ad–22(b)(3). CFR 240.17Ad–22(b)(1). 13 17 CFR 240.17Ad–22(d)(11). E:\FR\FM\18AUN1.SGM 18AUN1 Federal Register / Vol. 79, No. 159 / Monday, August 18, 2014 / Notices IV. Solicitation of Comments Interested persons are invited to submit written data, views and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml), or • Send an email to rule-comments@ sec.gov. Please include File No. SR– CME–2014–28 on the subject line. Paper Comments mstockstill on DSK4VPTVN1PROD with NOTICES • Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC, 20549–1090. All submissions should refer to File Number SR–CME–2014–28. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (http://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission’s Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours or 10:00 a.m. and 3:00 p.m. Copies of such filing also will be available for inspection and copying at the principal office of CME and on CME’s Web site at http://www.cmegroup.com/marketregulation/rule-filings.html. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–CME–2014–28 and should be submitted on or before September 8, 2014. 16:57 Aug 15, 2014 [FR Doc. 2014–19527 Filed 8–15–14; 8:45 am] BILLING CODE 8011–01–P proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in Sections A, B, and C below, of the most significant parts of such statements. SECURITIES AND EXCHANGE COMMISSION Electronic Comments VerDate Mar<15>2010 For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.14 Kevin M. O’Neill, Deputy Secretary. 48809 Jkt 232001 A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change [Release No. 34–72821; File No. SR–BATS– 2014–031] 1. Purpose Self-Regulatory Organizations; BATS Exchange, Inc.; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change To Reflect Changes to the Means of Achieving the Investment Objective Applicable to the iShares Short Maturity Bond Fund August 12, 2014. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (the ‘‘Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that on August 4, 2014, BATS Exchange, Inc. (the ‘‘Exchange’’ or ‘‘BATS’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I and II below, which Items have been prepared by the Exchange. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of the Substance of the Proposed Rule Change The Exchange filed a proposal to reflect changes to the means of achieving the investment objective applicable to the iShares Short Maturity Bond Fund (the ‘‘Fund’’). The shares of the Fund are currently listed and traded on the Exchange under BATS Rule 14.11(i). The text of the proposed rule change is available at the Exchange’s Web site at http://www.batstrading.com, at the principal office of the Exchange, and at the Commission’s Public Reference Room. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the Exchange included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the 14 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 1 15 PO 00000 Frm 00090 Fmt 4703 Sfmt 4703 The Commission has approved listing and trading on the Exchange of shares of the Fund (‘‘Shares’’), which are offered by the iShares U.S. ETF Trust (the ‘‘Trust’’),3 under BATS Rule 14.11(i), which governs the listing of Managed Fund Shares. The Shares are currently listed and traded on the Exchange under BATS Rule 14.11(i). The Shares are offered by the Trust, which was established as a Delaware statutory trust on June 21, 2011. The Trust is registered with the Commission as an open-end investment company and has filed a registration statement on behalf of the Fund on Form N–1A (‘‘Registration Statement’’) with the Commission.4 BlackRock Fund Advisors is the investment adviser (‘‘BFA’’ or ‘‘Adviser’’) to the Fund.5 BlackRock Financial Management, Inc. serves as sub-adviser for the Fund (‘‘SubAdviser’’).6 State Street Bank and Trust Company is the administrator, custodian, and transfer agent for the Trust. BlackRock Investments, LLC (‘‘Distributor’’) serves as the distributor for the Trust. 3 See Securities Exchange Act Release No. 67894 (September 20, 2012), 77 FR 59227 (September 26, 2012) (SR–BATS–2012–033 Amendment No. 1) (the ‘‘Prior Filing’’). 4 See Registration Statement on Form N–1A for the Trust, dated March 1, 2014 (File Nos. 333– 179904 and 811–22649). The descriptions of the Fund and the Shares contained herein are based, in part, on information in the Registration Statement. The Commission has issued an order granting certain exemptive relief to the Company under the Investment Company Act of 1940 (15 U.S.C. 80a– 1) (‘‘1940 Act’’) (the ‘‘Exemptive Order’’). See Investment Company Act Release No. 29571 (January 24, 2011) (File No. 812–13601). 5 BlackRock Fund Advisors is an indirect wholly owned subsidiary of BlackRock, Inc. 6 The Adviser manages the Fund’s investments and its business operations subject to the oversight of the Board of Trustees of the Trust (the ‘‘Board’’). While BFA is ultimately responsible for the management of the Fund, it is able to draw upon the trading, research and expertise of its asset management affiliates for portfolio decisions and management with respect to portfolio securities. The Adviser also has ongoing oversight responsibility. The Sub-Adviser, subject to the supervision and oversight of the Adviser and the Board, is responsible for day-to-day management of the Fund and, as such, typically makes all decisions with respect to portfolio holdings. E:\FR\FM\18AUN1.SGM 18AUN1

Agencies

[Federal Register Volume 79, Number 159 (Monday, August 18, 2014)]
[Notices]
[Pages 48805-48809]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-19527]



[[Page 48805]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72834; File No. SR-CME-2014-28]


Self-Regulatory Organizations; Chicago Mercantile Exchange Inc.; 
Notice of Filing of Proposed Rule Change Related to Enhancements to Its 
Risk Model for Credit Default Swaps

August 13, 2014.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on August 8, 2014, Chicago Mercantile Exchange 
Inc. (``CME'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change described in Items I, II and 
III below, which Items have been prepared primarily by CME. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change for interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.&
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The proposed change relating to the Risk Model for Credit Default 
Swaps (``CDS'') (the ``CDS Risk Model'') (such enhanced model, the 
``Proposed CDS Risk Model'') will apply only to broad-based index CDS 
products cleared by CME and will not apply to security-based swaps. CME 
will file separate proposed rule changes with the Commission in the 
future to implement any CDS risk model applicable to the clearing of 
security-based swaps.
    CME is proposing to change its current CDS Margin Model as follows 
(such new model, the ``Proposed CDS Margin Model''):
     Replacing the current multiple market risk factors with a 
single market risk component calculated by reference to scenarios 
obtained within a statistical framework that addresses relevant market 
risk factors affecting a given CDS portfolio;
     Enhancing the Idiosyncratic Risk Component with a more 
systematic approach that avoids double counting of risk with other 
elements of the Proposed CDS Margin Model;
     Enhancing the Liquidity/Concentration Risk Component to 
incorporate reference entity or index series and maturity-specific 
liquidity features and to address liquidation risk for highly 
concentrated positions with a progressively increasing margin 
requirement;
     Adding a risk component for interest rate/discount curve 
risk; and
     Addressing foreign exchange (``F/X'') related risk that 
may result from CDS portfolios that include CDS positions denominated 
in multiple currencies.
    CME is additionally proposing to add a new CDS Guaranty Fund charge 
to CDS Clearing Members that clear CDS Products that reference 
themselves or their affiliates and delete the current threshold based 
approach.
    Further, CME proposes to amend its CDS Stress Test Methodology to 
align with the Proposed CDS Margin Model framework. The CDS Guaranty 
Fund will continue to be sized so that CME's financial resources are 
sufficient to meet its financial obligations to its CDS Clearing 
Members notwithstanding a default by the two CDS Clearing Members 
creating the largest loss in extreme but plausible market conditions 
based upon the results of the new CDS Stress Test Methodology. In 
addition, CME proposes to add a new risk component to its CDS Stress 
Test Methodology to capture self-referencing risk arising from 
contracts that include component transactions for which the reference 
entity is a clearing member or one of its affiliates. In addition, CME 
proposes to add a new stress exposure calculation to size the self-
referencing risk discussed above.
    The text of the proposed change is also available at the CME's Web 
site at http://www.cmegroup.com, at the principal office of CME, and at 
the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, CME included statements 
concerning the purpose and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. CME has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

a. Purpose
1. Description of the Proposed Changes to the CDS Margin Model
    CME is proposing to make changes to the existing CDS Margin Model 
by changing the current Market Risk Factor, the Idiosyncratic Risk 
Factor and the Liquidity/Concentration Risk Factor as well as adding a 
new Interest Rate Sensitivity Component, and a methodology for 
addressing new F/X related risks for CDS portfolios denominated in 
multiple currencies. The Proposed CDS Margin Model aims to holistically 
model the risk of a CDS portfolio comprised of a variety of index and 
single-name CDS products using statistically derived scenarios.
1.1 Proposed Changes for Market Risk Component
    To reflect the variations in market value of a CDS portfolio, which 
may be comprised of positions in different index and single-name CDS 
products with different maturities, CME is proposing to use a scenario-
based approach which relies on a statistical model, for the Market Risk 
Component. The statistical model is designed to generate scenarios that 
aim to reproduce the salient characteristics of marginal and joint 
movement of credit spreads across different index series or reference 
entity and maturity combinations.
    The scenarios used for the modeling of the Market Risk Component 
are based on the log changes in:
     Par-spreads for ``run-rank'' (on-the-run (``OTR''), OTR-1, 
OTR-2, . . .) index CDS at standard maturities (1, 3, 5, 7 and 10 
years); and
     Par-spreads for single-name CDS at standard maturities (1, 
3, 5, 7 and 10 years).
    A joint probability distribution for the 5-day log changes in par 
spreads is estimated using historical data on daily log changes in par 
spreads, which are the driving risk factors of the Proposed CDS Margin 
Model. The distributional characteristics of these risk factors are 
represented through time-varying autocorrelations, volatilities and 
tail risk parameters.
    The volatility of each risk factor is an exponentially weighted 
moving average floored at an equal-weighted long-run average. The 
dependence across risk factors is modeled by historical and stressed 
correlation matrices combined with a copula function to model tail-risk 
dependence. The new statistical model allows CME to generate extreme 
but plausible spread scenarios across different index series and/or 
reference entities and maturities. Both the volatility floor and 
stressed correlation matrices add counter-cyclical features to the 
Market Risk Component.
    CME will employ a Monte Carlo simulation approach to generate 
spread scenarios for computing the Market Risk Component as further 
described below. The proposed Market Risk Component

[[Page 48806]]

(``MR'') is represented by the following formula:

MR = BMR + DR

Where
     the Base Market Risk Component (``BMR'') is determined 
as the Value-at-Risk (``VaR'') at a 99% confidence level for the CDS 
portfolio's theoretical changes in value over 5 days. This 
corresponds to the 1% greatest negative change in the CDS portfolio 
value based on spread scenarios generated by Monte Carlo simulation 
by reference to historical correlation matrix estimate; and
     the Dependence Risk Component (``DR'') is determined by 
computing the VaR at a 99% confidence level under stressed 
correlation scenarios for the CDS portfolio's theoretical changes in 
value over 5 days. A low and high correlation VaR is estimated 
through the 1% greatest negative change in the CDS portfolio value 
based on spread scenarios generated by Monte Carlo simulation by 
reference to stressed low and high correlation matrices, 
respectively. DR is computed as the excess of the greater of the low 
and high correlation VaR over BMR, multiplied by a risk-aversion 
coefficient.\3\
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    \3\ The risk-aversion coefficient was determined by back testing 
a collection of theoretical and production portfolios.

    The proposed Market Risk Component aims to more accurately capture 
different sources of market risk through a holistic and theoretically 
coherent scenario-based approach that is driven by conservative 
statistical assumptions. CME notes that the current CDS Margin Model 
relies on separate add-on factors which are modeled and calibrated in 
isolation and gives rise to the potential for double counting. Varying 
degrees of volatility and tail risks across par spreads of different 
index series or reference entities at different maturities are not 
represented in the current CDS Margin Model. Historical correlations, 
tail dependence and correlation risk are not explicitly and 
consistently accounted for within the current CDS Margin Model. In 
contrast, spread volatility and tail risks are modeled precisely and 
consistently in the Proposed CDS Margin Model. The effects of 
historical correlations, tail dependence and correlation risk on the 
co-movement of spreads of CDS products are explicitly addressed in the 
Proposed CDS Margin Model.
    The risk factors of the current CDS Margin Model such as curve, 
sector and convergence/divergence are replaced by a scenario-based 
approach which incorporates historical correlation matrices into the 
market risk computation. The Market Risk Component also aims to capture 
correlation risk that might arise from relying exclusively on 
historically-estimated correlations which can change under extreme 
market conditions. The correlation risk is addressed by employing two 
extreme correlation scenarios (high correlations and low correlations) 
to compute DR which addresses the risk of long-short or diversified 
portfolios driven by correlation uncertainty.
    Additionally, the proposed Market Risk Component incorporates 
counter-cyclical features for calibration and modeling of volatilities, 
autocorrelations and correlations.
    In comparison to the existing model, the proposed change to the 
manner in which the market risk is assessed may, in isolation, result 
in a reduction in the margin requirement for market risk. CME believes 
that this margin reduction does not come at the expense of adding more 
risk to the CME Clearing House since the statistical model and its 
different components were shown to appropriately cover the risk of a 
wide range of theoretical and production portfolios under extreme but 
plausible market conditions and in historical back testing, going back 
to 2008.
1.2 Proposed Idiosyncratic Risk Component
    The Idiosyncratic Risk Component is intended to address CME's 
potential exposure to possible ``jump-to-default'' (``JTD'') risk due 
to default of a reference entity as well as ``jump to health'' 
(``JTH'') risk where a reference entity benefits from an extreme drop 
in credit spreads (due to an improvement in credit quality) (in each 
case, beyond what is covered by the Market Risk Component). JTD risk of 
a reference entity is driven by the exposure to a scenario which 
reduces the price of the reference entity to a stressed recovery rate. 
JTH risk of a reference entity is driven by the exposure to a scenario 
which is a drastic improvement in credit quality of the entity. In 
addition to the price differential under current market and 
idiosyncratic scenarios, both JTD and JTH margin requirements take into 
account the risk concentration to a reference entity through dependence 
on position size. Within the Proposed CDS Margin Model, only the 
marginal risk contribution of idiosyncratic events will be reflected in 
the risk component. This is accomplished by coherent modeling of the 
associated market and idiosyncratic risks. Both JTD and JTH margin 
requirements are estimated by the difference between the pure market 
risk of the portfolio and the sum of the idiosyncratic risk and the 
market risk of the portfolio, excluding positions in the reference 
entity which drives the Idiosyncratic Risk Component.
1.3 New Interest Rate Sensitivity Component
    CME is proposing to introduce a new Interest Rate Sensitivity 
Component to capture the effect of changes in interest rates (relevant 
to the underlying discount curve) on the market value of CDS 
portfolios. The calculation of the Interest Rate Sensitivity Component 
relies on applying parallel up and down shocks to the discount curve 
relevant to the index series or reference entity.
1.4 Proposed Change to the Liquidity/Concentration Risk Component
    The Liquidity/Concentration Risk Component is designed to reflect 
CME's costs during the liquidation of a CDS portfolio following a CDS 
Clearing Member default, resulting from widening bid/ask spreads and/or 
increasing liquidation times due to the size of the CDS portfolio and/
or event-driven liquidity squeezes. The proposed changes to the 
Liquidity/Concentration Risk Component are intended to add granularity 
to the modeling of liquidity/concentration risk by taking into account 
varying liquidity profiles across index series or reference entities 
and relevant maturities. The different liquidity characteristics of 
various index families/series and reference entities are modeled using 
trading volume data on the specific index series or reference entities. 
The dependence on trading volume data enables the model to more 
sensitively react to changes in trading activity. The modeling of 
relative liquidity of instruments at different maturities relies on an 
analysis of bid/ask spreads across maturities for both index and 
single-name CDS products. Concentration risk is addressed by a 
progressively increasing super-linear dependence on position size 
relative to the trading volume of the underlying reference entity or 
index series and relevant maturity.
    The enhancements in the proposed Liquidity/Concentration Risk 
Component result in higher liquidity risk margin requirements for off-
the-run indices, which are generally in line with the change in 
observed trading activity when a series becomes off-the-run. For 
single-name CDS, the proposed Liquidity/Concentration Risk Component 
results in higher liquidity risk margin requirements for reference 
entities with relatively low trading volume. Furthermore, the proposed 
Liquidity/Concentration Risk Component generally yields higher 
liquidity risk margin requirements for short and long dated contracts.
    An analysis of proposed Liquidity/Concentration Risk Component on 
an

[[Page 48807]]

indicative set of CDS portfolios reveals that the proposed Liquidity/
Concentration Risk Component responds as expected to concentration, 
diversification and hedging. The overall effect of the enhancements 
made to the Liquidity/Concentration Risk Component is to reduce risk to 
the CME Clearing House by conservatively increasing margin requirements 
for positions which are expected to be more difficult to close out.
1.5 New F/X Related Risk Component
    CME is proposing to address F/X related risks associated with the 
inclusion of non-USD denominated CDS positions in CDS portfolios (each 
a ``Non-USD CDS Positions''). As proposed above, CME will allow for 
correlation based risk offsets with respect to both Market Risk 
Components and Idiosyncratic Risk Components of the Proposed CDS Margin 
Model. The calculation of such risk offsets will require that the 
Market Risk Components and Idiosyncratic Risk Components be calculated 
in USD (or other such common/base currency as may be chosen from time 
to time). In order to calculate the USD requirements, profit and loss 
due to market and idiosyncratic factors (``P&L'') will be converted 
into their USD equivalents based on conservative F/X rates. The USD 
equivalent requirements for the Market Risk Component and the 
Idiosyncratic Risk Component will then be apportioned into each 
currency specific sub-portfolio based on its Market Risk Component and 
Idiosyncratic Risk Component requirements.
    With respect to the Interest Rate Sensitivity Component and the 
Liquidity Risk/Concentration Component of the Proposed CDS Margin 
Model, where CME does not propose to offer risk or diversification 
offsets, only currency specific margin requirements are computed.
    The overall risk requirement for each specific currency is then 
calculated as the sum of (a) the currency specific Liquidity/
Concentration Risk Component requirement, (b) the currency specific 
Interest Rate Sensitivity Component requirement, and (c) the sum of the 
Market Risk Component and the Idiosyncratic Risk Component requirement 
(apportioned to each specific currency). Under the Proposed CDS Margin 
Model, CME will inform clearing members of their margin requirements 
with respect to their multi-currency CDS positions in amounts that are 
required to be posted for each denominated currency in their 
portfolios.
2. Description of the Proposed Changes to Stress Test Methodology
2.1 Proposed Changes to CDS Stress Test Methodology for Sizing and 
Allocation of CDS Financial Resources
    CME currently utilizes a stressed extension of its margin model to 
size the CDS Guaranty Fund and CDS Assessments (as defined in the CME 
Rules). The ``potential residual loss'' used to size and allocate the 
CDS Guaranty Fund and CDS Assessments is determined as the excess of 
the stressed exposure for CDS products over the margin deposited for 
CDS products. CME is proposing changes to the CDS Stress Test 
Methodology in order to align it with the Proposed CDS Margin Model. 
The proposed CDS Stress Test Methodology will rely on more extreme and 
counter-cyclical scenarios for the calculation of the different risk 
components compared to the scenarios used in the Proposed CDS Margin 
Model.
2.2 New Self-Referencing Risk Component
    Although CME does not permit a CDS Clearing Member or a customer to 
enter into or maintain a single-name CDS position referencing the 
clearing member or an affiliate, a self-referencing CDS position may 
arise where the CDS Clearing Member or its affiliate is the Reference 
Entity in respect of a component transaction within the index 
referenced in a CDS position. For example, such a situation may arise 
in the context of index CDS contracts which reference CDS Clearing 
Members or their affiliates. In such cases, the CDS Clearing Member (a 
``CDS SR Clearing Member''), either through its own account or that of 
a customer, has exposure to a CDS Product that references itself or its 
affiliate (each an ``SR Transaction''). CME proposes to address this 
potential exposure to self-referencing risk by allocating an additional 
JTD risk for each CDS SR Clearing Member under its Stress Test 
Methodology. CME considers a CDS Clearing Member default to be an 
extreme tail risk event which is subject to the CDS financial 
safeguards, including mutualization across all other CDS Clearing 
Members via the CDS Guaranty Fund.
    Currently, CDS SR Clearing Members, clearing self-referencing 
indices for itself or its customers, are required to collateralize the 
self-referencing exposure in an amount specified in the CME Rules. CME 
is now proposing to adopt a risk based approach without reference to 
any preset threshold, to capture this self-referencing risk. The 
additional risk associated with CDS SR Clearing Members will be added 
to the stress scenarios used to size the CDS Guaranty Fund and CME will 
require each CDS SR Clearing Member to make an additional CDS Guaranty 
Fund Deposit to address this risk (such additional deposit, the ``CDS 
SR Deposit''). The net theoretical self-referencing exposure of each 
CDS Clearing Member is computed as the additional theoretical self-
referencing ``potential residual loss'' to CME in extreme but plausible 
market conditions using the stress testing methodology determined by 
the CDS Risk Committee. The aggregate amount of CDS SR Deposits will be 
sized to cover the sum of the net theoretical self-referencing 
exposures of two CDS SR Clearing Members which would create the two 
largest net theoretical self-referencing exposures.\4\ The required CDS 
SR Deposit will then be allocated to each CDS SR Clearing Member in 
proportion to each such CDS SR Clearing Member's net self-referencing 
exposure.
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    \4\ For purposes of determining the two largest potential 
residual losses, the self-referencing exposure of a CDS SR Clearing 
Member will be aggregated with that of any affiliated CDS SR 
Clearing Member.
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    A new CME Rule 8H06 (CDS SR Deposit) has been added to accurately 
reflect these proposed changes to the CDS Guaranty Fund in the CME 
Rules, and CME Rule 8H802.B (Satisfaction of Clearing House 
Obligations) has been amended to reflect the introduction of the CDS SR 
Deposit. In addition, provisions in CME Rule 80104.A (Clearing Through 
Clearing Member's House (or Proprietary) Account) and CME Rule 80104.B 
(Clearing Through Clearing Members Customer Account) that relate to the 
requirement by clearing members that clear self-referencing indices for 
themselves or their customers to collateralize the self-referencing 
exposure in an amount specified in the CME Rules have been deleted.
    A CDS Clearing Member default may result in contagion among 
financial institutions, widening spreads and exposing portfolios 
consisting of index CDS that reference financial entities to potential 
wrong-way risk. For example, the default of a CDS Clearing Member based 
in the United States, which is not referenced in an index referencing 
European names, could lead to overall widening of the credit spreads 
among financial institutions worldwide, leading to widening of spreads 
in non-US indices. This may lead to variations in correlations between 
such non-US indices and other North American indices, potentially 
adversely impacting

[[Page 48808]]

certain portfolios which are sensitive to such correlations. This 
increase in potential exposure caused by contagion is addressed in the 
CME Proposed CDS Risk Model and Stress Test Methodology via 
incorporation of stressed correlation scenarios.
2.3 Portfolio Margining Implications
    The Proposed CDS Margin Model relies on a statistical model to 
support a scenario-based approach in line with the joint probability 
distribution characteristics of par spreads of index series or 
reference entities across standard maturities. The Market Risk 
Component of the Proposed CDS Margin Model provides risk offsets 
between single-name CDS positions and index CDS positions. Such risk 
offsets are driven by the dependence structure across spread scenarios 
imposed by historical and counter-cyclical stressed correlations.
    The Interest Rate Sensitivity Component for a portfolio containing 
index and single-name CDS products is designed as an aggregate risk 
component across index and single-name CDS positions.
    Under the Proposed CDS Margin Model, the JTD component of the 
margin is computed by aggregating the exposure to the default of a 
reference entity in both single-name CDS positions and index CDS 
positions. CME relies on a decomposition model to compute the JTD 
component of the margin requirement for a CDS portfolio containing 
index and single-name CDS products.
    The Liquidity/Concentration Risk Component of the Proposed CDS 
Margin Model is driven by an expected liquidation process in which the 
market risk exposure of the portfolio is first hedged with the most 
liquid CDS instrument and then the resulting basis (hedged) portfolio 
is liquidated. The margin requirements of the Liquidity/Concentration 
Risk Component that are driven by market risk hedging costs are 
calculated by aggregating the market risk exposure of the index and 
single-name CDS positions. Index and single-name CDS positions are 
handled separately for the calculation of the basis risk margin 
requirement (due to unwinding of hedged positions) of the Liquidity/
Concentration Risk Component and also for the modeling of the 
concentration margin requirement as a function of position size.
b. Statutory Basis
    CME believes the proposed rule change is consistent with the 
requirements of the Exchange Act, including Section 17A of the Exchange 
Act,\5\ and the applicable regulations thereunder. The proposed rule 
change is designed to promote the prompt and accurate clearance and 
settlement of securities transactions and, to the extent applicable, 
derivatives agreements, contracts, and transactions, to assure the 
safeguarding of securities and funds which are in the custody or 
control of the clearing agency or for which it is responsible, and, in 
general, to protect investors and the public interest consistent with 
Section 17A(b)(3)(F) of the Exchange Act.\6\
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    \5\ 15 U.S.C. 78q-1.
    \6\ 15 U.S.C. 78q-1(b)(3)(F).
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    The proposed rule change accomplishes these objectives because it 
is intended to more accurately capture different sources of risk 
through a holistic and theoretically coherent scenario-based approach 
that is driven by conservative statistical assumptions, which in turn 
allows CME to appropriately cover the risk of a wide range of 
theoretical and production portfolios under extreme but plausible 
market conditions and in historical back testing, going back to 2008. 
In particular, the amendments will enhance CME's margin methodology by 
more accurately addressing F/X risk and self-referencing risk presented 
by clearing index CDS contracts.
    CME will also promote the efficient use of margin for the 
clearinghouse and its Clearing Members and their customers by enabling 
CME to provide appropriate portfolio margining treatment between index 
and single-name CDS positions and as such contribute to the 
safeguarding of securities and funds in CME's custody or control or for 
which CME is responsible and the protection of investors.\7\
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    \7\ Id.
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    CME also believes the proposed rule change is consistent with the 
requirements of Rule 17Ad-22 of the Exchange Act.\8\ In particular, in 
terms of financial resources, CME believes that the proposed rule 
change will continue to ensure sufficient margin to cover its credit 
exposure to its clearing members, consistent with the requirements of 
Rule 17Ad-22(b)(2) \9\ and Rule 17Ad-22(d)(14) \10\ and that the CDS 
Guaranty Fund contributions and required margin, both as modified by 
the proposed rule change, will provide sufficient financial resources 
to withstand a default by the two participant families to which it has 
the largest exposures in extreme but plausible market conditions 
consistent with the requirements of Rule 17Ad-22(b)(3).\11\ In 
addition, CME believes that the proposed rule change is consistent with 
CME's requirement to limit its exposures to potential losses from 
defaults by its participants under normal market conditions pursuant to 
17Ad-22(b)(1).\12\ CME also believes that the proposed rule change will 
continue to allow for it to take timely action to contain losses and 
liquidity pressures and to continue meeting its obligations in the 
event of clearing member insolvencies or defaults, in accordance with 
Rule 17Ad-22(d)(11).\13\
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    \8\ 17 CFR 240.19b-4.
    \9\ 17 CFR 240.17Ad-22(b)(2).
    \10\ 17 CFR 240.17Ad-22(d)(14).
    \11\ 17 CFR 240.17Ad-22(b)(3).
    \12\ 17 CFR 240.17Ad-22(b)(1).
    \13\ 17 CFR 240.17Ad-22(d)(11).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CME does not believe that the proposed rule change will have any 
impact, or impose any burden, on competition. The proposed rule change 
reflects enhancements to CME's CDS Risk Model. CME does not believe 
that any increase in margin or CDS Guaranty Fund contributions, would 
significantly affect the ability of Clearing Members or other market 
participants to continue to clear CDS, consistent with the risk 
management requirements of CME, or otherwise limit market participants' 
choices for selecting clearing services. For the foregoing reasons, the 
Proposed CDS Risk Model does not, in CME's view, impose any unnecessary 
or inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments relating to the Proposed CDS Risk Model have not 
been solicited or received. CME will notify the Commission of any 
written comments received by CME.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

[[Page 48809]]

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml), or
     Send an email to rule-comments@sec.gov. Please include 
File No. SR-CME-2014-28 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC, 20549-1090.

All submissions should refer to File Number SR-CME-2014-28. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours or 
10:00 a.m. and 3:00 p.m. Copies of such filing also will be available 
for inspection and copying at the principal office of CME and on CME's 
Web site at http://www.cmegroup.com/market-regulation/rule-filings.html.
    All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make available 
publicly.
    All submissions should refer to File Number SR-CME-2014-28 and 
should be submitted on or before September 8, 2014.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-19527 Filed 8-15-14; 8:45 am]
BILLING CODE 8011-01-P