Self-Regulatory Organizations; The Depository Trust Company; Fixed Income Clearing Corporation; National Securities Clearing Corporation; Order Approving Proposed Rule Changes To Adopt the Clearing Agency Model Risk Management Framework, 41433-41438 [2017-18448]

Download as PDF Federal Register / Vol. 82, No. 168 / Thursday, August 31, 2017 / Notices Areas (MSAs) and non-metropolitan counties. The sample is selected using the United States Postal Service postal delivery sequence file (DSF) and, where the DSF has poor coverage (90% or less), field listing. The 17 largest MSAs are included with certainty, while other NFAs are sampled with probability proportionate to size (PPS) and with implicit stratification by geographic and demographic characteristics. Within all selected NFAs, tracts or block groups are further selected with PPS and implicit stratification by additional geographic and demographic characteristics. The tertiary sampling units, addresses, are a random sample from the DSF or, alternatively, a field inventory of addresses. When a housing unit is visited by a field interviewer, one person is selected to be interviewed from the housing unit at random. Not all GSS respondents are given the S&T Attitudes survey, which is a module on the GSS. Which GSS respondents get the S&T Attitudes module is determined by systematic sampling conducted to ensure that each NFA and segment (tract or block group) in the sample has an equal number of S&T Attitudes surveys. Dated: August 28, 2017. Suzanne H. Plimpton, Reports Clearance Officer, National Science Foundation. [FR Doc. 2017–18472 Filed 8–30–17; 8:45 am] BILLING CODE 7555–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–81485; File Nos. SR–DTC– 2017–008; SR–FICC–2017–014; SR–NSCC– 2017–008] Self-Regulatory Organizations; The Depository Trust Company; Fixed Income Clearing Corporation; National Securities Clearing Corporation; Order Approving Proposed Rule Changes To Adopt the Clearing Agency Model Risk Management Framework sradovich on DSK3GMQ082PROD with NOTICES August 25, 2017. On June 20, 2017, The Depository Trust Company (‘‘DTC’’), Fixed Income Clearing Corporation (‘‘FICC’’), and National Securities Clearing Corporation (‘‘NSCC,’’ each a ‘‘Clearing Agency,’’ and collectively, ‘‘Clearing Agencies’’) filed with the Securities and Exchange Commission (‘‘Commission’’), proposed rule changes SR–DTC–2017–008, SR– FICC–2017–014, and SR–NSCC–2017– 008 (collectively, the ‘‘Proposed Rule Changes’’), respectively, pursuant to Section 19(b)(1) of the Securities VerDate Sep<11>2014 20:54 Aug 30, 2017 Jkt 241001 Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder.2 The Proposed Rule Changes were published for comment in the Federal Register on July 11, 2017.3 The Commission did not receive any comment letters on the Proposed Rule Changes. For the reasons discussed below, the Commission approves the Proposed Rule Changes. I. Description of the Proposed Rule Changes The Proposed Rule Changes would adopt the Clearing Agency Model Risk Management Framework (‘‘Framework’’), which would set forth the model risk management practices adopted by the Clearing Agencies. Although the Framework would be a rule of each Clearing Agency, the Proposed Rule Changes do not require any changes to the Rules, By-Laws and Organizational Certificate of DTC, the Rulebook of GSD, the Clearing Rules of MBSD,4 or the Rules & Procedures of NSCC, as the Framework would be a standalone document for each Clearing Agency. In general, the Framework would describe the model risk management practices adopted by the Clearing Agencies. The Framework is designed to help identify, measure, monitor, and manage the risks associated with the design, development, implementation, use, and validation of quantitative models. The Framework would describe (i) governance of the Framework; (ii) key terms; (iii) model inventory procedures; (iv) model validation procedures; (v) model approval process; and (vi) model performance procedures. A. Governance of the Framework The Framework would outline the Clearing Agencies’ governance of the Framework itself. The Framework would be owned and managed by (i) the Clearing Agencies’ risk management area generally responsible for model 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 Securities Exchange Act Release No. 81074 (July 5, 2017), 82 FR 32030 (July 11, 2017) (SR–DTC– 2017–008; SR–FICC–2017–014; SR–NSCC–2017– 008) (‘‘Notice’’). 4 Available at https://www.dtcc.com/en/legal/ rules-and-procedures. FICC is comprised of two divisions: The Government Securities Division (‘‘GSD’’) and the Mortgage-Backed Securities Division (‘‘MBSD’’). Each division serves as a central counterparty, becoming the buyer and seller to each of their respective members’ securities transactions and guarantying settlement of those transactions, even if a member defaults. GSD provides, among other things, clearance and settlement for trades in U.S. Government debt issues. MBSD provides, among other things, clearance and settlement for trades in mortgagebacked securities. GSD and MBSD maintain separate sets of rules, margin models, and clearing funds. 2 17 PO 00000 Frm 00043 Fmt 4703 Sfmt 4703 41433 validation and control matters, (ii) the DTCC Model Validation and Control Group (‘‘MVC’’),5 and (iii) senior management and the Board of Directors of each Clearing Agency (‘‘Boards’’), which would have review and oversight authority.6 The Framework would provide that (i) any change to the Framework must be approved by the Boards or such committees as may be delegated authority by the Boards, from time to time, pursuant to the Boards’ charters, (ii) MVC shall review this Framework no less frequently than annually, and (iii) any and all changes to this Framework are subject to regulatory review and approval.7 B. Key Terms The Framework would define two key terms: Model and Model Risk. The term ‘‘Model’’ would refer to a quantitative method, system, or approach that applies statistical, economic, financial, or mathematical theories, techniques, and assumptions to process input data into quantitative estimates.8 A Model would consist of three components: (1) An information input component, which would deliver assumptions and data to the Model; (2) a processing component, which would transform inputs into estimates; and (3) a reporting component, which would translate the estimates into useful business information.9 A Model also would cover quantitative approaches whose inputs are partially or wholly qualitative or based on expert judgment, provided that the output is quantitative in nature.10 The term ‘‘Model Risk’’ would refer to the potential for adverse consequences from decisions based on incorrect or misused Model outputs and reports, and primarily occurring due to (i) fundamental errors in the design or development of Models; (ii) incorrect Model input or assumptions; (iii) erroneous implementation of Models; (iv) unauthorized or incorrect changes to Models; (v) changes in market conditions rendering existing Models 5 The parent company of the Clearing Agencies is The Depository Trust & Clearing Corporation (‘‘DTCC’’). DTCC operates on a shared services model with respect to the Clearing Agencies. Most corporate functions are established and managed on an enterprise-wide basis pursuant to intercompany agreements under which it is generally DTCC that provides a relevant service to a Clearing Agency. Notice, 82 at 32031. 6 Id. 7 Id. 8 Id. 9 Id. 10 Id.; see Supervisory Guidance on Model Risk Management, SR Letter 11–7, dated April 4, 2011, issued by the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency, at 3. E:\FR\FM\31AUN1.SGM 31AUN1 41434 Federal Register / Vol. 82, No. 168 / Thursday, August 31, 2017 / Notices unfit for their intended purpose; and (vi) misuse of or overreliance on Models.11 The Framework would state that it is designed to minimize the Clearing Agencies’ potential for financial loss, inaccurate financial or regulatory reporting, misaligned business strategies, or damage to their respective reputations resulting from a failure to properly manage Model Risk.12 sradovich on DSK3GMQ082PROD with NOTICES C. Model Inventory Procedures The Framework would describe the Clearing Agencies’ Model inventory procedures. All Clearing Agency Models would be subject to tracking for monitoring purposes within each Clearing Agency (‘‘Model Inventory’’).13 The Framework would describe how a Model Inventory survey is conducted at least annually across the Clearing Agencies to confirm that the Model Inventory is current.14 During this survey period, all Clearing Agency business areas and support functions that intend to develop a model (for Clearing Agency use) would submit a list of their planned models to MVC in order for MVC to conclude whether they meet the definition of Model under the Framework.15 The Framework would outline how MVC would assign a materiality/ complexity index rating to each Model when it is added to a Model Inventory, which would impact the Model’s prioritization and authority required for approval.16 All Model materiality/ complexity index assignments would be reviewed at least annually by MVC, as well as by the committee specifically created by the Clearing Agencies to address Model Risk governance matters, the DTCC Model Risk Governance Committee (‘‘MRGC’’).17 The Framework would further describe the initial and periodic validation protocols that would be applicable to all Models in the Model Inventory (‘‘Model Validation’’).18 The Framework would state that all Model Validations would be performed by qualified persons who are free from influence from the persons responsible for the development or operation of the Models being validated.19 MVC, which is responsible for performing all Model Validations, is functionally separate from all Clearing Agency areas that 11 Notice, develop or operate Models.20 The head of MVC directly reports to the head of the DTCC Group Chief Risk Office, rather than to anyone that is in charge of developing or operating Models for the Clearing Agencies.21 D. Model Validation Procedures The Framework would describe the Clearing Agencies’ Model Validation procedures. Each new Model would undergo a full Model Validation unless provisionally approved.22 The Framework would state that a full Model Validation would be applied (i) to all new Models prior to their use in production; (ii) during periodic Model Validations; and (iii) when Model changes are made that require an independent Model Validation.23 The Framework would provide that the DTCC Quantitative Risk Management Financial Engineering Unit, which is functionally separate from MVC, would be responsible for developing, testing, and signing-off on new Clearing Agency Models and enhancements to existing Clearing Agency Models before submitting any such Model to MVC for Model Validation and approval.24 The Framework would state that an active Model may require changes in either structure or technique.25 Details for any Model change request would be provided to MVC for review and a determination of whether full Model Validation is required.26 The Framework would describe that MVC would perform a Model Validation for each Clearing Agency Model approved for use in production not less than annually (or more frequently as may be contemplated by such Clearing Agency’s established risk management framework), including each credit risk Model, liquidity risk Model, and in the case of FICC and NSCC, as central counterparties (‘‘CCPs’’), on their margin systems and related Models.27 In conducting a full Model Validation, MVC would verify that the Model is performing as expected in accordance with its design objectives and business purpose. The full Model Validation standards for any new Model would include, but not be limited to: • Evaluation of the Model development documentation and testing; • evaluation of Model theory and assumptions, and identification of potential limitations; • evaluation of data inputs and parameters; • review of numerical implementation including replication for certain key Model components, which would vary from Model to Model; • independent testing, with respect to sensitivity analysis, stress testing, and benchmarking, as appropriate; and • evaluation of Model outputs, Model performance, and backtesting.28 The Framework would provide that all Models approved for use in production also would be subject to periodic Model Validations for purposes of confirming that the Models continue to operate as intended, identifying any deficiencies that would call into question the continuing validity of any such Model.29 The Framework would further provide that periodic Model Validations would generally use the same standards as an initial Model Validation.30 In certain cases, MVC may determine extra Model Validation activities are warranted based on previous Model Validation work and findings, changes in market conditions, or because a particular Model warrants extra validation.31 The Framework would provide that MVC would centrally track all findings from (i) a new Model Validation; (ii) a change in Model Validation; (iii) a periodic Model Validation; or (iv) the implementation of a new Model or Model change.32 The status of any changes to address a finding for approved Models would be reported to the MRGC on a monthly basis.33 If a finding is related to Model implementation errors, the persons responsible for the development or operation of the Model (‘‘Model Owner’’) would report such findings, incidents, or both in accordance with the policies and procedures of the Operational Risk Management unit (‘‘ORM’’) within the Group Chief Risk Office.34 If an adverse Model Validation finding cannot be resolved, the Model Owner would work with MVC and ORM to submit the finding for risk acceptance in accordance with ORM policies and procedures.35 82 at 32031. 12 Id. 20 Id. 28 Id. 13 Id. 21 Id. 29 Id. 14 Notice, 22 Id. 30 Id. 23 Id. 31 Id. 24 Id. 32 Id. 25 Id. 33 Id. 26 Id. 34 Id. 27 Id. 35 Id. 82 at 32031–32. 15 Notice, 82 at 32032. 16 Id. 17 Id. 18 Id. 19 Id. VerDate Sep<11>2014 20:54 Aug 30, 2017 Jkt 241001 PO 00000 Frm 00044 Fmt 4703 Sfmt 4703 E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 82, No. 168 / Thursday, August 31, 2017 / Notices E. Model Approval Process sradovich on DSK3GMQ082PROD with NOTICES The Framework would outline the approval process applicable to all new Models. All new Clearing Agency Models, and all material changes to existing Clearing Agency Models, would undergo Model Validation by MVC and must be approved prior to business use.36 If the Model’s materiality is ‘‘Medium’’ or ‘‘High,’’ such Model Validation would be reviewed by the MRGC and recommended by the MRGC to the Clearing Agencies’ management level committee responsible for Model Risk management matters, the Management Risk Committee (‘‘MRC’’), for approval.37 Regarding any proposed change to any backtesting methodology, prior to implementation thereof (and before any reporting thereof in any management and regulatory report), the Framework would provide that a description of the proposed change and impact study results would be presented to the MRGC for review and approval.38 If the impact study results reflect that implementation of the methodology would negatively impact any existing risk tolerance threshold range, such results would be escalated by the MRGC to the MRC, and subsequently to the Board Risk Committee (‘‘BRC’’), for approval prior to implementation.39 The Framework would provide that provisional approvals with respect to new Clearing Agency Models and material changes to existing Clearing Agency Models may be issued to allow a Model to be published for urgent business use prior to MVC’s Model Validation.40 Provisional approval requests for a Model along with appropriate control measures would be presented by the applicable Model Owners to MVC and the MRGC for review.41 The Framework would provide that Models would be provisionally approved by MVC for a limited period, not to exceed six months unless also approved by the MRGC.42 MVC would track all such provisional approvals and oversee compliance with control measures and provisional approval periods.43 The Framework would state that each periodic Model Validation would be presented to the MRGC for its review, and its recommendation for approval to 36 Id. 37 Id. 38 Id. 39 Id. 40 Id. 41 Id. 42 Id. 43 Id. VerDate Sep<11>2014 20:54 Aug 30, 2017 Jkt 241001 the MRC.44 The Framework would further provide that MRC approval must be obtained in order for any such periodic validation to be deemed complete.45 F. Model Performance Procedures The Framework would state that MVC would be responsible for Model performance monitoring and for each Clearing Agency’s backtesting process.46 The MRGC would be the primary forum for MVC’s regular reporting of Model Validation activities and material Model Risks identified through regular Model performance monitoring.47 Reports and recommendations with respect to Model Risk management would be made to the MRC.48 The Framework would describe that periodic reporting to the BRC of each Clearing Agency with regard to Model Risk matters may include: • Updates of Model Validation findings and the status of annual validations; • updates on significant Model Risk matters, and on compliance matters with respect to Model Risk policies and procedures (including the Framework); and • escalation of Model Risk matters as set forth in the market risk tolerance statement, which establishes the Clearing Agencies’ Model Risk tolerances (‘‘Market Risk Tolerance Statement’’), and subsequent, regular updates with respect thereto.49 The Framework would provide that MVC would prepare Model performance monitoring reports on both a monthly and daily basis.50 On a monthly basis, MVC would (i) perform sensitivity analysis on each of the CCP’s margin Model, (ii) review the key parameters and assumptions for backtesting, and (iii) consider modifications to ensure the backtesting practices of FICC and NSCC, as CCPs, are appropriate for determining the adequacy of the applicable CCP’s margin resources.51 The Framework would state that MRGC would review the Model performance monitoring, which includes review of risk-based Models 44 Id. 45 Id. 46 Id. The Clearing Agencies define Model performance monitoring is the process of (i) evaluating an active Model’s ongoing performance based on theoretical tests, (ii) monitoring the Model’s parameters through the use of threshold indicators, and/or (iii) backtesting using actual historical data/realizations to test a Value at Risk (‘‘VaR’’) Model’s predictive power. 47 Notice, 82 at 32033. 48 Id. 49 Id. 50 Id. 51 Id. PO 00000 Frm 00045 Fmt 4703 Sfmt 4703 41435 used to calculate margin requirements and relevant parameters/threshold indicators, sensitivity analysis, and Model backtesting results.52 Serious performance concerns would be escalated to the MRC.53 The Framework would further state that, in circumstances where the products cleared or the markets served by one or both of the CCPs display high volatility or become less liquid, or when the size or concentration of positions held by the applicable CCP’s members increases or decreases significantly, such sensitivity analysis and review of key Model parameters and assumptions would be conducted more frequently than monthly.54 The Framework would provide that VaR and Clearing Fund requirement (‘‘CFR’’) coverage backtesting for the CCPs would be performed by MVC on a daily basis or more frequently.55 CFR coverage would be backtested on an overall basis and for individual members and families of affiliated members.56 DTC backtesting would be performed by MVC on a daily basis for collateral group 57 collateral monitor coverage, collateral group level haircut 58 coverage, and security-level haircut coverage.59 The Framework would provide that thresholds for all backtests would be established for the rolling 12-month period coverage and calculated as the number of instances without deficiency over the total number of backtest instances, where deficiency is defined as the loss amount that exceeds the measure being tested (i.e., VaR, CFR, collateral monitor, or 52 Id. 53 Id. 54 Id. 55 Id. To mitigate default risk, FICC and NSCC collect funds from their members to maintain sufficient financial resources in the event a member or members default on their obligations. Those funds are held by FICC and NSCC in their respective Clearing Funds. As compared to the CFR, VaR Model backtesting tests Model performance at a specified confidence level, while the CFR backtesting tests margin sufficiency in case of a member default. 56 Notice, 82 at 32033. 57 A DTC Participant with multiple accounts may group its accounts into ‘‘families’’ (i.e., ‘‘collateral groups’’) and instruct DTC to allocate a specified portion of its overall Collateral Monitor and Net Debit Cap to each family. All accounts that a Participant designates as belonging to a common collateral group share a single Collateral Monitor and single Net Debit Cap. See Securities Exchange Act Release No. 38201 (January 23, 1997), 62 FR 4561 (January 30, 1997) (SR–DTC–96–17). 58 A haircut represents a percentage decrease applied to a Security’s Market Value solely for purposes of determining the collateral value of the Security. See DTC Settlement Service Guide, available at https://www.dtcc.com/∼/media/Files/ Downloads/legal/service-guides/Settlement.pdf, at 5. 59 Notice, 82 at 32033. E:\FR\FM\31AUN1.SGM 31AUN1 41436 Federal Register / Vol. 82, No. 168 / Thursday, August 31, 2017 / Notices haircut rate). Thresholds would be set as follows: 60 Threshold (%) Applicable to Backtesting risk metrics CCPs (FICC and NSCC) .......................... Overall CFR Coverage ................................................................................................. VaR Model Coverage ................................................................................................... Member Level CFR Coverage ..................................................................................... Family Level CFR Coverage ........................................................................................ Collateral Group Collateral Monitor Coverage ............................................................. Collateral Group Level Haircut Coverage .................................................................... Security-Level Haircut Coverage ................................................................................. sradovich on DSK3GMQ082PROD with NOTICES DTC ........................................................... The Framework would provide that the CFR coverage thresholds for FICC and NSCC would be based on applicable regulatory requirements that require them, as CCPs, to cover their credit exposure to their participants by establishing a risk-based margin system that, among other things calculates margin sufficient to cover their potential future exposure to participants in the interval between the last margin collection and the close out of positions following a participant default.61 As for DTC, which is not a CCP, the Framework would provide that the collateral group collateral monitor coverage threshold, among other controls, would be set to support the requirement that DTC maintain sufficient financial resources to cover its credit exposures to each participant fully with a high degree of confidence.62 Meanwhile, the ‘‘VaR Model Coverage,’’ ‘‘Collateral Group Level Haircut Coverage,’’ and ‘‘Security-Level Haircut Coverage’’ would be set and designed for Model performance monitoring purposes.63 The Framework would provide that, on at least a monthly basis, the key metrics relating to Model backtesting would be reviewed by the Market and Liquidity Risk Management unit within the Group Chief Risk Office and MVC, and reported to the MRC.64 Threshold breaches would be reviewed by the Managing Directors within the Financial Risk Management area (including the Market and Liquidity Risk Management unit) of the Group Chief Risk Office, and in the case of CFR coverage breaches by the CCPs and collateral group collateral monitor coverage by DTC, escalated to the BRC in accordance with the Market Risk Tolerance Statement.65 The Framework would state that the Managing Director of the Market and Liquidity Risk Management unit within the Group Chief Risk Office would be responsible for reviewing the Market Risk Tolerance Statement at least annually.66 The BRC would review and approve the Market Risk Tolerance Statement at least annually.67 The Framework would provide that all Model performance concerns would be escalated by MVC to the MRGC, including Model performance enhancement concerns.68 The MRGC may further recommend certain such matters for further escalation to the MRC, the BRC, or both.69 II. Discussion of Commission Findings Section 19(b)(2)(C) of the Act directs the Commission to approve a proposed rule change of a self-regulatory organization if it finds that such proposed rule change is consistent with the requirements of the Act and rules and regulations thereunder applicable to such organization.70 After carefully considering the Proposed Rule Changes, the Commission finds that the Proposed Rule Changes are consistent with the requirements of the Act and the rules and regulations thereunder applicable to the Clearing Agencies. In particular, the Commission believes the proposal is consistent with Section 17A(b)(3)(F) of the Act,71 as well as Rules 17Ad– 22(e)(4)(vii), 17Ad–22(e)(6)(vi) and (vii), and 17Ad–22(e)(7)(vii) thereunder.72 A. Consistency With Section 17A(b)(3)(F) of the Act Section 17A(b)(3)(F) of the Act requires, in part, that the rules of a clearing agency be designed to assure the safeguarding of securities and funds which are in the custody and control of the Clearing Agencies or for which they are responsible.73 60 Id. 62 Notice, 61 Id.; 63 Id. see 17 CFR 240.17Ad–22(e)(6)(iii). 17 CFR 240.17Ad–22(a)(13) defines the term ‘‘potential future exposure’’ to mean the maximum exposure estimated to occur at a future point in time with an established single-tailed confidence level of at least 99 percent with respect to the estimated distribution of future exposure. VerDate Sep<11>2014 20:54 Aug 30, 2017 Jkt 241001 64 Notice, 82 at 32033. B. Consistency With Rule 17Ad– 22(e)(4)(vii) The Commission believes that the changes proposed in the Proposed Rule Changes are consistent with Rule 17Ad– 22(e)(4)(vii) under the Act, which 70 15 U.S.C. 78s(b)(2)(C). U.S.C. 78q–1(b)(3)(F). 72 17 CFR 240.17Ad–22(e)(4)(vii), (e)(6)(vi) and (vii), and (e)(7)(vii). 73 15 U.S.C. 78q–1(b)(3)(F). 74 Id. 71 15 65 Id. 66 Id. 67 Id. 68 Id. PO 00000 The Commission believes that by establishing and describing in the proposed Framework (i) governance of the Framework; (ii) key terms; (iii) Model Inventory procedures; (iv) Model Validation procedures; (v) Model approval process; and (vi) Model performance procedures, as described above, the proposal is designed to help safeguard securities and funds in the Clearing Agencies’ custody and control. Specifically, the comprehensive nature of the practices described in the Framework, both individually and collectively, are designed to help improve the Clearing Agencies’ ability to determine and evaluate the risk presented by many of the Clearing Agencies’ members by measuring, monitoring, and managing the risks from using quantitative Models. Clearly documenting the Clearing Agencies’ ability to evaluate risk in the proposed Framework could enable the Clearing Agencies to deploy more effectively their risk management tools to manage the credit, market, and liquidity risks presented by such members. By enabling the Clearing Agencies to use their risk management tools more effectively, the proposed Framework is designed to help mitigate the risk that the Clearing Agencies would suffer a loss from a member default. Therefore, the Commission believes that these Proposed Rule Changes are designed to help safeguard funds within the Clearing Agencies’ custody and control, consistent with Section 17A(b)(3)(F) of the Act.74 69 Id. 82 at 32034. Frm 00046 Fmt 4703 Sfmt 4703 99 99 99 99 99 99 95 E:\FR\FM\31AUN1.SGM 31AUN1 Federal Register / Vol. 82, No. 168 / Thursday, August 31, 2017 / Notices sradovich on DSK3GMQ082PROD with NOTICES requires, in part, that the Clearing Agencies establish, implement, maintain and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage their credit exposures to participants and those arising from their payment, clearing, and settlement processes by performing a Model Validation for their credit risk Models not less than annually or more frequently as may be contemplated by the Framework.75 As discussed above, the Framework would provide for validation of quantitative credit-risk Models. The Framework would describe the procedures for conducting a Model Inventory to determine which Models should be reviewed. The Framework would then describe the process for reviewing such Models, before they are implemented, so that the Clearing Agencies can ensure that their credit exposures are effectively and efficiently modeled. The Framework would further describe the validation process for the review of existing quantitative creditrisk Models to determine whether the Models accurately capture the Clearing Agencies’ credit exposures, which would be performed not less than annually. Because the proposal is designed to meet the requirements of Rule 17Ad–22(e)(4)(vii) by establishing the proposed Framework for performing a Model Validation for the Clearing Agencies’ credit risk Models, the Commission believes the Proposed Rule Changes are consistent with Rule 17Ad– 22(e)(4)(vii) under the Act.76 C. Consistency With Rule 17Ad– 22(e)(6)(vi) and (vii) The Commission believes that the changes proposed in the Proposed Rule Changes are consistent with Rules 17Ad–22(e)(6) under the Act, specifically paragraphs (vi) and (vii) thereunder, as discussed below.77 Rule 17Ad–22(e)(6)(vi) under the Act requires, in part, that the Clearing Agencies that provide CCP services (i.e., FICC and NSCC) establish, implement, maintain and enforce written policies and procedures reasonably designed to cover their credit exposures to their participants by establishing a risk-based margin system that at minimum is monitored by management on an ongoing basis and is regularly reviewed, tested, and verified by (A) conducting backtests of their margin Models at least once each day using standard predetermined parameters and 75 17 CFR 240.17Ad–22(e)(4)(vii). assumptions; (B) conducting a sensitivity analysis of their margin Models and a review of their parameters and assumptions for backtesting on at least a monthly basis, and considering modifications to ensure the backtesting practices are appropriate for determining the adequacy of the their margin resources; (C) conducting a sensitivity analysis of their margin Models and a review of their parameters and assumptions for backtesting more frequently than monthly during periods of time when the products cleared or markets served display high volatility or become less liquid, or when the size or concentration of positions held by their participants increases or decreases significantly; and (D) reporting the results of their analyses to appropriate decision makers at the clearing agencies, including but not limited to, their risk management committee or board of directors, and using these results to evaluate the adequacy of and adjust their margin methodology, Model parameters, and any other relevant aspects of their credit risk management framework.78 As discussed above, the Framework would provide that FICC and NSCC, as CCPs, would (a) perform VaR and CFR backtesting on a daily basis using standard predetermined parameters and assumptions; (b) as part of Model performance monitoring, on at least a monthly basis, perform sensitivity analysis on each of the margin Models of FICC and NSCC, review the key parameters and assumptions for backtesting, and consider modifications to ensure the backtesting practices of FICC and NSCC are appropriate for determining the adequacy of the applicable CCP’s margin resources; (c) in circumstances where the products cleared or the markets served by FICC, NSCC, or both display high volatility or become less liquid, or when the size or concentration of positions held by the applicable CCP’s members increases or decreases significantly, conduct sensitivity analysis and review of key Model parameters and assumptions more frequently than monthly; and (d) report the results of their analyses under (b) and (c) to key decision makers, including but not limited to, the MRC, the BRC, or both, which could use these results to evaluate the adequacy of and adjust their margin methodology, Model parameters, and any other relevant aspects of their credit risk management framework. By establishing the proposed Framework for a risk-based margin system to help cover the credit exposures of FICC and NSCC, as CCPs, 76 Id. 77 17 that, at minimum, is monitored by management on an ongoing basis and is designed to address each of the enumerated requirements of Rule 17Ad– 22(e)(6)(vi), the Commission believes the Proposed Rule Changes are consistent with Rule 17Ad– 22(e)(6)(vi).79 Rule 17Ad–22(e)(6)(vii) under the Act requires, in part, that the Clearing Agencies that provide CCP services (i.e., FICC and NSCC) establish, implement, maintain and enforce written policies and procedures reasonably designed to cover their credit exposures to their participants by establishing a risk-based margin system that at minimum requires a model validation for their margin systems and related models to be performed not less than annually, or more frequently as may be contemplated by their risk management framework.80 As discussed above, the Framework would describe FICC and NSCC’s processes for determining which Models they should validate, including margin risk Models. After determining which Models to validate, FICC and NSCC would use the Model Validation processes for their margin systems and related Models, which would be performed not less than annually. In certain cases, FICC and NSCC may determine extra Model Validation activities are warranted based on previous Model Validation work and findings, changes in market conditions, or because a particular Model warrants extra validation. Because the proposal is designed to meet the requirements of Rule 17Ad–22(e)(6)(vii) by establishing the proposed Framework for a riskbased margin system to help cover the credit exposures of FICC and NSCC, as CCPs, that, at minimum, requires a Model Validation for the their margin systems and related Models to be performed not less than annually, the Commission believes the Proposed Rule Changes are consistent with Rule 17Ad– 22(e)(6)(vii).81 D. Consistency With Rule 17Ad– 22(e)(7)(vii) The Commission believes that the changes proposed in the Proposed Rule Changes are consistent with Rule 17Ad– 22(e)(7)(vii) under the Act, which requires, in part, that the Clearing Agencies establish, implement, maintain and enforce written policies and procedures reasonably designed to effectively measure, monitor, and manage the liquidity risk that arises in or is borne by the Clearing Agencies, 79 Id. 80 17 CFR 240.17Ad–22(e)(6). VerDate Sep<11>2014 20:54 Aug 30, 2017 78 17 Jkt 241001 PO 00000 CFR 240.17Ad–22(e)(6). Frm 00047 Fmt 4703 Sfmt 4703 41437 CFR 240.17Ad–22(e)(6)(vii). 81 Id. E:\FR\FM\31AUN1.SGM 31AUN1 41438 Federal Register / Vol. 82, No. 168 / Thursday, August 31, 2017 / Notices including measuring, monitoring, and managing their settlement and funding flows on an ongoing and timely basis, and their use of intraday liquidity by performing a Model Validation of their liquidity risk Models not less than annually or more frequently as may be contemplated by their risk management framework.82 As discussed above, the Framework would describe the Clearing Agencies’ process for determining which Models they should validate, including liquidity risk Models. After determining which Models to validate, the Clearing Agencies would use the Model Validation processes for their margin systems and related Models, which would be performed not less than annually. In certain cases, the Clearing Agencies may determine extra Model Validation activities are warranted based on previous Model Validation work and findings, changes in market conditions, or because a particular Model warrants extra validation. Because the proposal is designed to meet the requirements of Rule 17Ad– 22(e)(7)(vii) by establishing the proposed Framework to help measure, monitor, and manage the Clearing Agencies’ settlement and funding flows on an ongoing and timely basis, and the Clearing Agencies’ use of intraday liquidity by performing a Model Validation of their liquidity risk Models not less than annually, the Commission believes the Proposed Rule Changes are consistent with Rule 17Ad–22(e)(7)(vii) under the Act.83 III. Conclusion sradovich on DSK3GMQ082PROD with NOTICES On the basis of the foregoing, the Commission finds that the Proposed Rule Changes are consistent with the requirements of the Act, in particular the requirements of Section 17A of the Act 84 and the rules and regulations promulgated thereunder. It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that proposed rule changes SR– DTC–2017–008, SR–FICC–2017–014, and SR–NSCC–2017–008 be, and hereby are, approved.85 82 17 CFR 240.17Ad–22(e)(7)(vii). 83 Id. 84 15 U.S.C. 78q–1. approving the Proposed Rule Changes, the Commission considered the proposals’ impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). 86 17 CFR 200.30–3(a)(12). 85 In VerDate Sep<11>2014 20:54 Aug 30, 2017 Jkt 241001 For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.86 Eduardo A. Aleman, Assistant Secretary. [FR Doc. 2017–18448 Filed 8–30–17; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–81487; File No. SR–LCH SA–2017–006] Self-Regulatory Organizations; LCH SA; Notice of Filing of Proposed Rule Change Relating to Options on Index Credit Default Swaps August 25, 2017. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 notice is hereby given that on, August 18, 2017, Banque Centrale de Compensation, which conducts business under the name LCH SA (‘‘LCH SA’’), filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change described in Items I, II, and III below, which Items have been prepared primarily by LCH SA. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Clearing Agency’s Statement of the Terms of Substance of the Proposed Rule Change LCH SA is proposing to amend its (i) CDS Clearing Rule Book (the ‘‘Rule Book’’), (ii) CDS Clearing Supplement (the ‘‘Clearing Supplement’’), (iii) CDS Clearing Procedures (the ‘‘Procedures’’), and (iv) CDS Dispute Resolution Protocol (the ‘‘Dispute Resolution Protocol’’), to incorporate terms and to make conforming and clarifying changes to allow options on index credit default swaps (‘‘CDS’’) to be cleared by LCH SA.3 II. Clearing Agency’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, LCH SA included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 Capitalized terms used but not defined herein shall have the meaning specified in the Rule Book, Clearing Supplement, Procedures, and Dispute Resolution Protocol, as applicable. 2 17 PO 00000 Frm 00048 Fmt 4703 Sfmt 4703 in Item IV below. LCH SA has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of these statements. A. Clearing Agency’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose The purpose of the proposed rule change is to revise LCH SA’s rules and procedures to allow LCH SA to clear options on index CDS. An option on index CDS is a contract that gives the option buyer the right (and not the obligation) to enter into a specified index CDS contract (i.e., the underlying) with the option seller at a predefined exercise price called the strike. Upon the launch of clearing options on index CDS, LCH SA will provide central counterparty services for options on index CDS that are accepted for clearing and become the option seller for each option buyer and the option buyer for each option seller with respect to an option on index CDS novated by LCH SA. The terms of the option contract on index CDS will provide the buyer the right to sell or buy protection on the underlying index CDS at expiry of the option. The index CDS resulting from the exercise of the option will be automatically cleared by LCH SA as the central counterparty. A credit event (including a restructuring event) may occur with respect to a constituent of an underlying index. If the credit event occurs before the option expiry, such credit event may affect the option buyer’s decision regarding whether to exercise the option upon expiry. On the other hand, if a credit event occurs after the buyer has exercised the option, a cleared index CDS contract has been created from the option exercise and the situation would be the same as a credit event occurring to any other index CDS contract currently cleared by LCH SA. Initially, LCH SA proposes to include European index CDS currently cleared by CDSClear as the underlying, i.e., CDS on Markit iTraxx Europe Index and iTraxx Crossover Index, and may subsequently extend the underlying to include other index CDS contracts cleared by LCH SA, such as CDS on iTraxx Senior Financial Index, CDX NA IG, and CDX NA HY, subject to additional regulatory approvals, if necessary. Each of the changes is described in further detail below. E:\FR\FM\31AUN1.SGM 31AUN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 82, Number 168 (Thursday, August 31, 2017)]
[Notices]
[Pages 41433-41438]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-18448]


=======================================================================
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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81485; File Nos. SR-DTC-2017-008; SR-FICC-2017-014; SR-
NSCC-2017-008]


Self-Regulatory Organizations; The Depository Trust Company; 
Fixed Income Clearing Corporation; National Securities Clearing 
Corporation; Order Approving Proposed Rule Changes To Adopt the 
Clearing Agency Model Risk Management Framework

August 25, 2017.
    On June 20, 2017, The Depository Trust Company (``DTC''), Fixed 
Income Clearing Corporation (``FICC''), and National Securities 
Clearing Corporation (``NSCC,'' each a ``Clearing Agency,'' and 
collectively, ``Clearing Agencies'') filed with the Securities and 
Exchange Commission (``Commission''), proposed rule changes SR-DTC-
2017-008, SR-FICC-2017-014, and SR-NSCC-2017-008 (collectively, the 
``Proposed Rule Changes''), respectively, pursuant to Section 19(b)(1) 
of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder.\2\ The Proposed Rule Changes were published for comment in 
the Federal Register on July 11, 2017.\3\ The Commission did not 
receive any comment letters on the Proposed Rule Changes. For the 
reasons discussed below, the Commission approves the Proposed Rule 
Changes.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 81074 (July 5, 2017), 82 
FR 32030 (July 11, 2017) (SR-DTC-2017-008; SR-FICC-2017-014; SR-
NSCC-2017-008) (``Notice'').
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I. Description of the Proposed Rule Changes

    The Proposed Rule Changes would adopt the Clearing Agency Model 
Risk Management Framework (``Framework''), which would set forth the 
model risk management practices adopted by the Clearing Agencies. 
Although the Framework would be a rule of each Clearing Agency, the 
Proposed Rule Changes do not require any changes to the Rules, By-Laws 
and Organizational Certificate of DTC, the Rulebook of GSD, the 
Clearing Rules of MBSD,\4\ or the Rules & Procedures of NSCC, as the 
Framework would be a standalone document for each Clearing Agency.
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    \4\ Available at https://www.dtcc.com/en/legal/rules-and-procedures. FICC is comprised of two divisions: The Government 
Securities Division (``GSD'') and the Mortgage-Backed Securities 
Division (``MBSD''). Each division serves as a central counterparty, 
becoming the buyer and seller to each of their respective members' 
securities transactions and guarantying settlement of those 
transactions, even if a member defaults. GSD provides, among other 
things, clearance and settlement for trades in U.S. Government debt 
issues. MBSD provides, among other things, clearance and settlement 
for trades in mortgage-backed securities. GSD and MBSD maintain 
separate sets of rules, margin models, and clearing funds.
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    In general, the Framework would describe the model risk management 
practices adopted by the Clearing Agencies. The Framework is designed 
to help identify, measure, monitor, and manage the risks associated 
with the design, development, implementation, use, and validation of 
quantitative models. The Framework would describe (i) governance of the 
Framework; (ii) key terms; (iii) model inventory procedures; (iv) model 
validation procedures; (v) model approval process; and (vi) model 
performance procedures.

A. Governance of the Framework

    The Framework would outline the Clearing Agencies' governance of 
the Framework itself. The Framework would be owned and managed by (i) 
the Clearing Agencies' risk management area generally responsible for 
model validation and control matters, (ii) the DTCC Model Validation 
and Control Group (``MVC''),\5\ and (iii) senior management and the 
Board of Directors of each Clearing Agency (``Boards''), which would 
have review and oversight authority.\6\
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    \5\ The parent company of the Clearing Agencies is The 
Depository Trust & Clearing Corporation (``DTCC''). DTCC operates on 
a shared services model with respect to the Clearing Agencies. Most 
corporate functions are established and managed on an enterprise-
wide basis pursuant to intercompany agreements under which it is 
generally DTCC that provides a relevant service to a Clearing 
Agency. Notice, 82 at 32031.
    \6\ Id.
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    The Framework would provide that (i) any change to the Framework 
must be approved by the Boards or such committees as may be delegated 
authority by the Boards, from time to time, pursuant to the Boards' 
charters, (ii) MVC shall review this Framework no less frequently than 
annually, and (iii) any and all changes to this Framework are subject 
to regulatory review and approval.\7\
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    \7\ Id.
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B. Key Terms

    The Framework would define two key terms: Model and Model Risk. The 
term ``Model'' would refer to a quantitative method, system, or 
approach that applies statistical, economic, financial, or mathematical 
theories, techniques, and assumptions to process input data into 
quantitative estimates.\8\ A Model would consist of three components: 
(1) An information input component, which would deliver assumptions and 
data to the Model; (2) a processing component, which would transform 
inputs into estimates; and (3) a reporting component, which would 
translate the estimates into useful business information.\9\ A Model 
also would cover quantitative approaches whose inputs are partially or 
wholly qualitative or based on expert judgment, provided that the 
output is quantitative in nature.\10\
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    \8\ Id.
    \9\ Id.
    \10\ Id.; see Supervisory Guidance on Model Risk Management, SR 
Letter 11-7, dated April 4, 2011, issued by the Board of Governors 
of the Federal Reserve System and the Office of the Comptroller of 
the Currency, at 3. 
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    The term ``Model Risk'' would refer to the potential for adverse 
consequences from decisions based on incorrect or misused Model outputs 
and reports, and primarily occurring due to (i) fundamental errors in 
the design or development of Models; (ii) incorrect Model input or 
assumptions; (iii) erroneous implementation of Models; (iv) 
unauthorized or incorrect changes to Models; (v) changes in market 
conditions rendering existing Models

[[Page 41434]]

unfit for their intended purpose; and (vi) misuse of or overreliance on 
Models.\11\ The Framework would state that it is designed to minimize 
the Clearing Agencies' potential for financial loss, inaccurate 
financial or regulatory reporting, misaligned business strategies, or 
damage to their respective reputations resulting from a failure to 
properly manage Model Risk.\12\
---------------------------------------------------------------------------

    \11\ Notice, 82 at 32031.
    \12\ Id.
---------------------------------------------------------------------------

C. Model Inventory Procedures

    The Framework would describe the Clearing Agencies' Model inventory 
procedures. All Clearing Agency Models would be subject to tracking for 
monitoring purposes within each Clearing Agency (``Model 
Inventory'').\13\ The Framework would describe how a Model Inventory 
survey is conducted at least annually across the Clearing Agencies to 
confirm that the Model Inventory is current.\14\ During this survey 
period, all Clearing Agency business areas and support functions that 
intend to develop a model (for Clearing Agency use) would submit a list 
of their planned models to MVC in order for MVC to conclude whether 
they meet the definition of Model under the Framework.\15\
---------------------------------------------------------------------------

    \13\ Id.
    \14\ Notice, 82 at 32031-32.
    \15\ Notice, 82 at 32032.
---------------------------------------------------------------------------

    The Framework would outline how MVC would assign a materiality/
complexity index rating to each Model when it is added to a Model 
Inventory, which would impact the Model's prioritization and authority 
required for approval.\16\ All Model materiality/complexity index 
assignments would be reviewed at least annually by MVC, as well as by 
the committee specifically created by the Clearing Agencies to address 
Model Risk governance matters, the DTCC Model Risk Governance Committee 
(``MRGC'').\17\
---------------------------------------------------------------------------

    \16\ Id.
    \17\ Id.
---------------------------------------------------------------------------

    The Framework would further describe the initial and periodic 
validation protocols that would be applicable to all Models in the 
Model Inventory (``Model Validation'').\18\ The Framework would state 
that all Model Validations would be performed by qualified persons who 
are free from influence from the persons responsible for the 
development or operation of the Models being validated.\19\ MVC, which 
is responsible for performing all Model Validations, is functionally 
separate from all Clearing Agency areas that develop or operate 
Models.\20\ The head of MVC directly reports to the head of the DTCC 
Group Chief Risk Office, rather than to anyone that is in charge of 
developing or operating Models for the Clearing Agencies.\21\
---------------------------------------------------------------------------

    \18\ Id.
    \19\ Id.
    \20\ Id.
    \21\ Id.
---------------------------------------------------------------------------

D. Model Validation Procedures

    The Framework would describe the Clearing Agencies' Model 
Validation procedures. Each new Model would undergo a full Model 
Validation unless provisionally approved.\22\ The Framework would state 
that a full Model Validation would be applied (i) to all new Models 
prior to their use in production; (ii) during periodic Model 
Validations; and (iii) when Model changes are made that require an 
independent Model Validation.\23\
---------------------------------------------------------------------------

    \22\ Id.
    \23\ Id.
---------------------------------------------------------------------------

    The Framework would provide that the DTCC Quantitative Risk 
Management Financial Engineering Unit, which is functionally separate 
from MVC, would be responsible for developing, testing, and signing-off 
on new Clearing Agency Models and enhancements to existing Clearing 
Agency Models before submitting any such Model to MVC for Model 
Validation and approval.\24\
---------------------------------------------------------------------------

    \24\ Id.
---------------------------------------------------------------------------

    The Framework would state that an active Model may require changes 
in either structure or technique.\25\ Details for any Model change 
request would be provided to MVC for review and a determination of 
whether full Model Validation is required.\26\ The Framework would 
describe that MVC would perform a Model Validation for each Clearing 
Agency Model approved for use in production not less than annually (or 
more frequently as may be contemplated by such Clearing Agency's 
established risk management framework), including each credit risk 
Model, liquidity risk Model, and in the case of FICC and NSCC, as 
central counterparties (``CCPs''), on their margin systems and related 
Models.\27\
---------------------------------------------------------------------------

    \25\ Id.
    \26\ Id.
    \27\ Id.
---------------------------------------------------------------------------

    In conducting a full Model Validation, MVC would verify that the 
Model is performing as expected in accordance with its design 
objectives and business purpose. The full Model Validation standards 
for any new Model would include, but not be limited to:
     Evaluation of the Model development documentation and 
testing;
     evaluation of Model theory and assumptions, and 
identification of potential limitations;
     evaluation of data inputs and parameters;
     review of numerical implementation including replication 
for certain key Model components, which would vary from Model to Model;
     independent testing, with respect to sensitivity analysis, 
stress testing, and benchmarking, as appropriate; and
     evaluation of Model outputs, Model performance, and 
backtesting.\28\
---------------------------------------------------------------------------

    \28\ Id.
---------------------------------------------------------------------------

    The Framework would provide that all Models approved for use in 
production also would be subject to periodic Model Validations for 
purposes of confirming that the Models continue to operate as intended, 
identifying any deficiencies that would call into question the 
continuing validity of any such Model.\29\ The Framework would further 
provide that periodic Model Validations would generally use the same 
standards as an initial Model Validation.\30\ In certain cases, MVC may 
determine extra Model Validation activities are warranted based on 
previous Model Validation work and findings, changes in market 
conditions, or because a particular Model warrants extra 
validation.\31\
---------------------------------------------------------------------------

    \29\ Id.
    \30\ Id.
    \31\ Id.
---------------------------------------------------------------------------

    The Framework would provide that MVC would centrally track all 
findings from (i) a new Model Validation; (ii) a change in Model 
Validation; (iii) a periodic Model Validation; or (iv) the 
implementation of a new Model or Model change.\32\ The status of any 
changes to address a finding for approved Models would be reported to 
the MRGC on a monthly basis.\33\ If a finding is related to Model 
implementation errors, the persons responsible for the development or 
operation of the Model (``Model Owner'') would report such findings, 
incidents, or both in accordance with the policies and procedures of 
the Operational Risk Management unit (``ORM'') within the Group Chief 
Risk Office.\34\ If an adverse Model Validation finding cannot be 
resolved, the Model Owner would work with MVC and ORM to submit the 
finding for risk acceptance in accordance with ORM policies and 
procedures.\35\
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    \32\ Id.
    \33\ Id.
    \34\ Id.
    \35\ Id.

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[[Page 41435]]

E. Model Approval Process

    The Framework would outline the approval process applicable to all 
new Models. All new Clearing Agency Models, and all material changes to 
existing Clearing Agency Models, would undergo Model Validation by MVC 
and must be approved prior to business use.\36\ If the Model's 
materiality is ``Medium'' or ``High,'' such Model Validation would be 
reviewed by the MRGC and recommended by the MRGC to the Clearing 
Agencies' management level committee responsible for Model Risk 
management matters, the Management Risk Committee (``MRC''), for 
approval.\37\
---------------------------------------------------------------------------

    \36\ Id.
    \37\ Id.
---------------------------------------------------------------------------

    Regarding any proposed change to any backtesting methodology, prior 
to implementation thereof (and before any reporting thereof in any 
management and regulatory report), the Framework would provide that a 
description of the proposed change and impact study results would be 
presented to the MRGC for review and approval.\38\ If the impact study 
results reflect that implementation of the methodology would negatively 
impact any existing risk tolerance threshold range, such results would 
be escalated by the MRGC to the MRC, and subsequently to the Board Risk 
Committee (``BRC''), for approval prior to implementation.\39\
---------------------------------------------------------------------------

    \38\ Id.
    \39\ Id.
---------------------------------------------------------------------------

    The Framework would provide that provisional approvals with respect 
to new Clearing Agency Models and material changes to existing Clearing 
Agency Models may be issued to allow a Model to be published for urgent 
business use prior to MVC's Model Validation.\40\ Provisional approval 
requests for a Model along with appropriate control measures would be 
presented by the applicable Model Owners to MVC and the MRGC for 
review.\41\ The Framework would provide that Models would be 
provisionally approved by MVC for a limited period, not to exceed six 
months unless also approved by the MRGC.\42\ MVC would track all such 
provisional approvals and oversee compliance with control measures and 
provisional approval periods.\43\
---------------------------------------------------------------------------

    \40\ Id.
    \41\ Id.
    \42\ Id.
    \43\ Id.
---------------------------------------------------------------------------

    The Framework would state that each periodic Model Validation would 
be presented to the MRGC for its review, and its recommendation for 
approval to the MRC.\44\ The Framework would further provide that MRC 
approval must be obtained in order for any such periodic validation to 
be deemed complete.\45\
---------------------------------------------------------------------------

    \44\ Id.
    \45\ Id.
---------------------------------------------------------------------------

F. Model Performance Procedures

    The Framework would state that MVC would be responsible for Model 
performance monitoring and for each Clearing Agency's backtesting 
process.\46\ The MRGC would be the primary forum for MVC's regular 
reporting of Model Validation activities and material Model Risks 
identified through regular Model performance monitoring.\47\ Reports 
and recommendations with respect to Model Risk management would be made 
to the MRC.\48\
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    \46\ Id. The Clearing Agencies define Model performance 
monitoring is the process of (i) evaluating an active Model's 
ongoing performance based on theoretical tests, (ii) monitoring the 
Model's parameters through the use of threshold indicators, and/or 
(iii) backtesting using actual historical data/realizations to test 
a Value at Risk (``VaR'') Model's predictive power. 
    \47\ Notice, 82 at 32033.
    \48\ Id.
---------------------------------------------------------------------------

    The Framework would describe that periodic reporting to the BRC of 
each Clearing Agency with regard to Model Risk matters may include:
     Updates of Model Validation findings and the status of 
annual validations;
     updates on significant Model Risk matters, and on 
compliance matters with respect to Model Risk policies and procedures 
(including the Framework); and
     escalation of Model Risk matters as set forth in the 
market risk tolerance statement, which establishes the Clearing 
Agencies' Model Risk tolerances (``Market Risk Tolerance Statement''), 
and subsequent, regular updates with respect thereto.\49\
---------------------------------------------------------------------------

    \49\ Id.
---------------------------------------------------------------------------

    The Framework would provide that MVC would prepare Model 
performance monitoring reports on both a monthly and daily basis.\50\ 
On a monthly basis, MVC would (i) perform sensitivity analysis on each 
of the CCP's margin Model, (ii) review the key parameters and 
assumptions for backtesting, and (iii) consider modifications to ensure 
the backtesting practices of FICC and NSCC, as CCPs, are appropriate 
for determining the adequacy of the applicable CCP's margin 
resources.\51\
---------------------------------------------------------------------------

    \50\ Id.
    \51\ Id.
---------------------------------------------------------------------------

    The Framework would state that MRGC would review the Model 
performance monitoring, which includes review of risk-based Models used 
to calculate margin requirements and relevant parameters/threshold 
indicators, sensitivity analysis, and Model backtesting results.\52\ 
Serious performance concerns would be escalated to the MRC.\53\
---------------------------------------------------------------------------

    \52\ Id.
    \53\ Id.
---------------------------------------------------------------------------

    The Framework would further state that, in circumstances where the 
products cleared or the markets served by one or both of the CCPs 
display high volatility or become less liquid, or when the size or 
concentration of positions held by the applicable CCP's members 
increases or decreases significantly, such sensitivity analysis and 
review of key Model parameters and assumptions would be conducted more 
frequently than monthly.\54\
---------------------------------------------------------------------------

    \54\ Id.
---------------------------------------------------------------------------

    The Framework would provide that VaR and Clearing Fund requirement 
(``CFR'') coverage backtesting for the CCPs would be performed by MVC 
on a daily basis or more frequently.\55\ CFR coverage would be 
backtested on an overall basis and for individual members and families 
of affiliated members.\56\ DTC backtesting would be performed by MVC on 
a daily basis for collateral group \57\ collateral monitor coverage, 
collateral group level haircut \58\ coverage, and security-level 
haircut coverage.\59\ The Framework would provide that thresholds for 
all backtests would be established for the rolling 12-month period 
coverage and calculated as the number of instances without deficiency 
over the total number of backtest instances, where deficiency is 
defined as the loss amount that exceeds the measure being tested (i.e., 
VaR, CFR, collateral monitor, or

[[Page 41436]]

haircut rate). Thresholds would be set as follows: \60\
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    \55\ Id. To mitigate default risk, FICC and NSCC collect funds 
from their members to maintain sufficient financial resources in the 
event a member or members default on their obligations. Those funds 
are held by FICC and NSCC in their respective Clearing Funds. As 
compared to the CFR, VaR Model backtesting tests Model performance 
at a specified confidence level, while the CFR backtesting tests 
margin sufficiency in case of a member default.
    \56\ Notice, 82 at 32033.
    \57\ A DTC Participant with multiple accounts may group its 
accounts into ``families'' (i.e., ``collateral groups'') and 
instruct DTC to allocate a specified portion of its overall 
Collateral Monitor and Net Debit Cap to each family. All accounts 
that a Participant designates as belonging to a common collateral 
group share a single Collateral Monitor and single Net Debit Cap. 
See Securities Exchange Act Release No. 38201 (January 23, 1997), 62 
FR 4561 (January 30, 1997) (SR-DTC-96-17).
    \58\ A haircut represents a percentage decrease applied to a 
Security's Market Value solely for purposes of determining the 
collateral value of the Security. See DTC Settlement Service Guide, 
available at https://www.dtcc.com/~/media/Files/Downloads/legal/
service-guides/Settlement.pdf, at 5.
    \59\ Notice, 82 at 32033.
    \60\ Id.

------------------------------------------------------------------------
                                     Backtesting risk
         Applicable to                   metrics           Threshold (%)
------------------------------------------------------------------------
CCPs (FICC and NSCC)...........  Overall CFR Coverage...              99
                                 VaR Model Coverage.....              99
                                 Member Level CFR                     99
                                  Coverage.
                                 Family Level CFR                     99
                                  Coverage.
DTC............................  Collateral Group                     99
                                  Collateral Monitor
                                  Coverage.
                                 Collateral Group Level               99
                                  Haircut Coverage.
                                 Security-Level Haircut               95
                                  Coverage.
------------------------------------------------------------------------

    The Framework would provide that the CFR coverage thresholds for 
FICC and NSCC would be based on applicable regulatory requirements that 
require them, as CCPs, to cover their credit exposure to their 
participants by establishing a risk-based margin system that, among 
other things calculates margin sufficient to cover their potential 
future exposure to participants in the interval between the last margin 
collection and the close out of positions following a participant 
default.\61\ As for DTC, which is not a CCP, the Framework would 
provide that the collateral group collateral monitor coverage 
threshold, among other controls, would be set to support the 
requirement that DTC maintain sufficient financial resources to cover 
its credit exposures to each participant fully with a high degree of 
confidence.\62\ Meanwhile, the ``VaR Model Coverage,'' ``Collateral 
Group Level Haircut Coverage,'' and ``Security-Level Haircut Coverage'' 
would be set and designed for Model performance monitoring 
purposes.\63\
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    \61\ Id.; see 17 CFR 240.17Ad-22(e)(6)(iii). 17 CFR 240.17Ad-
22(a)(13) defines the term ``potential future exposure'' to mean the 
maximum exposure estimated to occur at a future point in time with 
an established single-tailed confidence level of at least 99 percent 
with respect to the estimated distribution of future exposure.
    \62\ Notice, 82 at 32033.
    \63\ Id.
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    The Framework would provide that, on at least a monthly basis, the 
key metrics relating to Model backtesting would be reviewed by the 
Market and Liquidity Risk Management unit within the Group Chief Risk 
Office and MVC, and reported to the MRC.\64\ Threshold breaches would 
be reviewed by the Managing Directors within the Financial Risk 
Management area (including the Market and Liquidity Risk Management 
unit) of the Group Chief Risk Office, and in the case of CFR coverage 
breaches by the CCPs and collateral group collateral monitor coverage 
by DTC, escalated to the BRC in accordance with the Market Risk 
Tolerance Statement.\65\
---------------------------------------------------------------------------

    \64\ Notice, 82 at 32034.
    \65\ Id.
---------------------------------------------------------------------------

    The Framework would state that the Managing Director of the Market 
and Liquidity Risk Management unit within the Group Chief Risk Office 
would be responsible for reviewing the Market Risk Tolerance Statement 
at least annually.\66\ The BRC would review and approve the Market Risk 
Tolerance Statement at least annually.\67\
---------------------------------------------------------------------------

    \66\ Id.
    \67\ Id.
---------------------------------------------------------------------------

    The Framework would provide that all Model performance concerns 
would be escalated by MVC to the MRGC, including Model performance 
enhancement concerns.\68\ The MRGC may further recommend certain such 
matters for further escalation to the MRC, the BRC, or both.\69\
---------------------------------------------------------------------------

    \68\ Id.
    \69\ Id.
---------------------------------------------------------------------------

II. Discussion of Commission Findings

    Section 19(b)(2)(C) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with the requirements of the 
Act and rules and regulations thereunder applicable to such 
organization.\70\ After carefully considering the Proposed Rule 
Changes, the Commission finds that the Proposed Rule Changes are 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to the Clearing Agencies. In 
particular, the Commission believes the proposal is consistent with 
Section 17A(b)(3)(F) of the Act,\71\ as well as Rules 17Ad-
22(e)(4)(vii), 17Ad-22(e)(6)(vi) and (vii), and 17Ad-22(e)(7)(vii) 
thereunder.\72\
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    \70\ 15 U.S.C. 78s(b)(2)(C).
    \71\ 15 U.S.C. 78q-1(b)(3)(F).
    \72\ 17 CFR 240.17Ad-22(e)(4)(vii), (e)(6)(vi) and (vii), and 
(e)(7)(vii).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, in part, that the rules 
of a clearing agency be designed to assure the safeguarding of 
securities and funds which are in the custody and control of the 
Clearing Agencies or for which they are responsible.\73\
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    \73\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission believes that by establishing and describing in the 
proposed Framework (i) governance of the Framework; (ii) key terms; 
(iii) Model Inventory procedures; (iv) Model Validation procedures; (v) 
Model approval process; and (vi) Model performance procedures, as 
described above, the proposal is designed to help safeguard securities 
and funds in the Clearing Agencies' custody and control. Specifically, 
the comprehensive nature of the practices described in the Framework, 
both individually and collectively, are designed to help improve the 
Clearing Agencies' ability to determine and evaluate the risk presented 
by many of the Clearing Agencies' members by measuring, monitoring, and 
managing the risks from using quantitative Models. Clearly documenting 
the Clearing Agencies' ability to evaluate risk in the proposed 
Framework could enable the Clearing Agencies to deploy more effectively 
their risk management tools to manage the credit, market, and liquidity 
risks presented by such members. By enabling the Clearing Agencies to 
use their risk management tools more effectively, the proposed 
Framework is designed to help mitigate the risk that the Clearing 
Agencies would suffer a loss from a member default. Therefore, the 
Commission believes that these Proposed Rule Changes are designed to 
help safeguard funds within the Clearing Agencies' custody and control, 
consistent with Section 17A(b)(3)(F) of the Act.\74\
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    \74\ Id.
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B. Consistency With Rule 17Ad-22(e)(4)(vii)

    The Commission believes that the changes proposed in the Proposed 
Rule Changes are consistent with Rule 17Ad-22(e)(4)(vii) under the Act, 
which

[[Page 41437]]

requires, in part, that the Clearing Agencies establish, implement, 
maintain and enforce written policies and procedures reasonably 
designed to effectively identify, measure, monitor, and manage their 
credit exposures to participants and those arising from their payment, 
clearing, and settlement processes by performing a Model Validation for 
their credit risk Models not less than annually or more frequently as 
may be contemplated by the Framework.\75\
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    \75\ 17 CFR 240.17Ad-22(e)(4)(vii).
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    As discussed above, the Framework would provide for validation of 
quantitative credit-risk Models. The Framework would describe the 
procedures for conducting a Model Inventory to determine which Models 
should be reviewed. The Framework would then describe the process for 
reviewing such Models, before they are implemented, so that the 
Clearing Agencies can ensure that their credit exposures are 
effectively and efficiently modeled. The Framework would further 
describe the validation process for the review of existing quantitative 
credit-risk Models to determine whether the Models accurately capture 
the Clearing Agencies' credit exposures, which would be performed not 
less than annually. Because the proposal is designed to meet the 
requirements of Rule 17Ad-22(e)(4)(vii) by establishing the proposed 
Framework for performing a Model Validation for the Clearing Agencies' 
credit risk Models, the Commission believes the Proposed Rule Changes 
are consistent with Rule 17Ad-22(e)(4)(vii) under the Act.\76\
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    \76\ Id.
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C. Consistency With Rule 17Ad-22(e)(6)(vi) and (vii)

    The Commission believes that the changes proposed in the Proposed 
Rule Changes are consistent with Rules 17Ad-22(e)(6) under the Act, 
specifically paragraphs (vi) and (vii) thereunder, as discussed 
below.\77\
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    \77\ 17 CFR 240.17Ad-22(e)(6).
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    Rule 17Ad-22(e)(6)(vi) under the Act requires, in part, that the 
Clearing Agencies that provide CCP services (i.e., FICC and NSCC) 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover their credit exposures to their 
participants by establishing a risk-based margin system that at minimum 
is monitored by management on an ongoing basis and is regularly 
reviewed, tested, and verified by (A) conducting backtests of their 
margin Models at least once each day using standard predetermined 
parameters and assumptions; (B) conducting a sensitivity analysis of 
their margin Models and a review of their parameters and assumptions 
for backtesting on at least a monthly basis, and considering 
modifications to ensure the backtesting practices are appropriate for 
determining the adequacy of the their margin resources; (C) conducting 
a sensitivity analysis of their margin Models and a review of their 
parameters and assumptions for backtesting more frequently than monthly 
during periods of time when the products cleared or markets served 
display high volatility or become less liquid, or when the size or 
concentration of positions held by their participants increases or 
decreases significantly; and (D) reporting the results of their 
analyses to appropriate decision makers at the clearing agencies, 
including but not limited to, their risk management committee or board 
of directors, and using these results to evaluate the adequacy of and 
adjust their margin methodology, Model parameters, and any other 
relevant aspects of their credit risk management framework.\78\
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    \78\ 17 CFR 240.17Ad-22(e)(6).
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    As discussed above, the Framework would provide that FICC and NSCC, 
as CCPs, would (a) perform VaR and CFR backtesting on a daily basis 
using standard predetermined parameters and assumptions; (b) as part of 
Model performance monitoring, on at least a monthly basis, perform 
sensitivity analysis on each of the margin Models of FICC and NSCC, 
review the key parameters and assumptions for backtesting, and consider 
modifications to ensure the backtesting practices of FICC and NSCC are 
appropriate for determining the adequacy of the applicable CCP's margin 
resources; (c) in circumstances where the products cleared or the 
markets served by FICC, NSCC, or both display high volatility or become 
less liquid, or when the size or concentration of positions held by the 
applicable CCP's members increases or decreases significantly, conduct 
sensitivity analysis and review of key Model parameters and assumptions 
more frequently than monthly; and (d) report the results of their 
analyses under (b) and (c) to key decision makers, including but not 
limited to, the MRC, the BRC, or both, which could use these results to 
evaluate the adequacy of and adjust their margin methodology, Model 
parameters, and any other relevant aspects of their credit risk 
management framework. By establishing the proposed Framework for a 
risk-based margin system to help cover the credit exposures of FICC and 
NSCC, as CCPs, that, at minimum, is monitored by management on an 
ongoing basis and is designed to address each of the enumerated 
requirements of Rule 17Ad-22(e)(6)(vi), the Commission believes the 
Proposed Rule Changes are consistent with Rule 17Ad-22(e)(6)(vi).\79\
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    \79\ Id.
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    Rule 17Ad-22(e)(6)(vii) under the Act requires, in part, that the 
Clearing Agencies that provide CCP services (i.e., FICC and NSCC) 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to cover their credit exposures to their 
participants by establishing a risk-based margin system that at minimum 
requires a model validation for their margin systems and related models 
to be performed not less than annually, or more frequently as may be 
contemplated by their risk management framework.\80\
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    \80\ 17 CFR 240.17Ad-22(e)(6)(vii).
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    As discussed above, the Framework would describe FICC and NSCC's 
processes for determining which Models they should validate, including 
margin risk Models. After determining which Models to validate, FICC 
and NSCC would use the Model Validation processes for their margin 
systems and related Models, which would be performed not less than 
annually. In certain cases, FICC and NSCC may determine extra Model 
Validation activities are warranted based on previous Model Validation 
work and findings, changes in market conditions, or because a 
particular Model warrants extra validation. Because the proposal is 
designed to meet the requirements of Rule 17Ad-22(e)(6)(vii) by 
establishing the proposed Framework for a risk-based margin system to 
help cover the credit exposures of FICC and NSCC, as CCPs, that, at 
minimum, requires a Model Validation for the their margin systems and 
related Models to be performed not less than annually, the Commission 
believes the Proposed Rule Changes are consistent with Rule 17Ad-
22(e)(6)(vii).\81\
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    \81\ Id.
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D. Consistency With Rule 17Ad-22(e)(7)(vii)

    The Commission believes that the changes proposed in the Proposed 
Rule Changes are consistent with Rule 17Ad-22(e)(7)(vii) under the Act, 
which requires, in part, that the Clearing Agencies establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to effectively measure, monitor, and manage the 
liquidity risk that arises in or is borne by the Clearing Agencies,

[[Page 41438]]

including measuring, monitoring, and managing their settlement and 
funding flows on an ongoing and timely basis, and their use of intraday 
liquidity by performing a Model Validation of their liquidity risk 
Models not less than annually or more frequently as may be contemplated 
by their risk management framework.\82\
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    \82\ 17 CFR 240.17Ad-22(e)(7)(vii).
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    As discussed above, the Framework would describe the Clearing 
Agencies' process for determining which Models they should validate, 
including liquidity risk Models. After determining which Models to 
validate, the Clearing Agencies would use the Model Validation 
processes for their margin systems and related Models, which would be 
performed not less than annually. In certain cases, the Clearing 
Agencies may determine extra Model Validation activities are warranted 
based on previous Model Validation work and findings, changes in market 
conditions, or because a particular Model warrants extra validation. 
Because the proposal is designed to meet the requirements of Rule 17Ad-
22(e)(7)(vii) by establishing the proposed Framework to help measure, 
monitor, and manage the Clearing Agencies' settlement and funding flows 
on an ongoing and timely basis, and the Clearing Agencies' use of 
intraday liquidity by performing a Model Validation of their liquidity 
risk Models not less than annually, the Commission believes the 
Proposed Rule Changes are consistent with Rule 17Ad-22(e)(7)(vii) under 
the Act.\83\
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    \83\ Id.
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III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
Proposed Rule Changes are consistent with the requirements of the Act, 
in particular the requirements of Section 17A of the Act \84\ and the 
rules and regulations promulgated thereunder. It is therefore ordered, 
pursuant to Section 19(b)(2) of the Act, that proposed rule changes SR-
DTC-2017-008, SR-FICC-2017-014, and SR-NSCC-2017-008 be, and hereby 
are, approved.\85\
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    \84\ 15 U.S.C. 78q-1.
    \85\ In approving the Proposed Rule Changes, the Commission 
considered the proposals' impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\86\
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    \86\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-18448 Filed 8-30-17; 8:45 am]
BILLING CODE 8011-01-P

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