Self-Regulatory Organizations; LCH SA; Order Approving Proposed Rule Change Relating to (i) Introduction of Clearing of the New Markit iTraxx Subordinated Financials Index CDS and the Related Single Name CDS Constituents; (ii) Enhancements to Wrong Way Risk Margin; and (iii) Modification to Default Fund Additional Margin, 61947-61950 [2019-24693]

Download as PDF Federal Register / Vol. 84, No. 220 / Thursday, November 14, 2019 / Notices the exchanges for which the Exchange uses the direct feed and/or SIP for the purposes described in the Rule. B. Self-Regulatory Organization’s Statement on Burden on Competition The Exchange does not believe that the proposed rule change will impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Act. The proposed rule change is not designed to address any competitive issue; instead, it is merely intended to reflect the fact that the Exchange will no longer consume the NYSE Chicago Book Feed, which NYSE Chicago plans to discontinue after November 1, 2019. The Exchange does not expect that its decision to utilize the SIP, going forward, to obtain NYSE Chicago quote data will have any competitive impacts. As noted above, the Exchange presently utilizes the SIP as its sole source of quote data for several other exchanges, including NYSE National and IEX. C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others No written comments were either solicited or received. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Because the foregoing proposed rule change does not: (i) Significantly affect the protection of investors or the public interest; (ii) impose any significant burden on competition; and (iii) become operative for 30 days from the date on which it was filed, or such shorter time as the Commission may designate, it has become effective pursuant to Section 19(b)(3)(A) of the Act 9 and Rule 19b– 4(f)(6) thereunder.10 A proposed rule change filed under Rule 19b–4(f)(6) 11 normally does not become operative for 30 days from the date of filing. However, Rule 19b– 4(f)(6)(iii) 12 permits the Commission to designate a shorter time if such action is consistent with the protection of investors and the public interest. The 9 15 U.S.C. 78s(b)(3)(A). CFR 240.19b–4(f)(6). In addition, Rule 19b– 4(f)(6)(iii) requires a self-regulatory organization to give the Commission written notice of its intent to file the proposed rule change, along with a brief description and text of the proposed rule change, at least five business days prior to the date of filing of the proposed rule change, or such shorter time as designated by the Commission. The Exchange has requested that the Commission waive the prefiling requirement. The Commission hereby waives that requirement. 11 17 CFR 240.19b–4(f)(6). 12 17 CFR 240.19b–4(f)(6)(iii). khammond on DSKJM1Z7X2PROD with NOTICES 10 17 VerDate Sep<11>2014 17:47 Nov 13, 2019 Jkt 250001 61947 Exchange has requested that the Commission waive the 30-day operative delay so that the Exchange can amend Rule 3304(a) prior to the discontinuation of the NYSE Chicago Book Feed. The Exchange states that waiver of the operative delay would prevent Rule 3304(a) from being inaccurate and causing confusion among investors and the public. For these reasons, the Commission believes that waiver of the 30-day operative delay is consistent with the protection of investors and the public interest. Accordingly, the Commission hereby waives the 30-day operative delay and designates the proposed rule change operative upon filing.13 At any time within 60 days of the filing of the proposed rule change, the Commission summarily may temporarily suspend such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act. If the Commission takes such action, the Commission shall institute proceedings to determine whether the proposed rule change should be approved or disapproved. 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 website viewing and printing in the Commission’s Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–Phlx–2019–47 and should be submitted on or before December 5, 2019. 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: For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.14 Jill M. Peterson, Assistant Secretary. Electronic Comments • Use the Commission’s internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number SR– Phlx–2019–47 on the subject line. SECURITIES AND EXCHANGE COMMISSION 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–Phlx–2019–47. 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 website (https://www.sec.gov/ 13 For purposes only of waiving the 30-day operative delay, the Commission has also considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). PO 00000 Frm 00080 Fmt 4703 Sfmt 4703 [FR Doc. 2019–24697 Filed 11–13–19; 8:45 am] BILLING CODE 8011–01–P [Release No. 34–87485; File No. SR–LCH SA–2019–005] Self-Regulatory Organizations; LCH SA; Order Approving Proposed Rule Change Relating to (i) Introduction of Clearing of the New Markit iTraxx Subordinated Financials Index CDS and the Related Single Name CDS Constituents; (ii) Enhancements to Wrong Way Risk Margin; and (iii) Modification to Default Fund Additional Margin November 7, 2019. I. Introduction On August 2, 2019, Banque Centrale de Compensation, which conducts business under the name LCH SA (‘‘LCH SA’’), filed with the Securities and Exchange Commission (‘‘Commission’’), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 14 17 E:\FR\FM\14NON1.SGM CFR 200.30–3(a)(12). 14NON1 61948 Federal Register / Vol. 84, No. 220 / Thursday, November 14, 2019 / Notices (‘‘Act’’),1 and Rule 19b–4 thereunder,2 a proposed rule change to amend its rules to (i) introduce clearing of new Markit iTraxx Subordinated Financials Index CDS and the Related Single Name CDS Constituents (together ‘‘Subordinated Financials’’); (ii) incorporate changes to the Wrong Way Risk (‘‘WWR’’) margin recommended as a result of a risk model validation; and (iii) modify the Default Fund Additional Margin (‘‘DFAM’’). The proposed rule change was published for comment in the Federal Register on August 9, 2019.3 On August 30, 2019, the Commission designated a longer period for taking action on the proposed rule change to November 7, 2019.4 The Commission did not receive comments on the proposed rule change. For the reasons discussed below, the Commission is approving the proposed rule change. II. Description of the Proposed Rule Change A. Subordinated Financials To introduce clearing of Subordinated Financials,5 the proposed rule change would make changes to (i) the Reference Guide: CDSClear Margin Framework and CDSClear Default Fund Methodology (together the ‘‘CDSClear Risk Methodology’’); (ii) the CDS Clearing Supplement (‘‘Supplement’’); and (iv) the CDS Clearing Procedures (‘‘Procedures’’).6 i. Changes to the CDSClear Risk Methodology LCH SA’s existing Total Initial Margin Framework is comprised of the following components: Self Referencing Margin; Spread Margin; WWR Margin; Short Charge Margin; Interest Rate Risk Margin; Recovery Rate Margin; Vega Margin; and certain additional margins, including Liquidity and Concentration Risk Margin. The proposed rule change would apply LCH SA’s existing margin methodology to the clearing of Subordinated Financials, and in doing so, would adapt certain components of that margin methodology for the 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 Securities Exchange Act Release No. 86576 (Aug. 6, 2019), 84 FR 39386 (Aug. 9, 2019) (SR– LCH–SA–2019–005) (‘‘Notice’’). 4 Securities Exchange Act Release No. 86834 (Aug. 30, 2019), 84 FR 46984 (Sep. 6, 2019) (SR– LCH–SA–2019–005). 5 The following description is substantially excerpted from the Notice. See Notice, 84 FR at 39386. For further explanation on the background and creation of Subordinated Financials, see Notice, 84 FR at 39386. 6 Capitalized terms not otherwise defined herein have the meanings assigned to them in the LCH SA rulebook, the CDSClear Risk Methodology, Supplement, or Procedures. khammond on DSKJM1Z7X2PROD with NOTICES 2 17 VerDate Sep<11>2014 17:47 Nov 13, 2019 Jkt 250001 clearing of Subordinated Financials. Specifically, the proposed rule change would adapt the Spread Margin, WWR Margin, Short Charge Margin, and Liquidity and Concentration Risk Margin components to the clearing of Subordinated Financials. With respect to the Spread Margin, LCH would use the historical data available for Subordinated Financials and would consider Subordinated Financials to be a different instrument than senior debt for purposes of portfolio margining. With respect to WWR Margin, the proposed rule change would cover Subordinated Financials with specific shocks calibrated from available historical data. With respect to the Short Charge, the proposed rule change would apply to Subordinated Financials the existing global short charge that covers nonfinancials, but would consider shocks in the recovery rates to ensure that the short charge covers the different recovery rates for Subordinated Financials. With respect to calculating the short charge for portfolios containing Subordinated Financials, LCH believes that considering shocks in the recovery rates without modifying the number of defaults would lead to overly conservative margins where jump-to-default would outweigh other components of the margin methodology.7 To avoid this outcome the proposed rule change would decrease the number of expected credit events in the five days following the default of a Clearing Member from two to one, by moving the second credit event to the ‘‘extreme market conditions’’ category as opposed to the ‘‘normal market conditions’’ category. The proposed rule change would also calculate the exposure the portfolio has to each underlying reference entity and the probability of each combination of defaults, to define the maximum amount that could be lost with a 99.7% confidence due to default events. The proposed rule change would then retain the greater of this calculated amount and the top exposure with a shifted recovery rate as the Short Charge margin. Finally, the proposed rule change would make similar changes with respect to the stressed short charge and global short charge, and a specific change for CDX.HY names, by taking the stress short charge as the maximum of the sum of the top two exposures and the average across the ten riskiest entities. 7 See PO 00000 Notice, 84 FR at 39387. Frm 00081 Fmt 4703 Sfmt 4703 With respect to Liquidity and Concentration Risk Margin, the proposed rule change would apply the existing liquidity charge to Subordinated Financials as a new instrument but would consider Subordinated Financials jointly with Senior CDS for purposes of the concentration charge component of the margin charge. ii. Changes to the Supplement The proposed rule change would amend the Supplement, which establishes the legal terms for CDS transactions cleared by LCH SA. The proposed rule change would amend the Supplement to include relevant language needed for clearing Subordinated Financials. Specifically, with respect to defining Credit Events, the proposed rule change would change various references to ‘‘Restructuring Credit Event’’ to ‘‘M(M)R Restructuring’’ or add references ‘‘M(M)R Restructuring’’, to make clear that these provisions apply to a restructuring that is a ‘‘M(M)R Restructuring.’’ This change is needed because clearing Subordinated Financials would introduce transactions for which Restructuring is a Credit Event but where ‘‘M(M)R Restructuring’’ is not applicable, and thus, in specifying provisions that would apply to ‘‘M(M)R Restructuring’’ the proposed rule change would clarify that these provisions would not apply to a restructuring of Subordinated Financials. Moreover, a number of provisions of the Supplement, such as the defined terms, apply to all Cleared Transactions that refer to a Reference Entity, which would include Cleared Transactions involving Subordinated Financials. However, the clearing of Subordinated Financials would mean that a portfolio could contain CDS contracts that have the same underlying Reference Entity but which reference different seniorities of debt issued by that Reference Entity. Certain Credit Events or Succession Events with respect to a Reference Entity could apply or not apply to a CDS contract, depending on seniority and/or transaction type. Thus, where appropriate and necessary, the proposed rule change would add wording to the relevant provisions of the Supplement to clarify that that, depending on the Reference Entity, Transaction Type, or Reference Obligation, those provisions may apply or not apply to a specific transaction. In connection with this change, the proposed rule change would also add a definition for, and various references to, the term ‘‘Component Transaction’’ to distinguish further cleared transactions by Reference Entity E:\FR\FM\14NON1.SGM 14NON1 Federal Register / Vol. 84, No. 220 / Thursday, November 14, 2019 / Notices and Transaction Type. The proposed rule change would also make various modifications to use of the Physical Settlement Matrix to accommodate clearing of Subordinated Financials. Finally, unrelated to the clearing of Subordinated Financials, the proposed rule change would modify inaccurate references to the CCM Client account structure. Earlier this year, LCH SA amended its rules to permit Clearing Members to create multiple account structures for a single client and multiple trade accounts per client within a single omnibus account structure.8 In line with that change, the proposed rule change would update certain portions of the Supplement to make clear that Clearing Members may create multiple account structures for a single client and multiple trade accounts per client within a single omnibus account structure. LCH SA did not make these changes in the earlier amendment, and the proposed rule change would make these changes now to ensure consistency with the amendment from earlier this year. The proposed rule change would also make various typographical and technical corrections to the CDS Clearing Supplement and update references as needed. khammond on DSKJM1Z7X2PROD with NOTICES iii. Changes to the Procedures Consistent with the changes to the Supplement, the proposed rule change would modify Section 4 of the Procedures to treat transactions differently depending upon the Transaction Type and/or seniority of a transaction. Similarly, the proposed rule change would add a reference to seniority and Reference Entity, Transaction Type, and Reference Obligation in Procedure 4.3. As discussed above, the clearing of Subordinated Financials would mean that a portfolio could contain CDS contracts that have the same underlying Reference Entity but which reference different seniorities of debt issued by that Reference Entity. Thus, the proposed rule change would modify Section 4 of the Procedures to distinguish the Reference Obligation by seniority level, if applicable. B. WWR Margin To address certain recommendations arising out of a recent model validation, the proposed rule change would make two changes to WWR margin designed to enhance the WWR margin’s stability and decrease its volatility. First, the 8 Securities Exchange Act Release No. 86376 (July 15, 2019), 84 FR 34955 (July 19, 2019) (SR–LCH– SA–2019–003). VerDate Sep<11>2014 17:47 Nov 13, 2019 Jkt 250001 proposed rule change would calculate WWR margin as if it was inside the expected shortfall. Second, the proposed rule change would include the iTraxx Main index in the WWR margin calculation, with a dedicated shock defined separately from the iTraxx Senior Financials and iTraxx Subordinated Financials indices. C. Modification to DFAM Independent of and unrelated to LCH SA’s proposal to introduce the clearing of Subordinated Financials, the proposed rule change would also modify DFAM. LCH SA’s intent in collecting DFAM is to ensure that LCH SA collects from a Clearing Member additional margin to account for the stress risk of that Clearing Member above a certain threshold (defined as a percentage of the size of the Default Fund and dependent on the internal credit score of the Clearing Member). In other words, DFAM gradually demutualizes a Clearing Member’s stress risk above and beyond a certain threshold of the Default Fund by collecting additional margin from that Clearing Member (rather than covering such stress risk through the Default Fund). However, according to LCH SA, it does not intend to require Clearing Members to deposit a total amount of resources for a given clearing service higher than that Clearing Member’s worst stress loss for that service. To ensure that the sum of all resources called from a Clearing Member, including DFAM, does not exceed the stress tested loss measured for that Clearing Member, consistent with LCH SA’s intent in collecting DFAM,9 the proposed rule change would put in place a cap on the amount of DFAM to ensure that, in collecting DFAM, LCH SA does not unintentionally require a Clearing Member to contribute resources greater than the Clearing Member’s worst stress loss. The proposed rule change would do so by amending the CDSClear Default Fund Methodology to ensure that DFAM could not exceed a Clearing Member’s Stress Test Loss Over Additional Margin, which would be defined as a Clearing Member’s Stress Test Loss, minus that Clearing Member’s contribution to the Default Fund. III. Commission Findings Section 19(b)(2)(C) of the Act directs the Commission to approve a proposed rule change of a self-regulatory organization if it finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to 9 See PO 00000 Notice, 84 FR at 39387. Frm 00082 Fmt 4703 Sfmt 4703 61949 the organization.10 For the reasons given below, the Commission finds that the proposed rule change is consistent with Section 17A(b)(3)(F) of the Act 11 and Rules 17Ad–22(e)(1) and (e)(6)(i) thereunder.12 A. Consistency With Section 17A(b)(3)(F) of the Act Section 17A(b)(3)(F) of the Act requires, among other things, that the rules of LCH SA be designed to promote the prompt and accurate clearance and settlement of securities transactions and, to the extent applicable, derivative agreements, contracts, and transactions, to assure the safeguarding of securities and funds which are in the custody or control of LCH SA or for which it is responsible, and, in general, to protect investors and the public interest.13 As described above, the proposed rule change would facilitate the clearing of Subordinated Financials by LCH SA, which, as discussed above, consist of the Markit iTraxx Subordinated Financials Index CDS and Related Single Name CDS Constituents. To do so, the proposed rule change would amend the CDSClear Risk Methodology to apply LCH SA’s existing margin methodology to Subordinated Financials and, relatedly, amend the Supplement and the Procedures to add new terms and revise existing terms and references as necessary to ensure that Subordinated Financials are clearly and accurately defined and referenced throughout LCH SA’s existing rulebook. By making these changes to facilitate LCH SA’s clearance and settlement of these additional CDS contracts, the Commission believes the proposed rule change would promote the prompt and accurate clearance and settlement of securities transactions. Moreover, as described above, the proposed rule change would make a number of changes to LCH SA’s margin methodology, which the Commission believes would improve the operation and effectiveness of the margin methodology. First, in adapting LCH SA’s margin methodology to the clearance and settlement of Subordinated Financials, the Commission believes that the proposed rule change would help to ensure that LCH SA’s margin system effectively deals with, and collects margin to cover, the risks associated with clearing these additional CDS contracts. Second, the Commission believes that, by incorporating the changes to the WWR 10 15 U.S.C. 78s(b)(2)(C). U.S.C. 78q–1(b)(3)(F). 12 17 CFR 240.17Ad–22(e)(1) and (e)(6)(i). 13 15 U.S.C. 78q–1(b)(3)(F). 11 15 E:\FR\FM\14NON1.SGM 14NON1 khammond on DSKJM1Z7X2PROD with NOTICES 61950 Federal Register / Vol. 84, No. 220 / Thursday, November 14, 2019 / Notices margin described above, the proposed rule change would help to ensure that WWR margin operates effectively and accurately captures and covers the wrong-way-risk associated with clearing certain portfolios. Finally, the Commission believes that in establishing a cap on DFAM the proposed rule change would help to ensure that LCH SA does not require Clearing Members to deposit a total amount of resources for a given clearing service higher than their worst stress loss for that service, consistent with LCH SA’s intent in collecting DFAM. Given that an effective margin system is necessary to manage LCH SA’s credit exposures to its Clearing Members and the risks associated with clearing security based swap-related portfolios, the Commission believes that the proposed rule change would help improve LCH SA’s ability to avoid potential losses that could result from the mismanagement of credit exposures and the risks associated with clearing security based swap-related portfolios. Because such losses could disrupt LCH SA’s ability to promptly and accurately clear security based swap transactions, the Commission believes that the proposed rule change, by improving the operation and effectiveness of LCH SA’s margin system, would thereby help promote the prompt and accurate clearance and settlement of securities transactions. Similarly, given that such losses could threaten LCH SA’s ability to operate, thereby threatening access to securities and funds in LCH SA’s control, the Commission believes that the proposed rule change would help assure the safeguarding of securities and funds which are in the custody or control of the LCH SA or for which it is responsible. For both of these reasons, the Commission believes the proposed rule change would, in general, protect investors and the public interest. Finally, the Commission believes that in helping to ensure that LCH SA does not collect from a Clearing Member DFAM higher than its worst stress loss, the proposed rule change would leave a Clearing Member with additional liquidity to engage in CDS transactions, which would therefore promote the clearance and settlement of CDS transactions. Finally, as discussed above, the proposed rule change would correct typographical errors, make technical corrections, and update references as needed to the Supplement and Procedures, including modifying inaccurate references to the CCM Client account structure. The Commission believes that these changes would help to ensure that the Supplement and VerDate Sep<11>2014 17:47 Nov 13, 2019 Jkt 250001 Procedures are clear and operate effectively, consistent with LCH SA’s intent. The Commission further believes that clear and effective Supplement and Procedures are necessary for LCH SA to promptly and accurately clear and settle CDS transactions, and therefore that this aspect of the proposed rule change also would promote the prompt and accurate clearance and settlement of securities transactions. Therefore, the Commission finds that the proposed rule change would promote the prompt and accurate clearance and settlement of securities transactions, assure the safeguarding of securities and funds in LCH SA’s custody and control, and in general, protect investors and the public interest, consistent with the Section 17A(b)(3)(F) of the Act.14 B. Consistency With Rule 17Ad–22(e)(1) Rule 17Ad-22(e)(1) requires that LCH SA establish, implement, maintain, and enforce written policies and procedures reasonably designed to provide for a well-founded, clear, transparent, and enforceable legal basis for each aspect of its activities in all relevant jurisdictions.15 The Commission believes that the proposed rule change, in introducing new terms, as well as correcting typographical errors and updating references, would help to ensure that the Supplement and Procedures provide a consistent and enforceable legal basis for clearing Subordinated Financials. Therefore, the Commission finds that the proposed rule change is consistent with Rule 17Ad–22(e)(1).16 C. Consistency With Rule 17Ad– 22(e)(6)(i) Rule 17Ad–22(e)(6)(i) requires that LCH SA establish, implement, maintain, and enforce written policies and procedures reasonably designed to cover its credit exposures to its participants by establishing a risk-based margin system that, at a minimum, considers, and produces margin levels commensurate with, the risks and particular attributes of each relevant product, portfolio, and market.17 The Commission believes that the proposed rule change, in adapting LCH SA’s margin methodology to the clearance and settlement of Subordinated Financials, would help to ensure that LCH SA’s margin system considers, and produces margin levels commensurate with, the risks and 14 15 15 17 U.S.C. 78q–1(b)(3)(F). CFR 240.17Ad–22(e)(1). 16 Id. 17 17 PO 00000 CFR 240.17Ad–22(e)(6)(i). Frm 00083 Fmt 4703 Sfmt 4703 particular attributes of these additional CDS contracts. Moreover, the Commission believes that, by incorporating the changes to the WWR margin described above, the proposed rule change would help to ensure that LCH SA’s margin system considers, and produces margin levels commensurate with, the wrong-way-risk associated with clearing certain portfolios. Finally, in capping DFAM to ensure that Clearing Members are not required to deposit a total amount of resources for a given clearing service higher than their worst stress loss for that service, consistent with LCH SA’s intent, the Commission believes that the proposed rule change would help to ensure that LCH SA’s margin requirement does not exceed the stress loss risk associated with a Clearing Member, and thus is set at a level commensurate with the stress risk posed by a particular Clearing Member’s portfolio. Because the proposed rule change would not prevent LCH SA from collecting DFAM up to the stress loss risk associated with a Clearing Member, however, the Commission believes the proposed rule change would not interfere with LCH SA’s ability to cover its credit exposures to Clearing Members through DFAM. Therefore, the Commission finds that the proposed rule change is consistent with Rule 17Ad–22(e)(6)(i).18 IV. Conclusion On the basis of the foregoing, the Commission finds that the proposed rule change is consistent with the requirements of the Act, and in particular, with the requirements of Section 17A(b)(3)(F) of the Act 19 and Rules 17Ad–22(e)(1) and (e)(6)(i) thereunder.20 It is therefore ordered pursuant to Section 19(b)(2) of the Act 21 that the proposed rule change (SR–LCH–SA– 2019–005), be, and hereby is, approved.22 For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.23 Jill M. Peterson, Assistant Secretary. [FR Doc. 2019–24693 Filed 11–13–19; 8:45 am] BILLING CODE 8011–01–P 18 Id. 19 15 U.S.C. 78q–1(b)(3)(F). CFR 240.17Ad–22(e)(1) and (e)(6)(i). 21 15 U.S.C. 78s(b)(2). 22 In approving the proposed rule change, the Commission considered the proposal’s impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). 23 17 CFR 200.30–3(a)(12). 20 17 E:\FR\FM\14NON1.SGM 14NON1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 84, Number 220 (Thursday, November 14, 2019)]
[Notices]
[Pages 61947-61950]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-24693]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87485; File No. SR-LCH SA-2019-005]


Self-Regulatory Organizations; LCH SA; Order Approving Proposed 
Rule Change Relating to (i) Introduction of Clearing of the New Markit 
iTraxx Subordinated Financials Index CDS and the Related Single Name 
CDS Constituents; (ii) Enhancements to Wrong Way Risk Margin; and (iii) 
Modification to Default Fund Additional Margin

November 7, 2019.

I. Introduction

    On August 2, 2019, Banque Centrale de Compensation, which conducts 
business under the name LCH SA (``LCH SA''), filed with the Securities 
and Exchange Commission (``Commission''), pursuant to Section 19(b)(1) 
of the Securities Exchange Act of 1934

[[Page 61948]]

(``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to 
amend its rules to (i) introduce clearing of new Markit iTraxx 
Subordinated Financials Index CDS and the Related Single Name CDS 
Constituents (together ``Subordinated Financials''); (ii) incorporate 
changes to the Wrong Way Risk (``WWR'') margin recommended as a result 
of a risk model validation; and (iii) modify the Default Fund 
Additional Margin (``DFAM''). The proposed rule change was published 
for comment in the Federal Register on August 9, 2019.\3\ On August 30, 
2019, the Commission designated a longer period for taking action on 
the proposed rule change to November 7, 2019.\4\ The Commission did not 
receive comments on the proposed rule change. For the reasons discussed 
below, the Commission is approving the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 86576 (Aug. 6, 2019), 84 
FR 39386 (Aug. 9, 2019) (SR-LCH-SA-2019-005) (``Notice'').
    \4\ Securities Exchange Act Release No. 86834 (Aug. 30, 2019), 
84 FR 46984 (Sep. 6, 2019) (SR-LCH-SA-2019-005).
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II. Description of the Proposed Rule Change

A. Subordinated Financials

    To introduce clearing of Subordinated Financials,\5\ the proposed 
rule change would make changes to (i) the Reference Guide: CDSClear 
Margin Framework and CDSClear Default Fund Methodology (together the 
``CDSClear Risk Methodology''); (ii) the CDS Clearing Supplement 
(``Supplement''); and (iv) the CDS Clearing Procedures 
(``Procedures'').\6\
---------------------------------------------------------------------------

    \5\ The following description is substantially excerpted from 
the Notice. See Notice, 84 FR at 39386. For further explanation on 
the background and creation of Subordinated Financials, see Notice, 
84 FR at 39386.
    \6\ Capitalized terms not otherwise defined herein have the 
meanings assigned to them in the LCH SA rulebook, the CDSClear Risk 
Methodology, Supplement, or Procedures.
---------------------------------------------------------------------------

i. Changes to the CDSClear Risk Methodology
    LCH SA's existing Total Initial Margin Framework is comprised of 
the following components: Self Referencing Margin; Spread Margin; WWR 
Margin; Short Charge Margin; Interest Rate Risk Margin; Recovery Rate 
Margin; Vega Margin; and certain additional margins, including 
Liquidity and Concentration Risk Margin. The proposed rule change would 
apply LCH SA's existing margin methodology to the clearing of 
Subordinated Financials, and in doing so, would adapt certain 
components of that margin methodology for the clearing of Subordinated 
Financials. Specifically, the proposed rule change would adapt the 
Spread Margin, WWR Margin, Short Charge Margin, and Liquidity and 
Concentration Risk Margin components to the clearing of Subordinated 
Financials.
    With respect to the Spread Margin, LCH would use the historical 
data available for Subordinated Financials and would consider 
Subordinated Financials to be a different instrument than senior debt 
for purposes of portfolio margining.
    With respect to WWR Margin, the proposed rule change would cover 
Subordinated Financials with specific shocks calibrated from available 
historical data.
    With respect to the Short Charge, the proposed rule change would 
apply to Subordinated Financials the existing global short charge that 
covers non-financials, but would consider shocks in the recovery rates 
to ensure that the short charge covers the different recovery rates for 
Subordinated Financials. With respect to calculating the short charge 
for portfolios containing Subordinated Financials, LCH believes that 
considering shocks in the recovery rates without modifying the number 
of defaults would lead to overly conservative margins where jump-to-
default would outweigh other components of the margin methodology.\7\ 
To avoid this outcome the proposed rule change would decrease the 
number of expected credit events in the five days following the default 
of a Clearing Member from two to one, by moving the second credit event 
to the ``extreme market conditions'' category as opposed to the 
``normal market conditions'' category. The proposed rule change would 
also calculate the exposure the portfolio has to each underlying 
reference entity and the probability of each combination of defaults, 
to define the maximum amount that could be lost with a 99.7% confidence 
due to default events. The proposed rule change would then retain the 
greater of this calculated amount and the top exposure with a shifted 
recovery rate as the Short Charge margin.
---------------------------------------------------------------------------

    \7\ See Notice, 84 FR at 39387.
---------------------------------------------------------------------------

    Finally, the proposed rule change would make similar changes with 
respect to the stressed short charge and global short charge, and a 
specific change for CDX.HY names, by taking the stress short charge as 
the maximum of the sum of the top two exposures and the average across 
the ten riskiest entities.
    With respect to Liquidity and Concentration Risk Margin, the 
proposed rule change would apply the existing liquidity charge to 
Subordinated Financials as a new instrument but would consider 
Subordinated Financials jointly with Senior CDS for purposes of the 
concentration charge component of the margin charge.
ii. Changes to the Supplement
    The proposed rule change would amend the Supplement, which 
establishes the legal terms for CDS transactions cleared by LCH SA. The 
proposed rule change would amend the Supplement to include relevant 
language needed for clearing Subordinated Financials. Specifically, 
with respect to defining Credit Events, the proposed rule change would 
change various references to ``Restructuring Credit Event'' to ``M(M)R 
Restructuring'' or add references ``M(M)R Restructuring'', to make 
clear that these provisions apply to a restructuring that is a ``M(M)R 
Restructuring.'' This change is needed because clearing Subordinated 
Financials would introduce transactions for which Restructuring is a 
Credit Event but where ``M(M)R Restructuring'' is not applicable, and 
thus, in specifying provisions that would apply to ``M(M)R 
Restructuring'' the proposed rule change would clarify that these 
provisions would not apply to a restructuring of Subordinated 
Financials. Moreover, a number of provisions of the Supplement, such as 
the defined terms, apply to all Cleared Transactions that refer to a 
Reference Entity, which would include Cleared Transactions involving 
Subordinated Financials. However, the clearing of Subordinated 
Financials would mean that a portfolio could contain CDS contracts that 
have the same underlying Reference Entity but which reference different 
seniorities of debt issued by that Reference Entity. Certain Credit 
Events or Succession Events with respect to a Reference Entity could 
apply or not apply to a CDS contract, depending on seniority and/or 
transaction type. Thus, where appropriate and necessary, the proposed 
rule change would add wording to the relevant provisions of the 
Supplement to clarify that that, depending on the Reference Entity, 
Transaction Type, or Reference Obligation, those provisions may apply 
or not apply to a specific transaction. In connection with this change, 
the proposed rule change would also add a definition for, and various 
references to, the term ``Component Transaction'' to distinguish 
further cleared transactions by Reference Entity

[[Page 61949]]

and Transaction Type. The proposed rule change would also make various 
modifications to use of the Physical Settlement Matrix to accommodate 
clearing of Subordinated Financials.
    Finally, unrelated to the clearing of Subordinated Financials, the 
proposed rule change would modify inaccurate references to the CCM 
Client account structure. Earlier this year, LCH SA amended its rules 
to permit Clearing Members to create multiple account structures for a 
single client and multiple trade accounts per client within a single 
omnibus account structure.\8\ In line with that change, the proposed 
rule change would update certain portions of the Supplement to make 
clear that Clearing Members may create multiple account structures for 
a single client and multiple trade accounts per client within a single 
omnibus account structure. LCH SA did not make these changes in the 
earlier amendment, and the proposed rule change would make these 
changes now to ensure consistency with the amendment from earlier this 
year. The proposed rule change would also make various typographical 
and technical corrections to the CDS Clearing Supplement and update 
references as needed.
---------------------------------------------------------------------------

    \8\ Securities Exchange Act Release No. 86376 (July 15, 2019), 
84 FR 34955 (July 19, 2019) (SR-LCH-SA-2019-003).
---------------------------------------------------------------------------

iii. Changes to the Procedures
    Consistent with the changes to the Supplement, the proposed rule 
change would modify Section 4 of the Procedures to treat transactions 
differently depending upon the Transaction Type and/or seniority of a 
transaction. Similarly, the proposed rule change would add a reference 
to seniority and Reference Entity, Transaction Type, and Reference 
Obligation in Procedure 4.3. As discussed above, the clearing of 
Subordinated Financials would mean that a portfolio could contain CDS 
contracts that have the same underlying Reference Entity but which 
reference different seniorities of debt issued by that Reference 
Entity. Thus, the proposed rule change would modify Section 4 of the 
Procedures to distinguish the Reference Obligation by seniority level, 
if applicable.

B. WWR Margin

    To address certain recommendations arising out of a recent model 
validation, the proposed rule change would make two changes to WWR 
margin designed to enhance the WWR margin's stability and decrease its 
volatility. First, the proposed rule change would calculate WWR margin 
as if it was inside the expected shortfall. Second, the proposed rule 
change would include the iTraxx Main index in the WWR margin 
calculation, with a dedicated shock defined separately from the iTraxx 
Senior Financials and iTraxx Subordinated Financials indices.

C. Modification to DFAM

    Independent of and unrelated to LCH SA's proposal to introduce the 
clearing of Subordinated Financials, the proposed rule change would 
also modify DFAM. LCH SA's intent in collecting DFAM is to ensure that 
LCH SA collects from a Clearing Member additional margin to account for 
the stress risk of that Clearing Member above a certain threshold 
(defined as a percentage of the size of the Default Fund and dependent 
on the internal credit score of the Clearing Member). In other words, 
DFAM gradually demutualizes a Clearing Member's stress risk above and 
beyond a certain threshold of the Default Fund by collecting additional 
margin from that Clearing Member (rather than covering such stress risk 
through the Default Fund). However, according to LCH SA, it does not 
intend to require Clearing Members to deposit a total amount of 
resources for a given clearing service higher than that Clearing 
Member's worst stress loss for that service. To ensure that the sum of 
all resources called from a Clearing Member, including DFAM, does not 
exceed the stress tested loss measured for that Clearing Member, 
consistent with LCH SA's intent in collecting DFAM,\9\ the proposed 
rule change would put in place a cap on the amount of DFAM to ensure 
that, in collecting DFAM, LCH SA does not unintentionally require a 
Clearing Member to contribute resources greater than the Clearing 
Member's worst stress loss. The proposed rule change would do so by 
amending the CDSClear Default Fund Methodology to ensure that DFAM 
could not exceed a Clearing Member's Stress Test Loss Over Additional 
Margin, which would be defined as a Clearing Member's Stress Test Loss, 
minus that Clearing Member's contribution to the Default Fund.
---------------------------------------------------------------------------

    \9\ See Notice, 84 FR at 39387.
---------------------------------------------------------------------------

III. Commission Findings

    Section 19(b)(2)(C) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
the proposed rule change is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to the 
organization.\10\ For the reasons given below, the Commission finds 
that the proposed rule change is consistent with Section 17A(b)(3)(F) 
of the Act \11\ and Rules 17Ad-22(e)(1) and (e)(6)(i) thereunder.\12\
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    \10\ 15 U.S.C. 78s(b)(2)(C).
    \11\ 15 U.S.C. 78q-1(b)(3)(F).
    \12\ 17 CFR 240.17Ad-22(e)(1) and (e)(6)(i).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of LCH SA be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and, to the extent 
applicable, derivative agreements, contracts, and transactions, to 
assure the safeguarding of securities and funds which are in the 
custody or control of LCH SA or for which it is responsible, and, in 
general, to protect investors and the public interest.\13\
---------------------------------------------------------------------------

    \13\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    As described above, the proposed rule change would facilitate the 
clearing of Subordinated Financials by LCH SA, which, as discussed 
above, consist of the Markit iTraxx Subordinated Financials Index CDS 
and Related Single Name CDS Constituents. To do so, the proposed rule 
change would amend the CDSClear Risk Methodology to apply LCH SA's 
existing margin methodology to Subordinated Financials and, relatedly, 
amend the Supplement and the Procedures to add new terms and revise 
existing terms and references as necessary to ensure that Subordinated 
Financials are clearly and accurately defined and referenced throughout 
LCH SA's existing rulebook. By making these changes to facilitate LCH 
SA's clearance and settlement of these additional CDS contracts, the 
Commission believes the proposed rule change would promote the prompt 
and accurate clearance and settlement of securities transactions.
    Moreover, as described above, the proposed rule change would make a 
number of changes to LCH SA's margin methodology, which the Commission 
believes would improve the operation and effectiveness of the margin 
methodology. First, in adapting LCH SA's margin methodology to the 
clearance and settlement of Subordinated Financials, the Commission 
believes that the proposed rule change would help to ensure that LCH 
SA's margin system effectively deals with, and collects margin to 
cover, the risks associated with clearing these additional CDS 
contracts. Second, the Commission believes that, by incorporating the 
changes to the WWR

[[Page 61950]]

margin described above, the proposed rule change would help to ensure 
that WWR margin operates effectively and accurately captures and covers 
the wrong-way-risk associated with clearing certain portfolios. 
Finally, the Commission believes that in establishing a cap on DFAM the 
proposed rule change would help to ensure that LCH SA does not require 
Clearing Members to deposit a total amount of resources for a given 
clearing service higher than their worst stress loss for that service, 
consistent with LCH SA's intent in collecting DFAM.
    Given that an effective margin system is necessary to manage LCH 
SA's credit exposures to its Clearing Members and the risks associated 
with clearing security based swap-related portfolios, the Commission 
believes that the proposed rule change would help improve LCH SA's 
ability to avoid potential losses that could result from the 
mismanagement of credit exposures and the risks associated with 
clearing security based swap-related portfolios. Because such losses 
could disrupt LCH SA's ability to promptly and accurately clear 
security based swap transactions, the Commission believes that the 
proposed rule change, by improving the operation and effectiveness of 
LCH SA's margin system, would thereby help promote the prompt and 
accurate clearance and settlement of securities transactions. 
Similarly, given that such losses could threaten LCH SA's ability to 
operate, thereby threatening access to securities and funds in LCH SA's 
control, the Commission believes that the proposed rule change would 
help assure the safeguarding of securities and funds which are in the 
custody or control of the LCH SA or for which it is responsible. For 
both of these reasons, the Commission believes the proposed rule change 
would, in general, protect investors and the public interest. Finally, 
the Commission believes that in helping to ensure that LCH SA does not 
collect from a Clearing Member DFAM higher than its worst stress loss, 
the proposed rule change would leave a Clearing Member with additional 
liquidity to engage in CDS transactions, which would therefore promote 
the clearance and settlement of CDS transactions.
    Finally, as discussed above, the proposed rule change would correct 
typographical errors, make technical corrections, and update references 
as needed to the Supplement and Procedures, including modifying 
inaccurate references to the CCM Client account structure. The 
Commission believes that these changes would help to ensure that the 
Supplement and Procedures are clear and operate effectively, consistent 
with LCH SA's intent. The Commission further believes that clear and 
effective Supplement and Procedures are necessary for LCH SA to 
promptly and accurately clear and settle CDS transactions, and 
therefore that this aspect of the proposed rule change also would 
promote the prompt and accurate clearance and settlement of securities 
transactions.
    Therefore, the Commission finds that the proposed rule change would 
promote the prompt and accurate clearance and settlement of securities 
transactions, assure the safeguarding of securities and funds in LCH 
SA's custody and control, and in general, protect investors and the 
public interest, consistent with the Section 17A(b)(3)(F) of the 
Act.\14\
---------------------------------------------------------------------------

    \14\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

B. Consistency With Rule 17Ad-22(e)(1)

    Rule 17Ad-22(e)(1) requires that LCH SA establish, implement, 
maintain, and enforce written policies and procedures reasonably 
designed to provide for a well-founded, clear, transparent, and 
enforceable legal basis for each aspect of its activities in all 
relevant jurisdictions.\15\ The Commission believes that the proposed 
rule change, in introducing new terms, as well as correcting 
typographical errors and updating references, would help to ensure that 
the Supplement and Procedures provide a consistent and enforceable 
legal basis for clearing Subordinated Financials. Therefore, the 
Commission finds that the proposed rule change is consistent with Rule 
17Ad-22(e)(1).\16\
---------------------------------------------------------------------------

    \15\ 17 CFR 240.17Ad-22(e)(1).
    \16\ Id.
---------------------------------------------------------------------------

C. Consistency With Rule 17Ad-22(e)(6)(i)

    Rule 17Ad-22(e)(6)(i) requires that LCH SA establish, implement, 
maintain, and enforce written policies and procedures reasonably 
designed to cover its credit exposures to its participants by 
establishing a risk-based margin system that, at a minimum, considers, 
and produces margin levels commensurate with, the risks and particular 
attributes of each relevant product, portfolio, and market.\17\
---------------------------------------------------------------------------

    \17\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------

    The Commission believes that the proposed rule change, in adapting 
LCH SA's margin methodology to the clearance and settlement of 
Subordinated Financials, would help to ensure that LCH SA's margin 
system considers, and produces margin levels commensurate with, the 
risks and particular attributes of these additional CDS contracts. 
Moreover, the Commission believes that, by incorporating the changes to 
the WWR margin described above, the proposed rule change would help to 
ensure that LCH SA's margin system considers, and produces margin 
levels commensurate with, the wrong-way-risk associated with clearing 
certain portfolios. Finally, in capping DFAM to ensure that Clearing 
Members are not required to deposit a total amount of resources for a 
given clearing service higher than their worst stress loss for that 
service, consistent with LCH SA's intent, the Commission believes that 
the proposed rule change would help to ensure that LCH SA's margin 
requirement does not exceed the stress loss risk associated with a 
Clearing Member, and thus is set at a level commensurate with the 
stress risk posed by a particular Clearing Member's portfolio. Because 
the proposed rule change would not prevent LCH SA from collecting DFAM 
up to the stress loss risk associated with a Clearing Member, however, 
the Commission believes the proposed rule change would not interfere 
with LCH SA's ability to cover its credit exposures to Clearing Members 
through DFAM.
    Therefore, the Commission finds that the proposed rule change is 
consistent with Rule 17Ad-22(e)(6)(i).\18\
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    \18\ Id.
---------------------------------------------------------------------------

IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act, 
and in particular, with the requirements of Section 17A(b)(3)(F) of the 
Act \19\ and Rules 17Ad-22(e)(1) and (e)(6)(i) thereunder.\20\
---------------------------------------------------------------------------

    \19\ 15 U.S.C. 78q-1(b)(3)(F).
    \20\ 17 CFR 240.17Ad-22(e)(1) and (e)(6)(i).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
\21\ that the proposed rule change (SR-LCH-SA-2019-005), be, and hereby 
is, approved.\22\
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    \21\ 15 U.S.C. 78s(b)(2).
    \22\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\23\
---------------------------------------------------------------------------

    \23\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-24693 Filed 11-13-19; 8:45 am]
 BILLING CODE 8011-01-P

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