
[Federal Register Volume 77, Number 250 (Monday, December 31, 2012)]
[Notices]
[Pages 77160-77162]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-31241]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-68529; File No. SR-CME-2012-34]


Self-Regulatory Organizations; Chicago Mercantile Exchange Inc.; 
Notice of Filing of Proposed Rule Change Related to the Liquidity 
Factor of CME's CDS Margin Methodology

December 21, 2012.
    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 December 10, 2012, Chicago Mercantile Exchange Inc. (``CME'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared primarily by CME. The Commission is publishing 
this notice to solicit comments on the proposed rule change from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CME proposes to make an adjustment to one particular component of 
its current CDS margin model. The text of the proposed rule change is 
below. Italicized text indicates additions; bracketed text indicates 
deletions.
* * * * *

CME CDS Liquidity Margin Factor Calculation Methodology

    The Liquidity Factor will be calculated as the sum of two 
components:
    (1) A concentration charge for market exposure as a function of 
absolute Spread DV01 (a portfolio sensitivity to 1% par spread shock); 
and
    (2) A concentration charge for portfolio basis exposure as a 
function of Residual Spread DV01 (which is the difference between the 
Gross Spread DV01 and the Net Spread DV01 of the portfolio).
    CME will also establish a floor component to the Liquidity Factor 
using the current Gross Notional Function with the following 
modifications: (1) the concentration scalar will be removed; and (2) 
the maximum DST would be replaced by series-tenor specific DST values 
based on the series and tenor of the relevant HY and IG positions, as 
applicable.
* * * * *
    The text of the proposed change is also available at CME's Web site 
at http://www.cmegroup.com, at the principal office of CME, and at the 
Commission's Public Reference Room.

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

    In its filing with the Commission, CME included statements 
concerning the purpose 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 in 
Item IV below. CME has prepared summaries, set forth in sections A, B,

[[Page 77161]]

and C below, of the most significant aspects of such statements.\3\
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    \3\ The Commission has modified the text of the summaries 
prepared by CME.
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A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    CME's currently approved credit default swap margin methodology 
utilizes a ``multi-factor'' portfolio model to determine margin 
requirements for credit default swap (``CDS'') instruments. The model 
incorporates risk-based factors that are designed to represent the 
different risks inherent to CDS products. The factors are aggregated to 
determine the total amount of margin required to protect a portfolio 
against exposures resulting from daily changes in CDS spreads. For both 
total and minimum margin calculations, CME evaluates each CDS contract 
held within a portfolio. These positions are distinguished by the 
single name of the underlying entity, the CDS tenor, the notional 
amount of the position, and the fixed spread or coupon rate. For 
consistency, margins for CDS indices in a portfolio are handled based 
on the required margin for each of the underlying components of the 
index.
    CME proposes to make an adjustment to one particular component of 
its current CDS margin model, the liquidity risk factor. This CDS 
margin model component is designed to capture the risk that 
concentrated positions may be difficult or costly to unwind following 
the default of a CDS clearing member.
The Liquidity Risk Factor in CME's Current CDS Margin Model
    The current liquidity/concentration factor (``Liquidity Factor'') 
of CME's margin methodology for a portfolio of CDS indices is the 
product of (1) the gross notional amount for each family (i.e., CDX IG 
or CDX HY) of CDS positions in a portfolio (2) the current bid/ask of 
the 5 year tenor of the ``on the run'' (OTR) contract (3) the Duration/
Series/Tenor (``DST'') factor and (4) a concentration factor based upon 
the gross notional for each of the CDX IG and CDX HY contracts (``Gross 
Notional Function''). The associated margin for a CDS portfolio 
attributed to the Liquidity Factor is the sum of the Liquidity Factor 
calculations for each family of CDS positions in the portfolio.
    The calculation of the Liquidity Factor is based on the premise 
that the 5-year OTR index is the most liquid CDS index product. As 
such, the methodology is designed to evaluate the liquidity exposure of 
each position in a CDS portfolio relative to the 5-year OTR index.
    For each index family (i.e., CDX IG and CDX HY), a DST matrix is 
calculated based on the historical bid-ask averages of each cleared 
position relative to the OTR 5-year historical bid-ask averages. Then, 
the maximum DST values are used as the DST factors. Such maximum DST 
factors are then applied to the product of 5-year OTR bid-ask spread 
(adjusted for duration for CDX IG only) and the Gross Notional of all 
positions within each index family. The resulting products are further 
scaled by concentration factors in order to account for oversized (as 
measured by Gross Notional) portfolios. The concentration factors are 
based on exponential functions of the Gross Notional of each index 
family in a given portfolio.
Proposed Changes to the Liquidity Risk Factor
    As liquidation costs are dependent on the risk in a portfolio, CME 
is proposing to use an index portfolio's market risk rather than its 
gross notional as the basis for determining the margins associated with 
the Liquidity Factor. The proposed changes would calculate the 
Liquidity Factor as the sum of two components:
    (1) A concentration charge for market exposure as a function of 
absolute Spread DV01 (a portfolio sensitivity to 1% par spread shock); 
and
    (2) A concentration charge for portfolio basis exposure as a 
function of Residual Spread DV01 (which is the difference between the 
Gross Spread DV01 and the Net Spread DV01 of the portfolio).
    CME expects that these proposed changes would not generally impact 
smaller portfolios whose liquidation costs are driven by the market 
bid/ask spread rather than by the cost of hedging, and are therefore 
adequately captured by the existing Liquidity Factor methodology. To 
account for the risks associated with such smaller portfolios, CME also 
proposes to establish a floor component to the Liquidity Factor using 
the current Gross Notional Function described above with the following 
modifications: (1) the concentration scalar would be removed as 
concentration risk would already be accounted for by the concentration 
charge component outlined above; and (2) the maximum DST would be 
replaced by series-tenor specific DST values based on the series and 
tenor of the relevant HY and IG positions, as applicable. CME expects 
that large (by notional amount) portfolios will be impacted by the 
proposed changes more than smaller portfolios.
    The proposed liquidity risk factor model adjustments do not require 
any changes to rule text in the CME rulebook and do not necessitate any 
changes to CME's CDS Manual of Operations. The change will be announced 
to CDS market participants in an advisory notice that will be issued 
prior to implementation.
    CME believes the proposed rule changes are consistent with the 
requirements of the Exchange Act including Section 17A of the Exchange 
Act.\4\ The enhancements to CME's current CDS margin methodology will 
facilitate the prompt and accurate settlement of security-based swaps 
and contribute to the safeguarding of securities and funds associated 
with security-based swap transactions. CME believes the proposed rule 
changes accomplish those objectives because the changes are designed to 
incorporate how the liquidity risk factor is affected by not only 
portfolio concentration based on gross notional, but also the 
composition of the portfolio based on an underlying strategy. CME 
believes the proposed rule changes would also better align CME's margin 
methodology with the liquidity profile of the actual instruments in the 
portfolio.
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    \4\ 15 U.S.C. 78q-1.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CME does not believe that the proposed rule change will have any 
impact, or impose any burden, on competition.

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

    CME has not solicited comments regarding this proposed rule change. 
CME has not received any unsolicited written comments from interested 
parties.

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

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

[[Page 77162]]

IV. Solicitation of Comments

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

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-CME-2012-34 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-CME-2012-34. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of such filing also will be available 
for inspection and copying at the principal office of CME and on CME's 
Web site at http://www.cmegroup.com/market-regulation/files/SEC_19B-4_12-34.pdf.
    All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to File Number SR-CME-2012-34 
and should be submitted on or before January 22, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\5\
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    \5\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary .
[FR Doc. 2012-31241 Filed 12-28-12; 8:45 am]
BILLING CODE 8011-01-P


