
[Federal Register Volume 79, Number 37 (Tuesday, February 25, 2014)]
[Notices]
[Pages 10578-10581]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-03973]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-71574; File No. SR-ICEEU-2014-04]


Self-Regulatory Organizations; ICE Clear Europe Limited; Notice 
of Filing of Proposed Rule Change To Clear New Sovereign Contracts

February 19, 2014.
    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 February 11, 2014, ICE Clear Europe Limited (``ICE Clear Europe'') 
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 ICE Clear Europe. 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

    The principal purpose of the change is to provide for the clearance 
of new CDS contracts that are Western European Sovereign CDS contracts 
referencing the Republic of Ireland, Italian Republic, Portuguese 
Republic, and Kingdom of Spain (the ``New Sovereign Contracts'').

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

    In its filing with the Commission, ICE Clear Europe 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. ICE Clear Europe has prepared summaries, 
set forth in sections A, B, and C below, of the most significant 
aspects of these statements.

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

1. Purpose
    The purpose of the additional CDS products is to allow ICE Clear 
Europe Clearing Members the ability to clear additional European CDS 
products through ICE Clear Europe's platform.
    ICE Clear Europe has identified Western European Sovereign CDS 
Contracts as a product that has become increasingly important for 
market participants to manage risk and express views with respect to 
the European sovereign credit markets. ICE Clear Europe believes 
clearance of the New Sovereign Contracts will benefit the markets for 
credit default swaps on Western European sovereigns by offering to 
market participants the benefits of clearing, including reduction in 
counterparty risk and safeguarding of margin assets pursuant to 
clearing house rules. The terms of the New Sovereign Contracts will be 
governed by Paragraph 12 of the CDS Procedures. Clearing of the New 
Sovereign Contracts will not require any changes to ICE Clear Europe's 
existing Clearing Rules and CDS Procedures (although ICE Clear Europe 
has updated its risk management

[[Page 10579]]

framework (including relevant policies) and margin model as discussed 
herein).
    ICE Clear Europe's CDS risk management framework, including the 
margin methodology (the ``CDS Model''),\3\ has been enhanced to include 
several features designed to address particular risks of the New 
Sovereign Contracts. To address so-called general wrong way risk 
(``General Wrong Way Risk'') involving correlation between the risk of 
default of an underlying sovereign and the risk of default of a 
clearing member that has written credit protection through a New 
Sovereign Contract on such sovereign, additional jump-to-default 
requirements for initial margin are established for portfolios that 
present such risk.
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    \3\ ICE Clear Europe has performed a variety of empirical 
analyses related to clearing of the New Sovereign Contracts under 
its margin methodology, including back tests and stress tests.
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    ICE Clear Europe proposes to adopt a combination of qualitative and 
quantitative approaches to capture General Wrong Way Risk. Under the 
enhanced CDS Model, an additional contribution to initial margin will 
be required when the seller of protection exhibits a high degree of 
association with an underlying Western European Sovereign reference 
entity by virtue of domicile (qualitative approach) or high spread 
return correlation (quantitative approach). To address General Wrong 
Way Risk arising from clearing member domicile, ICE Clear Europe will 
require full collateralization of the jump-to-default loss for a 
protection seller under a contract referencing the sovereign where the 
protection seller is domiciled.
    Under the quantitative approach, which applies where the protection 
seller is not domiciled in the jurisdiction of the underlying 
sovereign, two types of thresholds are introduced: A loss threshold and 
a correlation threshold. Additional General Wrong Way Risk 
collateralization will be collected if both thresholds are exceeded. If 
the spread return correlation between the member and the sovereign is 
above the correlation threshold and the sovereign CDS jump-to-default 
loss is above the loss threshold, General Wrong Way Risk 
collateralization is assessed as a function of the spread return 
correlation and amount by which the loss threshold is exceeded. The 
charge becomes more conservative as the spread return correlation 
increases. The application of additional initial margin requirements 
under the quantitative approach is not subject to discretion, although 
the thresholds are subject to review by the CDS Risk Committee as part 
of its periodic review of ICE Clear Europe's margin methodology.
    Other forms of wrong way risk arising from currency risk are also 
addressed. To mitigate the currency risk between a sovereign reference 
entity and a New Sovereign Contract involving that entity, and to 
facilitate greater market liquidity, the New Sovereign Contracts (and 
related margin and guaranty fund requirements) are denominated in U.S. 
dollars, rather than Euro. In addition, the rules contain prohibitions 
on self-referencing trades (i.e., trades where the clearing member is 
an affiliate of the underlying sovereign reference entity). Such trades 
may not be submitted for clearing, and if a clearing member 
subsequently becomes affiliated with the underlying reference entity, 
the rules applicable to New Sovereign Contracts provide for the 
termination of relevant positions.
    The ICE Clear Europe CDS Risk Policy, the CDS Risk Model 
Description methodology document and CDS Wrong Way Risk Policy have 
been updated to account for these additional features of the risk model 
for the New Sovereign Contracts.
2. Statutory Basis
    ICE Clear Europe believes that clearing of the proposed New 
Sovereign Contracts is consistent with the requirements of Section 17A 
of the Act \4\ and regulations thereunder applicable to it, including 
the standards under Rule 17Ad-22.\5\ The amendments will provide for 
clearing of New Sovereign Contracts by ICE Clear Europe, consistent 
with ICE Clear Europe's existing clearing arrangements and related 
financial safeguards, protections and risk management procedures. ICE 
Clear Europe has adopted enhancements to the existing CDS Model to 
address the clearing of the New Sovereign Contracts, including the 
additional initial margin requirements under the qualitative and 
quantitative approaches to General Wrong Way Risk discussed above. The 
New Sovereign Contracts that will be cleared are Western European 
Sovereign CDS contracts substantially similar to other CDS contracts 
currently cleared by ICE Clear Europe. Acceptance of New Sovereign 
Contracts for clearing, on the terms and conditions set out in the ICE 
Clear Europe Rules and the enhanced CDS Model, is consistent with the 
prompt and accurate clearance of and settlement of securities 
transactions and derivative agreements, contracts and transactions 
cleared by ICE Clear Europe, the safeguarding of securities and funds 
in the custody or control of ICE Clear Europe and the protection of 
investors and the public interest, within the meaning of Section 
17A(b)(3)(F) of the Act.\6\ Clearing of the New Sovereign Contracts 
will also satisfy the relevant requirements of Rule 17Ad-22,\7\ as 
discussed below.
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    \4\ 15 U.S.C. 78q-1.
    \5\ 17 CFR 240.17Ad-22.
    \6\ 15 U.S.C. 78q-1(b)(3)(F).
    \7\ 17 CFR 240.17Ad-22.
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    Financial Resources. ICE Clear Europe will apply its existing 
margin methodology to the New Sovereign Contracts, with the 
enhancements to address General Wrong Way Risk discussed above. ICE 
Clear Europe believes that this model, including the additional initial 
margin that may be required to address General Wrong Way Risk, will 
provide sufficient margin to cover its credit exposure to its clearing 
members from clearing such contracts, consistent with the requirements 
of Rule 17Ad-22(b)(2) and Rule 17Ad-22(d)(14).\8\ In addition, ICE 
Clear Europe believes the CDS Guaranty Fund, under its existing 
methodology, will, together with the required margin, provide 
sufficient financial resources to support the clearing of New Sovereign 
Contracts consistent with the requirements of Rule 17Ad-22(b)(3).\9\
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    \8\ 17 CFR 240.17Ad-22(b)(2), (d)(14).
    \9\ 17 CFR 240.17Ad-22(b)(3).
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    Operational Resources. ICE Clear Europe will have the operational 
and managerial capacity to clear the New Sovereign Contracts as of the 
commencement of clearing, consistent with the requirements of Rule 
17Ad-22(d)(4).\10\ ICE Clear Europe believes that its existing systems 
are appropriately scalable to handle the additional New Sovereign 
Contracts, which are generally similar from an operational perspective 
to the CDS contracts currently cleared by ICE Clear Europe.
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    \10\ 17 CFR 240.17Ad-22(d)(4).
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    Settlement. ICE Clear Europe believes that the rule changes will be 
consistent with the requirements of Rule 17Ad-22(d)(5), (12) and (15) 
\11\ as to the finality and accuracy of its daily settlement process 
and avoidance of the risk to ICE Clear Europe of settlement failures. 
ICE Clear Europe will use its existing settlement procedures, account 
structures and approved financial institutions as used in other CDS 
clearing for the New Sovereign Contracts. ICE Clear Europe believes 
that its Rules and procedures related to settlements (including 
physical settlements), appropriately identify and manage the risks 
associated with

[[Page 10580]]

settlements under New Sovereign Contracts.
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    \11\ 17 CFR 240.17Ad-22(d)(5), (12) and (15).
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    Default Procedures. ICE Clear Europe's existing Rules and default 
management policies and procedures for CDS will apply to the New 
Sovereign Contracts as well. ICE Clear Europe believes that the Rules 
and procedures allow for it to take timely action to contain losses and 
liquidity pressures and to continue meeting its obligations in the 
event of clearing member insolvencies or defaults, including in respect 
of New Sovereign Contracts, in accordance with Rule 17Ad-22(d)(11).\12\
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    \12\ 17 CFR 240.17Ad-22(d)(11).
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    Governance. ICE Clear Europe has determined to accept the New 
Sovereign Contracts for clearing in accordance with its governance 
process, including review of the contracts and related risk management 
considerations (and the enhancements to the margin methodology for 
General Wrong Way Risk discussed herein) by the CDS Risk Committee and 
approval by its Board. These arrangements are consistent with the 
requirements of Rule 17Ad-22(d)(8).\13\ Although the General Wrong Way 
Risk approaches, when applied to all clearing members who clear the New 
Sovereign Contracts, may result in clearing members being subject to 
different margin charges based on their domicile and correlation with 
the underlying sovereign for a contract, ICE Clear Europe believes that 
the policy properly aligns the margin requirements to the risks 
presented by clearing members in this regard. The policy on General 
Wrong Way Risk has been established with well-defined, objective 
parameters and is applicable to all clearing members that choose to 
clear the New Sovereign Contracts. Further, ICE Clear Europe does not 
believe the revised margin methodology creates a conflict of interest 
between ICE Clear Europe and its clearing members or among clearing 
members. The revised margin methodology operates without the need for 
the CDS Risk Committee, ICE Clear Europe Board or management to 
exercise discretion concerning particular clearing members or the 
margin levels applicable to them. The qualitative and quantitative 
components to the methodology do not contain discretionary elements, 
and once the relevant threshold is exceeded, the clearing house is 
required under the policy to assess an additional initial margin charge 
based on the margin methodology. This approach should minimize any 
potential conflicts of interest. As noted above, the CDS Risk Committee 
and ICE Clear Europe management will regularly review the 
appropriateness of the quantitative threshold. Accordingly, the policy 
does not, in ICE Clear Europe's view, result in unfair discrimination 
among clearing members within the meaning of Section 17A(b)(3)(F) of 
the Act and Rule 17Ad-22(d)(8).\14\ ICE Clear Europe further notes that 
it has extensively consulted with its CDS Risk Committee as to this 
aspect of the clearing of the New Sovereign Contracts.
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    \13\ 17 CFR 240.17Ad-22(d)(8).
    \14\ 15 U.S.C. 78q-1(b)(3)(F); 17 CFR 240.17Ad-22(d)(8).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    ICE Clear Europe does not believe the proposed New Sovereign 
Contracts would have any impact, or impose any burden, on competition 
not necessary or appropriate in furtherance of the purpose of the Act. 
ICE Clear Europe does not anticipate that its commencement of clearing 
for the New Sovereign Contracts will adversely affect the trading 
market for those contracts or for CDS more generally. Specifically, 
allowing clearing of the New Sovereign Contracts will provide market 
participants with the additional choice to have their transactions in 
these types of contracts cleared, and should generally promote the 
further development of the market for these contracts. Moreover, ICE 
Clear Europe has established fair and objective criteria for 
eligibility to clear the New Sovereign Contracts, consistent with its 
criteria for other cleared CDS. Although clearance of New Sovereign 
Contracts may result in an increase in margin requirements for some 
clearing members as a result of the General Wrong Way Risk 
requirements, ICE Clear Europe believes that these changes will 
properly align margin requirements to the risks presented by such 
clearing members with respect to the New Sovereign Contracts. As a 
result, ICE Clear Europe is of the view that these changes are 
necessary and appropriate in furtherance of the purpose of the Act and 
the Commission's regulations thereunder, including the financial 
resources and risk management requirements of Rule 17Ad-22.\15\ 
Furthermore, ICE Clear Europe does not believe that any such increase 
in margin requirements would significantly affect the ability of 
clearing members or other market participants to continue to clear CDS, 
consistent with the risk management requirements of the clearing house, 
or otherwise limit market participants' choices for selecting clearing 
services. Accordingly ICE Clear Europe does not believe that clearance 
of the New Sovereign Contracts will impose any burden on competition 
among clearing members not necessary or appropriate in furtherance of 
the purposes of the Act.
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    \15\ 17 CFR 240.17Ad-22.
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C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    Written comments relating to the current proposal for acceptance of 
the New Sovereign Contracts for clearing have not been solicited or 
received. One comment letter was received in connection with ICE Clear 
Europe's prior filing with respect thereto (File No. 2012-08), which 
suggested, in relevant part, consideration of additional wrong way risk 
raised by credit exposures of protection sellers to underlying 
sovereign reference entities. (The letter raised other issues 
concerning the disclosure of risk management processes generally and 
the effectiveness of market-standard sovereign CDS contracts as a 
hedge, which ICE Clear Europe believes are outside the scope of this 
rule change). ICE Clear Europe believes that the combination of the 
qualitative and quantitative approaches discussed herein provides 
appropriate initial margin protection for General Wrong Way Risk, and 
notes that ICE Clear Europe management and the CDS Risk Committee 
regularly review the appropriateness of the margin methodology. ICE 
Clear Europe will notify the Commission of any written comments 
received by ICE Clear Europe.
    The CDS Risk Committee raised no objection to the clearing of the 
New Sovereign Contracts on the terms described herein on December 10, 
2013. The clearing of the New Sovereign Contracts was approved by the 
ICE Clear Europe board on August 1, 2012.

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.

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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-ICEEU-2014-04 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-ICEEU-2014-04. 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 filings will also be available 
for inspection and copying at the principal office of ICE Clear Europe 
and on ICE Clear Europe's Web site at https://www.theice.com/notices/Notices.shtml?regulatoryFilings.
    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-ICEEU-2014-04 
and should be submitted on or before March 18, 2014.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-03973 Filed 2-24-14; 8:45 am]
BILLING CODE 8011-01-P


