
[Federal Register Volume 79, Number 72 (Tuesday, April 15, 2014)]
[Notices]
[Pages 21331-21332]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-08422]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-71920; File No. SR-ICEEU-2014-04]


Self-Regulatory Organizations; ICE Clear Europe Limited; Order 
Approving Proposed Rule Change To Clear New Sovereign Contracts

April 9, 2014.

I. Introduction

    On February 11, 2014, ICE Clear Europe Limited (``ICE Clear 
Europe'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change SR-ICEEU-2014-04 pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ 
and Rule 19b-4 thereunder.\2\ The proposed rule change was published 
for comment in the Federal Register on February 25, 2014.\3\ The 
Commission did not receive any comments on the proposed rule change. 
This order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Exchange Act Release No. 34-71574 (Feb. 19, 2014), 79 FR 
10578 (Feb. 25, 2014) (SR-ICEEU-2014-04).
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II. Description of the Proposed Rule Change

    ICE Clear Europe proposes to adopt rules to provide for the 
clearance of new credit default swap (``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''). 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 CDS 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 ICE Clear Europe's CDS Procedures. ICE 
Clear Europe has stated that 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 framework (including relevant policies) and margin 
model as discussed herein.
    ICE Clear Europe proposes to enhance its CDS risk management 
framework, including the margin methodology (the ``CDS Model''),\4\ 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, ICE Clear Europe proposes to 
establish additional jump-to-default requirements for initial margin 
for portfolios that present such risk.
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    \4\ 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 
proposes to 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 proposed quantitative approach, which will apply where 
the protection seller is not domiciled in the jurisdiction of the 
underlying sovereign, two types of thresholds will be 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 will be subject to review by the CDS Risk Committee as 
part of its periodic review of ICE Clear Europe's margin methodology.
    ICE Clear Europe's proposal also addresses other forms of wrong way 
risk arising from currency risk. 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) 
will be denominated in U.S. dollars, rather than Euro. In addition, ICE 
Clear Europe's 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.
    ICE Clear Europe proposes to 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,

[[Page 21332]]

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. 
Furthermore, ICE Clear Europe believes that its 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.
    ICE Clear Europe believes it will have the operational and 
managerial capacity to clear the New Sovereign Contracts as of the 
commencement of clearing, and 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.
    ICE Clear Europe has stated that 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. ICE Clear 
Europe has also stated that 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. ICE Clear Europe believes this approach should 
minimize any potential conflicts of interest.

III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \5\ 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 the rules and regulations thereunder 
applicable to such organization. Section 17A(b)(3)(F) of the Act \6\ 
requires, among other things, that the rules of a clearing agency are 
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 the 
clearing agency or for which it is responsible, and in general, to 
protect investors and the public interest.
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    \5\ 15 U.S.C. 78s(b)(2)(C).
    \6\ 15 U.S.C. 78q-1(b)(3)(F).
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    After careful review, the Commission finds that the proposed rule 
change is consistent with Section 17A of the Act \7\ and the rules 
thereunder applicable to ICE Clear Europe. Specifically, the Commission 
believes that ICE Clear Europe's proposal to clear the New Sovereign 
Contracts in accordance with its existing Clearing Rules and procedures 
applicable to CDS contracts is designed to promote the prompt and 
accurate clearance and settlement of securities transactions and to 
assure the safeguarding of securities and funds which are in the 
custody or control of the clearing agency or for which it is 
responsible, consistent with Section 17A(b)(3)(F) of the Act.\8\
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    \7\ 15 U.S.C. 78q-1.
    \8\ 15 U.S.C. 78q-1(b)(3)(F).
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    Additionally, the Commission believes that the proposed 
enhancements to ICE Clear Europe's CDS risk management framework to 
address the General Wrong Way Risks associated with clearing New 
Sovereign Contracts, including the correlation and currency risks 
discussed above, are designed to assure the safeguarding of securities 
and funds which are in the custody or control of the clearing agency or 
for which it is responsible, and in general, to protect investors and 
the public interest, consistent with Section 17A(b)(3)(F) of the 
Act.\9\ The proposal will require additional contributions to initial 
margin 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). These proposed margin model 
enhancements will provide additional resources to ICE Clear Europe to 
address the potential risks associated with the 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. The Commission also believes that 
the enhanced risk management framework, in combination with ICE Clear 
Europe's existing rules and procedures related to margin and guaranty 
fund, is reasonably designed to meet the requirements of Rules 17Ad-
22(b)(1)--(3) \10\ related to the measurement and management of credit 
exposures, margin requirements, and the maintenance of sufficient 
financial resources required for a registered clearing agency acting as 
a central counterparty for security-based swaps.
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    \9\ 15 U.S.C. 78q-1(b)(3)(F).
    \10\ 17 CFR 240.17Ad-22(b)(1)--(3).
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    As noted above, ICE Clear Europe's proposed 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. 
ICE Clear Europe has stated that the qualitative and quantitative 
components to the methodology do not contain discretionary elements, 
and once the relevant thresholds are exceeded, the clearing house is 
required under the policy to assess an additional initial margin charge 
based on the margin methodology. The Commission does not believe that 
these proposed changes will result in unfair discrimination among 
clearing members within the meaning of Section 17A(b)(3)(F) of the Act 
\11\ and believes that these proposed changes are consistent with the 
requirements of Rule 17Ad-22(d)(8).\12\
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    \11\ 15 U.S.C. 78q-1(b)(3)(F).
    \12\ 17 CFR 240.17Ad-22(d)(8).
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    Finally, the Commission believes that ICE Clear Europe's proposal 
to clear New Sovereign Contracts in accordance with its existing rules, 
procedures, and operational framework is reasonably designed to 
identify sources of operational risk and minimize them through the 
development of appropriate systems, controls, and procedures, and to 
implement systems that are reliable, resilient and secure, and have 
adequate, scalable capacity consistent with Rule 17Ad-22(d)(4).\13\
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    \13\ 17 CFR 240.17Ad-22(d)(4).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act and in 
particular with the requirements of Section 17A of the Act\14\ and the 
rules and regulations thereunder.
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    \14\ 15 U.S.C. 78q-1.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the proposed rule change (SR-ICEEU-2014-04) be, and 
hereby is, approved.\16\
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    \15\ 15 U.S.C. 78s(b)(2).
    \16\ 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).
    \17\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\17\
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-08422 Filed 4-14-14; 8:45 am]
BILLING CODE 8011-01-P


