
[Federal Register Volume 82, Number 74 (Wednesday, April 19, 2017)]
[Notices]
[Pages 18488-18490]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-07872]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-80450; File No. SR-LCH SA-2017-003]


Self-Regulatory Organizations; LCH SA; Notice of Filing of 
Proposed Rule Change Relating to Recovery Risk Margin

April 13, 2017.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder \2\ notice is hereby given that 
on April 4, 2017, Banque Centrale de Compensation, which conducts 
business under the name LCH SA (``LCH SA''), filed with the Securities 
and Exchange Commission (``Commission'') the proposed rule change 
described in Items I, II, and III below, which Items have been prepared 
primarily by LCH SA. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    LCH SA is proposing to revise its margin methodology with respect 
to credit default swaps (``CDS'') in the Reference Guide: CDS Margin 
Framework. The proposed rule change will (i) eliminate the recovery 
rate risk charge as a component of the margin methodology as it applies 
to index CDS (ii) correct a hyperlink and add a cross reference and 
hyperlink to the general inputs considered by LCH SA in constructing 
the CDS pricing for European and US dollar denominated contracts.

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

    In its filing with the Commission, LCH SA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. LCH SA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of these statements.

[[Page 18489]]

A. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

1. Purpose
    The purpose of the proposed rule change is to revise LCH SA's 
margin methodology to eliminate the recovery rate risk charge as a 
component of its margin methodology for index CDS.
    Currently, LCH SA applies a recovery rate risk charge to both 
single-name CDS and index CDS in a Clearing Member's portfolio. LCH SA 
considers recovery rate a risk factor affecting the market value of a 
CDS contract, in addition to the credit spread as the primary risk 
factor, and imposes a recovery rate risk charge as an add-on component 
of margin to address the adverse effect of the recovery rate change on 
the profits and losses of a Clearing Member's portfolio in the event of 
the recovery rate moving in the most adverse direction for each CDS 
instrument in the portfolio. However, while the recovery rate for a 
single-name CDS instrument may vary from day to day, the concept of 
``recovery rate'' does not exist for index CDS. In fact, market 
convention is to assume a pre-defined recovery rate for pricing an 
index CDS, such as a CDS on iTraxx indices. Therefore, the credit 
spread of an index CDS already reflects both the probabilities of 
default and recovery rate. Since the recovery rate risk charge is 
designed to capture the worst adverse effect of the recovery rate 
moving in the most adverse direction, applying the recovery rate risk 
charge to the index CDS contracts cleared by LCH SA would be trying to 
capture a stress loss incurred in a Clearing Member's portfolio should 
the pre-defined recovery rate for these index CDS change, which is not 
consistent with market convention in normal market conditions. 
Therefore, LCH SA believes that recovery rate risk is a superfluous 
concept for index CDS and is proposing to limit the application of the 
recovery rate risk charge to single-name CDS.
    Text is added to the beginning of Section 6 of ``Reference Guide: 
CDS Margin Framework'' to explain the reason for including the Recovery 
Rate Risk charge as a component of the margin, in addition to the 
spread risk considered in the VaR calculation. An additional paragraph 
is added and conforming changes are made to limit the application of 
the Recovery Rate Risk charge to single-name CDS.
    In addition, LCH is also proposing to correct a hyperlink and add a 
cross reference and hyperlink to the general inputs considered by LCH 
SA in constructing the CDS pricing for European and US dollar 
denominated contracts in Section 2.2 of ``Reference Guide: CDS Margin 
Framework''. The purpose of these changes is to enhance readability and 
clarity of the Reference Guide: CDS Margin Framework.
2. Statutory Basis
    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of a clearing agency be designed to assure safeguarding of 
securities and funds which are in the custody or control of the 
clearing agency or for which it is responsible.\3\ LCH SA believes that 
limiting the application of the Recovery Rate Risk charge to single-
name CDS would sufficiently capture the stress loss that would result 
in the event that recovery rates change in the most adverse direction 
for each instrument in a Clearing Member's portfolio. Since the 
recovery rate is set at pre-defined levels with respect to index CDS, 
the proposed rule change would better align LCH SA's margin methodology 
with the way recovery rate movements affect the CDS market value in 
reality. LCH SA expects deviations from the market convention with 
respect to the pre-defined recovery rates for index CDS only in extreme 
market conditions, which would be captured by LCH SA's stress scenarios 
used to size the Default Fund. Therefore, LCH SA believes that the 
proposed rule change is consistent with the requirement of safeguarding 
securities and funds in Section 17(A)(b)(3)(F) [sic] of the Act and the 
requirements of maintaining margin and limiting a clearing agency's 
exposures to potential losses from participants' defaults under normal 
market conditions in Rule 17Ad-22(b)(1) and (2).\4\
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    \3\ 15 U.S.C. 78q-1(b)(3)(F).
    \4\ 17 CFR 240.17Ad-22(b)(1) and (2).
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    Moreover, LCH SA also believes that the proposed rule change is 
consistent with the requirements in Rule 17Ad-22(e)(6).\5\ Rule 17Ad-
22(e)(6) requires a covered clearing agency that provides central 
counterparty services to cover its credit exposures to its participants 
by establishing a risk-based margin system that, among other things, 
calculates margin sufficient to cover its potential future exposure to 
participants in the interval between the last margin collection and the 
close out of positions following a participant default and uses an 
appropriate method for measuring credit exposure that accounts for 
relevant product risk factors and portfolio effects across products.\6\ 
The margin framework takes into account appropriate risk factors that 
would affect the market value of a CDS contract, including credit 
spread and recovery rate risk, and calculates margin to include, among 
other things, spread margin and recovery rate risk charge to ensure 
sufficient coverage of its potential future exposure to participants in 
the interval between the last margin collection and the close out of 
positions following a participant default. As stated above, the 
proposed rule change to limit the application of the recovery rate risk 
charge to single-name CDS would better align LCH SA's margin 
methodology with the way recovery rate movements affect the CDS market 
value in reality and would improve LCH SA's margin methodology for 
measuring credit exposure that accounts for relevant product risk 
factors. Therefore, LCH SA believes that the proposed rule change is 
consistent with Rule 17Ad-22(e)(6)(iii) and (v).\7\
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    \5\ 17 CFR 240.17Ad-22(e)(6).
    \6\ 17 CFR 240.17Ad-22(e)(6)(iii) and (v).
    \7\ 17 CFR 240.17Ad-22(e)(6)(iii) and (v).
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    Finally, Rule 17Ad-22(e)(1) provides that a covered clearing agency 
shall 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 jurisdiction.\8\ LCH SA believes that the 
proposed modifications made to Section 2.2 of ``Reference Guide: CDS 
Margin Framework'' will correct an error and provide additional cross-
reference regarding the general inputs considered by LCH SA in 
constructing CDS pricing for European and US dollar denominated 
contracts, and therefore, will improve the clarity of the Reference 
Guide and enable the Reference Guide to provide a clear margin 
framework, consistent with Rule 17Ad-22(e)(1).
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    \8\ 17 CFR 240.17Ad-22(e)(1).
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B. Clearing Agency's Statement on Burden on Competition

    Section 17A(b)(3)(I) of the Act requires that the rules of a 
clearing agency not impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Act.\9\ LCH SA does 
not believe the proposed rule change will impose any burden on 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Act. While the proposed rule change may result in 
various margin changes among the participants, the revisions to the 
margin methodology will uniformly apply across all participants. In 
addition, as stated above, the proposed rule change is consistent with 
the applicable requirements of the Act and

[[Page 18490]]

is appropriate in order to better align LCH SA's margin methodology to 
the way recovery rate movements affect the CDS market value in reality. 
Therefore, LCH SA does not believe that the proposed rule change 
imposes any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.
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    \9\ 15 U.S.C. 78q-1(b)(3)(I).
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C. Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received From Members, Participants or Others

    Written comments relating to the proposed rule change have not been 
solicited or received. LCH SA will notify the Commission of any written 
comments received by LCH SA.

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 such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

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-LCH SA-2017-003 on the subject line.

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-LCH SA-2017-003. 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 LCH SA and on LCH 
SA's Web site at http://www.lch.com/asset-classes/cdsclear. 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-LCH SA-2017-003 and should 
be submitted on or before May 10, 2017.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\10\
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    \10\ 17 CFR 200.30-3(a)(12).
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Brent J. Fields,
Secretary.
[FR Doc. 2017-07872 Filed 4-18-17; 8:45 am]
BILLING CODE 8011-01-P


