
[Federal Register Volume 82, Number 94 (Wednesday, May 17, 2017)]
[Notices]
[Pages 22699-22702]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-09935]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-80666; File No. SR-LCH SA-2017-005]


Self-Regulatory Organizations; LCH SA; Notice of Proposed Rule 
Change, as modified by Amendment No. 1 Thereto, To Add Rules Related to 
the Clearing of CDX.NA.HY CDS

May 11, 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 28, 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. On May 5, 2017, LCH SA filed Amendment No. 1 to 
the proposal.\3\ 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.
    \3\ LCH SA filed Amendment No. 1 to replace the initial filing 
in its entirety for the purpose of clarifying various changes to its 
CDS Margin Framework.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    LCH SA is proposing to amend its (i) CDS Margin Framework and (ii) 
CDSClear Default Fund Methodology to incorporate terms and make 
conforming changes to provide for credit default swaps (``CDS'') on the 
CDX.NA.HY index to be cleared by LCH SA.

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,

[[Page 22700]]

and C below, of the most significant aspects of these statements.

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 modify LCH SA's CDS 
Margin Framework and CDSClear Default Fund Methodology to allow LCH SA 
to clear additional CDS contracts on the CDX.NA.HY index consisting of 
North America high-yield reference entities. Specifically, LCH SA 
proposes to amend Sections 3, 4, 5, 6, 8, 10, and 11 of its CDS Margin 
Framework and Section 2 and 3 of the CDSClear Default Fund Methodology. 
Each of these changes is described in further detail below.
    With respect to the CDS Margin Framework, the heading in Section 3 
and the fourth column in the table in Section 3.1.1 will be amended to 
clarify that the summary of the margin framework also applies to CDX HY 
contracts.
    Section 4.1 of the CDS Margin Framework, setting forth the short 
charge component of LCH SA's margin methodology, will be amended to 
describe the purpose of the short charge component within LCH SA's 
margin methodology and to adjust the calculation to account for 
CDX.NA.HY index contracts. The purpose of the short charge component is 
to address the probability of a credit event occurring during the 
period from the default of a Clearing Member to liquidation of the 
defaulting Clearing Member's portfolio, i.e., the so-called ``jump to 
default'' risk. Under the proposed rule change, the short charge 
component of the margin methodology will take into account the risk of 
clearing CDS contracts on high yield indices. Currently, with respect 
to a Clearing Member's portfolio, the short charge in the margin 
methodology considers the greater of (x) a ``Global Short Charge,'' 
derived from the Clearing Member's largest, or ``top,'' net short 
exposure (in respect of any CDS contracts) and its top net short 
exposure amongst the three ``riskiest'' reference entities (in respect 
of any entity type) that are most probable to default in its portfolio 
and (y) the top two net short exposures in respect of CDS contracts on 
senior financial entities. Because high yield entities are riskier than 
senior financial entities by nature and historically defaults of high 
yield entities appeared more clustered than investment grade or 
European entities, LCH SA proposes to introduce a ``High Yield Short 
Charge'' to replace the top two net short exposures in respect of CDS 
on senior financial entities in the short charge calculation. Based 
upon historical data and the maximum number of defaults that have been 
observed in respect of reference entities in all CDSClear eligible 
contracts within a 5 business day period, LCH SA believes that the 
``High Yield Short Charge'' should consider not only a Clearing 
member's top net short exposure in respect of the high yield CDS 
contracts in its portfolio but also the top two net short exposures 
among the three ``riskiest'' high yield reference entities to reflect 
the possibility of defaults of multiple, or clustered, high yield 
entities. As a result, the new short charge under the proposed rule 
change will be the greater of (x) the ``Global Short Charge,'' as 
described above and (y) a ``High Yield Short Charge,'' derived from a 
member's top net short exposure (in respect of high yield CDS) and its 
top two net short exposures amongst the three ``riskiest'' reference 
entities (in the high yield category) in its portfolio.
    Conforming changes will be made throughout Section 4.1.1, which 
describes the ``net short exposure'' calculation, to accommodate 
CDX.NA.HY contracts and to clarify that to obtain margin in Euros all 
USD denominated variables are converted to Euros utilizing the current 
USD/Euro foreign exchange rate and calibrated haircut based upon 
historical data. Similarly, conforming changes will be made in Section 
4.1.2 of the CDS Margin Framework, which describes the ``top exposure'' 
component of the short charge and Section 4.1.3 of the CDS Margin 
Framework, which describes the process by which LCH SA identifies the 
``riskiest'' entities in determining the short charge, to incorporate 
terms for CDX.NA.HY index contracts and to clarify the calculation as 
it applies to high yield indices. Clarification changes will be made in 
Section 4.1.4 of the CDS Margin Framework to summarize the calculation 
for the short charge amount.
    Section 4.3 of the CDS Margin Framework will be deleted in its 
entirety because the substance of that section will be contained in 
Section 4.1, as described above.
    In addition, LCH SA also proposes to amend Section 5.1 of the CDS 
Margin Framework, which sets forth the wrong way risk (``WWR'') 
component of LCH SA's methodology. Currently, LCH SA considers the 
correlation between the default of a Clearing Member and the default(s) 
of one or more other financial institutions as part of its WWR 
management. Specifically, the current approach leverages on the Short 
Charge framework by calculating the top two net short exposures of 
financial entities in a Clearing Member's portfolio following the 
algorithm described above for the Short Charge margin. LCH SA then 
compares these top two net short exposures of financial entities to the 
short charge margin and imposes the greater of those two as the 
adjusted jump-to-default charge, to address the WWR arising from the 
correlation between a Clearing Member default and the default(s) of one 
or more financial entities in the Clearing Member's portfolio. The 
proposed rule change does not substantively change this approach but 
amends Section 5.1 of the CDS Margin Framework to clarify that, when 
the top two net short exposures in respect of financial entities 
exceeds the short charge margin, as described above, LCH SA will impose 
a charge equal to such excess to address the jump-to-default WWR.
    Other conforming changes in the CDS Margin Framework will be made 
in Sections 5, 6, 8, 10, and 11 to clarify that the those sections also 
apply to high yield indices.
    With respect to the CDSClear Default Fund Methodology, Section 2.3 
will be amended to facilitate clearing of CDS contracts on the CDX High 
Yield index and to modify the existing stressed short charge component 
of the CDSClear Default Fund Methodology. Currently, the stressed short 
charge covers the greater of (x) the top net short exposure plus the 
top two net short exposures amongst the three entities most likely to 
default in the Clearing Member's portfolio and (y) the top two net 
short exposures which are senior financial entities plus the top net 
short exposures amongst the three senior financial entities most likely 
to default in the Clearing Member's portfolio. The proposed rule change 
will take the default of high yield entities into account and add a 
third prong to the stressed short charge calculation, which will take 
the greater of (x) and (y), each as described above, and (z) the top 
two net short exposure which are high yield entities plus the top two 
net short exposures amongst the three high yield entities most likely 
to default in the Clearing Member's portfolio.
    Finally, Section 3.8 of the CDSClear Default Fund Methodology, 
which describes the correlation between index families and series, will 
be updated to reflect additional data.
2. Statutory Basis
    LCH SA believes that the proposed rule change and the clearing of 
CDX.NA.HY contracts is consistent with the requirements of Section 17A 
of the

[[Page 22701]]

Act \4\ and the regulations thereunder, including the standards under 
Rule 17Ad-22.\5\ Section 17(A)(b)(3)(F) of the Act \6\ requires, among 
other things, that the rules of a clearing agency be designed to 
promote the prompt and accurate clearance and settlement of securities 
transactions and derivative agreements, contracts, and 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. As noted above, the proposed rule change is designed to 
provide for the clearing of CDX.NA.HY contracts. CDX.NA.HY contracts 
are similar to the contracts currently cleared by LCH SA and will be 
cleared in the same manner as other index contracts, consistent with 
LCH SA's existing operational arrangements. Clearing of the additional 
contracts will allow market participants to manage additional risk and 
ensure the safeguarding of margin and assets pursuant to LCH SA's 
rules. Therefore, LCH SA believes that the clearing of CDX.NA.HY and 
the related changes described herein are consistent with the prompt and 
accurate clearance and settlement of securities transactions and 
derivative agreements, contracts and transactions, in accordance with 
17(A)(b)(3)(F) of the Act.\7\
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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\ 15 U.S.C. 78q-1(b)(3)(F).
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    In addition, the proposed amendments to LCH SA's CDS Margin 
Framework and CDSClear Default Fund Methodology also satisfy the 
relevant requirements of Rule 17Ad-22, including Rule 17Ad-22(b)(2), 
(b)(3), (e)(4) and (e)(6).\8\ Rule 17Ad-22(b)(2) requires a clearing 
agency to use margin requirements to limit its credit exposures to 
participants under normal market conditions and use risk-based models 
and parameters to set margin requirements.\9\ Rule 17Ad-22(e)(4)(i) 
requires a covered clearing agency to maintain sufficient financial 
resources to cover its credit exposure to each participant fully with a 
high degree of confidence,\10\ and Rule 17Ad-22(e)(6)(i) 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, at a minimum, considers and produces margin 
levels commensurate with the risks and particular attributes of each 
relevant product, portfolio, and market.\11\ The proposed rule change 
to LCH SA's CDS Margin Framework will take into account the risk 
particular to clearing CDS on high yield entities as part of LCH SA's 
jump-to-default risk management and wrong way risk management and 
produce margin levels commensurate with the risks and attributes of CDS 
on high yield entities and maintain margin sufficient to cover its 
credit exposure to its participants fully in normal market conditions, 
consistent with requirements of Rule 17Ad-22(b)(2), (e)(4)(i) and 
(e)(6)(i).\12\ Moreover, Rule 17Ad-22(b)(3) requires a clearing agency 
acting as a central counterparty for security-based swaps to establish 
policies and procedures reasonably designed to maintain sufficient 
financial resources to withstand, at a minimum, a default by the two 
participant families to which it has the largest exposures in extreme 
but plausible market conditions (the ``cover two standard'').\13\ 
Similarly, Rule 17Ad-22(e)(4)(ii) requires a covered clearing agency 
that provides central counterparty services for security-based swaps to 
maintain financial resources additional to margin to enable it to cover 
a wide range of foreseeable stress scenarios that include, but are not 
limited to, meeting the cover two standard.\14\ LCH SA believes that 
its CDSClear Default Fund Methodology, with the modifications described 
herein, will provide a stress short charge appropriately incorporating 
the risk of clearing CDS on high yield entities, which, together with 
its margin methodology, will ensure that LCH SA maintains sufficient 
financial resources to meet the cover two standard, in accordance with 
Rule 17Ad-22(b)(3) and (e)(4)(ii).\15\ LCH SA also believes that the 
clearing of CDX.NA.HY contracts is consistent with Rule 17Ad-22(d)(4) 
and (e)(17),\16\ in that clearing the additional contracts will be 
substantially the same from an operational perspective as clearing 
existing contracts and LCH SA believes that its existing systems are 
adequately scalable to facilitate the clearing of additional contracts
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    \8\ 17 CFR 240.17Ad-22.
    \9\ 17 CFR 240.17Ad-22(b)(22).
    \10\ 17 CFR 240.17Ad-22(e)(4)(i).
    \11\ 17 CFR 240.17Ad-22(e)(6)(i).
    \12\ 17 CFR 240.17Ad-22(b)(2), (e)(4)(i) and (e)(6)(i).
    \13\ 17 CFR 240.17Ad-22(b)(3).
    \14\ 17 CFR 240.17Ad-22(e)(4)(ii).
    \15\ 17 CFR 240.17Ad-22(b)(3) and (e)(4)(ii).
    \16\ 17 CFR 240.17Ad-22(d)(4) and (e)(17).
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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.\17\ LCH SA does 
not believe that its clearing of CDX.NA.HY contracts will adversely 
affect the trading market for those contracts or CDS generally. By 
allowing LCH SA to clear CDX.NA.HY contracts, market participants will 
have additional choices on where to clear CDX.NA.HY contracts, which, 
in turn, will promote competition and further the development of 
CDX.NA.HY contracts for risk management. Further, LCH SA will apply its 
existing fair and open access criteria to the clearing of CDX.NA.HY 
contracts. Accordingly LCH SA does not believe that the proposed rule 
change will impose any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act.
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    \17\ 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

[[Page 22702]]

     Send an email to rule-comments@sec.gov. Please include 
File Number SR-LCH SA-2017-005 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-2017-005. 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 the filing also will 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-
005 and should be submitted on or before June 7, 2017.
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    \18\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
Brent J. Fields,
Secretary.
[FR Doc. 2017-09935 Filed 5-16-17; 8:45 am]
 BILLING CODE 8011-01-P


