
[Federal Register Volume 82, Number 109 (Thursday, June 8, 2017)]
[Notices]
[Pages 26728-26729]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-11864]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-80848; File No. SR-LCH SA-2017-003]


Self-Regulatory Organizations; LCH SA; Order Approving Proposed 
Rule Change Relating to Recovery Risk Margin

June 2, 2017.

I. Introduction

    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''), pursuant to Section 19(b)(1) 
of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change (SR-LCH SA-2017-003) to revise 
its margin methodology with respect to credit default swaps (``CDS'') 
in the Reference Guide: CDS Margin Framework (``Reference Guide''). The 
proposed rule change was published for comment in the Federal Register 
on April 19, 2017.\3\ The Commission received no comment letters 
regarding the proposed change. For the reasons discussed below, the 
Commission is approving the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 34-80450 (April 13, 
2017), 82 FR 18488 (April 19, 2017) (SR-LCH SA-2017-003) (the 
``Notice'').
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II. Description of the Proposed Rule Change

    The proposed rule change seeks to amend the Reference Guide by 
eliminating the recovery rate risk charge as a component of the margin 
methodology, as it applies to index CDS. LCH SA, however, does not 
propose to alter the recovery rate risk charge as a component of the 
margin methodology, as it applies to single name CDS. The proposed rule 
change also seeks to make minor updates and clarifications to the 
Reference Guide.\4\
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    \4\ LCH SA has proposed changes to the Reference Guide to (i) 
correct a hyperlink and (ii) add a cross reference and hyperlink to 
the general inputs considered by LCH SA in constructing the CDS 
pricing for European and U.S. dollar denominated contracts. See 
Notice, 82 FR at 18489.
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    With respect to the portion of the proposed rule change that 
eliminates the recovery rate risk charge as a margin component for 
index CDS positions, LCH SA believes that recovery rate risk is 
irrelevant to index CDS in normal market conditions and it therefore 
should not need to charge margin to address it. In support, LCH SA 
represents that ``[the] market convention is to assume a pre-defined 
recovery rate for pricing an index CDS, such as a CDS on iTraxx 
indices.'' \5\ Therefore, according to LCH SA, there is no need to 
charge margin for an adverse recovery rate movement for an index CDS 
position because, pursuant to market convention for pricing an index 
CDS in normal market conditions, the rate will not move. Moreover, LCH 
SA characterizes any drop in the recovery rate for index CDS as a 
stress loss, and states that applying a margin charge to address this 
risk ``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.'' \6\ Furthermore, while LCH SA does expect 
deviations from this market convention in extreme market conditions, 
LCH SA believes that these deviations--and any resultant recovery rate 
risk on the affected index CDS positions--should not be addressed 
through its margin framework but rather ``would be captured by LCH SA's 
stress scenarios used to size the Default Fund.'' \7\ Therefore, LCH SA 
maintains that elimination of recovery rate risk charge from its margin 
framework is appropriate and consistent with applicable provisions of 
the Exchange Act and Commission Rules promulgated thereunder.
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    \5\ Id.
    \6\ Id.
    \7\ Id.

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[[Page 26729]]

III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act 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.\8\ Section 17A(b)(3)(F) of the Act requires,\9\ among 
other things, that the rules of a registered clearing agency be 
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. Rule 17Ad-22(b)(2) requires that a registered clearing 
agency that performs central counterparty services shall establish, 
implement, maintain, and enforce written policies and procedures 
reasonably designed to use margin requirements to limit its credit 
exposures to participants under normal market conditions.\10\ Rule 
17Ad-22(e)(6) requires that a covered clearing agency \11\ shall 
establish, implement, maintain, and enforce written policies and 
procedures reasonably designed to cover its credit exposures to its 
participants by establishing a risk-based margin system that, at a 
minimum, 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.\12\ Rule 17Ad-22(e)(1) requires 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 jurisdictions.\13\
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    \8\ 15 U.S.C. 78s(b)(2)(C).
    \9\ 15 U.S.C. 78q-1(b)(3)(F).
    \10\ 17 CFR 240.17Ad-22(b)(2).
    \11\ See 17 CFR 240.17Ad-22(a)(5) (defining ``covered clearing 
agency'').
    \12\ See 17 CFR 240.17Ad-22(e)(6)(iii), (e)(6)(v).
    \13\17 CFR 240.17Ad-22(e)(1).
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    The Commission finds that the proposed rule change is consistent 
with Section 17A of the Act and Rule 17Ad-22 thereunder. In particular, 
the Commission finds that the elimination of recovery rate risk charges 
is consistent with market convention for pricing index CDS, as 
represented by LCH SA and discussed above. Moreover, the Commission 
notes that the elimination of this component of LCH SA's margin is 
expected to have only a minor impact on the total amount of margin LCH 
SA collects with respect to index CDS. Furthermore, the Commission 
notes that LCH SA will continue to consider and address recovery rate 
risk on index CDS in its stress scenarios used to size its default 
fund. Based on these findings and considerations, the Commission 
believes that the proposed rule change is reasonably designed to use 
margin requirements to limit its credit exposures to participants under 
normal market conditions, calculate 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 use an appropriate method for measuring credit 
exposure that accounts for relevant product risk factors and portfolio 
effects across products, consistent with Section 17A(b)(3)(F) of the 
Exchange Act,\14\ and Rules 17Ad-22(b)(2), (e)(6)(iii), and (e)(6)(v) 
thereunder.\15\
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    \14\ 15 U.S.C. 78q-1(b)(3)(F).
    \15\ 17 CFR 240.17Ad-22(b)(2), (e)(6)(iii), and (e)(6)(v).
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    With respect to the portion of the proposed rule change that 
revises the Reference Guide to (i) correct a hyperlink and (ii) add a 
cross reference and hyperlink to the general inputs considered by LCH 
SA in constructing the CDS pricing for European and U.S. dollar 
denominated contracts, the Commission believes that correcting an 
erroneous hyperlink and providing an additional cross-reference and 
hyperlink would make the Reference Guide more clear to those who use 
it, consistent with Rule 17Ad-22(e)(1).\16\
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    \16\ 17 CFR 240.17Ad-22(e)(1).
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IV. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
that the proposed rule change (SR-LCH SA-2017-003) be, and hereby is, 
approved.\17\
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    \17\ 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).
    \18\ 17 CFR 200.30-3(a)(12).

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-11864 Filed 6-7-17; 8:45 am]
 BILLING CODE 8011-01-P


