
[Federal Register Volume 82, Number 128 (Thursday, July 6, 2017)]
[Notices]
[Pages 31364-31366]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-14239]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81056; File No. SR-LCH SA-2017-005]


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

June 30, 2017.

I. Introduction

    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''), 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-2017-005) to amend LCH 
SA's CDS Margin Framework and CDSClear Default Fund Methodology in 
order to permit LCH SA to clear CDS contracts on the CDX.NA.HY index. 
On May 5, 2017, LCH SA filed Amendment No. 1.\3\ The proposed rule 
change was published in the Federal Register on May 17, 2017.\4\ 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\ LCH SA filed Amendment No. 1 to replace the initial filing 
in its entirety in order to clarify certain changes to the CDSClear 
Margin Framework.
    \4\ Securities Exchange Act Release No. 34-80666 (May 11, 2017), 
82 FR 22699 (May 17, 2017) (SR-LCH SA-2017-005) (``Notice'').
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II. Description of the Proposed Rule Change

    LCH SA has proposed various changes to its CDS Margin Framework and 
CDSClear Default Fund Methodology for the purpose of permitting LCH SA 
to clear CDS contracts on the CDX.NA.HY index.

A. Changes to CDS Margin Framework

    With respect to the CDS Margin Framework, LCH SA proposed to amend 
the short charge component of its margin methodology to provide a 
description of the purpose of the short charge, noting that it is 
intended to account for 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, as well as to adjust the 
method for calculating the short charge to account for CDX.NA.HY index 
contracts. Under its current CDS Margin Framework, LCH SA calculates 
the short charge component by taking the larger of (1) a ``Global Short 
Charge,'' derived from the Clearing Member's top net short exposure 
with respect to any CDS contract and its top net short exposure among 
the three ``riskiest'' reference entities (of any type), i.e. those 
that are most likely to default, in the Clearing Member's portfolio, 
and (2) the top two net short exposures with respect to CDS contracts 
on senior financial entities.\5\ LCH SA believes that high yield 
entities are risker than senior financial entities, and as a result it 
proposed to introduce a ``High Yield Short Charge'' that would replace 
the top two net short exposures to CDS on senior financial entities in 
its approach to calculating the short charge.\6\ Consequently, the 
short charge under the proposed rule change would be the greater of (1) 
the ``Global Short Charge,'' as described above, and (2) a ``High Yield 
Short Charge,'' calculated from a member's top net short exposure (with 
respect to high yield CDS) and its top two net short exposures among 
the three ``riskiest'' reference entities in the high yield category in 
the Clearing Member's portfolio.\7\
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    \5\ Notice, 82 FR at 22700.
    \6\ Id.
    \7\ Id.
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    LCH SA also proposed to make certain conforming changes throughout 
Section 4.1.1 of the CDS Margin Framework, which describes the ``net 
short exposure'' calculation, to refer to CDX.NA.HY contracts, as well 
as to clarify that in order to calculate margin in Euros, all US dollar 
denominated variables are converted to Euros utilizing the current USD/
Euro foreign exchange rate and calibrated haircut based upon historical 
data. Furthermore, LCH SA proposed conforming changes to 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 (of any type) 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. LCH SA also proposed 
clarifying changes to Section 4.1.4 of the CDS Margin Framework to 
summarize the calculation for the short charge amount.\8\
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    \8\ Id.
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    LCH SA proposed to amend the CDS Margin Framework by deleting 
Section 4.3 in its entirety because the substance of that section would 
be contained in other sections of the CDS Margin Framework as a result 
of the proposed changes described above.\9\
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    \9\ Id.
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    In addition, LCH SA also proposed to amend Section 5.1 of the CDS 
Margin Framework, which sets forth the wrong way risk (``WWR'') 
component of LCH SA's margin methodology. According to LCH SA, the 
current approach leverages the short charge framework by calculating 
the top two net short exposures of financial entities in a Clearing 
Member's portfolio following the calculation described above for the 
short charge margin. LCH SA then compares these top two net short 
exposures of financial entities to the Global Short Charge and imposes 
the

[[Page 31365]]

greater of those two as the short charge, which addresses the WWR 
arising from the correlation between a Clearing Member default and the 
default(s) of the top two financial entities in the Clearing Member's 
portfolio.\10\ The proposed rule change amends Section 5.1 of the CDS 
Margin Framework to make the WWR component more explicit, such that, 
when the top two net short exposures in respect of financial entities 
exceeds the short charge margin, as amended to equal the greater of the 
Global Short Charge and the High Yield Short Charge, LCH SA will charge 
the incremental amount that is attributable to the top two financial 
entities as part of the WWR Margin.\11\
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    \10\ Id.
    \11\ Id.
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    LCH SA further proposed to amend a heading in Section 3 and a table 
in Section 3.1.1 to clarify that the summary of the margin framework 
also applies to CDX HY contracts. Additional conforming changes in the 
CDS Margin Framework were proposed with respect to Sections 5, 6, 8, 
10, and 11 of the CDS Margin Framework to clarify that the those 
sections also apply to high yield indices.\12\
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    \12\ Id.
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B. Changes to CDSClear Default Fund Methodology

    LCH SA also proposed changes to its CDSClear Default Fund 
Methodology. Specifically, LCH SA proposed to amend Section 2.3 of the 
CDSClear Default Fund Methodology to modify the existing stressed short 
charge. Under its current approach, LCH SA calculates a stressed short 
charge, which equals the greater of (1) the top net short exposure plus 
the top two net short exposures among the three entities most likely to 
default in the Clearing Member's portfolio, and (2) the top two net 
short exposures which are senior financial entities plus the top net 
short exposures among the three riskiest senior financial entities in 
the Clearing Member's portfolio. Under the proposed rule change, LCH SA 
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 (1) and (2) as described above in this paragraph, or (3) 
the top two net short exposures which are high yield entities plus the 
top two net short exposures among the three high yield entities most 
likely to default in the Clearing Member's portfolio.\13\
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    \13\ Id.
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    Finally, LCH SA also proposed to amend Section 3.8 of the CDSClear 
Default Fund Methodology, which describes the correlation between index 
families and series, to reflect that additional data will be used.\14\
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    \14\ Id.
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III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \15\ directs the Commission to 
approve a proposed rule of a self-regulatory organization if the 
Commission 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 \16\ 
requires, in relevant part, that the rules of a registered clearing 
agency be designed to promote the prompt and accurate clearance and 
settlement of securities transactions and, to the extent applicable, 
derivative agreements, contracts, and transactions. Rule 17Ad-22(b)(2) 
\17\ requires, in relevant part, a registered clearing agency that 
performs central counterparty services to 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 and use risk-based models 
and parameters to set margin requirements. Rule 17Ad-22(b)(3) \18\ 
requires, in relevant part, a registered clearing agency that performs 
central counterparty services to establish, implement, maintain and 
enforce written policies and procedures reasonably designed to maintain 
additional financial resources sufficient 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 where such 
registered clearing agency acts as a central counterparty for security-
based swaps. Rule 17Ad-22(e)(4)(i) and (ii) \19\ require a covered 
clearing agency to establish, implement, maintain and enforce written 
policies and procedures reasonably designed to maintain sufficient 
financial resources to cover its credit exposure to each participant 
fully with a high degree of confidence, and for a covered clearing 
agency involved in activities with a more complex risk profile,\20\ 
maintaining additional financial resources at the minimum to enable it 
to cover a wide range of foreseeable stress scenarios that include, but 
are not limited to, the default of the two participant families that 
would potentially cause the largest aggregate credit exposure for the 
covered clearing agency in extreme but plausible market conditions. 
Finally, Rule 17Ad-22(e)(6)(i) \21\ requires a covered clearing agency 
that provides central counterparty services to 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 considers, 
and produces margin levels commensurate with, the risks and particular 
attributes of each relevant product, portfolio and market.
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    \15\ 15 U.S.C. 78s(b)(2)(C).
    \16\ 15 U.S.C. 78q-1(b)(3)(F).
    \17\ 17 CFR 240.17Ad-22(b)(2).
    \18\ 17 CFR 240.17Ad-22(b)(3).
    \19\ 17 CFR 240.17Ad-22(e)(4)(i) and (ii).
    \20\ Rule 17Ad-22(a)(4)(i) defines a covered clearing agency 
involved in activities with a more complex risk profile as a 
clearing agency registered with the Commission under Section 17A of 
the Act that provides central counterparty services for security-
based swaps. See 17 CFR 240.17Ad-22(a)(4)(i).
    \21\ 17 CFR 240.17Ad-22(e)(6)(i).
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    The Commission finds that the proposed rule change, which amends 
LCH SA's CDS Margin Framework and CDSClear Default Fund Methodology to 
permit LCH SA to clear CDS contracts on the CDX.NA.HY index, is 
consistent with Section 17A of the Act and the applicable provisions of 
Rule 17Ad-22 thereunder. By amending its CDS Margin Framework, LCH SA 
amends the approach to its short charge component of its margin 
methodology to consider the specific risks associated with, and 
incorporate parameters addressing the risks, associated with clearing 
contracts on the CDX.NA.HY index, and as a result, LCH SA will be able 
to calculate margin requirements to cover its exposures associated with 
clearing contracts on the CDX.NA.HY index. Therefore, the Commission 
finds that the proposed rule changes are consistent with Rule 17Ad-
22(b)(2), 17Ad-22(e)(4)(i), and 17Ad-22(e)(6)(i).
    Additionally, by amending its CDSClear Default Fund Methodology to 
change the manner in which it calculates its short charge to consider 
the risks introduced by clearing contracts on the CDX.NA.HY index, the 
Commission believes that LCH SA will be able to more appropriately 
calculate and maintain the financial resources necessary to cover the 
default of by the two participant families to which it has the largest 
exposures in extreme but plausible market conditions. Therefore, the 
Commission finds that the proposed rule change is consistent with the 
requirements of Rule 17Ad-22(b)(3) and Rule 17Ad-22(e)(4)(ii).
    Because the proposed rule change amends LCH SA's CDS Margin 
Framework and CDSClear Default Fund Methodology in such a manner as to

[[Page 31366]]

allow LCH SA to more appropriately take into consideration the risks 
associated with clearing contracts on the CDX.NA.HY index, and to 
collect margin and other financial resources that reflect such risks, 
the Commission believes that the proposed changes are designed to 
promote the prompt and accurate clearance and settlement of such 
contracts. As a result, the Commission finds that the proposed rule 
changes are consistent with Section 17A(b)(3)(F) of the Act.

IV. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
that the proposed rule change (SR-LCH SA-2017-005), as amended by 
Amendment No. 1, be, and hereby is, approved.\22\
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    \22\ 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).

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\23\
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    \23\ 17 CFR 200.30-3(a)(12).
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Brent J. Fields,
Secretary.
[FR Doc. 2017-14239 Filed 7-5-17; 8:45 am]
BILLING CODE 8011-01-P


