[Federal Register Volume 83, Number 146 (Monday, July 30, 2018)]
[Notices]
[Pages 36655-36658]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-16164]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-83690; File No. SR-ICC-2018-004]


Self-Regulatory Organizations; ICE Clear Credit LLC; Order 
Approving Proposed Rule Change Relating To Formalization of the ICC 
Model Validation Framework

July 24, 2018.

I. Introduction

    On May 23, 2018, ICE Clear Credit LLC (``ICC'') 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 to formalize the 
ICC Model Validation Framework. The proposed rule change was published 
in the Federal Register on June 12, 2018.\3\ The Commission has not 
received any comments on the proposed rule 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. 34-83386 (June 6, 2018), 
83 FR 27360 (June 12, 2018) (SR-ICC-2018-004) (``Notice'').
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II. Description of the Proposed Rule Change

    The proposed rule change would formalize the ICC Model Validation 
Framework (``Framework''), which sets forth ICC's model validation 
procedures.\4\ Through the use of these model validation procedures, 
ICC determines the effectiveness of the risk models underpinning ICC's 
risk management system, considers new components and enhancements to 
existing components of the risk models, and monitors and validates on 
an ongoing basis the risk models. The Framework also describes the 
personnel responsible for, and the governance process associated with, 
the successful operation and maintenance of the model validation 
procedures. Specifically, the Framework designates ICC's Risk Oversight 
Officer (``ROO'') as the Framework owner and makes the ROO responsible 
to the ICC President for the successful operation and maintenance of 
the Framework.\5\
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    \4\ Notice, 83 FR at 27361. Capitalized terms used herein but 
not otherwise defined have the meaning set forth in the Framework 
and ICE Clear Europe rulebook, which is available at https://www.theice.com/clear-europe/regulation#rulebook.
    \5\ Notice, 83 FR at 27361.
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    ICC has a proprietary risk management system that uses models to 
assess the risk of the credit default swap-based portfolios that ICC 
clears. ICC uses its risk management system to determine the 
appropriate Initial Margin and Guaranty Fund requirements that offset 
the risks of the credit default swap-based portfolios ICC clears. The 
risk management system is composed of risk model components (``Model 
Components''), which employ a combination of statistical analysis of 
credit spread time series and stress test simulation scenarios to 
address different sources of risk. These sources of risk addressed by 
the Model Components constitute the foundation of total Initial Margin 
and Guaranty Fund requirements for the credit default swap-based 
portfolios that ICC clears.\6\
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    \6\ Id.
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    The Framework considers both new Model Components and enhancements 
to existing Model Components (collectively, ``Model Change''). New 
Model Components consider sources of risk that are not currently 
included in the risk management system.\7\ Enhancements to existing 
Model Components improve upon the methodologies already used by the 
risk management system to consider a given source or sources of 
risk.\8\ The Framework classifies Model Changes as either Materiality A 
or Materiality B, depending on how substantially the Model Change 
affects the risk management system's assessment of risk for the related 
source or sources of risk.\9\ Materiality A Model Changes substantially 
affect the risk management system's assessment of risk for the related 
source or sources of risk. Materiality B Model Changes do not 
substantially affect the risk management system's assessment of risk 
for the related source or sources of risk. The Framework requires that 
the ICC Chief Risk Officer (``CRO'') and the ROO review and determine 
which enhancements to the risk management system qualify as Model 
Changes and classify Model Changes as Materiality A or B.\10\ The 
Framework requires that the ICC Risk Committee review the materiality 
classifications and provide feedback as necessary.\11\ The Framework 
also describes the Model Inventory which is maintained by the ICC Risk 
Department and which contains key information about all Model 
Components and Model Changes.\12\ The Framework requires that the ICC 
ROO review the model

[[Page 36656]]

inventory at least quarterly to ensure that it contains accurate and up 
to date information relating to Model Components and Model Changes.\13\
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    \7\ Id.
    \8\ Notice, 83 FR at 27361.
    \9\ Id.
    \10\ Id.
    \11\ Id.
    \12\ Id.
    \13\ Id.
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    To assure the effectiveness of ICC's risk management system, the 
Framework employs four controls: Initial validation; ongoing monitoring 
and validation; investigation; and independent periodic review.\14\ 
Before going live with any Model Change, the Framework requires an 
initial validation of the conceptual soundness of the methodology and 
the proposed ongoing monitoring and validation approach.\15\ In 
addition, the Framework subjects Materiality A Model Changes to an 
additional independent initial validation.\16\
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    \14\ Notice, 83 FR at 27361.
    \15\ Id.
    \16\ Id.
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    Ongoing monitoring and validation provides assurances that ICC has 
appropriately configured and calibrated the risk management system, 
including any recent Model Change, and that the risk management system 
is achieving the desired level of performance.\17\ Ongoing monitoring 
and validation consists of three areas: Parameter setting, execution 
monitoring, and outcome analysis.\18\ Through execution monitoring ICC 
reviews on a daily basis the changes generated by its risk management 
system and explains them in relation to known changes in cleared 
portfolios, prices, and market conditions.
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    \17\ Id.
    \18\ Id.
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    If ongoing monitoring and validation identifies features of the 
risk management system that might indicate weakness in a Model 
Component, the Framework requires ICC to investigate and identify the 
root cause.\19\ If weakness in a Model Component is discovered during 
investigation, the Framework requires the ICC CRO to inform the ICC 
Risk Committee of the results of the investigation.\20\ ICC must then 
remediate the identified weakness through an appropriate Model Change, 
which passes through the required steps of the Framework starting with 
an Initial validation.\21\
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    \19\ Notice, 83 FR at 27361.
    \20\ Id.
    \21\ Id.
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    The Framework sets forth the process for selecting independent 
validators and describes the independent validator criteria, including 
technical expertise and independence requirements. The Framework 
requires that the ICC CRO provide support and information to allow the 
independent validators to perform periodic reviews of all Model 
Components and related practices at least once in every calendar 
year.\22\ At ICC's choosing, the scope of an independent periodic 
review may cover all Model Components used by the risk management 
system, or a subset of Model Components, as long as all Model 
Components are included in one or more independent periodic reviews 
each year.\23\ The independent periodic review must demonstrate that 
the Model Components remain fit for purpose; that the assumptions 
associated with the Model Components are still valid; that ICC has 
adequately addressed any open items of medium priority \24\ from Model 
Change initial validations and any other implementation conditions; and 
that ICC has been complying with its ongoing monitoring and validation 
requirements and the Model Components are performing without any 
significant weakness.\25\ The ICC CRO must present the periodic review 
to the ICC Risk Committee and describe ICC's plans in relation to any 
open high or medium priority items in the report.\26\
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    \22\ Id.
    \23\ Id.
    \24\ The Framework defines as medium priority those items that 
reflect deficiencies in the Model Components, assumptions, usage, or 
compliance with stated procedures that create risks that ICC can 
mitigate with viable workarounds until it remediates them fully, 
within a reasonable timeframe agreed with the Risk Committee.
    \25\ Notice, 83 FR at 27361.
    \26\ Id.
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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.\27\ For the reasons given below, the Commission finds 
that the proposal is consistent with Section 17A(b)(3)(F) of the Act 
\28\ and Rules 17Ad-22(b)(2), 17Ad-22(b)(3), 17Ad-22(b)(4), and 17Ad-
22(d)(8) thereunder.\29\
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    \27\ 15 U.S.C. 78s(b)(2)(C).
    \28\ 15 U.S.C. 78q-1(b)(3)(F).
    \29\ 17 CFR 240.17Ad-22(b)(2)-(4), (d)(8).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of ICC be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and, to the extent 
applicable, derivative agreements, contracts, and transactions, as well 
as to assure the safeguarding of securities and funds which are in the 
custody or control of ICC or for which it is responsible, and, in 
general, to protect investors and the public interest.\30\
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    \30\ 15 U.S.C. 78q-1(b)(3)(F).
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    As described above, the Framework would provide a process for 
reviewing and enhancing ICC's risk management system. The Framework 
would also designate the personnel responsible for, and the governance 
process associated with, the successful operation and maintenance of 
the model validation procedures and would set forth the process and 
criteria for selecting independent validators.
    Taken together, the Commission believes these aspects of the 
Framework would help ensure that ICC's risk management system 
appropriately and effectively addresses the risks associated with 
clearing security based swap-related portfolios by providing ICC a 
means for reviewing and enhancing the risk management system as needed. 
In providing for independent validators, the Commission believes the 
Framework would help ensure that ICC receives unbiased and objective 
views regarding its risk management system, which would improve such 
review and enhancement. The Commission believes that both of these 
aspects of the Framework would improve the effectiveness of ICC's risk 
management system, thereby improving ICC's ability to manage the risks 
associated with clearing security based swap-related portfolios. Given 
that mismanagement of the risks associated with clearing security based 
swap-related portfolios could cause ICC to realize losses on such 
portfolios and disrupt ICC's ability to promptly and accurately clear 
security based swap transactions, the Commission believes that the 
Framework would promote the prompt and accurate clearance and 
settlement of securities transactions. Similarly, given that 
mismanagement of the risks associated with clearing security based 
swap-related portfolios could cause ICC to realize losses on such 
portfolios and threaten ICC's ability to operate, thereby threatening 
access to securities and funds in ICC's control, the Commission 
believes that the Framework would help assure the safeguarding of 
securities and funds which are in the custody or control of the ICC or 
for which it is responsible. Finally, for both of these reasons, the 
Commission believes the Framework would, in general, protect investors 
and the public interest.
    Therefore, the Commission finds that the proposed rule change would 
promote the prompt and accurate

[[Page 36657]]

clearance and settlement of securities transactions, assure the 
safeguarding of securities and funds in ICC's custody and control, and, 
in general, protect investors and the public interest, consistent with 
the Section 17A(b)(3)(F) of the Act.\31\
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    \31\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(b)(2)

    Rule 17Ad-22(b)(2) requires that ICC 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 and review such margin requirements and the 
related risk-based models and parameters at least monthly.\32\
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    \32\ 17 CFR 240.17Ad-22(b)(2).
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    As described above, the Framework would describe how ICC would 
review and enhance its risk management system, including the selection 
and use of independent validators. In doing so, the Commission believes 
that the Framework would help ensure that ICC's risk management system 
is appropriate and effective for dealing with the risks associated with 
clearing security based swap-related portfolios. The Commission 
believes that the Framework would also enable ICC to improve its margin 
requirements by allowing ICC to review and improve the models that 
generate such margin requirements. The Commission believes that these 
aspects of the Framework would improve ICC's use of margin requirements 
to limit its credit exposures to participants under normal market 
conditions and ICC's use of risk-based models and parameters to set 
margin requirements.
    In addition, the Framework would describe ICC's process for 
execution monitoring, whereby ICC would review on a daily basis the 
changes generated by its risk management system and would explain those 
changes in relation to known changes in cleared portfolios, prices, and 
market conditions. The Framework would require ICC to then investigate 
any anomalies identified. In reviewing such changes and anomalies, the 
Commission believes ICC would review its margin requirements and the 
models that generate such requirements. Thus, the Commission believes 
the Framework would enable ICC to review its margin requirements and 
the models that generate such requirements on a daily basis.
    Therefore, for the above reasons the Commission finds that the 
proposed rule change is consistent with Rule 17Ad-22(b)(2).\33\
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    \33\ 17 CFR 240.17Ad-22(b)(2).
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C. Consistency With Rule 17Ad-22(b)(3)

    Rule 17Ad-22(b)(3) requires that ICC establish, implement, maintain 
and enforce written 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, in its capacity 
as a central counterparty for security-based swaps.\34\
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    \34\ 17 CFR 240.17Ad-22(b)(3).
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    As described above, the Framework would provide a process for 
reviewing and enhancing ICC's risk management system and would set 
forth the process and criteria for selecting independent validators. In 
doing so, the Commission believes that the Framework would help ensure 
that ICC's risk management system appropriately and effectively deals 
with the risks associated with clearing security based swap-related 
portfolios, including the risk associated with the default by the two 
participant families to which ICC has the largest exposures in extreme 
but plausible market conditions. The Commission believes that the 
Framework would also help ICC improve its guaranty fund requirements by 
allowing ICC to review and improve the models that generate such 
requirements. The Commission believes that these aspects of the 
Framework would help ensure that ICC effectively establishes and 
maintains financial resources sufficient to withstand, at a minimum, a 
default by the two participant families to which ICC has the largest 
exposures in extreme but plausible market conditions.
    Therefore, for the above reasons the Commission finds that the 
proposed rule change is consistent with Rule 17Ad-22(b)(3).\35\
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    \35\ 17 CFR 240.17Ad-22(b)(3).
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D. Consistency With Rule 17Ad-22(b)(4)

    Rule 17Ad-22(b)(4) requires that ICC establish, implement, maintain 
and enforce written policies and procedures reasonably designed to 
provide for an annual model validation consisting of evaluating the 
performance of its margin models and the related parameters and 
assumptions associated with such models by a qualified person who is 
free from influence from the persons responsible for the development or 
operation of the models being validated.\36\
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    \36\ 17 CFR 240.17Ad-22(b)(4).
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    As discussed above, the Framework would require the ICC CRO to 
provide support and information to allow independent validators to 
perform periodic reviews of all Model Components and related practices 
at least once in every calendar year. The Framework would further 
provide that the scope of an independent periodic review may cover all 
Model Components used by the risk management system, or a subset of 
Model Components, as long as all Model Components are included in one 
or more independent periodic reviews each year. The Framework would 
also provide the process and criteria (including independence) for 
selecting independent validators. Finally, the Framework would describe 
the required components of an independent review and the documentation 
required to be produced by the independent validators.
    The Commission believes these aspects of the Framework would enable 
ICC to validate the models underpinning its risk management system on 
an annual basis including the related parameters and assumptions 
associated with such models. The Commission also believes that by 
setting out the process and criteria (including independence) for 
selecting independent validators, the Framework would help ensure that 
such validations are performed by qualified persons free from influence 
from the persons responsible for the development or operation of the 
models being validated.
    Therefore, for the reasons described above the Commission finds 
that the proposed rule change is consistent with Rule 17Ad-
22(b)(4).\37\
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    \37\ 17 CFR 240.17Ad-22(b)(4).
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E. Consistency With Rule 17Ad-22(d)(8)

    Rule 17Ad-22(d)(8) requires that ICC establish, implement, maintain 
and enforce written policies and procedures reasonably designed to have 
governance arrangements that are clear and transparent to fulfill the 
public interest requirements in Section 17A of the Act \38\ applicable 
to clearing agencies, to support the objectives of owners and 
participants, and to promote the effectiveness of the clearing agency's 
risk management procedures.\39\
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    \38\ 15 U.S.C. 78q-1.
    \39\ 17 CFR 240.17Ad-22(d)(8).
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    As discussed above, the Framework would describe the personnel 
responsible for, and the governance process associated with, the 
successful operation and maintenance of the model validation 
procedures. Specifically, the Framework would designate ICC's ROO

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as the Framework owner and would make the ROO responsible to the ICC 
President for the successful operation and maintenance of the 
Framework. The Framework would also designate certain responsibilities 
to ICC's CRO and the Risk Committee. The Commission believes that in 
doing so the Framework would allow ICC to establish clear and 
transparent arrangements for governing the Framework and its model 
validation procedures. The Commission further believes that these same 
arrangements would contribute to ICC's fulfilling the public interest 
requirements in Section 17A of the Act \40\ applicable to clearing 
agencies, and the objectives of owners and participants. Finally, the 
Commission believes that these procedures and arrangements would 
promote the effectiveness of ICC's risk management procedures by 
clarifying the process for, and responsibilities associated with, using 
the Framework to improve ICC's risk management system.
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    \40\ 15 U.S.C. 78q-1.
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    Therefore, for the above reasons the Commission finds that the 
proposed rule change is consistent with Rule 17Ad-22(d)(8).\41\
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    \41\ 17 CFR 240.17Ad-22(d)(8).
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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(b)(3)(F) of the Act 
\42\ and Rules 17Ad-22(b)(2), 17Ad-22(b)(3), 17Ad-22(b)(4), and 17Ad-
22(d)(8) thereunder.\43\
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    \42\ 15 U.S.C. 78q-1(b)(3)(F).
    \43\ 17 CFR 240.17Ad-22(b)(2)-(4), (d)(8).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
\44\ that the proposed rule change (SR-ICC-2018-004) be, and hereby is, 
approved.\45\
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    \44\ 15 U.S.C. 78s(b)(2).
    \45\ 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.\46\
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    \46\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-16164 Filed 7-27-18; 8:45 am]
 BILLING CODE 8011-01-P


