
[Federal Register Volume 84, Number 34 (Wednesday, February 20, 2019)]
[Notices]
[Pages 5137-5140]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-02733]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-85128; File No. SR-ICEEU-2018-024]


Self-Regulatory Organizations; ICE Clear Europe Limited; Order 
Approving Proposed Rule Change, as Modified by Amendment No. 1, 
Relating to the ICE Clear Europe Model Risk Governance Framework

February 13, 2019.

I. Introduction

    On November 21, 2018, ICE Clear Europe Limited (``ICE Clear 
Europe'') 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 adopt a Model Risk Governance Framework 
(``MRGF'') and related Independent Validator Selection Guidelines 
(``Guidelines''). On December 21, 2018, ICE Clear Europe filed 
Amendment No. 1 to the proposed rule change.\3\ The proposed rule 
change, as modified by Amendment No. 1, was published for comment in 
the Federal Register on December 31, 2018.\4\ The Commission did not 
receive 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\ The amendment clarified Items 1(a) and 2(a) in the Form 19b-
4 but did not change any other items in Form 19b-4, any exhibits to 
the filing, or the text of the proposed rule change.
    \4\ Securities Exchange Act Release No. 84933 (Dec. 21, 2018), 
83 FR 67810 (Dec. 31, 2018) (SR-ICEEU-2018-024) (``Notice'').
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II. Description of the Proposed Rule Change

    The proposed rule change would adopt a new MRGF and related 
Guidelines. The MRGF would establish overall standards and principles 
for managing and mitigating model risk for all product categories that 
ICE Clear Europe clears.\5\ Specifically, the MRGF would (1) establish 
a definition of model and model risk; (2) establish and define criteria 
for assessing the materiality and significance of models and model 
changes; (3) establish procedures for oversight and validation of 
models and model changes; and (4) establish related governance 
structures. The MRGF would apply to models developed internally, third-
party models, and models shared with other group entities (but not to 
models in research and development or that are already retired), and 
would apply throughout the life cycle of all such models used by the 
Clearing House. In addition, the Guidelines would establish standards 
for the independence and competence of the persons that validate models 
pursuant to the MRGF.
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    \5\ Capitalized terms not otherwise defined herein have the 
meaning given to them in the MRGF or the ICE Clear Europe rulebook.
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A. Definition of Model and Model Changes

    The MRGF would define a ``model'' as a quantitative method, system 
or approach that applies statistical, economic, financial or 
mathematical theories, techniques and assumptions to process input data 
into quantitative estimates.\6\ The MRGF would also define ``model 
risk'' as the risk that a model does not perform as it was designed, 
either due to error or failure in the model specification or 
inappropriate use.\7\
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    \6\ Notice, 84 FR at 67811.
    \7\ Notice, 84 FR at 67811.
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    The MRGF would assess the materiality of models based on the 
potential impact the related model risk may have on ICE Clear Europe 
and its clearing members. In particular, the MRGF would treat a model 
as material where the output of the model is the primary factor 
affecting risk management decisions relating to counterparty and 
liquidity risk.\8\ The MRGF may also treat a model as material if it 
has a high error potential with sizeable impact resulting from: (1) 
Complexities in the data model and inputs (like complex manipulation of 
input data); (2) the modelling approach (such as reliance on a large 
number of assumptions); (3) the model output (such as a large number of 
other models dependent on the output); or (4) model users and 
operations (such as a large number of independent systems that use the 
model).\9\
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    \8\ Notice, 84 FR at 67811.
    \9\ Notice, 84 FR at 67811, n.5.
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    With respect to model changes, the MRGF would categorize changes as 
significant and not significant. In determining whether a model change 
is significant, the MRGF would consider the size of resulting changes 
in risk requirements calculated by the model, alterations in the scope 
of model use and the risk profile of products covered, and the 
development of new model features.\10\
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    \10\ Notice, 84 FR at 67811.

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[[Page 5138]]

B. Oversight and Validation of Models and Model Changes

    The MRGF would set out a general oversight process for models 
throughout their life cycle, including development of new models, model 
changes, review of existing models, and model retirements. For new 
models, the MRGF would require that they be subject to validation 
before being approved and introduced into use.\11\ For model changes, 
the MRGF would require that significant changes be validated before 
being approved using the same process as for new models.\12\ The MRGF 
would validate model changes that are not significant in accordance 
with ICE Clear Europe's periodic re-validation pipeline, as discussed 
below.\13\
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    \11\ Notice, 84 FR at 67811.
    \12\ Notice, 84 FR at 67811.
    \13\ Notice, 84 FR at 67811.
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    The MRGF would re-validate and assess the performance of models to 
determine whether they continue to be fit for use. The Risk Oversight 
Department (``ROD'') would establish a validation pipeline, meaning a 
periodic cycle for re-validation of existing models.\14\ The ROD would 
establish the frequency of re-validation based on applicable regulatory 
requirements, which may be annually where required or more frequently 
as needed.\15\ Similarly, the MRGF would require that performance 
assessments be conducted on a periodic basis at least annually, in 
accordance with applicable regulatory requirements.\16\
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    \14\ Notice, 84 FR at 67811.
    \15\ Notice, 84 FR at 67811.
    \16\ Notice, 84 FR at 67811.
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    The MRGF would make the ROD responsible for conducting the 
independent validation (if done internally) at the appropriate 
frequency and coordinating an external independent validation when 
appropriate.\17\ The Guidelines would establish both technical 
expertise and independence requirements for model validations.\18\ The 
Guidelines would provide that the Clearing House may engage an external 
independent model validator when (1) there are insufficient internal 
resources to meet both the technical expertise and independence 
requirements for the model undergoing independent validation; (2) 
internal resources do not have the operational capacity to perform the 
validation within the required timeframe; or (3) otherwise at the 
discretion of the ROD.\19\
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    \17\ Notice, 84 FR at 67811.
    \18\ Notice, 84 FR at 67811.
    \19\ Notice, 84 FR at 67811.
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    Under the MRGF and the Guidelines, ICE Clear Europe's Model 
Oversight Committee (``MOC'') would be required to review and approve 
the use of external independent model validators.\20\ The ROD would 
maintain a list of external validators approved by the MOC.\21\ The 
Guidelines would provide that the MOC may decide, for models deemed 
complex and material, to perform a competitive selection process for 
external independent validators. Similarly, the ROD may, with the 
consent of the MOC, split components of the independent model 
validation scope across one or more external independent validators.
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    \20\ Notice, 84 FR at 67812.
    \21\ Notice, 84 FR at 67812.
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    The MRGF would also provide a process for model retirements and 
deactivations (retirement would permanently discontinue a model while 
deactivation would be a temporary discontinuation).\22\ Prior to 
retiring or deactivating a model, the MRGF would require an impact 
assessment of the risks and consequences of such retirement or 
deactivation.
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    \22\ Notice, 84 FR at 67811.
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C. Governance

    The MRGF would establish the roles of the MOC and ICEEU Board in 
controlling overall model risk, including reviewing and approving 
models and changes. Under the MRGF, the MOC would be responsible for 
model risk governance at an executive level and for advising the Board 
on material model risk.\23\ Under the MRGF, the MOC also would be 
responsible for approving new models, model changes, retirement of 
models, the periodic validation cycle, remediation actions, external 
validators, and reviewing model performance assessments.\24\ The MRGF 
would assign the ICE Clear Europe Board ultimate responsibility for 
model risk governance, approving material new models and significant 
model changes for material models, reviewing the actions of the MOC, 
reviewing performance of material models outside of acceptable levels 
for model risk, and reviewing impact assessments for the retirement of 
material models.\25\
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    \23\ Notice, 84 FR at 67811.
    \24\ Notice, 84 FR at 67811.
    \25\ Notice, 84 FR at 67811.
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    The MRGF would further apply a three-tiered approach to the 
development and validation of models and changes. Specifically, the 
MRGF would: (1) Designate the owner of the models as the First Line; 
(2) designate the ROD as the Second Line; and (3) designate the 
Internal Audit Department as the Third Line. The First Line (owners of 
the models) would be responsible for ensuring that models are properly 
developed, implemented and used, establishing a model inventory, 
proposing new models, proposing model changes, proposing model 
retirements, conducting performance and impact assessments, and 
proposing and implementing remediation actions as needed. The Second 
Line (ROD) would be responsible for performing or overseeing 
independent validations, reviewing and performing performance 
assessments, establishing risk appetite metrics for model performance, 
establishing guidelines for validations and external validators, and 
reporting results of validations and assessments. The Third Line 
(Internal Audit Department) would be responsible for assessing the 
overall effectiveness of the MRGF and related governance policies and 
assessing independent validation work.\26\
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    \26\ Notice, 84 FR at 67811.
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III. 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 proposed rule change is consistent with Section 17A(b)(3)(F) 
of the Act \28\ and Rules 17Ad-22(e)(2)(i) and (v), (e)(3), 
(e)(4)(vii), (e)(6)(vii), and (e)(7)(vii) 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(e)(2)(i) and (v), (e)(3), (e)(4)(vii), 
(e)(6)(vii), and (e)(7)(vii).
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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 ICE Clear Europe 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 discussed above, the proposed rule change would adopt the MRGF 
and Guidelines. The MRGF would establish overall standards and 
principles for managing and mitigating model risk for all product 
categories that ICE Clear Europe clears. The MRGF would do so

[[Page 5139]]

by establishing processes for the oversight and validation of models 
and changes to models and defining related governance responsibilities. 
Finally, the Guidelines would help ensure the independence and 
competence of validations by establishing standards for model 
validators regarding independence and technical proficiency.
    The Commission believes that these changes, taken as a whole, would 
help ICE Clear Europe establish and maintain effective and functioning 
models. For example, in requiring the validation of new models and 
significant model changes, the Commission believes that the MRGF would 
help ICE Clear Europe to identify and remediate possible errors in 
models and changes thereto before such models or changes are put into 
effect. Doing so may help ICE Clear Europe avoid the potential harm 
that could result from models that do not function properly, such as 
margin requirements that are not effective at mitigating risk. 
Similarly, the Commission believes that the Guidelines, in establishing 
standards for independence and technical proficiency of validators, 
would help ensure that validations are completed objectively and 
competently. Because biased or ineffective validations could miss 
potential errors in models and model changes, the Commission believes 
that the Guidelines may also help ICE Clear Europe avoid the potential 
harm that could result from models that do not function properly.
    Given that ICE Clear Europe uses its models, such as its margin 
models, to manage and mitigate ICE Clear Europe's credit exposures to 
its Clearing Members and the risks associated with clearing security 
based swap-related portfolios, the Commission believes that the 
proposed rule change would enhance ICE Clear Europe's ability to avoid 
losses that could result from the mismanagement of such credit 
exposures and risks. Because such losses could disrupt ICE Clear 
Europe's ability to promptly and accurately clear security based swap 
transactions, by adopting the MRGF and the Guidelines, the Commission 
believes that the proposed rule change would enhance ICE Clear Europe's 
ability to promote the prompt and accurate clearance and settlement of 
securities transactions.
    Similarly, appropriate management of ICE Clear Europe's credit 
exposures to its Clearing Members and the risks associated with 
clearing security based swap-related portfolios is critical to avoiding 
the realization of losses on such portfolios that could threaten ICE 
Clear Europe's ability to operate, thereby threatening access to 
securities and funds in ICE Clear Europe's control. Because the 
proposed rule change would improve the processes to review and maintain 
the models that ICE Clear Europe uses to manage and mitigate such 
exposures, the Commission believes that the proposed rule change would 
help assure the safeguarding of securities and funds which are in the 
custody or control of ICE Clear Europe or for which it is responsible. 
Finally, for both of these reasons, the Commission believes the 
proposed rule change is consistent with protecting investors and the 
public interest.
    Therefore, the Commission finds that the proposed rule change would 
promote the prompt and accurate clearance and settlement of securities 
transactions, assure the safeguarding of securities and funds in ICE 
Clear Europe'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 Rules 17Ad-22(e)(2)(i) and (v)

    Rules 17Ad-22(e)(2)(i) and (v) require that ICE Clear Europe 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to provide for governance arrangements 
that are clear and transparent and specify clear and direct lines of 
responsibility.\32\
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    \32\ 17 CFR 240.17Ad-22(e)(2)(i) and (v).
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    As discussed above, the MRGF would define the responsibilities of 
the MOC and ICEEU Board in model review and approval. For example, 
under the MRGF, the MOC would be responsible for approving new models, 
model changes, and retirement of models, while the Board ultimately 
would be responsible for model risk governance, and approving material 
new models and significant model changes for material models, among 
other things. In doing so, the Commission believes that the MRGF would 
clearly and transparently define who is responsible for which aspect of 
oversight of the MRGF (i.e., the MOC or the Board) and specify the 
responsibilities of the MOC and the Board under the MRGF.
    Moreover, the proposed rule change would establish the 
responsibilities of the first line model owners, ROD, and ICE Clear 
Europe Internal Audit Department in performing certain functions under, 
and assessing the effectiveness of, the MRGF. For example, the MRGF 
would make the First Line responsible for developing models, the ROD, 
as the Second Line, responsible for validating models, and the Internal 
Audit Department, as the Third Line, responsible for assessing the 
effectiveness of the MRGF and validations. In doing so, the Commission 
believes the proposed rule change would improve the transparency of the 
governance related to the MRGF by defining the relevant 
responsibilities for the development and validation of models and the 
review of the overall effectiveness of the MRGF. The Commission 
believes these aspects of the MRGF would also clearly define the 
responsibilities of the first line model owners, ROD, and ICE Clear 
Europe Internal Audit Department with respect to the MRGF.
    Therefore, for the above reasons the Commission finds that the 
proposed rule change is consistent with Rules 17Ad-22(e)(2)(i) and 
(v).\33\
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    \33\ 17 CFR 240.17Ad-22(e)(2)(i) and (v).
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C. Consistency With Rule 17Ad-22(e)(3)

    Rule 17Ad-22(e)(3) requires that ICE Clear Europe establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to maintain a sound risk management framework for 
comprehensively managing legal, credit, liquidity, operational, general 
business, investment, custody, and other risks that arise in or are 
borne by ICE Clear Europe which includes risk management policies, 
procedures, and systems designed to identify, measure, monitor, and 
manage the range of risks that arise in or are borne by ICE Clear 
Europe, that are subject to review on a specified periodic basis and 
approved by the board of directors annually.\34\
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    \34\ 17 CFR 240.17Ad-22(e)(3).
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    As discussed above, the MRGF would require the review and 
validation of new models, existing models, and model changes, which the 
Commission believes would identify and remediate possible errors in 
models and changes thereto before such models or changes are put into 
effect. In this way, the Commission believes the MRGF would help reduce 
model risk at ICE Clear Europe. Moreover, the Commission believes the 
Guidelines would help ensure the objectivity and competence of 
validations by establishing standards for model validators regarding 
independence and technical proficiency. The Commission believes that 
competent and objective validations would, in turn, help to reduce 
model risk. Finally, the Commission believes that the governance 
aspects of the MRGF discussed above would help ensure that the MRGF and 
its processes are effectively reviewed and

[[Page 5140]]

maintained. Thus, the Commission believes that the proposed rule change 
would enable ICE Clear Europe to maintain a sound risk management 
framework for comprehensively managing its model risk.
    Therefore, the Commission finds that the proposed rule change is 
consistent with Rule 17Ad-22(e)(3).\35\
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    \35\ 17 CFR 240.17Ad-22(e)(3).
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D. Consistency With Rules 17Ad-22(e)(4)(vii), (e)(6)(vii), and 
(e)(7)(vii)

    Rule 17Ad-22(e)(4)(vii) requires that ICE Clear Europe establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to effectively identify, measure, monitor, and 
manage its credit exposures to participants and those arising from its 
payment, clearing, and settlement processes, including by performing a 
model validation for its credit risk models not less than annually or 
more frequently as may be required by its risk management 
framework.\36\ Rule 17Ad-22(e)(6)(vii) requires that ICE Clear Europe 
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, among 
other things, requires a model validation for its margin system and 
related models to be performed not less than annually, or more 
frequently as may be contemplated by its risk management framework.\37\ 
Rule 17Ad-22(e)(7)(vii) requires that ICE Clear Europe establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to effectively measure, monitor, and manage the 
liquidity risk that arises in or is borne by ICE Clear Europe, 
including measuring, monitoring, and managing its settlement and 
funding flows on an ongoing and timely basis, and its use of intraday 
liquidity by, among other things, performing a model validation of its 
liquidity risk models not less than annually or more frequently as may 
be contemplated by its risk management framework.\38\
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    \36\ 17 CFR 240.17Ad-22(e)(4)(vii).
    \37\ 17 CFR 240.17Ad-22(e)(6)(vii).
    \38\ 17 CFR 240.17Ad-22(e)(7)(vii).
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    As discussed above, the MRGF would specify the frequency of model 
validations. Specifically, the MRGF would provide that model 
validations shall comply with applicable regulatory requirements, in 
particular in regards to annual validation cycles, and that model 
performance assessments shall also be conducted on a periodic basis, 
with cycles no greater than one year.
    The Commission believes that these aspects of the MRGF would help 
ensure that ICE Clear Europe complies with the aspects of Rules 17Ad-
22(e)(4)(vii), (e)(6)(vii), and (e)(7)(vii) \39\ that require annual 
model validations by providing that the frequency of model validations 
shall comply with applicable regulatory requirements, in particular in 
regards to annual validation cycles, and that model performance 
assessments shall also be conducted on cycles no greater than one year.
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    \39\ 17 CFR 240.17Ad-22(e)(4)(vii), (e)(6)(vii), and 
(e)(7)(vii).
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    Therefore, the Commission finds that the proposed rule change is 
consistent with Rules 17Ad-22(e)(4)(vii), (e)(6)(vii), and 
(e)(7)(vii).\40\
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    \40\ 17 CFR 240.17Ad-22(e)(4)(vii), (e)(6)(vii), and 
(e)(7)(vii).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act, 
and in particular, with the requirements of Section 17A(b)(3)(F) of the 
Act \41\ and Rules 17Ad-22(e)(2)(i) and (v), (e)(3), (e)(4)(vii), 
(e)(6)(vii), and (e)(7)(vii) thereunder.\42\
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    \41\ 15 U.S.C. 78q-1(b)(3)(F).
    \42\ 17 CFR 240.17Ad-22(e)(2)(i) and (v), (e)(3), (e)(4)(vii), 
(e)(6)(vii), and (e)(7)(vii).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
\43\ that the proposed rule change, as modified by Amendment No. 1 (SR-
ICEEU-2018-024), be, and hereby is, approved.\44\
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    \43\ 15 U.S.C. 78s(b)(2).
    \44\ 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.\45\
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    \45\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-02733 Filed 2-19-19; 8:45 am]
 BILLING CODE 8011-01-P


