[Federal Register Volume 84, Number 154 (Friday, August 9, 2019)]
[Notices]
[Pages 39386-39391]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-17108]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-86576; File No. SR-LCH SA-2019-005]


Self-Regulatory Organizations; LCH SA; Notice of Filing of 
Proposed Rule Change Relating to Introduction of Clearing of the New 
Markit iTraxx Subordinated Financials Index CDS and the Related Single 
Name CDS Constituents and Enhancements to Wrong Way Risk Margin

August 6, 2019.
    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 August 2, 2019, 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. 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.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    Banque Centrale de Compensation, which conducts business under the 
name LCH SA (``LCH SA''), is proposing to amend its (i) Reference 
Guide: CDSClear Margin Framework and (ii) CDSClear Default Fund 
Methodology (together the ``CDSClear Risk Methodology'') and (iii) CDS 
Clearing Supplement (``Supplement'') and (iv) CDS Clearing Procedures 
(``Procedures'') to incorporate new terms and to make conforming, 
clarifying and changes [sic] to allow clearing of the new Markit iTraxx 
Subordinated Financials Index CDS and the related single name CDS 
constituents.
    LCH SA is also amending its CDSClear Margin Framework to 
incorporate changes to the Wrong Way Risk margin in order to address 
some recommendations in respect of the risk model validation.
    The text of the proposed rule change has been annexed as Exhibit 
5.\3\
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    \3\ All capitalized terms not defined herein have the same 
definition as the Rule Book, Supplement or Procedures, as 
applicable.
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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, 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
    LCH SA is proposing to introduce clearing of the Markit iTraxx 
Subordinated Financials Index CDS and the related single name CDS 
constituents (``SubFins'') which is the natural next step following the 
recent changes in financial entities' issuance patterns that are being 
rolled out in the wider industry.
    In August 2016, IHSMarkit initiated the Markit iTraxx Europe rule 
review which prescribes how bank entities are included in the Markit 
iTraxx Europe Indices. At the time, the iTraxx Europe Index Advisory 
Committee identified that three differing regulatory approaches to 
TLAC/MREL regulations (Total Loss Absorbing Capacity/Minimum 
Requirements and Eligible Liabilities) eligible debt were driving new 
bank debt issuance patterns:

 Structural Subordination
[cir] Operating Company versus Holding Company (referred to as 
OpCoHoldCo)
 Contractual Subordination
[cir] Senior Non-Preferred Tier 3 Bonds, adopted by Danish, French and 
Spanish banks, (Seniority tier is SNRLAC: Senior Loss Absorbing 
Capacity)
 Statutory Subordination
[cir] All senior unsecured debt made eligible, adopted by German banks

    Structural subordination was introduced in September 2017 and 
Contractual subordination in March 2018.
    As a result of these different approaches, LCH SA now manages 
different levels of debt seniorities in its product scope and risk 
framework.
    The proposed change will naturally extend the product scope 
eligible for clearing by completing the set of seniority with 
subordinated debt for financial entities.
    For the purpose of introducing clearing of SubFins, LCH SA proposes 
to modify its CDS Clearing Supplement and Procedures to include the 
relevant language to allow the clearing of the SubFins.
    LCH SA is also taking this opportunity to introduce a few changes 
to the Wrong Way Risk (``WWR'') margin in order to address some of the 
open model validation recommendations meant to improve the stability of 
the WWR margin and to include positions on the iTraxx Main index in the 
scope of products subject to the WWR margin.
    Finally, a clarification to the Default Fund Additional Margin 
(``DFAM''), independent from the SubFins initiative, is also added to 
the CDSClear Default Fund Methodology to reflect an adjustment 
requested by LCH SA's Risk Department for any clearing service in order 
to cap the DFAM to the Stress Test Loss Over Additional Margin 
(``STLOAM'').
(1) CDSClear Risk Methodology
    The introduction of CDS with subordinated debt as an underlier is 
akin to introducing Senior Non Preferred debt, therefore the same 
margins need to be adapted, namely spread margin, wrong way risk, 
liquidity charge and jump-to-default risk margins (Short Charge and 
Self-Referencing Margin).
    The Senior Non Preferred CDS differ from Subordinated financial CDS 
with respect to the availability of the historical market data and the 
recovery rate which for Subordinated debt is conventionally 20% (versus 
40% for Senior debt).
    The spread margin will use the historical data available for 
SubFins, and consider Subordinated and Senior debt as different 
financial instruments with regards to portfolio margining.\4\
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    \4\ See Article 27 of Commission Delegated Regulation (EU) No 
153/2013).
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    Similarly, the WWR margin is extended to cover SubFins in addition 
to Senior CDS, as if they were different names from an offset 
perspective, and with shocks defined specifically for SubFins 
calibrated from the historical data available.
    The Liquidity Charge will consider Markit iTraxx Subordinated 
Financials index to be a new hedging instrument,

[[Page 39387]]

thus extending the existing framework. Then, similarly to the change 
introduced for Senior Non Preferred CDS, Senior and Subordinated 
financial CDS will be considered jointly from a concentration 
perspective. This leads to the need to define a common concentration 
threshold, linearly interpolated between the thresholds that would be 
determined by our existing framework for each seniority.
    The Short Charge margin is modified in two ways:
    (i) The recovery rates used in the calculation of exposures are 
shocked to capture any adverse move, hence increasing the exposure.
    (ii) The number of expected credit events in the 5 days following 
the default of a member has been decreased from 2 to 1, meaning we only 
retain the top exposure and no longer consider one of the riskiest 
entities.
    Considering shocks in the recovery rates is necessary to ensure the 
difference between Senior and Subordinated CDS recovery rates is 
covered. Doing this without modifying the number of defaults would have 
led to overly conservative margins, with jump-to-default risk far 
outweighing the other risks. The second credit event has therefore been 
reclassified to being under the ``extreme market conditions'' category 
as opposed to the ``normal market conditions'' category.
    In addition to moving from covering the default of two entities to 
one a floor to the short charge will be introduced. This floor is 
calculated as the 99.7% quantile of a loss distribution based on a 
single factor model. In other words, having calculated the exposure the 
portfolio has to each underlying reference entity, the probability of 
each combination of defaults is calculated (up to all entities in the 
portfolio defaulting at the same time) to define the maximum amount 
that could be lost with a 99.7% confidence due to default events. The 
greater of this calculated amount and the top exposure with a shifted 
recovery rate will be retained as being the Short Charge margin.
    Consequently, the Stressed Short Charge has been revised with a 
similar calculation for exposures, with a recovery of 10% for senior 
debt and 0% for subordinated debt. The global short charge will now 
consider the top exposure plus the average of the riskiest entities 
(for an improved stability), while the financial short charge will 
consider the top two exposures on financial entities. For CDX.HY names 
specifically, the sum of the top two exposures and the average across 
the ten riskiest entities will be retained. The Stressed Short Charge 
would then be the max across those three components.
    Separately, the model validation recommendations will lead to two 
changes to the WWR margin:
    (i) The calculation will be done as if the WWR margin was 
calculated inside the expected shortfall, leading to (a) the starting 
spread for the WWR P&L reflecting the spread level simulated in the 
scenarios selected as part of the spread margin and (b) the cap on the 
offset formula considering the maximum between the portfolio 
calculation and 20% of the sum of the instrument level calculations 
will now be applied to the sum of the spread margin and WWR margin (as 
opposed to the spread margin alone).
    (ii) The iTraxx Main index will now be included in the WWR margin 
calculation, with a dedicated shock defined, separately from the iTraxx 
Senior Financials and iTraxx Subordinated Financials indices.
    Finally, the DFAM is updated and capped to the STLOAM to ensure 
that the sum of all resources called from a Clearing Member do not 
exceed the stress tested loss measured for that member. LCH SA's risk 
framework demands that the stress risk of a given Clearing Member above 
and beyond a certain threshold (defined as a percentage of the size of 
the default fund and dependent on the internal credit score (ICS) of 
such member) be demutualised gradually through the DFAM.
    On the other hand, as a CCP, LCH SA doesn't require its Clearing 
Members to deposit a total amount of resources for a given clearing 
service higher than their worst stress loss for that service. That is 
why the DFAM needs to be capped at the STLOAM as it is now defined in 
the CDSClear Default Fund Methodology.
(2) CDS Clearing Supplement
    The Supplement will be amended in order to include the relevant 
language to allow the clearing of the new Markit iTraxx Subordinated 
Financials Index CDS and related single name CDS.
    In Part A of the Supplement, only Section 8.1. `Creation of Matched 
Pairs' will be modified to correct inaccurate references to the CCM 
Client account structure in the current version of the Supplement. This 
change is not related to the SubFins initiative.
    In Part B of the Supplement, the various references to 
'Restructuring Credit Event' will be changed to 'M(M)R Restructuring' 
or new references to `M(M)R Restructuring' will be created. Indeed, 
these provisions apply to transactions for which either `Mod R' or `Mod 
Mod R' is applicable. This change is required as clearing SubFins will 
introduce transactions for which Restructuring is an applicable Credit 
Event but where neither `Mod R' nor `Mod Mod R' are applicable. This is 
usually referred to as ``Old R'' (these terms are, for example, 
applicable to transactions under the Standard Subordinated European 
Insurance Corporate Transaction Type).
    Such change will be reflected in Section 1.2. for the term `CEN 
Triggering Period', `Compression Cut-off Date', `DC Restructuring 
Announcement Date', `DTCC Notice Facility', `First Novation Date', 
`NEMO Triggering Period', `Novation Cut-off Date', `Restructuring 
Matched Pair', `Spin-off Single Name Cleared Transaction', and also in 
Section 2.4 `Amendments to 2014 ISDA Credit Derivatives Definitions', 
Section 4.1 ``Determination of Credit Events and Successions Events', 
Section 4.3 `Novation and Compression following Credit Events', Section 
4.4. `Re-couponing of Restructuring Cleared Transactions', Section 5.1. 
`Creation and Notification of Restructuring Matched Pairs', Section 5.2 
`Creation of Restructuring Cleared Transactions', Section 5.3 
`Triggering of Restructuring Cleared Transaction', Section 5.5 
`Reversal of DC Credit Event Announcements', Section 7.4 `Notification 
of DTCC Failure and Resolution', Section 7.6 `Clearing Member 
Communications Failure Event, Section 8.1 `Creation of Matched Pairs', 
Section 9.1 `Occurrence of Clearing Member Self Referencing 
Transaction', Section 9.2 `Occurrence of Client Self Referencing 
Transactions' and Sections 4.4 `Communications Failure Event'; 5 
`Determination of Credit Events and Succession Events' and 8.2 
`Notification of Self Referencing Transactions' of the `Appendix XIII: 
CCM Client Transaction requirements'.
    There is also currently a number of provisions which are stated to 
apply to all Cleared Transactions which reference a Reference Entity. 
Clearing SubFins will introduce transactions which have the same 
underlying Reference Entity, but which have different seniorities (e.g. 
Senior Transactions and Subordinated Transactions) and in certain cases 
different Transactions Types. The treatment of transactions in case of 
credit event or succession event with respect to the relevant Reference 
Entity may vary depending upon these terms, as it is possible for 
certain events only to apply to certain Transaction Types, or only to a 
certain seniority. Therefore, the current references to Reference 
Entity will no longer be sufficiently

[[Page 39388]]

granular. As a result, we will add wording (predominantly in the 
relevant defined terms) which will enable a different treatment 
depending upon the Transaction Type and/or Reference Obligation. It is 
to be noted that the Reference Obligation is used to determine the 
seniority of a transaction.
    Accordingly, in Section 1.2., the term `Affected Cleared 
Transaction' will be amended in order to take into account the case 
where credit events or succession events apply to a Cleared Transaction 
(or, in the case of an Index Cleared Transaction, there [sic] relevant 
portion of such transaction defined as a Component Transaction) based 
on the Reference Entity but also on the applicable Transaction Type 
and/or Reference Obligation.
    In addition, the term `Component Transaction' will be created as it 
is currently mentioned in different Sections of the Supplement. The 
terms `Index Cleared Transaction', `Index CCM Client Transaction', and 
`Spin-off Single Name Cleared Transaction' will be modified 
accordingly.
    The terms `First Novation Date', `Novation Cut-off Date', and 
`Spin-off Single Name Cleared Transaction' will be amended to provide 
for the correct treatment of transactions based on the combination of 
the Reference Entity, Transaction Type and Reference Obligation, and 
not only in respect of a Reference Entity.
    Section 2.3. `Single Name Cleared Transaction Confirmation' will be 
modified in order to take into account the fact that the form of 
confirmation for use with the Physical Settlement Matrix that 
incorporates the 2014 ISDA Credit Derivatives Definitions only requires 
the election with respect to Restructuring to be included for the North 
American Corporate and the Standard North American Corporate 
Transaction Types, and that it be specified as ``Not Applicable''. The 
proposed changes will simplify the wording and also enable the correct 
treatment of new Transaction Types introduced by the clearing of 
SubFins initiative.
    Section 2.5. `Physical Settlement Matrix Updates' will be modified 
to ensure the assessment of fungibility between terms of a Revised 
Matrix and an Existing Matrix is conducted for the relevant combination 
of Reference Entity, Transaction Type and Reference Obligation, and no 
longer only in respect of a Reference Entity.
    In addition, for clarification/consistency purposes, in Section 
1.2. the term ``Relevant Physical Settlement Matrix'' has been added, 
with a reference to Section 4.3 of the Procedures.
    Furthermore, in line with the changes proposed under Part A of the 
Supplement, Section 8.1 `Creation of Matched Pairs' will be modified to 
correct inaccurate references to the CCM Client account structure in 
the current version of the Supplement. This change is not related to 
the SubFins initiative.
    In Part C of the Supplement, the term `M(M)R Restructuring Credit 
Event' will be changed to `M(M)R Restructuring' in order to align with 
the wording mentioned in Part B of the Supplement and with the 2014 
ISDA Credit Derivatives Definitions.
    Accordingly, in Section 1.2 the term `CEN Triggering Period', 
`Compression Cut-off Date', `DC Restructuring Announcement Date', 
`First Novation Date', `NEMO Triggering Period', `Novation Cut-off 
Date', `SRMP Triggerable Amount' and Section `2.3 `Amendments to 2014 
ISDA Credit Derivatives Definitions', Section 4.1 `Determination of 
Credit Events and Succession Events', Section 4.2 `M(M)R Restructuring 
Credit Event Timeline', Section 5.1 `Creation and Notification of 
Swaption Restructuring Matched Pairs', Section 5.3 `Triggering of 
Swaption Restructuring Cleared Transactions, Section 5.8 `Effect of 
Credit Event Notices and Notices to Exercise Movement Option', Section 
5.9 `Reversal of DC Credit Event Announcements', Section 5.11 `Expiry 
of CEN Triggering Period', Section 6.1 `Creation and Notification of 
Exercise Matched Pairs', Section 7.1 `Creation of Index Cleared 
Transactions', Section 7.2 `Creation of Initial Single Name Cleared 
Transactions for Settlement purposes in respect of Credit Events other 
than M(M)R Restructuring', Section 7.3 `Creation of Restructuring 
Cleared Transactions for Triggering and/or Settlement purposes', 
Section 7.4 `Creation of Initial Single Name Cleared Transactions in 
respect of untriggered M(M)R Restructuring Credit Events', Appendix III 
`Form of Credit Event Notice' and Section 8.2 `Creation of 
Restructuring Single Name Transaction' of Appendix VIII `CCM Client 
Transaction Requirements', will be modified.
    Further, as mentioned supra, additional granularity is required to 
provide for appropriate treatment in case of a credit or succession 
event with respect to a Reference Entity, as such treatment will also 
be dependent upon the applicable Transaction Type and seniority. As a 
result, we will add wording (predominantly in the relevant defined 
terms) which will enable a different treatment depending upon the 
Transaction Type and/or seniority of a transaction. Accordingly, 
Section 4.2 `M(M)R Restructuring Credit Event Timeline' will be 
modified in order to take into account the case where a M(M)R 
Restructuring is applicable to a combination of Reference Entity, 
Transaction Type and Reference Obligation, and not only in respect of a 
Reference Entity.
    Furthermore, the term `Component Transaction' will be created for 
consistency purposes, as it is currently mentioned in different 
Sections of the Supplement and will be created in Part B of the 
Supplement. The terms `First Novation Date', `Novation Cut-off Date' 
and Section 4.2 `M(M)R Restructuring Credit Event Timeline, Section 5.1 
`Creation and Notification of Swaption Restructuring Matched Pairs', 
Section 7.2 `Creation of Initial Single Name Cleared Transactions for 
Settlement purposes in respect of Credit Events other than M(M)R 
Restructuring', Section 7.3 `Creation of Restructuring Cleared 
Transactions for Triggering and/or Settlement purposes' and Section 7.4 
`Creation of Initial Single Name Cleared Transactions in respect of 
untriggered M(M)R Restructuring Credit Events' will be modified 
accordingly.
    In addition, the cross-references mentioned in Section 1.2 
`Swaption Clearing Member Notice', `Swaption Clearing Member Notice 
Deadline', Section 5.1 `Creation and Notification of Swaption 
Restructuring Matched Pairs', Section 5.3 `Triggering of Swaption 
Restructuring Cleared Transactions', Section 5.9 (e) `Reversal of DC 
Credit Event Announcements', Section 6.1 `Creation and Notification of 
Exercise Matched Pairs', Section 6.3 `Exercise and Abandonment by way 
of EEP', Section 6.5 `EEP failure and resolution', Section 6.7 
`Termination of Exercise Cleared Transactions', Section 6.8 
`Consequences of no Swaption Clearing Member Notice or Swaption CCM 
Client Notice being received by LCH SA', Section 8.1 `General Rules 
relating to Notices', Section 8.2 `Failure to notify Matched Pairs', 
Section 8.4 `Disputes as to Notices', Section 9.1 `Creation of Matched 
Pairs', Section 9.6 `Clearing Member matched with Itself', Section 12 
`Forms of Notices' and Section 5.4 `Consequences of EEP Failure' and 
5.8 `Confidentiality Waiver' of, Appendix VIII `CCM Client Transaction 
Requirements' will be updated as they are not correct. These 
corrections are not related to the SubFins initiative but are due to an 
error in the cross references system.
    Finally, in line with the proposed changes under Parts A and B of 
the Supplement, Section 9.1 `Creation of Matched Pairs' will be 
modified to correct inaccurate references to the CCM

[[Page 39389]]

Client account structure in the current version of the Supplement. This 
change is not related to the SubFins initiative.
    The amendments to the CDS Clearing Supplement also contain 
typographical amendments and similar technical corrections.
(3) CDS Clearing Procedures
    LCH SA also proposes to modify Section 4 of the Procedures in order 
to take into account the changes to the CDS Clearing Supplement and 
therefore to enable different treatments depending upon the Transaction 
Type and/or seniority of a transaction.
    In Procedure 4.3. `Eligible Reference Entities', a reference to the 
Seniority Level of the Reference Obligation will be added, and the 
wording will also be modified in order to take into account a 
combination of Reference Entity, Transaction Type and Reference 
Obligation.
2. Statutory Basis
    LCH SA believes that the proposed rule change in connection with 
the clearing of SubFins is consistent with the requirements of Section 
17A of the Securities Exchange Act of 1934 \5\ (the ``Act'') and the 
regulations thereunder, including the standards under Rule 17Ad-22.\6\ 
In particular, Section 17(A)(b)(3)(F) \7\ of the Act 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.
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    \5\ 15 U.S.C. 78q-1.
    \6\ 17 CFR 240.17Ad-22.
    \7\ 15 U.S.C. 78q-1(b)(3)(F).
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    As noted above, the proposed rule change is designed:

--To manage the risk arising from the clearing of SubFins indices and 
single name CDS constituents, including collecting and maintaining 
financial resources intended to cover the risks to which LCH SA is 
exposed in connection with offering clearing services for SubFins. As 
such LCH SA will be able to minimize the risk that the losses 
associated with the default of a participant (or participants) in the 
clearing service will extend to other participants in the service.
--To streamline the description of the existing margin framework and 
default fund methodology for CDS to take into account SubFins and 
improve the organization and clarity of the CDSClear Margin Framework 
and Default Fund Methodology. The proposed changes to the Methodology 
guide provide additional clarity regarding LCH SA's risk methodology 
and enhance readability to further ensure that the documentation 
remains up-to-date, clear, and transparent. LCH SA believes that having 
policies and procedures that clearly and accurately document LCH SA's 
risk methodology and practices are an important component to the 
effectiveness of LCH SA's risk management systems, which promotes the 
prompt and accurate clearance and settlement of securities 
transactions, derivatives agreements, contracts and transactions and 
contributes to the safeguarding of securities and funds associated with 
security-based swap transactions in LCH SA's custody or control, or for 
which LCH SA is responsible.
--To address the independent model validation recommendations on the 
WWR margin framework which LCH SA believes will enhance the WWR margin 
model by improving its ability to determine the total amount of margin 
that should be called and therefore collected to mitigate the spread 
risk on financial instruments, including on iTraxx Main indices for 
which circa 24% of the constituents reference Financial single names. 
This in turn would improve LCH SA's ability to manage financial risk 
exposures that may arise in the course of its ongoing clearance and 
settlement activities and thus better allow LCH SA to complete the 
clearance and settlement process in the event of a member default.

    For these reasons, LCH SA believes that the proposed rule change 
should help promote the prompt and accurate clearance and settlement of 
securities transactions, derivatives agreements, contracts and 
transactions. Similarly, it should enhance LCH SA's ability to help 
assure the safeguarding of securities and funds which are in the 
custody or control of LCH SA or for which it is responsible.
    LCH SA believes that the proposed changes to the CDSClear Margin 
Framework and the Default Fund Methodology satisfy the requirements of 
Rule 17Ad-22(e).\8\
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    \8\ 17 CFR 240.17Ad-22(e).
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    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 to use risk-based models and parameters to set 
margin requirements.\9\ Rule 17Ad-22(b)(3) requires each clearing 
agency acting as a central counterparty for security-based swaps to 
maintain sufficient financial resources to withstand, at a minimum, a 
default by the two participant families to which it has the largest 
exposure in extreme but plausible market conditions (the ``cover two 
standard''). Rule 17Ad-22(e)(4) requires a covered clearing agency to 
effectively identify, measure, monitor, and manage its credit exposures 
to participants and those arising from its payment, clearing and 
settlement processes by maintaining sufficient financial resources,\10\ 
and Rule 17Ad-22(e)(6) 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 meets 
certain minimum requirements.\11\
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    \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).
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    As described above, LCH SA proposes to amend its CDSClear 
Methodology Framework to manage the risks associated with clearing 
SubFins. Specifically, the proposed rule change amends the Short Charge 
margin by shocking the recovery rates used in the calculation of the 
jump to default exposure as a function of the seniority of the 
underlying single name as well as by only considering the largest 
exposure and not the largest and the largest amongst the 3 riskiest 
anymore. It also amends the Liquidity Charge margin by setting the 
Markit iTraxx Subordinated Financial Index as an additional hedging 
pillar as well as by commingling exposures on all seniorities of a 
given single name underlying reference to capture concentration risk 
appropriately. Finally, it updates all the other margin components of 
the total initial margin to incorporate SubFins. These changes are 
designed to use a risk-based model to set margin requirements and use 
such margin requirements to limit LCH SA's credit exposures to 
participants in clearing SubFins CDS and/or other CDS and CDS Options 
under normal market conditions, consistent with Rule 17Ad-22(b)(2). LCH 
SA also believes that its risk-based margin methodology takes into 
account, and generates margin levels commensurate with, the risks and 
particular attributes of each of the SubFins and other CDS as well as 
CDS Options at the product and portfolio levels, appropriate to the 
relevant market it serves, consistent with Rule 17Ad-22(e)(6)(i) and 
(v). In addition, LCH SA believes that the margin

[[Page 39390]]

calculation under the revised CDSClear Margin Framework would 
sufficiently account for the 5-day liquidation period for house account 
portfolio and 7-day liquidation period for client portfolio and 
therefore, is reasonably designed to cover LCH SA's potential future 
exposure to participants in the interval between the last margin 
collection and the close out of positions following a participant 
default, consistent with Rule 17Ad-22(e)(6)(iii). LCH SA also believes 
that the current pricing methodology with respect to CDS, based on 
widely accepted ISDA Model with appropriate adjustments for SubFins, as 
supplemented by methodology for circumstances in which pricing data are 
not readily available, would generate reliable data set to enable LCH 
SA to calculate spread margin, consistent with Rule 17Ad-22(e)(6)(iv).
    Further, 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 the cover two standard.\12\ 
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.\13\ LCH SA believes that 
its Default Fund Methodology, with the modifications described herein, 
will appropriately incorporate the risk of clearing SubFins CDS, which, 
together with the proposed changes to the CDSClear Margin Framework, 
will be reasonably designed to 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).\14\
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    \12\ 17 CFR 240.17Ad-22(b)(3).
    \13\ 17 CFR 240.17Ad-22(e)(4)(ii).
    \14\ 17 CFR 240.17Ad-22(b)(3) and (e)(4)(ii).
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    LCH SA also believes that the proposed rule changes are consistent 
with the requirements of Rule 17Ad-22.\15\ Rule 17Ad-22(e)(17) requires 
a covered clearing agency to manage operational risks by (i) 
identifying the plausible sources of operational risk, both internal 
and external, and mitigating their impact through the use of 
appropriate systems, policies, procedures, and controls; (ii) ensuring 
that systems have a high degree of security, resiliency, operational 
reliability, and adequate, scalable capacity; and (iii) establishing 
and maintaining a business continuity plan that addresses events posing 
a significant risk of disrupting operations.\16\
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    \15\ 17 CFR 240.17Ad-22.
    \16\ 17 CFR 240.17Ad-22(e)(17).
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    As described above, the proposed rule change will enable LCH SA to 
extend its CDSClear product offering to SubFins as CDSClear has been 
clearing Senior Financials Indices and Single Names since June 2015. 
The process and controls already in place to manage Senior Financials 
will apply to SubFins and no additional operational risk is created in 
relation to SubFins.
    In accordance with the model validation recommendations, the 
proposed changes on WWR would also improve the stability and accuracy 
of the WWR margin so that LCH SA can better determine the full margin 
amount to be collected by the CCP that LCH SA believes is consistent 
with the relevant requirements of Rule 17Ad-22.\17\ Rule 17Ad-
22(e)(6)(i) \18\ requires LCH SA to establish, implement, maintain and 
enforce written policies and procedures reasonably designed to result 
in a 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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    \17\ 17 CFR 240. 17Ad-22.
    \18\ 17 CFR 240. 17Ad-22(e)(6).
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    Rule 17Ad-22(e)(2) \19\ requires LCH SA to have governance 
arrangements that are clear and transparent to fulfill the public 
interest requirements in Section 17A of the Act.\20\
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    \19\ 17 CFR 240. 17Ad-22(e)(2).
    \20\ 15 U.S.C. 78q-1.
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    LCH SA's governance arrangements clearly assign and document 
responsibility for risk decisions and require consultation with or 
approval from the LCH SA Board, Risk committees, or management. 
CDSClear's proposed rule changes were decided in accordance with the 
LCH SA governance process, which included review of the changes to the 
CDSClear Margin Framework and related risk management considerations by 
the LCH SA Risk Committee and approval by the Board. These governance 
arrangements continue to be clear and transparent, such that 
information relating to the assignment of responsibilities for risk 
decisions and the requisite involvement of the LCH SA Board, 
committees, and management is clearly documented, consistent with the 
requirements of Rule 17Ad-22(e)(2).\21\
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    \21\ 17 CFR 240.17Ad-22(e)(2).
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    For the reasons stated above, LCH SA believes that the proposed 
rule change with respect to the CDSClear Margin Framework, the CDSClear 
Default Fund Methodology, as well as the Supplement and Procedures in 
connection with the clearing of SubFins are consistent with the 
requirements of prompt and accurate clearance and settlement of 
securities transactions and derivative agreements, contracts and 
transactions, and assuring the safeguarding of securities and funds in 
the custody or control of the clearing agency or for which it is 
responsible, in accordance with Section 17(A)(b)(3)(F) \22\ of the Act, 
with the requirements of operational risk management in Rule 17Ad-
22(e)(17),\23\ and with clear and transparent governance arrangements 
in Rule 17Ad-22(e)(2).\24\
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    \22\ 15 U.S.C. 78q-1(b)(3)(F).
    \23\ 17 CFR 240.17Ad-22(e)(17).
    \24\ 17 CFR 240.17Ad-22(e)(2).
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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.\25\ LCH SA does 
not believe that the proposed rule change would impose burdens on 
competition that are not necessary or appropriate in furtherance of the 
purposes of the Act. Specifically, the proposed changes to the CDSClear 
Margin Framework, Default Fund Methodology, Supplement and Procedures 
would apply equally to all Clearing Members whose portfolios includes 
SubFins and other CDS and CDS Options. Because the margin methodology 
and default fund sizing methodology are risk-based, consistent with the 
requirements in Rule 17Ad-22(b)(2) and (e)(6), depending on a Clearing 
Member's portfolio, each Clearing Member would be subject to a margin 
requirement and default fund contribution commensurate with the risk 
particular to its portfolio. Such margin requirement and default fund 
contribution impose burdens on a Clearing Member but such burdens would 
be necessary and appropriate to manage LCH SA's credit exposures to its 
CDSClear participants and to maintain sufficient financial resources to 
withstand a default of two participant families to which LCH SA has the 
largest exposures in extreme but plausible market conditions, 
consistent with the requirements under the Act as described above.
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    \25\ 15 U.S.C. 78q-1(b)(3)(I).
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    Therefore, LCH SA does not believe that the proposed rule change 
would impose a burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act.

[[Page 39391]]

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
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-LCH SA-2019-005 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-2019-005. 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 website (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 website 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 website 
at: https://www.lch.com/resources/rules-and-regulations/proposed-rule-changes-0.
    All comments received will be posted without change. Persons 
submitting comments are cautioned that we do not redact or edit 
personal identifying information from comment submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-LCH SA-2019-005 and should 
be submitted on or before August 30, 2019.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\26\
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    \26\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-17108 Filed 8-8-19; 8:45 am]
 BILLING CODE 8011-01-P


