[Federal Register Volume 84, Number 242 (Tuesday, December 17, 2019)]
[Notices]
[Pages 68989-68992]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-27092]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87720; File No. SR-LCH SA-2019-008]


Self-Regulatory Organizations; LCH SA; Order Approving Rule 
Change Relating to the Updated 2018 Version of the Recovery Plan

December 11, 2019.

I. Introduction

    On October 8, 2019, 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 (``the ``Proposed Rule Change'') 
to adopt an updated recovery plan (the ``RP''). The proposed rule 
change was published for comment in the Federal Register on October 29, 
2019.\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. 34-87388 (October 23, 
2019), 84 FR 57897 (October 29, 2019) (SR-LCH SA-2018-008) 
(``Notice'').
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II. Description of the Proposed Rule Change

    The purpose of LCH SA's RP is to maintain the continuity of 
critical services in times of extreme stress and to facilitate its 
recovery.\4\ Generally, the RP identifies if and to what level LCH SA's 
services are critical for the market

[[Page 68990]]

and what internal or external services/systems are critical for the 
continuity of LCH SA's activity; outlines the scenarios under which 
recovery of the LCH SA might be necessary; defines the early warning 
indicators and triggers for initiating the recovery measures; defines 
the governance framework to trigger these recovery measures; and 
identifies the available recovery tools to manage crisis situations and 
to restore business as usual.
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    \4\ The description herein is substantially excerpted from the 
Notice, 84 FR 57897.
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    Significant scenarios that could prevent LCH SA from providing its 
critical services discussed in the RP include the default of one or 
multiple clearing members; liquidity shortfalls as result of a clearing 
member or allied clearing house default; default of an investment 
counterparty of LCH SA or any other investment losses resulting from 
changes in the market value on the investments; losses resulting from 
an operational risk event; failure of a critical IT service provider; 
and failure of financial market infrastructures such as an allied 
clearing house, CSD, or Trades Repository.
    The proposed rule change intends to incorporate the following main 
changes from the updated 2018 version of the RP: (1) Inclusion of 
details on handling of the recovery from a cyber-risk scenario, (2) 
inclusion of fraud as an operational risk, (3) inclusion of tools for 
non-Euro transactions and collateral, (4) implementation of CC&G 
rulebook changes related to service closure, (5) inclusion of a 
comprehensive list of LCH SA's critical service providers, (6) 
inclusion of details regarding the monitoring of capital related tools, 
and (7) inclusion of details for managing the failure of LCH Ltd as a 
service provider.

A. Recovery From a Cyber-Risk Scenario

    Under the proposed rule change, the RP would include more details 
on the management of a cyber-risk scenario with the addition of the 
Cyber Crisis Management Plan as a new recovery tool. The Cyber Crisis 
Management Plan would define ``cyber-crisis'' and provide a framework 
of procedures describing and specifying how LCH SA would respond to a 
potential breach of a system, service or network indicating possible 
problems with information security policy or a failure of controls. The 
RP further defines cyber-risks as a single or a series of unwanted or 
unexpected information security events that have a significant 
probability of compromising business operations and threatening 
information security taking the form of unauthorized scans or probes, 
malicious code, denial of service, or attempts to gain access. The 
framework and procedures would be activated in event that LCH SA 
detected a cyber incident that could potentially cause a significant 
impact on LCH SA business objectives.

B. Fraud Risk

    In addition to losses resulting from a clearing member default 
scenarios, the RP covers losses resulting from a non-default 
operational risk event. While the current version of the RP addresses 
operational risks such as failure of third party service providers or 
cyber risks, the proposed rule change would include as an operational 
risk losses resulting from a fraud which impacts the critical services 
provided by LCH SA. As is the case with other operational risks, the RP 
would specify that business lines and operational risk departments have 
the responsibility to identify potential fraud and to put into place 
relevant controls to monitor for fraud risk.

C. Non-Euro Recovery Tools

    Currently, the RP includes various tools to deal with liquidity 
needs resulting from default losses or other events giving rise to 
liquidity constrains, including deferral of settlement for fixed income 
and cash equity as well as collateral limits. The RP would now specify 
that to bolster its recovery tools, LCH SA can use several new tools to 
meet liquidity needs, including using non-Euro collateral to raise 
liquidity, transforming liquidity received in non-Euro currencies into 
Euro through bi-lateral repo transactions with the ``FXmarkets'' 
recovery tool, receiving liquidity directly in Euro from Gilt or USD 
securities, and performing payments in an alternate currency than the 
original obligation.

D. CC&G Rulebook Changes

    The current version of the RP provides as a recovery tool the 
closure of the interoperability link on Italian debt, which is 
triggered when CC&G is declared in default or CC&G has performed a 
service closure. Upon triggering this tool, LCH SA will proceed with 
closing out all outstanding contracts. Further, uncovered losses from 
the cash settlement and close out after a CC&G default will be covered 
by deposited collateral of CC&G and the application of a haircut on 
outgoing payments to clearing members. In order to cover a potential 
cash shortfall in case of a CC&G default, LCH SA is proposing that the 
RP would state that in the event of a closure of CC&G, LCH SA will not 
be obliged to perform payment to clearing members until it receives 
deposited collateral from the CC&G estate, which addresses LCH SA's 
potential inability to retrieve the deposited collateral with CC&G.

E. Critical Service Providers

    The current RP in general describes critical services such as those 
provided by LCH Ltd and other entities providing technological 
services. The RP describes LCH SA's approach to the maintaining 
continuity of services to LCH SA, including contractual rights. In this 
rule proposal, the RP would describe that LCH SA will implement a new 
framework to manage critical service providers. The framework would 
identify the various types of critical service providers and include a 
new list of such providers in an annex to the RP. This would layout the 
overall landscape of providers and facilitate LCH SA's ability to 
monitor for potential financial or operational failure of a critical 
service provider and plan to replace service providers or otherwise 
sustain any disruption caused by their failure.

F. Monitoring of Capital Related Tools

    The quantitative assessment section of the recovery plan would 
include more details on the monitoring of capital related recovery 
tools like surplus capital, variable payments and dividend payments in 
order to help ensure their adequacy to cover the identified scenarios. 
This additional detail would list each tool and describe their 
efficiency as recovery tools. The RP currently notes that LCH SA will 
monitor that surplus/buffers capital is adequate to cover both default 
and non-default losses. The proposed rule would revise the RP to 
describe the stress scenarios and associated indicators as well as the 
capital coverage tools available in each case. In addition to the 
capital requirements and available headroom, the RP would note that LCH 
SA follows indicators such as the Liquidity Coverage Ratio, the 
aggregate credit risk and market risk exposure on its investment 
portfolio, operational risk and business risks indicators. The RP would 
indicate that the capital and buffers are monitored in order to allow 
LCH SA to always be in a situation to replenish the skin in the game 
within one month if the CCP was to face multiple defaults.
    In addition to surplus capital, the RP would indicate that the LCH 
Board may decide to withhold Dividend payment and Variable bonus 
payment to be used as additional buffers.

G. LCH Ltd Exit Plan

    In response to French regulatory recommendations, the RP would 
provide information related to the dependency between LCH SA and LCH

[[Page 68991]]

Ltd. LCH Ltd provides IT services to LCH SA and an approach on how LCH 
SA will manage a potential wind down of LCH Ltd would be included in 
the RP. The RP would include scenarios and mitigating actions in case 
of failure of LCH Ltd as a service provider. For example, LCH SA will 
take steps to replicate the exact information technology services 
provided by LCH Ltd.

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.\5\ For the reasons given below, the Commission finds that 
the proposed rule change is consistent with Section 17A(b)(3)(F) of the 
Act \6\ and Rules 17Ad-22(e)(2) and (3) thereunder.\7\
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    \5\ 15 U.S.C. 78s(b)(2)(C).
    \6\ 15 U.S.C. 78q-1(b)(3)(F).
    \7\ 17 CFR 240.17Ad-22(e)(2) and (3).
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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 LCH SA 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 LCH SA or for which it is responsible, and, in 
general, to protect investors and the public interest.\8\
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    \8\ 15 U.S.C. 78q-1(b)(3)(F).
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    As noted above, the updates to the RP reflected in this proposed 
rule change would add more details on the management of a cyber-
scenario and the Cyber Crisis Management Plan has been added as a new 
recovery tool. By providing a framework of procedures for allowing LCH 
SA to respond to or prevent cyber incidents, the Commission believes 
that LCH SA will improve its ability to cope with, prevent, and plan 
for disruptions to its clearing services by responding quickly to such 
things as software malfunctions or cyber breaches. Further, the 
Commission believes that LCH SA will be in a position to prioritize 
incidents and activate the relevant response teams and plans.
    Similarly, by updating the RP to account for the failure of 
entities such as linked CCPs and critical service providers as 
described above, the Commission believes that the proposed rule change 
provides LCH SA the ability to timely and efficiently plan for, 
monitor, and respond to failures or disruptions of these other parties. 
Specifically, the RP would note that LCH SA has implemented the rules 
relating to CC&G service closure related to a potential loss on 
investment of the cash collateral with CC&G. LCH SA may not immediately 
be able to retrieve the deposited collateral with CC&G if it is 
insolvent and has to wait for the relevant payment of the estate. 
However, the RP would clarify that LCH SA is only obliged to perform 
payment to clearing members if and when it has received the relevant 
funds from the CC&G estate. The Commission believes that these changes 
strengthen LCH SA's ability to recover from the liquidity and credit 
challenges that could arise from CC&G's closure. This in turn enhances 
LCH SA's financial position and ultimately its ability to continue to 
provide prompt and accurate clearance and settlement. Likewise, the RP 
would include scenarios and mitigating actions in case of the failure 
of LCH Ltd as a service provider and include a list of other critical 
service providers. The Commission believes that these proposed changes 
enhance LCH SA's management of important relationships by including 
details of these services and the steps that it can take to replace or 
otherwise respond to disrupted services. The Commission believes that 
this in turn promotes LCH SA's ability to continue to promptly and 
accurately clear transactions.
    Additionally, as noted above, the RP would include more details on 
the monitoring of capital related recovery tools like surplus capital, 
variable payments and dividend payments. For example, the RP would note 
that LCH SA will monitor that ``surplus/buffers capital'' is adequate 
to cover both default and non-default losses. By including within the 
RP the scenarios, indicators, and capital coverage tools available in 
each case, the Commission believes that LCH SA will enhance its ability 
to preserve the requisite financial resources and hence its ability to 
continue to promptly and accurately clear transactions and safeguard 
securities and funds in its custody and control.
    Further, the proposed rule change would provide that LCH SA can use 
several new tools to meet liquidity needs, including using non-Euro 
collateral to raise liquidity, transforming liquidity received in non-
Euro currencies through bi-lateral repo transactions with the 
``FXmarkets'' recovery tool, receiving liquidity directly in Euro from 
Gilt or USD securities, and performing payments in an alternate 
currency than the original obligation. The Commission believes that 
this enhances LCH SA's ability to resolve a specific currency liquidity 
shortfall resulting from a management of a defaulting clearing member 
and thereby maintains its financial strength and ultimately its ability 
to promptly and accurately clear transactions.
    Overall, the Commission believes that with the additional detail 
described above, the updated RP would continue to strengthen the 
purpose of the RP as originally adopted of maintaining the continuity 
LCH SA's critical services by reducing the likelihood of a disorderly 
or unsuccessful recovery through planning for various disruptive 
scenarios. Therefore, for the reasons stated above 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 LCH SA's custody and control, 
and, in general, protect investors and the public interest, consistent 
with the Section 17A(b)(3)(F) of the Act.\9\
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    \9\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(2)

    Rule 17Ad-22(e)(2) requires that a covered clearing agency 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to, as applicable, provide for 
governance arrangements that are clear and transparent and clearly 
prioritize the safety and efficiency of the covered clearing agency, to 
support the public interest requirements in Section 17A of the Act.\10\
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    \10\ 17 CFR 240.17Ad-22(e)(2).
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    As noted above, more details on the management of a cyber-scenario 
and the Cyber Crisis Management Plan have been added as a new recovery 
tool. The purpose of this document is to provide a framework of 
procedures allowing LCH SA to respond to cyber incidents and crises. 
The RP would contain details about the procedures utilized to identify 
incidents, notification of hierarchy, and for notifying and activating 
the Crisis Management Team. The Commission believes that proposed 
details regarding the cyber scenario will enhance LCH SA's governance 
procedures as they relate to cyber crisis by setting forth a clear 
process for detecting and notifying required

[[Page 68992]]

management as well as activation of a specific plan for managing cyber 
crisis.
    Therefore, for the above reasons the Commission finds that the 
proposed rule change is consistent with Rule 17Ad-22(e)(2).

C. Consistency With Rule 17Ad-22(e)(3)

    Rule 17Ad-22(e)(3) requires that a covered clearing agency 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to, as applicable, 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 the covered clearing agency, 
which must include plans for the recovery and orderly wind-down of the 
covered clearing agency necessitated by credit losses, liquidity 
shortfalls, losses from general business risk, or any other losses.
    Overall, the Commission believes that the rule proposal enhances 
LCH SA's ability to manage legal, credit, liquidity, operational, 
general business, investment, and other risks that arise in or are 
borne by the covered clearing agency in the recovery context. As noted 
above, the rule proposal updates the RP to address operational, 
liquidity, and investment risks. Specifically, the RP would include 
fraud as an operational risk and incorporate it into its system for the 
monitoring and management of losses. The Commission believes that with 
this addition, the RP is more attentive to fraud as an operational 
risk. Additionally, the Commission believes that the inclusion of non-
Euro recovery tools described above will enhance LCH SA's ability to 
cope with liquidity challenges by giving it additional ways to access 
and meet liquidity needs. The Commission also believes that by 
implementing the rules relating to CC&G service closure discussed 
above, LCH SA has resolved a potential liquidity risk relating to a 
CC&G default.
    Further, the Commission believes that the proposed changes to the 
RP related to LCH Ltd. and other critical service providers strengthen 
LCH SA's ability to maintain the continuity of critical services in 
times of extreme stress and to facilitate the recovery of LCH SA. For 
instance, the Commission believes that the list of critical service 
providers and scope of each service enhances LCH SA's ability to 
identify those services which could impact the continuity of LCH SA's 
operations and the LCH Ltd exit plan strengthens LCH SA's ability to 
manage a potential wind down of LCH Ltd. and replicate or replace the 
services provided by LCH Ltd. on short notice.
    Additionally, because the quantitative assessment section of the 
RP, as described above, now includes more details on the monitoring of 
capital related recovery tools, the Commission believes that LCH SA's 
ability to monitor and sustain its capital requirements under various 
scenarios has been strengthened.
    Therefore, for the above reasons the Commission finds that the 
proposed rule change is consistent with Rule 17Ad-22(e)(3).

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, Section 17A(b)(3)(F) of the Act \11\ and Rules 17Ad-
22(e)(2) and (3) thereunder.\12\
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    \11\ 15 U.S.C. 78q-1(b)(3)(F).
    \12\ 17 CFR 240.17Ad-22(e)(2) and (3).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
that the proposed rule change (SR-LCH SA-2019-008) be, and hereby is, 
approved.\13\
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    \13\ In approving the proposed rule change, the Commission 
considered the proposal's impacts 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.\14\


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    \14\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-27092 Filed 12-16-19; 8:45 am]
 BILLING CODE 8011-01-P


