[Federal Register Volume 85, Number 5 (Wednesday, January 8, 2020)]
[Notices]
[Pages 947-949]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-00062]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87881; File No. SR-LCH SA-2019-009]


Self-Regulatory Organizations; LCH SA; Order Approving Proposed 
Rule Change Relating to Amendments to CDSClear Reference Guide To Allow 
Index Basis Packages Margining

January 2, 2020.

I. Introduction

    On October 29, 2019, Banque Centrale de Compensation, which 
conducts business under the name LCH SA (``LCH SA'' or ``CDSClear''), 
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 
relating to amendments to the CDSClear Reference Guide (the ``CDSClear 
Risk Methodology'') to allow Index Basis Packages margining. The 
proposed rule change was published for comment in the Federal Register 
on November 19, 2019.\3\ The Commission did not receive comments 
regarding 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\ Self-Regulatory Organizations; LCH SA; Notice of Filing of 
Proposed Rule Change Relating to Amendments to CDSClear Reference 
Guide To Allow Index Basis Packages Margining; Exchange Act Release 
No. 87522 (Nov. 13, 2019); 84 FR 63912 (Nov. 19, 2019) (``Notice'').
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II. Description of the Proposed Rule Change

    LCH SA is proposing to amend its CDSClear Risk Methodology in order 
to allow Index Basis Packages margining as a single instrument.\4\ LCH 
SA CDSClear currently clears CDS on a number of indices such as iTraxx 
Main, iTraxx Cross-over, iTraxx Senior Financials as well as all the 
Single Name constituents of these indices. Indices and their 
constituents are currently managed and margined as independent 
instruments. However, market participants may execute Index Basis 
Packages consisting of an Index CDS trade and individual Single Name 
CDS trades on each of the reference entities constituents of such Index 
perfectly offsetting the Index.
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    \4\ The description herein is substantially excerpted from the 
Notice, 84 FR 63912.
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    A transaction would need to satisfy the following criteria to 
constitute an Index Basis Package:
     The package is constituted of an Index CDS and Single Name 
CDS on all the entities constituting the index;
     The position (Long/Short) on the Index offsets the 
positions on the Single Names (Short/Long);
     The notional of the Index and across all the Singles Names 
match exactly;
     All the Single Names CDS trades have the same currency, 
coupon, and maturity as constituents of the Index CDS; and
     All the Single Name CDS trades have the same Seniority, 
ISDA Definition and Restructuring Clause as constituents of the Index 
CDS.
    Clearing Members and/or Clients would be required to identify all 
trades being part of an Index Basis Package and to notify LCH SA 
CDSClear. CDSClear would then perform controls to ensure all principles 
and requirements stated above for qualifying the trades as an Index 
Basis Package are satisfied and would flag them with a common ID 
number. These trades would continue to be margined as different trades 
until LCH SA completes these controls and confirms the qualification as 
an Index Basis Package.
    Once an Index Basis Package is validated as complete, the margin 
enhancement proposed in the current rule change would then be applied 
as part of the overnight margin calculation.
    In order to ensure that the trades continue to meet the criteria of 
an Index Basis Package, controls would be performed every day at the 
start of the overnight batch process.
    Index Basis Packages identified and flagged as such would be 
excluded from compression runs with the rest of the portfolio in order 
to avoid breaking any packages.
    Index Basis Packages could be un-flagged as such at the Clearing 
Member and/or Client's request. The Index CDS and the Single Name CDS 
would then be treated and margined separately as per the current 
framework.
    In case of a Clearing Member's default, CDSClear would have the 
ability to liquidate Index Basis Packages in a dedicated auction should 
it be advised to do so by the Default Management Group in order to 
minimize the liquidation costs.

A. Proposed Changes to CDSClear Risk Methodology

    In order to take into account the specific risk created by Index 
Basis Packages positions, LCH SA proposes to amend the calculation of 
the Spread Margin and the calculation of the Liquidity Charge Margin as 
described in its Reference Guide, CDSClear Margin Framework.
1. Spread Margin
    LCH SA CDSClear currently considers an Index Basis Package as 
multiple instruments in the calculation of its Spread Margin. In 
accordance with the portfolio margining requirements under Article 27 
of Commission Delegated Regulation (EU) No 153/2013 \5\ (the ``RTS''), 
LCH SA CDSClear applies a cap of 80% to the possible margin offsets 
reduction. Therefore, the Spread Margin of an Index Basis Package is 
calculated as the maximum between the expected shortfall of the package 
and 20% of the sum of the expected shortfalls

[[Page 948]]

calculated for each components of the package.
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    \5\ See https://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2013:052:0041:0074:EN:PDF.
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    CDSClear believes that this does not appropriately reflect the 
actual risk of an Index Basis Package meeting the criteria stated 
above, so it is proposing to amend its CDSClear Risk Methodology in 
order to consider Index Basis Packages identified as such as a single 
instrument when calculating the amount of margins required. In 
particular, the 80% cap on offsets between the components of the Index 
Basis Package would not be applied in the calculation of the Spread 
Margin, but would be maintained between an Index Basis Package and all 
the other positions in the portfolio. This may result in a lower amount 
of margin being collected on an Index Basis Package.
    In the opinion published in April 2017 \6\ and clarifying the 
application of Article 27 of the RTS, the European Securities and 
Market Authority (``ESMA''), acknowledges the low level of risk 
presented by a package consisting of a future on an index and futures 
on each of the constituents of the index and allows a CCP to 
acknowledge margin reduction in excess of 80% in this specific case. 
This proposal acknowledges this position.
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    \6\ See https://www.esma.europa.eu/sites/default/files/library/esma70-708036281-18_opinion_on_portfolio_margining.pdf.
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2. Liquidity Charge Margin
    Considering that an Index Basis Package would likely be sold off in 
a dedicated auction in case of default of a Clearing Member, LCH SA 
also proposes to amend the calculation of the Liquidity Charge Margin 
described in the CDSClear Risk Methodology in order to better reflect 
the actual cost it would incur when liquidating an Index Basis Package. 
CDSClear proposes to charge a specific bid/ask spread for each Index 
family underlying an Index Basis Package identified as such rather than 
use the current Liquidity Charge Margin algorithm based on charging 
bid/ask spreads for each individual component in the package taken 
independently. The current Liquidity Charge Margin methodology would 
nevertheless remain in the calculation specific to Index Basis Packages 
identified as such by acting as a cap to the new calculation method. 
Because the bid/ask spread may be smaller, a lower amount of this 
category of margin could be collected.
3. Other Exclusions
    Finally, Index Basis Packages flagged as such would be excluded 
from the Recovery Risk, Interest Risk, or Wrong Way Risk Margin 
calculations as by construction Index Basis Packages are immune to the 
risks these margins aim at capturing.

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.\7\ For the reasons given below, the Commission finds that 
the proposed rule change is consistent with Section 17A(b)(3)(F) of the 
Act \8\ and Rules 17Ad-22(e)(6)(i) and (iii) thereunder.\9\
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    \7\ 15 U.S.C. 78s(b)(2)(C).
    \8\ 15 U.S.C. 78q-1(b)(3)(F).
    \9\ 17 CFR 240.17Ad-22(e)(6)(i) and (iii).
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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.\10\ As discussed 
above, the proposed rule change would amend the LCH SA CDSClear Risk 
Methodology to allow Index Basis Packages margining as a single 
instrument. As a result, LCH SA would require a lesser amount of margin 
to better reflect the lower risk of an Index Basis Package compared to 
its individual component instruments. The Commission believes that 
these changes would help ensure that LCH SA's margin requirements are 
commensurate with the risks associated with clearing Index Basis 
Packages, which in turn would help ensure that LCH SA does not require 
higher margins than necessary and that Clearing Members are able to 
effectively accumulate and manage their financial resources.
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    \10\ 15 U.S.C. 78q-1(b)(3)(F).
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    Additionally, as noted above, LCH SA also proposes to amend the 
calculation of the Liquidity Charge Margin to better reflect the actual 
cost it would incur when liquidating an Index Basis Package. Similarly, 
LCH SA proposes to exclude Index Basis Packages from inapplicable 
margin calculations such as the Recovery Risk, Interest Risk, and Wrong 
Way Risk Margin calculations because Index Basis Packages are not 
subject to these risks. Similar to the Spread Margins discussed above, 
the Commission believes that these changes would result in the 
collection of margins more commensurate to the risks associated with 
clearing Index Basis Packages, which in turn would help ensure that LCH 
SA does not require higher margins than necessary and that Clearing 
Members are able to effectively accumulate and manage their financial 
resources.
    Taken together, the Commission believes that these changes would 
enhance the operation and effectiveness of LCH SA's margin collection 
system, which is necessary to manage LCH SA's credit exposures to its 
Clearing Members and the risks associated with clearing security based 
swap-related portfolios. By managing such exposures and risks, LCH SA's 
margin system helps it avoid losses that could result from the 
mismanagement of such credit exposures and risks. Because such losses 
could disrupt LCH SA's ability to promptly and accurately clear 
security based swap transactions, by making the above-described 
improvements to LCH SA's margin system, the proposed rule change would 
help promote the prompt and accurate clearance and settlement os 
securities transactions. Similarly, given that such losses could 
threaten LCH SA's access to securities and funds in LCH SA's control, 
by making the above-described improvements to LCH SA's margin system, 
the Commission believes that the proposed rule change would help assure 
the safeguarding of funds and securities which are in the custody or 
control of LCH SA or for which it is responsible. As noted above, the 
Commission believes that these changes also would help promote the 
prudent and accurate accumulation and management of financial resources 
by both LCH SA and its Clearing Members.
    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.\11\
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    \11\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(6)(i)

    Rule 17Ad-22(e)(6)(i) 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

[[Page 949]]

that, as applicable, considers, and produces margin levels commensurate 
with, the risks and particular attributes of each relevant product, 
portfolio, and market.\12\ As noted above, LCH SA is proposing to amend 
its CDSClear Risk Methodology in order to allow Index Basis Packages 
margining as a single instrument as long as it meets the criteria noted 
above. As a result, LCH SA would amend its Spread Margin and Liquidity 
Charge Margin so that these margin requirements reflect a single rather 
than separate trades, which may result in a lower level of margin being 
collected. The Commission believes that these changes would help ensure 
that LCH SA's margin requirements are commensurate with the risks 
associated with clearing Index Basis Packages, including by reflecting 
the lower risk levels commensurate with Index Basis Packages viewed as 
a single instrument, as opposed to the individual component instruments 
that make up the Index Basis Package.
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    \12\ 17 CFR 240.17Ad-22(e)(6)(i).
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    Therefore, for the above reasons the Commission finds that the 
proposed rule change is consistent with Rule 17Ad-22(e)(6)(i).\13\
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    \13\ 17 CFR 240.17Ad-22(e)(6)(i).
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C. Consistency With Rule 17Ad-22(e)(6)(iii)

    Rule 17Ad-22(e)(6)(iii) 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, as 
applicable, calculates margin sufficient to cover its potential future 
exposure to participants in the interval between the last margin 
collection and the close out of positions following a participant 
default.\14\ As noted above, with respect to the liquidity charge 
margin, LCH SA proposes to charge a specific bid/ask spread for each 
Index family underlying an Index Basis Package identified as such, 
rather than use the current Liquidity Charge Margin algorithm based on 
charging bid/ask spreads for each individual component in the package 
taken independently. These proposed changes reflect that, in the event 
of a Clearing Member default, Index Basis Packages most likely would be 
sold off as a single instrument in a dedicated auction, rather than 
broken apart into individual components with each component instrument 
sold in an independent auction. By helping to ensure that the liquidity 
charge margin applied to Index Basis Packages would be commensurate 
with the risks associated with clearing Index Basis Packages, the 
Commission believes that the proposed rule change would be consistent 
with the requirement to have margin sufficient to cover potential 
future exposure to participants in the interval between the last margin 
collection and the close out of positions following a participant 
default.
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    \14\ 17 CFR 240.17Ad-22(e)(6)(iii).
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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 \15\ and Rules 17Ad-22(e)(6)(i) and (iii) thereunder.\16\
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    \15\ 15 U.S.C. 78q-1(b)(3)(F).
    \16\ 17 CFR 240.17Ad-22(e)(6)(i) and (iii).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
\17\ that the proposed rule change (SR-LCH SA-2019-009), be, and hereby 
is, approved.\18\
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    \17\ 15 U.S.C. 78s(b)(2).
    \18\ 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).
    \19\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\19\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-00062 Filed 1-7-20; 8:45 am]
 BILLING CODE 8011-01-P


