[Federal Register Volume 85, Number 14 (Wednesday, January 22, 2020)]
[Notices]
[Pages 3724-3727]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-00915]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87971; File No. SR-ICC-2019-013]


Self-Regulatory Organizations; ICE Clear Credit LLC; Order 
Approving Proposed Rule Change Relating to the ICC Clearing Rules To 
Reflect the ISDA NTCE Supplement

January 15, 2020.

I. Introduction

    On November 15, 2019, ICE Clear Credit LLC (``ICE Clear Credit'' or 
``ICC'') filed with the Securities and

[[Page 3725]]

Exchange Commission pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 \1\ and Rule 19b-4thereunder,\2\ a proposed rule 
change to make certain changes to the ICC Clearing Rules (the 
``Rules'') \3\ to implement the 2019 Narrowly Tailored Credit Event 
Supplement to the 2014 ISDA Credit Derivatives Definitions (the ``NTCE 
Supplement'') that are being adopted in the broader credit default swap 
(``CDS'') market to address so-called narrowly tailored credit events 
and related matters. The proposed rule change was published for comment 
in the Federal Register on December 2, 2019.\4\ The Commission did not 
receive comments on the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Capitalized terms used but not defined herein have the 
meanings specified in the Rules.
    \4\ Securities Exchange Act Release No. 87612 (November 25, 
2019), 84 FR 66036 (Dec. 2, 2019) (SR-ICC-2019-013) (``Notice'').
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II. Description of the Proposed Rule Change

A. Background

    Following certain events in the CDS \5\ market, the International 
Swaps and Derivatives Association, Inc. (``ISDA''), in consultation 
with market participants, developed and published the NTCE 
Supplement.\6\ The NTCE Supplement reflects an effort by ISDA to 
address so-called narrowly-tailored credit events. According to ISDA, a 
narrowly-tailored credit event is an arrangement between a participant 
in the CDS marketplace and a corporation, through which the corporation 
triggers a credit event on CDS covering the corporation, thereby 
increasing payment to the buyers of CDS protection on the corporation 
while minimizing the impact on the corporation.\7\
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    \5\ The following description is substantially excerpted from 
the Notice. See Notice, FR at 66036.
    \6\ See ISDA Board Statement on Narrowly Tailored Credit Events 
available at https://www.isda.org/2018/04/11/isda-board-statement-on-narrowly-tailored-credit-events/; see also Joint Statement on 
Opportunistic Strategies in the Credit Derivatives Market (``The 
continued pursuit of various opportunistic strategies in the credit 
derivatives markets, including but not limited to those that have 
been referred to as `manufactured credit events,' may adversely 
affect the integrity, confidence and reputation of the credit 
derivatives markets, as well as markets more generally.'') available 
at https://www.sec.gov/news/press-release/2019-106.
    \7\ See ISDA Board Statement on Narrowly Tailored Credit Events, 
available at https://www.isda.org/2018/04/11/isda-board-statement-on-narrowly-tailored-credit-events/.
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    The NTCE Supplement, if applied to a CDS transaction, would make 
two principal changes to the 2014 ISDA Credit Derivatives Definitions 
to address narrowly-tailored credit events.\8\ First, the NTCE 
Supplement would change the definition of the ``Failure to Pay'' credit 
event to exclude certain narrowly tailored credit events through a new 
Credit Deterioration Requirement. The Credit Deterioration Requirement 
would provide that a failure of a corporation to make a payment on an 
obligation would not constitute a Failure to Pay Credit Event 
triggering CDS on that corporation if the failure does not directly or 
indirectly either result from, or result in, a deterioration in the 
creditworthiness or financial condition of the corporation.\9\ Thus, a 
narrowly tailored or manufactured failure to pay that does not reflect 
or result in a credit deterioration by a corporation would not 
constitute a Credit Event for CDS Contracts that incorporate the NTCE 
Supplement and thus would not necessarily trigger payment to buyers of 
CDS protection. The NTCE Supplement would also provide guidance related 
to the factors that would be relevant to determining whether the Credit 
Deterioration Requirement had been met, which determination would, 
under the 2014 Definitions, in the ordinary course be made by the 
relevant Credit Derivatives Determinations Committee.
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    \8\ See ISDA 2019 NTCE Protocol FAQ, available at https://www.isda.org/protocol/isda-2019-ntce-protocol.
    \9\ See ISDA 2019 Narrowly Tailored Credit Event Supplement to 
the 2014 ISDA Credit Derivatives Definitions (Published on July 15, 
2019), available at https://www.isda.org/a/KDqME/Final-NTCE-Supplement.pdf.
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    Second, the NTCE Supplement would reduce the amount of payout a CDS 
protection buyer could claim in certain circumstances by imposing a new 
provision for Fallback Discounting. Fallback Discounting would discount 
a CDS protection buyer's claim for payout under a CDS contract where 
that claim for payout is based on an obligation issued by a corporation 
at a discount.\10\ This would address the potential scenario where a 
corporation agrees to issue a bond at a substantial discount to its 
principal amount and the bond is delivered in settlement of a CDS at 
its full principal amount. In this scenario, Fallback Discounting would 
prevent a buyer of CDS protection from using the full principal amount 
of the bond issued at a discount as a basis for payout under the CDS 
contract.
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    \10\ Id.
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B. Changes to the ICC Clearing Rules

    Because ICC will clear and settle CDS contracts to which the NTCE 
Supplement will apply, it must ensure that its relevant Rules 
accurately reflect the changes described above that will be implemented 
by the NTCE Supplement. Accordingly, the proposed rule change would 
ensure that the changes being implemented by the NTCE Supplement are 
accurately reflected in its relevant Rules for both new and existing 
cleared transactions that incorporate the 2014 ISDA Credit Derivatives 
Definitions.\11\ For this purpose, the proposed ICC amendments will 
apply to all cleared CDS contracts with corporate (i.e., non-sovereign) 
reference entities.\12\
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    \11\ Notice, 84 FR at 66037.
    \12\ Id.
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    Specifically, ICC would amend Rule 20-102 to include new 
definitions for (i) the ``NTCE Supplement,'' which would be the 
Narrowly Tailored Credit Event Supplement to the 2014 ISDA Credit 
Derivatives Definitions published by ISDA on July 15, 2019, (ii) ``NTCE 
Amending Contracts,'' which would be those Contracts being amended to 
incorporate the NTCE Supplement as specified in a list to be maintained 
by ICC, and (iii) the ``NTCE Effective Date,'' which will be January 
27, 2020 (the date of implementation of the amendment), or such later 
date as designated by ICC by Circular.\13\
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    \13\ Id.
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    In addition, ICC would amend each relevant subchapter of Chapter 26 
of the Rules to implement the NTCE Supplement and ensure that relevant 
contracts already being cleared and settled by ICE Clear Credit but 
that do not reference the new standard terms supplement are fungible 
with new contracts cleared and settled by ICE Clear Credit that do 
reference the new standard terms supplement.\14\ One set of amendments 
would apply to index CDS transactions and a separate but substantially 
similar set of amendments would apply to single-name CDS 
transactions.\15\
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    \14\ Id.
    \15\ Id.
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    In the case of index CDS, for CDX.NA Index CDS transactions, the 
definition of CDX.NA Untranched Terms Supplement in Rule 26A-102 in 
subchapter 26A would be amended to include the new 2020 standard terms 
supplement for such transactions, as published by ISDA, which 
incorporates the NTCE Supplement, along with conforming changes to 
cross-references.\16\ Rule 26A-316 would be amended by adding a new 
paragraph (e), which provides that open positions in CDX.NA Untranched 
Contracts that are NTCE Amending Contracts would be amended, effective 
as of the NTCE Effective Date, to reference the updated 2020 standard 
terms supplement in lieu

[[Page 3726]]

of the standard terms supplement previously in effect.\17\ This will 
have the effect of converting all existing CDX.NA Untranched Contracts 
to reference the new standard terms supplement, such that they will be 
fungible with new CDX.NA Untranched Contracts, which will also 
reference the new standard terms supplement.\18\ New paragraph (e) 
would also provide that the amendments will be effective regardless of 
whether any transaction record in the Deriv/SERV warehouse is updated 
to reflect the change.\19\
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    \16\ Id.
    \17\ Id.
    \18\ Id.
    \19\ Id.
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    Substantially similar changes for other categories of index CDS 
would also be made in subchapters 26F (for iTraxx Europe Untranched 
Contracts) and 26J (for iTraxx Asia/Pacific Untranched Contracts).\20\
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    \20\ Id.
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    In the case of single-name CDS, for Standard North American 
Corporate (SNAC) Contracts, in subchapter 26B, Rule 26B-616 would be 
amended by adding a new paragraph (c), which provides that open 
positions in SNAC Contracts that are NTCE Amending Contracts would be 
amended, effective as of the NTCE Effective Date, to incorporate the 
NTCE Supplement and specify that the Fallback Discounting and Credit 
Deterioration Requirement provisions will be applicable.\21\ The 
contracts would also be amended to reference the new ISDA physical 
settlement matrix, to be published as of the NTCE Effective Date (or 
other relevant implementation date as determined by ICC).\22\ The 
amendments will have the effect of converting existing SNAC Contracts 
to reference the updated physical settlement matrix, such that they 
will be fungible with new SNAC Contracts, which will also reference 
that matrix.\23\ New paragraph (c) would also provide that the 
amendments will be effective regardless of whether any transaction 
record in the Deriv/SERV warehouse is updated to reflect the 
change.\24\
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    \21\ Id.
    \22\ Id.
    \23\ Id.
    \24\ Id.
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    Substantially similar changes for other categories of single-name 
CDS would also be made in subchapters 26G (for Standard European 
Corporate Contracts), 26H (for Standard European Financial Corporate 
Contracts), 26M (for Standard Australian Corporate Contracts), 26N (for 
Standard Australia Financial Corporate Contracts), 26O (for Standard 
Asia Corporate Contracts), 26P (for Standard Asia Financial Corporate 
Contracts) and 26Q (for Standard Emerging Market Corporate 
Contracts).\25\
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    \25\ Notice, 84 FR at 66037-66038.
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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 
the proposed rule change is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to the 
organization.\26\ For the reasons given below, the Commission finds 
that the proposed rule change is consistent with Section 17A(b)(3)(F) 
of the Act \27\ and Rule 17Ad-22(d)(1) thereunder.\28\
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    \26\ 15 U.S.C. 78s(b)(2)(C).
    \27\ 15 U.S.C. 78q-1(b)(3)(F).
    \28\ 17 CFR 240.17Ad-22(d)(1).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of ICC be designed to promote the prompt and accurate 
clearance and settlement of securities transactions and, to the extent 
applicable, derivative agreements, contracts, and transactions, 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.\29\
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    \29\ 15 U.S.C. 78q-1(b)(3)(F).
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    As described above, the NTCE Supplement would amend the underlying 
legal terms applicable to CDS contracts to which it applies by, among 
other things, limiting Credit Events to those that reflect a 
deterioration in the creditworthiness or financial condition of the 
relevant company. It also would reduce the amount of payout a CDS 
protection buyer could claim in certain circumstances where the claim 
for payout is based on an obligation issued by a company at a discount. 
Further, because ISDA has set an implementation date of January 27, 
2020, the NTCE Supplement will apply to all single-name CDS contracts 
and components of index CDS contracts that incorporate the 2014 ISDA 
Credit Derivatives Definitions entered into on or after that date.
    As noted above, because ICC will clear and settle CDS contracts 
that are subject to the changes being made by the NTCE Supplement, the 
proposed rule change would amend the ICC Clearing Rules to incorporate 
the amendments resulting from the NTCE Supplement, thereby ensuring 
that ICC's Rules accurately reflect and appropriately apply the legal 
terms and conditions applicable to such CDS contracts, and that 
existing contracts that do not reference the new standard terms 
supplement will be fungible with new contract that do.
    In the Commission's view, a lack of clarity in the underlying legal 
terms and conditions applicable to the transactions that ICC clears and 
settles could hinder ICC's ability to promptly and accurately clear and 
settle such transactions. Likewise, disputes regarding the applicable 
legal terms and conditions of such transactions could lead to disputes 
or confusion regarding the necessary and appropriate margin submitted 
in connection with such transactions, thereby threatening ICC's ability 
to safeguard such margin. Accordingly, by making the changes described 
above, and in particular by ensuring the ICC's Rules accurately reflect 
and appropriately apply the legal terms and conditions applicable to 
the CDS contracts that are cleared and settled by ICC and that existing 
contracts that do not reference the new standard terms supplement will 
be fungible with new contract that do, the Commission believes that the 
proposed rule change would help ensure that ICC's Rules continue to 
promote the prompt and accurate clearance and settlement of such the 
CDS contracts and assure the safeguarding of securities and funds in 
ICC's custody and control. For these same reasons the Commission also 
finds that the proposed rule change would, in general, protect 
investors and the public interest.
    Therefore, the Commission finds that the proposed rule change is 
consistent with Section 17A(b)(3)(F) of the Act.\30\
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    \30\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(d)(1)

    Rule 17Ad-22(d)(1) requires a clearing agency to establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to provide for a well-founded, transparent and 
enforceable legal framework for each aspect of its activities in all 
relevant jurisdictions.\31\
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    \31\ 17 CFR 240.17Ad-22(d)(1).
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    As discussed above, the proposed rule change would help to clarify 
and ensure that ICC's Rules accurately reflect and appropriately apply 
the legal terms and conditions applicable to the CDS contracts that are 
cleared and settled by ICC and that existing contracts that do not 
reference the new standard terms supplement will be fungible with new 
contract that do. The Commission believes that this, in turn, would 
help

[[Page 3727]]

ensure that the ICC Clearing Rules provide a consistent and enforceable 
legal basis for clearing and settling CDS contracts to which the NTCE 
Supplement applies in light of the amendments made by the NTCE 
Supplement.
    Therefore, the Commission finds that the proposed rule change is 
consistent with Rule 17Ad-22(d)(1).

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 \32\ and Rule 17Ad-22(d)(1) thereunder.\33\
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    \32\ 15 U.S.C. 78q-1(b)(3)(F).
    \33\ 17 CFR 240.17Ad-22(d)(1).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
\34\ that the proposed rule change (SR-ICC-2019-013), be, and hereby 
is, approved.\35\
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    \34\ 15 U.S.C. 78s(b)(2).
    \35\ 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).
    \36\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\36\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-00915 Filed 1-21-20; 8:45 am]
 BILLING CODE 8011-01-P


