[Federal Register Volume 85, Number 21 (Friday, January 31, 2020)]
[Notices]
[Pages 5744-5746]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-01517]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88021; File No. SR-LCH SA-2019-011]


Self-Regulatory Organizations; LCH SA; Notice of Filing of 
Partial Amendment No. 1 and Order Granting Accelerated Approval of 
Proposed Rule Change, as Modified by Partial Amendment No. 1, Relating 
to Amendments to CDS Clearing Supplement To Reflect the ISDA NTCE 
Protocol and Supplement

January 23, 2020.

I. Introduction

    On November 21, 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 to amend its CDS 
Clearing Supplement (``LCH SA CDS Supplement'') to: (1) Implement the 
2019 Narrowly Tailored Credit Event Supplement to the 2014 ISDA Credit 
Derivatives Definitions (the ``NTCE Supplement'') and (2) make certain 
clarifications as to the defined term ``Outstanding Principal 
Balance''. The proposed rule change was published for comment in the 
Federal Register on December 9, 2019.\3\ The Commission did not receive 
comments on the proposed rule change. On January 6, 2020, LCH SA filed 
Partial Amendment No. 1 to the proposed rule change.\4\ The Commission 
is publishing this notice to solicit comments on Partial Amendment No. 
1 from interested persons and is approving the proposed rule change, as 
modified by Partial Amendment No. 1 (hereinafter, ``proposed rule 
change'') on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 87649 (Dec. 3, 2019), 84 
FR 67325 (Dec. 9, 2019) (SR-LCH-SA-2019-011) (``Notice'').
    \4\ Partial Amendment No. 1 clarifies the proposed rule change 
by modifying certain references in the CDS Clearing Supplement. 
Currently, the CDS Clearing Supplement refers to certain supplements 
to the standard contract terms as published by ISDA on certain 
dates. Rather than referring to the supplements as published by ISDA 
on certain dates, Partial Amendment No. 1 modifies the CDS Clearing 
Supplement to refer to the latest versions of the supplements in 
force. In other words, Partial Amendment No. 1 amends the CDS 
Clearing Supplement to incorporate whichever versions of the ISDA 
supplements are most recent and therefore currently effective, 
rather than referring to multiple supplements with specific dates.
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II. Description of the Proposed Rule Change

A. Background

    Following certain events in the credit default swap (``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, 84 FR at 67325. Capitalized terms not 
otherwise defined herein have the meanings assigned to them in the 
LCH SA rulebook or LCH SA CDS Supplement.
    \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 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 a Failure 
to Pay Credit Event satisfies the Credit Deterioration Requirement. As 
would be the case with other Failure to Pay Credit Events under CDS 
contracts, the relevant Credit Derivatives Determinations Committee 
would, in the normal course, make the determination as to whether a 
Failure to Pay Credit Event satisfies the Credit Deterioration 
Requirement.
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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 issues 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 LCH SA CDS Supplement

    Because LCH SA 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 LCH SA's relevant Rules by making substantially 
similar amendments to both Part B of

[[Page 5745]]

the CDS Supplement, which applies to single-name CDS contracts and 
components of index CDS contracts that incorporate the 2014 ISDA Credit 
Derivatives Definitions, and Part C of the CDS Supplement, which 
applies to swaptions transactions. The proposed rule change would do so 
by amending the CDS Clearing Supplement to incorporate the versions of 
the ISDA supplement and confirmations that are currently in-force. 
After the NTCE Supplement becomes effective, the latest versions of the 
ISDA supplement and confirmations will incorporate the NTCE Supplement 
and by default specify that the two concepts described above--the 
Credit Deterioration Requirement and Fallback Discounting--are 
applicable. Thus, in specifying that the versions of the ISDA 
supplement and confirmations that are currently in-force would apply to 
single-name CDS contracts and components of index CDS contracts that 
incorporate the 2014 ISDA Credit Derivatives Definitions and swaptions, 
the proposed rule change would automatically apply the NTCE Supplement 
to such transactions.
    The proposed rule change would also specify that the amendments 
resulting from the NTCE Supplement to the 2014 ISDA Credit Derivatives 
Definitions would only be applicable where the Protocol Effectiveness 
Condition, as defined in the ISDA 2019 Narrowly Tailored Credit Event 
Protocol, is satisfied. Because ISDA has already determined that the 
Protocol Effectiveness Condition is satisfied, effectively the proposed 
rule change would apply the amendments resulting from the NTCE 
Supplement to all single-name CDS contracts and components of index CDS 
contracts that incorporate the 2014 ISDA Credit Derivatives Definitions 
and all swaptions transactions currently in place or that are entered 
into on or after January 27, 2020 (the implementation date determined 
by ISDA).\11\
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    \11\ See ISDA 2019 NTCE Protocol, available at https://www.isda.org/protocol/isda-2019-ntce-protocol/.
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C. Outstanding Principal Balance

    Unrelated to the changes discussed above, the proposed rule change 
would also harmonize the use of the term ``Outstanding Principal 
Balance'' throughout the LCH SA CDS Supplement by ensuring that the 
term is only used with capital letters. Section 1.1 of the LCH SA CDS 
Supplement specifies that capitalized terms not otherwise defined 
therein shall have the meaning given pursuant to, among other 
documents, the ISDA 2003 and 2014 Credit Derivatives Definitions, and 
explicitly incorporates into the LCH SA CDS Supplement such defined 
terms. The term ``Outstanding Principal Balance'' is defined in the 
ISDA 2003 and 2014 Credit Derivatives Definitions, and according to LCH 
SA is intended to be incorporated into the LCH SA CDS Supplement. 
However, the term ``Outstanding Principal Balance'' is not consistently 
capitalized throughout the current version of the LCH SA CDS 
Supplement. Accordingly, because LCH SA intends that the term 
``Outstanding Principal Balance'' should be an incorporated defined 
term as defined in Section 1.1 of the LCH SA CDS Supplement, the 
proposed rule change would amend the LCH SA CDS Supplement by 
capitalizing the term ``Outstanding Principal Balance'' where not 
already capitalized.

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.\12\ For the reasons given below, the Commission finds 
that the proposed rule change is consistent with Section 17A(b)(3)(F) 
of the Act \13\ and Rule 17Ad-22(e)(1) thereunder.\14\
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    \12\ 15 U.S.C. 78s(b)(2)(C).
    \13\ 15 U.S.C. 78q-1(b)(3)(F).
    \14\ 17 CFR 240.17Ad-22(e)(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 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, 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.\15\
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    \15\ 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 and swaptions 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 determined that the Protocol 
Effectiveness Condition is satisfied and set an implementation date of 
January 27, 2020, the NTCE Supplement will apply to all swaptions and 
single-name CDS contracts and components of index CDS contracts that 
incorporate the 2014 ISDA Credit Derivatives Definitions currently in 
place or entered into on or after that date.
    As noted above, because LCH SA will clear and settle CDS contracts 
and swaptions that are subject to the changes being made by the NTCE 
Supplement, the proposed rule change would amend the LCH SA CDS 
Supplement to incorporate the amendments resulting from the NTCE 
Supplement, thereby ensuring that LCH SA's Rules accurately reflect and 
appropriately apply the legal terms and conditions applicable to such 
CDS contracts and swaptions. Separately, to help clarify and ensure 
that the term ``Outstanding Principal Balance'' is and remains an 
incorporated defined term pursuant to Section 1.1 of the CDS 
Supplement, the proposed rule change would amend the CDS Supplement to 
capitalize the term ``Outstanding Principal Balance'' consistently 
throughout the document.
    In the Commission's view, a lack of clarity in the underlying legal 
terms and conditions applicable to the transactions that LCH SA clears 
and settles could hinder LCH SA'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 LCH 
SA's ability to safeguard such margin. Accordingly, by making the 
changes described above, and in particular by ensuring LCH SA's Rules 
accurately reflect and appropriately apply the legal terms and 
conditions applicable to the CDS contracts and swaptions that are 
cleared and settled by LCH SA, the Commission believes that the 
proposed rule change would help ensure that LCH SA's Rules continue to 
promote the prompt and accurate clearance and settlement of such the 
CDS contracts and swaptions and assure the safeguarding of securities 
and funds in LCH SA'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.

[[Page 5746]]

    Therefore, the Commission finds that the proposed rule change is 
consistent with Section 17A(b)(3)(F) of the Act.\16\
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    \16\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(1)

    Rule 17Ad-22(e)(1) requires that LCH SA establish, implement, 
maintain, and enforce written policies and procedures reasonably 
designed to provide for a well-founded, clear, transparent, and 
enforceable legal basis for each aspect of its activities in all 
relevant jurisdictions.\17\ As discussed above, the proposed rule 
change would help to clarify and ensure that LCH SA's Rules accurately 
reflect and appropriately apply the legal terms and conditions 
applicable to the CDS contracts and swaptions that are cleared and 
settled by LCH SA. The Commission believes that this, in turn, would 
help ensure that the LCH SA CDS Supplement provides a consistent and 
enforceable legal basis for clearing and settling CDS contracts and 
swaptions to which the NTCE Supplement applies in light of the 
amendments made by the NTCE Supplement.
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    \17\ 17 CFR 240.17Ad-22(e)(1).
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    Therefore, the Commission finds that the proposed rule change is 
consistent with Rule 17Ad-22(e)(1).\18\
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    \18\ Id.
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as modified by Partial Amendment No. 1, 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-2019-011 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-2019-011. 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-2019-011 and should 
be submitted on or before February 21, 2020.

V. Accelerated Approval of the Proposed Rule Change, as Modified by 
Partial Amendment No. 1

    The Commission finds good cause, pursuant to Section 19(b)(2) of 
the Act,\19\ to approve the proposed rule change prior to the 30th day 
after the date of publication of Partial Amendment No. 1 in the Federal 
Register. As discussed above, Partial Amendment No. 1 amends the CDS 
Clearing Supplement so that, instead of referring to the specific date 
for various ISDA supplements, it explicitly refers to and incorporates 
whichever versions of the supplements to the standard contract terms 
are currently effective. By providing this additional clarity, Partial 
Amendment No. 1 provides for a more clear and comprehensive 
understanding of the estimated application of the proposed rule change, 
which helps to improve the Commission's review of the proposed rule 
change for consistency with the Act and helps market participants 
understand the impact of the proposed rule change.
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    \19\ 15 U.S.C. 78s(b)(2).
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    Additionally, because Partial Amendment No. 1 would help clarify 
and ensure that the appropriate legal terms and conditions are applied 
to the CDS contracts and swaptions cleared and settled by LCH SA, and 
for similar reasons as discussed above, the Commission finds that 
Partial Amendment No. 1 is designed to promote the prompt and accurate 
clearance and settlement of securities transactions, help assure the 
safeguarding of securities and funds which are in the custody or 
control of LCH SA, and, in general, to protect investors and the public 
interest, consistent with Section 17A(b)(3)(F) of the Act.\20\ 
Accordingly, the Commission finds good cause for approving the proposed 
rule change, as modified by Partial Amendment No. 1, on an accelerated 
basis, pursuant to Section 19(b)(2) of the Exchange Act.\21\
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    \20\ 15 U.S.C. 78q-1(b)(3)(F).
    \21\ 15 U.S.C. 78s(b)(2).
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VI. 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 \22\ and Rule 17Ad-22(e)(1) thereunder.\23\
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    \22\ 15 U.S.C. 78q-1(b)(3)(F).
    \23\ 17 CFR 240.17Ad-22(e)(1).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
\24\ that the proposed rule change, as modified by Partial Amendment 
No. 1 (SR-LCH-SA-2019-011), be, and hereby is, approved on an 
accelerated basis.\25\
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    \24\ 15 U.S.C. 78s(b)(2).
    \25\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\26\
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    \26\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2020-01517 Filed 1-30-20; 8:45 am]
 BILLING CODE 8011-01-P


