[Federal Register Volume 85, Number 170 (Tuesday, September 1, 2020)]
[Notices]
[Pages 54452-54454]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-19191]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-89678; File No. SR-LCH SA-2020-002]


Self-Regulatory Organizations; LCH SA; Order Approving Proposed 
Rule Change, as Modified by Amendment No. 1, Relating to Clearing of 
Markit iTraxx MSCI ESG Screened Europe Index Contracts

August 26, 2020.

I. Introduction

    On June 26, 2020, 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,\2\ 
a proposed rule change to amend the LCH SA Methodology Services 
Reference Guide: CDS Margin Framework (``CDS Margin Framework'') to: 
(i) Permit the clearing of CDS contracts on the iTraxx MSCI ESG 
Screened Europe index (the ``ESG Index''); (ii) make certain 
clarifications to facilitate validations of the CDS Margin Framework; 
and (iii) correct drafting errors in the CDS Margin Framework. On July 
8, 2020, LCH SA filed Amendment No. 1 to the proposed rule change.\3\ 
The proposed rule change, as modified by Amendment No. 1 (hereafter the 
``proposed rule change''), was published for comment in the Federal 
Register on July 15, 2020.\4\ The Commission did not receive 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\ Amendment No. 1 corrected minor errors in the description of 
the proposed rule change as originally filed with the Commission by 
explaining the clarifications made to Sections 3.2 and 3.8 of the 
CDS Margin Framework and removing a description of a change not 
being made as part of this filing.
    \4\ Self-Regulatory Organizations; LCH SA; Notice of Filing of 
Proposed Rule Change, as Modified by Amendment No. 1, Relating to 
Introduction of Clearing of the New Markit iTraxx MSCI ESG Screened 
Europe Index Contracts, Exchange Act Release No. 89268 (July 9, 
2020), 85 FR 42959 (July 15, 2020) (SR-LCH-SA-2020-002) 
(``Notice'').
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II. Description of the Proposed Rule Change

A. Clearing of the ESG Index

    As described further in the Notice, the ESG Index is a subset of 
the iTraxx Europe Main Index containing companies from the iTraxx 
Europe Main Index (transactions on which LCH SA currently clears) that 
meet certain corporate responsibility criteria.\5\ Before clearing CDS 
contracts on the ESG Index, LCH SA must ensure it can account for the 
risks associated with clearing transactions in the ESG Index. To 
account for such risks, LCH SA would apply its CDS Margin Framework to 
CDS contracts on the ESG Index. Thus, by modifying the CDS Margin 
Framework to apply to CDS contracts on the ESG Index, the proposed rule 
change would permit LCH SA to clear transactions in the ESG Index.
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    \5\ See Notice, 85 FR at 42960. This description is excerpted 
from the Notice, 85 FR at 42959. Capitalized terms not otherwise 
defined herein have the meanings assigned to them in the CDS Margin 
Framework or the LCH SA CDS Clearing Rule Book, as applicable.
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    To apply the CDS Margin Framework to transactions in the ESG Index, 
the proposed rule change would make two changes to the CDS Margin 
Framework. First, in Sections 2.3.3 and 3.8.1.3, the proposed rule 
change would remove references to specific CDS indices so that the CDS 
Margin Framework no longer refers to these indices by name (like the 
iTraxx Europe Main Index). The proposed rule change would replace these 
specific references with generic references to an index or indices. 
Thus, the proposed rule change would help to ensure that the CDS Margin 
Framework applies to CDS contracts on all indices that LCH SA clears, 
including the ESG Index, rather than the specific indices currently 
named in the CDS Margin Framework.
    Second, in Section 3.8.1.3, the proposed rule change would replace 
a specific reference to the constituents of the iTraxx Europe Main 
Index with a more generic reference to the constituents of the indices 
cleared by LCH SA and revise a formula to make the formula applicable 
to the iTraxx Europe Main Index and its sub-indices, which would 
include the ESG Index (as mentioned above, the ESG Index is a subset of 
the iTraxx Europe Main Index). Again, these changes would help to 
ensure that these aspects of the CDS Margin Framework apply to CDS 
contracts on all indices that LCH SA clears, including the ESG Index.
    LCH SA represents that clearing of CDS contracts on the ESG Index 
will not require any other changes to the CDS Margin Framework or LCH 
SA CDS Clearing Rule Book.\6\
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    \6\ See Notice, 85 FR at 42960.
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B. Clarifications to the CDS Margin Framework To Facilitate Validations

    The proposed rule change would also make the following changes to 
the CDS Margin Framework. These changes

[[Page 54453]]

address changes requested by LCH SA's Risk Model Validation team so 
that it can better assess the CDS Margin Framework.
    First, the proposed rule change would amend Section 3.8 with 
respect to wrong way risk margin. In Section 3.8.1.2, the proposed rule 
change would add a distinction between CDS contracts on Senior 
Unsecured Debt securities and CDS contracts on Senior Loss Absorbing 
Capacity securities. With this change, LCH would calculate wrong way 
risk margin for CDS contracts on these securities separately, as two 
different instruments. Next, the proposed rule change would add 
explanation to Section 3.8.2 to better describe the calibration of 
certain changes to the calculation of the wrong-way risk component of 
margin when applying that component to certain indices that contain 
U.S.-based companies.
    Similarly, the proposed rule change would amend Section 4.1, 
regarding liquidity and concentration risk margin. The proposed rule 
change would add further description to Section 4.1 of the parameters 
used in a formula that is part of the calculation of liquidity and 
concentration risk margin. Also in Section 4.1, the proposed rule 
change would add description to explain further a variable in a formula 
that LCH SA uses to compute the Average Liquidity Score and how the 
value of that variable corresponds to the particular days in the time 
period that LCH uses to compute the average of the score. Finally, the 
proposed rule change would amend Section 4.1.8, regarding a formula 
used in the determination of the liquidity charge for index basis 
packages, to make a component of that formula an absolute value.
    Finally, in anticipation of the transition from the Euro Overnight 
Index Average (EONIA) to the new Euro Short-Term Rate and the Fed Funds 
Rate to the Secured Overnight Financing Rate, the proposed rule change 
replace references to a specific named interest rate (like EONIA) with 
more generic references to a rate, in Section 5.2.

C. Corrections to the CDS Margin Framework

    In addition to the clarifications requested by LCH SA's Risk Model 
Validation team, the proposed rule change would make a number of other 
updates to the CDS Margin Framework to correct drafting errors.
    First, Section 2.3.3 names three specific dealers that LCH may use 
as sources for historical price data. The proposed rule change would 
remove references to these specific dealers and instead refer 
generically to dealers and their history of prices. LCH SA is making 
this change because it may wish to contact other dealers, as needed, 
beyond those currently named in Section 2.3.3. Thus, the revised 
drafting would remove an unintentional limitation on LCH SA's ability 
to obtain historical price data from a variety of dealers.
    Next, Section 3.2 contains a table that describes, in a summary 
format, the various components of LCH SA's margin methodology and 
whether those components apply to CDS and options on index CDS. This 
table in Section 3.2 currently incorrectly states that wrong way risk 
margin does not apply to options on index CDS. The proposed rule change 
would correct this drafting error by amending the table to state that 
wrong way risk margin does apply to options on index CDS.
    Section 3.5.6 contains formulas that LCH SA uses to calculate 
profit and loss for the spread margin and short charge component of 
margin. The proposed rule change would correct these formulas to 
reflect the fact that the same date is selected to calculate the 
portfolio profit and loss for all contracts in the portfolio.
    Similarly, the proposed rule change would update the list of CDS 
contracts considered in Section 3.6. Section 3.6 describes LCH SA's 
calculation of margin associated with interest rate risk. This 
calculation considers CDS contracts of varying lengths, starting at one 
month. The proposed rule change would remove from this calculation CDS 
contracts lasting nine months. Due to a change imposed by ISDA related 
to the interest rate curve, LCH SA represents that it is no longer 
correct to include CDS contracts lasting nine months.
    Section 3.8 provides an overview of wrong way risk margin. As part 
of this overview, Section 3.8 also describes the short charge component 
of margin. As currently stated, this description of the short charge 
component is incorrect because it states that short charge covers the 
risk that two entities default. LCH SA represents that this is not 
correct and is a drafting error because the short charge component 
covers the risk that at least one entity defaults. The proposed rule 
change would correct this description to note that the short charge 
covers the risk that at least one entity defaults.
    Finally, Section 3.8.1 contains a number of formulas related to the 
calculation of wrong way risk margin. LCH SA states that these formulas 
as drafted are incomplete because they are missing a second value of 
zero. The proposed rule change would correct this drafting error by 
adding to the formulas the second value of zero.

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.\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 Rule 17Ad-22(e)(6)(i) 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).
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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 and to 
assure the safeguarding of securities and funds which are in the 
custody or control of LCH SA or for which it is responsible.\10\
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    \10\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission believes the changes to the CDS Margin Framework 
described in Section II.A above should facilitate LCH SA's clearing of 
CDS contracts on the ESG Index by ensuring that LCH SA's margin 
calculations apply to the risks of clearing such contracts. Because 
accounting for the risks of clearing CDS contracts on the ESG Index is 
necessary before LCH SA may begin clearing such contracts, the 
Commission believes this aspect of the proposed rule change should 
facilitate LCH SA's clearing of CDS contracts on the ESG Index and, 
therefore, the prompt and accurate clearance and settlement of CDS 
contracts and transactions.
    Moreover, the Commission believes the changes to the CDS Margin 
Framework described in Section II.B above should improve LCH SA's 
ability to assess and validate the CDS Margin Framework.\11\ Because 
such assessments could identify potential errors or other issues with 
the CDS Margin Framework,

[[Page 54454]]

the Commission believes that, by improving LCH SA's ability to assess 
and validate the CDS Margin Framework, the changes described in Section 
II.B above should help to ensure the continued performance of the CDS 
Margin Framework and, therefore, LCH SA's ability to calculate margin 
using the CDS Margin Framework. For similar reasons, the Commission 
believes the changes described in Section II.C above should improve the 
CDS Margin Framework, and LCH SA's ability to calculate margin using 
the CDS Margin Framework, by correcting drafting errors.
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    \11\ The Commission notes that, pursuant to Rule 17Ad-
22(e)(6)(vii), LCH SA must establish, implement, maintain, and 
enforce written policies and procedures reasonably designed to cover 
its credit exposures to its participants by establishing a risk-
based margin system that, at a minimum requires a model validation 
for its margin system and related models to be performed not less 
than annually or more frequently as required by its risk management 
framework.
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    Because they should improve LCH SA's ability to calculate margin 
using the CDS Margin Framework, the Commission believes that the 
changes described in Section II.B and Section II.C above should enhance 
LCH SA's ability to use margin to avoid losses that could result from 
miscalculating the risks associated with clearing transactions. The 
Commission further believes that these losses could negatively affect 
LCH SA's ability to clear and settle transactions and safeguard funds. 
Therefore, the Commission believes that by improving LCH SA's ability 
to avoid losses that could result from mismanaging the risks associated 
with clearing transactions, these aspects of the proposed rule change 
should promote the prompt and accurate clearance and settlement of CDS 
contracts and transactions and assure the safeguarding of securities 
and funds which are in the custody or control of LCH SA or for which it 
is responsible.
    For these reasons, the Commission finds that the proposed rule 
change is consistent with Section 17A(b)(3)(F) of the Act.\12\
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    \12\ 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 that LCH SA establish, implement, 
maintain, and enforce written policies and procedures reasonably 
designed to cover its credit exposures to its participants by 
establishing a risk-based 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.\13\ As 
discussed above, the Commission believes the changes to the CDS Margin 
Framework described in Section II.A above should facilitate LCH SA's 
clearing of CDS contracts on the ESG Index by modifying LCH SA's margin 
calculations to take into account the risks of clearing such contracts. 
The Commission therefore believes these changes should help to ensure 
that LCH SA's margin system considers, and produces margin levels 
commensurate with, the risks and particular attributes of CDS contracts 
on the ESG Index.
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    \13\ 17 CFR 240.17Ad-22(e)(6)(i).
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    Moreover, as discussed above, the Commission believes the changes 
described in Section II.B above should improve LCH SA's ability to 
assess and validate the CDS Margin Framework. The Commission further 
believes this aspect of the proposed rule change should help LCH SA to 
identify any possible errors in, and make improvements to, the CDS 
Margin Framework. Similarly, as discussed above, the Commission 
believes the changes described in Section II.C above should improve the 
CDS Margin Framework by correcting drafting errors. The Commission 
further believes this aspect of the proposed rule change should help 
resolve possible errors in applying the CDS Margin Framework and reduce 
the possibility for confusion or mistakes in using the CDS Margin 
Framework. Finally, by helping to improve the CDS Margin Framework, 
resolve possible errors, and reduce the possibility for confusion or 
mistakes, the Commission believes that the changes described in Section 
II.B and Section II.C above should help to ensure that LCH SA's margin 
system considers, and produces margin levels commensurate with, the 
risks and particular attributes of the transactions cleared by LCH SA.
    For these reasons, the Commission finds that the proposed rule 
change is consistent with Rule 17Ad-22(e)(6)(i).\14\
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    \14\ 17 CFR 240.17Ad-22(e)(6)(i).
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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 Rule 17Ad-22(e)(6)(i) 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).
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    IT IS THEREFORE ORDERED pursuant to Section 19(b)(2) of the Act 
\17\ that the proposed rule change, as modified by Amendment No. 1 (SR-
LCH-SA-2020-002), 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).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2020-19191 Filed 8-31-20; 8:45 am]
BILLING CODE 8011-01-P


