[Federal Register Volume 85, Number 235 (Monday, December 7, 2020)]
[Notices]
[Pages 78888-78889]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-26783]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90541; File No. SR-LCH SA-2020-006]


Self-Regulatory Organizations; LCH SA; Order Approving Proposed 
Rule Change Relating to the Amendments to LCH SA's Liquidity Risk 
Modelling Framework

December 1, 2020.

I. Introduction

    On October 20, 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 thereunder,\2\ a proposed rule change to amend its 
Liquidity Risk Modelling Framework (the ``Framework'') \3\ with respect 
to the assignment and exercise of equity American options.\4\ The 
Proposed Rule Change was published for comment in the Federal Register 
on October 30, 2020.\5\ 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\ Capitalized terms used but not defined herein have the 
meanings specified in the LCH SA CDS Clearing Rule Book, Supplement, 
Procedures, or the Framework as applicable.
    \4\ See Notice infra note 5, 85 FR at 68935.
    \5\ Self-Regulatory Organizations; LCH SA; Notice of Filing of 
Proposed Rule Change Relating to the Amendments of LCH SA Risk 
Liquidity Modeling Framework, Exchange Act Release No. 90270 
(October 26, 2020), 85 FR 68935 (October 30, 2020) (SR-LCH SA-2020-
006) (``Notice'').
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II. Description of the Proposed Rule Change

    LCH SA is proposing to amend the Framework in order to address more 
accurately its liquidity requirements arising from the physical 
settlement of equity American options involving a defaulting clearing 
member during any liquidation of such clearing member. The current 
Framework accounts for liquidity provision related to the risk of 
assignment and exercise of equity American options and equity European 
options at expiration.\6\ Given that equity American options can be 
exercised before their expiration dates (referred to below as 
``expiry''), LCH SA represented that there is a resulting funding risk 
with respect to the exercise of equity American options prior to expiry 
during the liquidation period of a defaulting clearing member that 
needs to be modelled and accounted for in its daily liquidity coverage 
ratio (``LCR'') calculation.\7\
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    \6\ See Notice, 85 FR at 68936.
    \7\ Id.
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    The LCR is the ratio of available assets over the liabilities of 
LCH SA under the stressed scenario of the default of the two largest 
clearing members (``Cover 2 scenario''), based on their liquidity 
needs.\8\ On a daily basis, the LCR calculation identifies all of the 
potential option positions that are in the money or at the money on 
that day and the next business day.\9\ Given the potential option 
exercise, the LCR calculation generates a liquidity need.\10\ LCH SA 
represented that the proposed rule change would be an enhancement to 
the current Framework to address the funding risk posed by the 
potential exercise of an equity American option at any time before 
expiry when the two largest clearing members in terms of liquidity 
needs may face liquidity issues.\11\
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    \8\ Id.
    \9\ Id.
    \10\ Id.
    \11\ Id.
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    To address this risk, LCH SA is proposing specific modifications to 
the Framework that would enable its LCR calculation to generate an 
enhanced liquidity need in a Cover 2 scenario involving the physical 
settlement of equity American options. The proposed rule change would 
replace the term ``expiry'' with the term ``exercise'' in both section 
5.3.1.3 (Cash Equity) and section 5.3.4 (Cover 2 selection, Cash Equity 
Settlement Liquidity Requirement) to account for equity settlements 
arising from the options' exercise, rather than their expiry. The 
proposed rule change would also revise the assumption about when equity 
American options are considered to be exercised, which is set forth in 
the ``Options Expiry'' paragraph of section 5.3.1.3 of the Framework. 
In that paragraph, the proposed rule change would replace the term ``at 
expiry'' with the phrase ``any time by defaulting members in order to 
raise liquidity.'' \12\
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    \12\ Id.
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    In practice, LCH SA represents that the process under the amended 
Framework will work as follows on a daily basis:
     The liquidity needs arising from the equity American 
options that are in the money or at the money will be computed, without 
applying a stress scenario to the equities.
     The liquidity needs from the equity American options that 
are in the money or at the money will be computed, by applying a stress 
scenario to the equities.
     LCH SA will select the positions consistent with the two 
largest clearing members in terms of liquidity needs for both modes 
described above and will retain the most punitive one.
     This liquidity amount that LCH SA will potentially need 
for the settlement of equity American options (i.e., the most punitive 
amount identified in the previous bullet) will then be added to the 
current cash equity settlement amount in the LCR.\13\
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    \13\ Id.
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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 
the proposed rule change is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to the 
organization.\14\ For the reasons given below, the Commission finds 
that the proposed rule change is consistent with Section 17A(b)(3)(F) 
of the Act \15\ and Rule 17Ad-22(e)(7)(i) thereunder.\16\
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    \14\ 15 U.S.C. 78s(b)(2)(C).
    \15\ 15 U.S.C. 78q-1(b)(3)(F).
    \16\ 17 CFR 240.17Ad-22(e)(7)(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, to 
assure the safeguarding of securities and funds which are in the 
custody or control of LCH SA or for which it is responsible.\17\
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    \17\ 15 U.S.C. 78q-1(b)(3)(F).
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    As described above, the proposed rule change would amend the 
Framework with specific changes in order to address more accurately LCH 
SA's

[[Page 78889]]

liquidity requirements arising from the physical settlement of equity 
American options involving a defaulting clearing member during any 
liquidation of such clearing member. Such changes should enhance LCH 
SA's daily LCR calculations to determine more accurate liquidity levels 
in the event of the assignment and exercise of equity American options 
involving a defaulting clearing member prior to expiry. The Commission 
believes the proposed rule change should help LCH SA anticipate 
increased liquidity needs and maintain appropriate levels of liquidity 
in a Cover 2 scenario in which LCH SA would be required, pursuant to 
the Framework, to step in and meet a defaulter's obligation in the 
event of the assignment or exercise of equity American options. The 
Commission also believes that, by anticipating and ensuring that LCH SA 
meets its liquidity needs in this manner, the proposed rule change 
should facilitate LCH SA's ability to meet its obligations as a central 
counterparty in stressed situations, which, in turn, should allow LCH 
SA to continue to meet its obligation to promptly and accurately clear 
and settle securities transactions in such situations.
    In addition, the proposed rule change should help mitigate the 
funding risk that may arise when equity American options are exercised 
before expiry and settled during the liquidation period of a defaulting 
clearing member, which in turn should help LCH SA safeguard securities 
and funds for which it is responsible.
    For the reasons stated above, the Commission believes that the 
proposed rule change is consistent with Section 17A(b)(3)(F) of the 
Act.\18\
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    \18\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(7)(i)

    Rule 17Ad-22(e)(7)(i) requires that, among other things, LCH SA 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to, as applicable, effectively measure, 
monitor, and manage the liquidity risk that arises in or is borne by 
the covered clearing agency, including measuring, monitoring, and 
managing its settlement and funding flows on an ongoing and timely 
basis, and its use of intraday liquidity by maintaining sufficient 
liquid resources at the minimum in all relevant currencies to effect 
same-day, and, where appropriate, intraday and multiday settlement of 
payment obligations with a high degree of confidence under a wide range 
of foreseeable stress scenarios, that includes, but is not limited to, 
the default of the participant family that would generate the largest 
aggregate payment obligation for LCH SA in extreme but plausible market 
conditions.\19\
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    \19\ 17 CFR 240.17Ad-22(e)(7)(i).
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    As discussed above, LCH SA is proposing specific modifications to 
the Framework that would enable its daily LCR calculation to generate 
an enhanced liquidity need in a Cover 2 scenario involving the physical 
settlement of equity American options. By using the daily LCR 
calculation process to determine in advance LCH SA's liquidity needs in 
the event of the assignment and exercise of equity American options 
arising in a Cover 2 scenario, the Commission believes the amended 
Framework should enhance LCH SA's ability to determine whether it has 
sufficient resources to meet its liquidity needs should such a default 
occur, thus requiring LCH SA to step in and meet a defaulter's payment 
obligation. The Commission believes that this should, in turn, enable 
LCH SA to avoid any potential disruptions to its operations caused by 
the liquidity needs arising from such a default.
    By applying both stressed and non-stressed scenarios to the 
underlying equities, and then selecting the option positions that are 
consistent with the two largest clearing members in terms of liquidity 
needs under both scenarios to determine the largest liquidity need, LCH 
SA's daily LCR calculation process under the amended Framework should 
help LCH SA determine a more accurate amount to add to the current cash 
equity settlement amount in the LCR to cover a potential increase in 
liquidity needs arising from the physical settlement of equity American 
options that are exercised prior to expiry under stressed liquidity 
conditions. The Commission therefore believes that the amended 
Framework should enable LCH SA to maintain sufficient liquid resources 
to effect settlement of its payment obligations under a wide range of 
foreseeable stress scenarios, including the default of the participant 
family that would generate the largest aggregate payment obligation for 
LCH SA in extreme but plausible market conditions.
    For the above reasons, the Commission therefore finds that the 
proposed rule change is consistent with Rule 17Ad-22(e)(7)(i).\20\
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    \20\ 17 CFR 240.17Ad-22(e)(7)(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 \21\ and Rule 17Ad-22(e)(7)(i) thereunder.\22\
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    \21\ 15 U.S.C. 78q-1(b)(3)(F).
    \22\ 17 CFR 240.17Ad-22(e)(7)(i).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
\23\ that the proposed rule change (SR-LCH SA-2020-006) be, and hereby 
is, approved.\24\
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    \23\ 15 U.S.C. 78s(b)(2).
    \24\ 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.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-26783 Filed 12-4-20; 8:45 am]
BILLING CODE 8011-01-P


