[Federal Register Volume 87, Number 133 (Wednesday, July 13, 2022)]
[Notices]
[Pages 41788-41791]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-14879]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-95207; File No. SR-LCH SA-2022-004]


Self-Regulatory Organizations; LCH SA; Notice of Filing of 
Proposed Rule Change Relating to the Clearing of Markit iTraxx[supreg] 
Australia Indices and the Associated Single Name Constituents and 
Remediation of WWR Margin Instability

July 7, 2022.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 thereunder \2\ notice 
is hereby given that on June 30, 2022, Banque Centrale de Compensation, 
which conducts business under the name LCH SA (``LCH SA''), filed with 
the Securities and Exchange Commission (``Commission'' or ``SEC'') the 
proposed rule change described in Items I, II, and III below, which 
Items have been prepared primarily by LCH SA. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    (a) LCH SA is proposing to amend its CDSClear Risk methodology and 
its CDS Clearing Supplement (the ``Clearing Supplement'') to allow LCH 
SA to enhance and expand its clearing services as follows: LCH SA 
intends to (i) permit the clearing of Markit iTraxx[supreg] Australia 
indices and the associated single name constituents, (the ``iTraxx 
Change'') and (ii) provide a remediation to one independent model 
validation recommendation regarding the Wrong Way Risk (WWR) margin 
instability (the ``WWR Change'') (all together the ``Proposed Rule 
Change'').
    The text of the Proposed Rule Change is in Exhibit 5.\3\
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    \3\ All capitalized terms not defined herein have the same 
definition as in the CDS Clearing Rule Book, Supplement or 
Procedures, as applicable.
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    The implementation of the Proposed Rule Change will be contingent 
on LCH SA's receipt of all necessary regulatory approvals.
    (b) Not applicable.
    (c) Not applicable.

II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

    In its filing with the Commission, LCH SA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. LCH SA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of these statements.

A. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

(a) Purpose

    The purpose of the Proposed Rule Change is to revise LCH SA's 
rules, procedures and supplement to (1) permit the clearing of Markit 
iTraxx[supreg] Australia indices and the associated single name 
constituents and (2) provide the remediation to the WWR margin 
instability.
(1) Proposed Amendments To Permit the Clearing of Markit iTraxx[supreg] 
Australia Indices
(a) Amendments to the Clearing Supplement
    The Clearing Supplement has been amended in order to include the 
relevant provisions to allow the clearing of the new Markit 
iTraxx[supreg] Australia indices.
    In Part B of the Clearing Supplement, Section 1.2 (Terms defined in 
the CDS Clearing Supplement) has been amended to include a new sub-
paragraph (a) to the definition of an ``Index Cleared Transaction 
Confirmation'' in order to make a reference to the form of confirmation 
which incorporates the iTraxx[supreg] Asia/Pacific Untranched Standard 
Terms Supplement. As a consequence, the sub-paragraphs (a), (b), (c), 
and (d) have been re-lettered as (b), (c), (d), (e), respectively.
    Section 2.2 (Index Cleared Transaction Confirmation) of Part B of 
the Clearing Supplement has been also amended to make appropriate 
references

[[Page 41789]]

to any Index Cleared Transaction that is a Markit iTraxx[supreg] 
Australia Index in paragraphs (a)(i), (b)(i), (c)(i) and (f)(i).
(b) Proposed Amendments to the CDSClear Risk Framework
    LCH SA is proposing to amend its Methodology Services Reference 
Guide: CDS Margin Framework (``CDSClear Risk Methodology'') under 
Section 2.1.1.1 (Interest Rate Curve) to proceed with the removal of 
the interest rate curve name used with the International Swaps and 
Derivatives Association, Inc. (ISDA) standard model pricer (used as a 
converter between upfront cash and quoted spread in basis points, as 
described on www.cdsmodel.com) that does not need to be clearly 
specified in such risk documentation. The objective now is to refer to 
the original website when the market moves to the new Risk Free Rates, 
so that the CDSClear Risk Methodology always automatically refers to 
the latest state in the market without risking becoming outdated.
    For clarity purposes only, LCH SA is proposing to remove ``through 
a CDS index'' under the provisions of Section 3.2 (Self-referencing 
margin risk) as the Self-Referencing Margin would apply as soon as the 
clearing member sells protection on itself whatever the financial 
instrument used.
    The other proposed change specified under Section 3.4.5 (Portfolio 
Margining) is intended to add iTraxx[supreg] Australia to the list of 
indices on which index basis packages can be cleared.
    As there are financial single name constituents in the 
iTraxx[supreg] Australia index family, positions on this index will be 
subject to the Wrong Way Risk margin, a margin that aims at capturing 
the potential contagion effect off the default of a clearing member 
(that is a financial institution) on instruments with open positions in 
the defaulter's portfolio. Here, it would be the risk that Australian 
financials credit spreads may widen following the default of a clearing 
member, to an extent that goes beyond the spread move already covered 
by the spread margin. This requirement, coupled with the need to 
address a recommendation raised by the independent risk model 
validation on the instability of the Wrong Way Risk margin component, 
result in LCH SA also proposing to amend the provisions under Section 
3.8 of the CDSClear Risk Methodology about the Wrong Way Risk margin to 
introduce the following updates:

--the introduction of the shocks applied to Australian entities in 
Section 3.8.1.1 (Spread parallel moves), alongside the shocks applied 
to existing products.
--a generalisation of the calculation to all indices under Section 
3.8.1.4 (Index Shocks) instead of just referring to Senior Financial or 
its parent index Main as it was previously in Section 3.8.1.3.
--a description of the way the shocks on indices are defined in Section 
3.8.1.4 (Index Shocks), being derived directly from the shocks applied 
on constituents as a spread and CS01 weighted average. This would apply 
to iTraxx[supreg] Australia as well as other indices containing 
financial names, although no financial impact is expected since index 
shocks are currently already calibrated as the average shock of their 
constituents.
--As required to address the recommendation raised by the Independent 
Model Validation, a specification that the contribution to the spread 
margin used to derive the spread_SM under Sections 3.8.1.5 (Wrong-Way/
Right-Way P&L) and 3.8.1.6 (Instrument level Expected Shortfall) would 
now consider the contribution of a single tenor, instead of the joint 
contribution of all tenors on a given product, to address the WWR 
margin instability observed with curve trades.
--the introduction of iTraxx[supreg] Australia alongside other regions 
under Section 3.8.1.8 (Trigger) when aggregating Wrong way and Right 
way across regions.
--Some of the existing provisions under Sections 3.8.2 (Offsets inter-
region) and 3.8.3 (Final WWR Margin) have been moved to the general 
Section 3.8.1 explaining the overall WWR calculation. The shocks 
defined when extending to CDX products are now part of the table inside 
Section 3.8.1.1 (Spread parallel moves) and the relevant provision has 
been moved at the end of this same section. The provision about Sub 
Financials has been moved to the Section 3.8.1.2 (Sub Financials) as a 
subsection of 3.8.1 (WWR: Parallel Move).

    Further, the provisions of Section 4 on Additional Margin are 
proposed to be updated for the Liquidity and Concentration Risk Margin 
under paragraphs 4.1.2 (Macro Hedging Phase) and 4.1.4.1 
(Diversification Ratio) to specify that iTraxx[supreg] Australia index 
would be used for hedging and would define an additional sub-portfolio 
when considering liquidation costs.
    Finally, LCH SA is also taking this opportunity to propose changes 
for consistency purposes by removing from its CDSClear Risk methodology 
documentation any reference to IBOR curves in Section 2.1.1.1, and 
refer instead to the cdsmodel.com website which details the pricer used 
by all market participants to convert from quoted spreads to upfronts 
in parallel to the cessation of IBOR and the transition to Risk Free 
Rates, and also clarify in Section 1, Introduction that the short 
charge can cover 1 or 2 credit events, as the CDX.HY component does 
cover 2 defaults and was not correctly reflected in the introduction.
(b) Statutory Basis
    LCH SA believes that the Proposed Rule Change is consistent with 
the requirements of Section 17A of the Act \4\ and regulations 
thereunder applicable to it, including Commission Rule 17Ad-22(e).\5\ 
In particular, Section 17A(b)(3)(F) of the Act requires, inter alia, 
that the rules of a clearing agency be designed to ``promote the prompt 
and accurate clearance and settlement of . . . derivatives agreements, 
contracts, and transactions''.\6\ By proposing to amend its CDS 
Clearing Supplement to authorize the acceptance of the new 
iTraxx[supreg] Australia transactions, on the terms and conditions set 
out in the Proposed Rule Change, LCH SA considers that this would 
encourage Clearing Members to clear additional indices and single name 
CDS through its CDSClear service, which, in turn, should promote the 
prompt and accurate clearance and settlement of those instruments 
within the meaning of Section 17A(b)(3)(F) of the Act.\7\
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    \4\ 15 U.S.C. 78q-1.
    \5\ 17 CFR 240.17Ad-22.
    \6\ 15 U.S.C. 78q-1(b)(3)(F).
    \7\ 15 U.S.C. 78q-1(b)(3)(F).
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    By improving the stability of the WWR margin in order for LCH SA 
CDSClear to collect the appropriate level of margin amount required for 
any clearing member portfolio, the proposed WWR Change is also 
consistent with the SEC requirement for accurate clearance and 
settlement of transactions cleared by LCH SA.
    Further, from the perspective of financial risk management and 
margin requirements, the clearing of the proposed new iTraxx[supreg] 
Australia index and the associated single name constituents would not 
require changes to LCH SA's existing margin methodology, default 
management policies and procedures and operational process, as the 
proposed products do not include any new risk factor compared to the 
Corporates and Financials indices or single names already cleared by 
the LCH SA CDSClear service. The iTraxx[supreg] Australia transactions 
would be cleared pursuant to LCH SA's existing clearing

[[Page 41790]]

arrangements and related financial safeguards, protections and risk 
management procedures which are consistent with Exchange Act Rule 17Ad-
22(e)(17),\8\ requiring a covered clearing agency to establish, 
implement, maintain and enforce written policies and procedures 
reasonably designed to manage the covered clearing agency's operational 
risks by, among other things, identifying the plausible sources of 
operational risk, both internal and external, and mitigating their 
impact through the use of appropriate systems, policies, procedures, 
and controls.
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    \8\ 17 CFR 240.17Ad-22(e)(17).
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    Adopting rules to facilitate the clearing of the iTraxx[supreg] 
Australia transactions would also be consistent with other relevant 
requirements of Rule 17Ad-22(e),\9\ as set forth in the following 
discussion.
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    \9\ 17 CFR 240.17Ad-22(e).
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    Margin Requirements. Rule 17Ad-22(e)(4) \10\ requires LCH SA to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to effectively identify, measure, 
monitor, and manage its credit exposures to participants and those 
arising from its payment, clearing, and settlement processes, among 
other requirements. In terms of financial resources, LCH SA would apply 
its existing margin methodology--including its Wrong Way Risk margin 
framework--to the new iTraxx[supreg] Australia Index, which are similar 
to the European indices currently cleared by LCH SA. LCH SA believes 
that the proposed rules that would apply this risk model to the new 
iTraxx[supreg] Australia Index will provide sufficient margin 
requirements to cover its credit exposure to its clearing members from 
clearing such contracts, consistent with the requirements of Rule 17Ad-
22(e)(4).\11\
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    \10\ 17 CFR 240.17Ad-22(e)(4).
    \11\ 17 CFR 240.17Ad-22(e)4.
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    Financial Resources. Rule 17Ad-22(e)(4)(i) \12\ requires LCH SA to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to effectively identify, measure, 
monitor, and manage its credit exposures to participants and those 
arising from its payment, clearing, and settlement processes by 
maintaining sufficient financial resources to cover its credit exposure 
to each participant fully with a high degree of confidence. To the 
extent not already maintained pursuant to paragraph (e)(4)(i), Rule 
17Ad-22(e)(4)(ii) \13\ requires LCH SA's policies and procedures be 
reasonably designed to maintain additional financial resources at the 
minimum to enable it to cover a wide range of foreseeable stress 
scenarios that include, but are not limited to, the default of the two 
participant families that would potentially cause the largest aggregate 
credit exposure for the covered clearing agency in extreme but 
plausible market conditions. As explained in the above paragraph on 
Margin Requirements, LCH SA also believes its Default Fund, under its 
existing methodology, will, together with the required margin, provide 
sufficient financial resources to support the clearing of the new 
iTraxx[supreg] Australia Index contracts, consistent with the 
requirements of Rules 17Ad22(e)(4)(i) and (ii).
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    \12\ 17 CFR 240.17Ad-22(e)(4)(i).
    \13\ 17 CFR 240.17Ad-22(e)(4)(ii).
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    Operational Resources. Rule 17Ad-22(e)(3) \14\ requires LCH SA to 
establish, implement, maintain and enforce written policies and 
procedures reasonably designed to maintain a sound risk management 
framework for comprehensively managing legal, credit, liquidity, 
operational, general business, investment, custody, and other risks 
that arise in or are borne by the covered clearing agency. LCH SA 
believes that its existing operational and risk management resources 
will be sufficient for clearing of the iTraxx Australia transactions, 
consistent with the requirements of Rule 17Ad-22(e)(3),\15\ as this new 
index contract is substantially the same from an operational and risk 
management perspective as the existing index contracts.
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    \14\ 17 CFR 240.17Ad-22(e)(3).
    \15\ 17 CFR 240.17Ad-22(e)(3).
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    LCH SA will also apply its existing default management policies and 
procedures for the iTraxx[supreg] Australia transactions. As with 
current CDSClear products with similar risk profile, LCH SA believes 
that these procedures allow for it to take timely action to contain 
losses and liquidity pressures and to continue meeting its obligations 
in the event of clearing member insolvencies or defaults in respect of 
the additional single names, in accordance with Rule 17Ad-22(e)(3).\16\
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    \16\ 17 CFR 240.17Ad-22(e)(3).
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    Exchange Act Rule 17Ad-22(e)(1) \17\ requires that a covered 
clearing agency 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. As described 
above, the proposed [iuml]Traxx Change is also modifying the CDSClear 
framework for indices and single names CDS to take into account the new 
product iTraxx[supreg] Australia indices and the associated single name 
constituents and provide for a clear and transparent legal basis for 
LCH SA's CDS Clearing rules consistent with the requirements of 
Exchange Act Rule 17Ad-22(e)(1).\18\
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    \17\ 17 CFR 240.17Ad-22(e)(1).
    \18\ 17 CFR 240.17Ad-22(e)(1).
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    Following the recommendation raised by the LCH SA CDSClear Risk 
model validation, the proposed WWR Change is improving the stability 
and accuracy of the WWR margin so that LCH SA can determine and duly 
collect the full margin amount required for the level of risk exposure 
of any clearing member portfolio. Therefore LCH SA believes it is 
consistent with Rule 17Ad-22(e)(6)(i),\19\ requiring a covered clearing 
agency to 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.
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    \19\ 17 CFR 240. 17Ad-22(e)(6).
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    Credit default swap (CDS) is an over-the-counter (OTC) market on 
which participants can be active at any time in the context of market 
stress. The LCH SA CDSClear risk model is considering 5-d moves of 
unhedged portfolios and the back testing results confirmed that the 
margins were sufficient to cover the exposure in the interval between 
the last margin collection and the close out of the portfolio a 
defaulting cleating member which is consistent with the requirements of 
SEC Rule 17Ad-22(e)(6)(iii).\20\
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    \20\ 17 CFR 240. 17Ad-22(e)(6)(iii).
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    For all these reasons, LCH SA believes that the Proposed Rule 
Change is consistent with the requirements of Section 17A of the Act 
and the regulations thereunder, including the standards under Rule 
17Ad-22 \21\ as discussed above.
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    \21\ 17 CFR 240.17Ad-22.
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B. Clearing Agency's Statement on Burden on Competition
    Section 17A(b)(3)(I) of the Exchange Act requires that the rules of 
a clearing agency not impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Act.\22\
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    \22\ 15 U.S.C. 78q-1(b)(3)(I).
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    LCH SA does not believe that its proposed clearing of Markit 
iTraxx[supreg] Australia indices and the associated single name 
constituents will adversely

[[Page 41791]]

affect competition in the trading market for those contracts or CDS 
generally. By allowing LCH SA to clear Markit iTraxx[supreg] Australia 
indices and the associated single name constituents, market 
participants will have additional choices on where to clear and which 
products to use for risk management purposes, which, in turn, will 
promote competition and further the development of CDS for risk 
management.
    In addition, LCH SA will continue to apply its existing fair and 
open access criteria to the clearing of these additional products and 
will apply the same criteria to every clearing member or client who 
proposes to enter into this clearing activity.
    Further, as explained above, the WWR Change is proposed to improve 
the stability and accuracy of the WWR margin so that LCH SA can collect 
the full margin amount as duly and equally required for any CDSClear 
market participant.
    Accordingly, LCH SA does not believe that the Proposed Rule Change 
would impose any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act.
C. Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received From Members, Participants or Others
    Written comments relating to the proposed rule change have not been 
solicited or received. LCH SA will notify the Commission of any written 
comments received by LCH SA.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change 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 [email protected]. Please include 
File Number SR-LCH SA-2022-004 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-2022-004. 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/rulebooks/proposed-rule-changes. 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-2022-004 and should 
be submitted on or before August 3, 2022.
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    \23\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\23\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2022-14879 Filed 7-12-22; 8:45 am]
BILLING CODE 8011-01-P


