[Federal Register Volume 84, Number 242 (Tuesday, December 17, 2019)]
[Notices]
[Pages 68989-68992]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-27092]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-87720; File No. SR-LCH SA-2019-008]
Self-Regulatory Organizations; LCH SA; Order Approving Rule
Change Relating to the Updated 2018 Version of the Recovery Plan
December 11, 2019.
I. Introduction
On October 8, 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 (``the ``Proposed Rule Change'')
to adopt an updated recovery plan (the ``RP''). The proposed rule
change was published for comment in the Federal Register on October 29,
2019.\3\ The Commission has not received any 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\ Securities Exchange Act Release No. 34-87388 (October 23,
2019), 84 FR 57897 (October 29, 2019) (SR-LCH SA-2018-008)
(``Notice'').
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II. Description of the Proposed Rule Change
The purpose of LCH SA's RP is to maintain the continuity of
critical services in times of extreme stress and to facilitate its
recovery.\4\ Generally, the RP identifies if and to what level LCH SA's
services are critical for the market
[[Page 68990]]
and what internal or external services/systems are critical for the
continuity of LCH SA's activity; outlines the scenarios under which
recovery of the LCH SA might be necessary; defines the early warning
indicators and triggers for initiating the recovery measures; defines
the governance framework to trigger these recovery measures; and
identifies the available recovery tools to manage crisis situations and
to restore business as usual.
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\4\ The description herein is substantially excerpted from the
Notice, 84 FR 57897.
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Significant scenarios that could prevent LCH SA from providing its
critical services discussed in the RP include the default of one or
multiple clearing members; liquidity shortfalls as result of a clearing
member or allied clearing house default; default of an investment
counterparty of LCH SA or any other investment losses resulting from
changes in the market value on the investments; losses resulting from
an operational risk event; failure of a critical IT service provider;
and failure of financial market infrastructures such as an allied
clearing house, CSD, or Trades Repository.
The proposed rule change intends to incorporate the following main
changes from the updated 2018 version of the RP: (1) Inclusion of
details on handling of the recovery from a cyber-risk scenario, (2)
inclusion of fraud as an operational risk, (3) inclusion of tools for
non-Euro transactions and collateral, (4) implementation of CC&G
rulebook changes related to service closure, (5) inclusion of a
comprehensive list of LCH SA's critical service providers, (6)
inclusion of details regarding the monitoring of capital related tools,
and (7) inclusion of details for managing the failure of LCH Ltd as a
service provider.
A. Recovery From a Cyber-Risk Scenario
Under the proposed rule change, the RP would include more details
on the management of a cyber-risk scenario with the addition of the
Cyber Crisis Management Plan as a new recovery tool. The Cyber Crisis
Management Plan would define ``cyber-crisis'' and provide a framework
of procedures describing and specifying how LCH SA would respond to a
potential breach of a system, service or network indicating possible
problems with information security policy or a failure of controls. The
RP further defines cyber-risks as a single or a series of unwanted or
unexpected information security events that have a significant
probability of compromising business operations and threatening
information security taking the form of unauthorized scans or probes,
malicious code, denial of service, or attempts to gain access. The
framework and procedures would be activated in event that LCH SA
detected a cyber incident that could potentially cause a significant
impact on LCH SA business objectives.
B. Fraud Risk
In addition to losses resulting from a clearing member default
scenarios, the RP covers losses resulting from a non-default
operational risk event. While the current version of the RP addresses
operational risks such as failure of third party service providers or
cyber risks, the proposed rule change would include as an operational
risk losses resulting from a fraud which impacts the critical services
provided by LCH SA. As is the case with other operational risks, the RP
would specify that business lines and operational risk departments have
the responsibility to identify potential fraud and to put into place
relevant controls to monitor for fraud risk.
C. Non-Euro Recovery Tools
Currently, the RP includes various tools to deal with liquidity
needs resulting from default losses or other events giving rise to
liquidity constrains, including deferral of settlement for fixed income
and cash equity as well as collateral limits. The RP would now specify
that to bolster its recovery tools, LCH SA can use several new tools to
meet liquidity needs, including using non-Euro collateral to raise
liquidity, transforming liquidity received in non-Euro currencies into
Euro through bi-lateral repo transactions with the ``FXmarkets''
recovery tool, receiving liquidity directly in Euro from Gilt or USD
securities, and performing payments in an alternate currency than the
original obligation.
D. CC&G Rulebook Changes
The current version of the RP provides as a recovery tool the
closure of the interoperability link on Italian debt, which is
triggered when CC&G is declared in default or CC&G has performed a
service closure. Upon triggering this tool, LCH SA will proceed with
closing out all outstanding contracts. Further, uncovered losses from
the cash settlement and close out after a CC&G default will be covered
by deposited collateral of CC&G and the application of a haircut on
outgoing payments to clearing members. In order to cover a potential
cash shortfall in case of a CC&G default, LCH SA is proposing that the
RP would state that in the event of a closure of CC&G, LCH SA will not
be obliged to perform payment to clearing members until it receives
deposited collateral from the CC&G estate, which addresses LCH SA's
potential inability to retrieve the deposited collateral with CC&G.
E. Critical Service Providers
The current RP in general describes critical services such as those
provided by LCH Ltd and other entities providing technological
services. The RP describes LCH SA's approach to the maintaining
continuity of services to LCH SA, including contractual rights. In this
rule proposal, the RP would describe that LCH SA will implement a new
framework to manage critical service providers. The framework would
identify the various types of critical service providers and include a
new list of such providers in an annex to the RP. This would layout the
overall landscape of providers and facilitate LCH SA's ability to
monitor for potential financial or operational failure of a critical
service provider and plan to replace service providers or otherwise
sustain any disruption caused by their failure.
F. Monitoring of Capital Related Tools
The quantitative assessment section of the recovery plan would
include more details on the monitoring of capital related recovery
tools like surplus capital, variable payments and dividend payments in
order to help ensure their adequacy to cover the identified scenarios.
This additional detail would list each tool and describe their
efficiency as recovery tools. The RP currently notes that LCH SA will
monitor that surplus/buffers capital is adequate to cover both default
and non-default losses. The proposed rule would revise the RP to
describe the stress scenarios and associated indicators as well as the
capital coverage tools available in each case. In addition to the
capital requirements and available headroom, the RP would note that LCH
SA follows indicators such as the Liquidity Coverage Ratio, the
aggregate credit risk and market risk exposure on its investment
portfolio, operational risk and business risks indicators. The RP would
indicate that the capital and buffers are monitored in order to allow
LCH SA to always be in a situation to replenish the skin in the game
within one month if the CCP was to face multiple defaults.
In addition to surplus capital, the RP would indicate that the LCH
Board may decide to withhold Dividend payment and Variable bonus
payment to be used as additional buffers.
G. LCH Ltd Exit Plan
In response to French regulatory recommendations, the RP would
provide information related to the dependency between LCH SA and LCH
[[Page 68991]]
Ltd. LCH Ltd provides IT services to LCH SA and an approach on how LCH
SA will manage a potential wind down of LCH Ltd would be included in
the RP. The RP would include scenarios and mitigating actions in case
of failure of LCH Ltd as a service provider. For example, LCH SA will
take steps to replicate the exact information technology services
provided by LCH Ltd.
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
such proposed rule change is consistent with the requirements of the
Act and the rules and regulations thereunder applicable to such
organization.\5\ For the reasons given below, the Commission finds that
the proposed rule change is consistent with Section 17A(b)(3)(F) of the
Act \6\ and Rules 17Ad-22(e)(2) and (3) thereunder.\7\
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\5\ 15 U.S.C. 78s(b)(2)(C).
\6\ 15 U.S.C. 78q-1(b)(3)(F).
\7\ 17 CFR 240.17Ad-22(e)(2) and (3).
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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, as well
as 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.\8\
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\8\ 15 U.S.C. 78q-1(b)(3)(F).
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As noted above, the updates to the RP reflected in this proposed
rule change would add more details on the management of a cyber-
scenario and the Cyber Crisis Management Plan has been added as a new
recovery tool. By providing a framework of procedures for allowing LCH
SA to respond to or prevent cyber incidents, the Commission believes
that LCH SA will improve its ability to cope with, prevent, and plan
for disruptions to its clearing services by responding quickly to such
things as software malfunctions or cyber breaches. Further, the
Commission believes that LCH SA will be in a position to prioritize
incidents and activate the relevant response teams and plans.
Similarly, by updating the RP to account for the failure of
entities such as linked CCPs and critical service providers as
described above, the Commission believes that the proposed rule change
provides LCH SA the ability to timely and efficiently plan for,
monitor, and respond to failures or disruptions of these other parties.
Specifically, the RP would note that LCH SA has implemented the rules
relating to CC&G service closure related to a potential loss on
investment of the cash collateral with CC&G. LCH SA may not immediately
be able to retrieve the deposited collateral with CC&G if it is
insolvent and has to wait for the relevant payment of the estate.
However, the RP would clarify that LCH SA is only obliged to perform
payment to clearing members if and when it has received the relevant
funds from the CC&G estate. The Commission believes that these changes
strengthen LCH SA's ability to recover from the liquidity and credit
challenges that could arise from CC&G's closure. This in turn enhances
LCH SA's financial position and ultimately its ability to continue to
provide prompt and accurate clearance and settlement. Likewise, the RP
would include scenarios and mitigating actions in case of the failure
of LCH Ltd as a service provider and include a list of other critical
service providers. The Commission believes that these proposed changes
enhance LCH SA's management of important relationships by including
details of these services and the steps that it can take to replace or
otherwise respond to disrupted services. The Commission believes that
this in turn promotes LCH SA's ability to continue to promptly and
accurately clear transactions.
Additionally, as noted above, the RP would include more details on
the monitoring of capital related recovery tools like surplus capital,
variable payments and dividend payments. For example, the RP would note
that LCH SA will monitor that ``surplus/buffers capital'' is adequate
to cover both default and non-default losses. By including within the
RP the scenarios, indicators, and capital coverage tools available in
each case, the Commission believes that LCH SA will enhance its ability
to preserve the requisite financial resources and hence its ability to
continue to promptly and accurately clear transactions and safeguard
securities and funds in its custody and control.
Further, the proposed rule change would provide that LCH SA can use
several new tools to meet liquidity needs, including using non-Euro
collateral to raise liquidity, transforming liquidity received in non-
Euro currencies through bi-lateral repo transactions with the
``FXmarkets'' recovery tool, receiving liquidity directly in Euro from
Gilt or USD securities, and performing payments in an alternate
currency than the original obligation. The Commission believes that
this enhances LCH SA's ability to resolve a specific currency liquidity
shortfall resulting from a management of a defaulting clearing member
and thereby maintains its financial strength and ultimately its ability
to promptly and accurately clear transactions.
Overall, the Commission believes that with the additional detail
described above, the updated RP would continue to strengthen the
purpose of the RP as originally adopted of maintaining the continuity
LCH SA's critical services by reducing the likelihood of a disorderly
or unsuccessful recovery through planning for various disruptive
scenarios. Therefore, for the reasons stated above the Commission finds
that the proposed rule change would promote the prompt and accurate
clearance and settlement of securities transactions, assure the
safeguarding of securities and funds in LCH SA's custody and control,
and, in general, protect investors and the public interest, consistent
with the Section 17A(b)(3)(F) of the Act.\9\
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\9\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(2)
Rule 17Ad-22(e)(2) requires that a covered clearing agency
establish, implement, maintain and enforce written policies and
procedures reasonably designed to, as applicable, provide for
governance arrangements that are clear and transparent and clearly
prioritize the safety and efficiency of the covered clearing agency, to
support the public interest requirements in Section 17A of the Act.\10\
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\10\ 17 CFR 240.17Ad-22(e)(2).
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As noted above, more details on the management of a cyber-scenario
and the Cyber Crisis Management Plan have been added as a new recovery
tool. The purpose of this document is to provide a framework of
procedures allowing LCH SA to respond to cyber incidents and crises.
The RP would contain details about the procedures utilized to identify
incidents, notification of hierarchy, and for notifying and activating
the Crisis Management Team. The Commission believes that proposed
details regarding the cyber scenario will enhance LCH SA's governance
procedures as they relate to cyber crisis by setting forth a clear
process for detecting and notifying required
[[Page 68992]]
management as well as activation of a specific plan for managing cyber
crisis.
Therefore, for the above reasons the Commission finds that the
proposed rule change is consistent with Rule 17Ad-22(e)(2).
C. Consistency With Rule 17Ad-22(e)(3)
Rule 17Ad-22(e)(3) requires that a covered clearing agency
establish, implement, maintain and enforce written policies and
procedures reasonably designed to, as applicable, 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,
which must include plans for the recovery and orderly wind-down of the
covered clearing agency necessitated by credit losses, liquidity
shortfalls, losses from general business risk, or any other losses.
Overall, the Commission believes that the rule proposal enhances
LCH SA's ability to manage legal, credit, liquidity, operational,
general business, investment, and other risks that arise in or are
borne by the covered clearing agency in the recovery context. As noted
above, the rule proposal updates the RP to address operational,
liquidity, and investment risks. Specifically, the RP would include
fraud as an operational risk and incorporate it into its system for the
monitoring and management of losses. The Commission believes that with
this addition, the RP is more attentive to fraud as an operational
risk. Additionally, the Commission believes that the inclusion of non-
Euro recovery tools described above will enhance LCH SA's ability to
cope with liquidity challenges by giving it additional ways to access
and meet liquidity needs. The Commission also believes that by
implementing the rules relating to CC&G service closure discussed
above, LCH SA has resolved a potential liquidity risk relating to a
CC&G default.
Further, the Commission believes that the proposed changes to the
RP related to LCH Ltd. and other critical service providers strengthen
LCH SA's ability to maintain the continuity of critical services in
times of extreme stress and to facilitate the recovery of LCH SA. For
instance, the Commission believes that the list of critical service
providers and scope of each service enhances LCH SA's ability to
identify those services which could impact the continuity of LCH SA's
operations and the LCH Ltd exit plan strengthens LCH SA's ability to
manage a potential wind down of LCH Ltd. and replicate or replace the
services provided by LCH Ltd. on short notice.
Additionally, because the quantitative assessment section of the
RP, as described above, now includes more details on the monitoring of
capital related recovery tools, the Commission believes that LCH SA's
ability to monitor and sustain its capital requirements under various
scenarios has been strengthened.
Therefore, for the above reasons the Commission finds that the
proposed rule change is consistent with Rule 17Ad-22(e)(3).
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, Section 17A(b)(3)(F) of the Act \11\ and Rules 17Ad-
22(e)(2) and (3) thereunder.\12\
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\11\ 15 U.S.C. 78q-1(b)(3)(F).
\12\ 17 CFR 240.17Ad-22(e)(2) and (3).
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It is therefore ordered pursuant to Section 19(b)(2) of the Act
that the proposed rule change (SR-LCH SA-2019-008) be, and hereby is,
approved.\13\
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\13\ In approving the proposed rule change, the Commission
considered the proposal's impacts 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.\14\
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\14\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-27092 Filed 12-16-19; 8:45 am]
BILLING CODE 8011-01-P