[Federal Register Volume 85, Number 14 (Wednesday, January 22, 2020)]
[Notices]
[Pages 3724-3727]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-00915]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-87971; File No. SR-ICC-2019-013]
Self-Regulatory Organizations; ICE Clear Credit LLC; Order
Approving Proposed Rule Change Relating to the ICC Clearing Rules To
Reflect the ISDA NTCE Supplement
January 15, 2020.
I. Introduction
On November 15, 2019, ICE Clear Credit LLC (``ICE Clear Credit'' or
``ICC'') filed with the Securities and
[[Page 3725]]
Exchange Commission pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 \1\ and Rule 19b-4thereunder,\2\ a proposed rule
change to make certain changes to the ICC Clearing Rules (the
``Rules'') \3\ to implement the 2019 Narrowly Tailored Credit Event
Supplement to the 2014 ISDA Credit Derivatives Definitions (the ``NTCE
Supplement'') that are being adopted in the broader credit default swap
(``CDS'') market to address so-called narrowly tailored credit events
and related matters. The proposed rule change was published for comment
in the Federal Register on December 2, 2019.\4\ The Commission did not
receive comments on 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 Rules.
\4\ Securities Exchange Act Release No. 87612 (November 25,
2019), 84 FR 66036 (Dec. 2, 2019) (SR-ICC-2019-013) (``Notice'').
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II. Description of the Proposed Rule Change
A. Background
Following certain events in the 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, FR at 66036.
\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 either 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 the Credit
Deterioration Requirement had been met, which determination would,
under the 2014 Definitions, in the ordinary course be made by the
relevant Credit Derivatives Determinations Committee.
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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 agrees to issue 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 ICC Clearing Rules
Because ICC 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 its relevant Rules for both new and existing
cleared transactions that incorporate the 2014 ISDA Credit Derivatives
Definitions.\11\ For this purpose, the proposed ICC amendments will
apply to all cleared CDS contracts with corporate (i.e., non-sovereign)
reference entities.\12\
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\11\ Notice, 84 FR at 66037.
\12\ Id.
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Specifically, ICC would amend Rule 20-102 to include new
definitions for (i) the ``NTCE Supplement,'' which would be the
Narrowly Tailored Credit Event Supplement to the 2014 ISDA Credit
Derivatives Definitions published by ISDA on July 15, 2019, (ii) ``NTCE
Amending Contracts,'' which would be those Contracts being amended to
incorporate the NTCE Supplement as specified in a list to be maintained
by ICC, and (iii) the ``NTCE Effective Date,'' which will be January
27, 2020 (the date of implementation of the amendment), or such later
date as designated by ICC by Circular.\13\
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\13\ Id.
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In addition, ICC would amend each relevant subchapter of Chapter 26
of the Rules to implement the NTCE Supplement and ensure that relevant
contracts already being cleared and settled by ICE Clear Credit but
that do not reference the new standard terms supplement are fungible
with new contracts cleared and settled by ICE Clear Credit that do
reference the new standard terms supplement.\14\ One set of amendments
would apply to index CDS transactions and a separate but substantially
similar set of amendments would apply to single-name CDS
transactions.\15\
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\14\ Id.
\15\ Id.
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In the case of index CDS, for CDX.NA Index CDS transactions, the
definition of CDX.NA Untranched Terms Supplement in Rule 26A-102 in
subchapter 26A would be amended to include the new 2020 standard terms
supplement for such transactions, as published by ISDA, which
incorporates the NTCE Supplement, along with conforming changes to
cross-references.\16\ Rule 26A-316 would be amended by adding a new
paragraph (e), which provides that open positions in CDX.NA Untranched
Contracts that are NTCE Amending Contracts would be amended, effective
as of the NTCE Effective Date, to reference the updated 2020 standard
terms supplement in lieu
[[Page 3726]]
of the standard terms supplement previously in effect.\17\ This will
have the effect of converting all existing CDX.NA Untranched Contracts
to reference the new standard terms supplement, such that they will be
fungible with new CDX.NA Untranched Contracts, which will also
reference the new standard terms supplement.\18\ New paragraph (e)
would also provide that the amendments will be effective regardless of
whether any transaction record in the Deriv/SERV warehouse is updated
to reflect the change.\19\
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\16\ Id.
\17\ Id.
\18\ Id.
\19\ Id.
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Substantially similar changes for other categories of index CDS
would also be made in subchapters 26F (for iTraxx Europe Untranched
Contracts) and 26J (for iTraxx Asia/Pacific Untranched Contracts).\20\
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\20\ Id.
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In the case of single-name CDS, for Standard North American
Corporate (SNAC) Contracts, in subchapter 26B, Rule 26B-616 would be
amended by adding a new paragraph (c), which provides that open
positions in SNAC Contracts that are NTCE Amending Contracts would be
amended, effective as of the NTCE Effective Date, to incorporate the
NTCE Supplement and specify that the Fallback Discounting and Credit
Deterioration Requirement provisions will be applicable.\21\ The
contracts would also be amended to reference the new ISDA physical
settlement matrix, to be published as of the NTCE Effective Date (or
other relevant implementation date as determined by ICC).\22\ The
amendments will have the effect of converting existing SNAC Contracts
to reference the updated physical settlement matrix, such that they
will be fungible with new SNAC Contracts, which will also reference
that matrix.\23\ New paragraph (c) would also provide that the
amendments will be effective regardless of whether any transaction
record in the Deriv/SERV warehouse is updated to reflect the
change.\24\
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\21\ Id.
\22\ Id.
\23\ Id.
\24\ Id.
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Substantially similar changes for other categories of single-name
CDS would also be made in subchapters 26G (for Standard European
Corporate Contracts), 26H (for Standard European Financial Corporate
Contracts), 26M (for Standard Australian Corporate Contracts), 26N (for
Standard Australia Financial Corporate Contracts), 26O (for Standard
Asia Corporate Contracts), 26P (for Standard Asia Financial Corporate
Contracts) and 26Q (for Standard Emerging Market Corporate
Contracts).\25\
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\25\ Notice, 84 FR at 66037-66038.
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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.\26\ For the reasons given below, the Commission finds
that the proposed rule change is consistent with Section 17A(b)(3)(F)
of the Act \27\ and Rule 17Ad-22(d)(1) thereunder.\28\
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\26\ 15 U.S.C. 78s(b)(2)(C).
\27\ 15 U.S.C. 78q-1(b)(3)(F).
\28\ 17 CFR 240.17Ad-22(d)(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 ICC 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 ICC or for which it is responsible, and, in
general, to protect investors and the public interest.\29\
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\29\ 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 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 set an implementation date of January 27,
2020, the NTCE Supplement will apply to all single-name CDS contracts
and components of index CDS contracts that incorporate the 2014 ISDA
Credit Derivatives Definitions entered into on or after that date.
As noted above, because ICC will clear and settle CDS contracts
that are subject to the changes being made by the NTCE Supplement, the
proposed rule change would amend the ICC Clearing Rules to incorporate
the amendments resulting from the NTCE Supplement, thereby ensuring
that ICC's Rules accurately reflect and appropriately apply the legal
terms and conditions applicable to such CDS contracts, and that
existing contracts that do not reference the new standard terms
supplement will be fungible with new contract that do.
In the Commission's view, a lack of clarity in the underlying legal
terms and conditions applicable to the transactions that ICC clears and
settles could hinder ICC'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 ICC's ability
to safeguard such margin. Accordingly, by making the changes described
above, and in particular by ensuring the ICC's Rules accurately reflect
and appropriately apply the legal terms and conditions applicable to
the CDS contracts that are cleared and settled by ICC and that existing
contracts that do not reference the new standard terms supplement will
be fungible with new contract that do, the Commission believes that the
proposed rule change would help ensure that ICC's Rules continue to
promote the prompt and accurate clearance and settlement of such the
CDS contracts and assure the safeguarding of securities and funds in
ICC'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.
Therefore, the Commission finds that the proposed rule change is
consistent with Section 17A(b)(3)(F) of the Act.\30\
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\30\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(d)(1)
Rule 17Ad-22(d)(1) requires a clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide for a well-founded, transparent and
enforceable legal framework for each aspect of its activities in all
relevant jurisdictions.\31\
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\31\ 17 CFR 240.17Ad-22(d)(1).
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As discussed above, the proposed rule change would help to clarify
and ensure that ICC's Rules accurately reflect and appropriately apply
the legal terms and conditions applicable to the CDS contracts that are
cleared and settled by ICC and that existing contracts that do not
reference the new standard terms supplement will be fungible with new
contract that do. The Commission believes that this, in turn, would
help
[[Page 3727]]
ensure that the ICC Clearing Rules provide a consistent and enforceable
legal basis for clearing and settling CDS contracts to which the NTCE
Supplement applies in light of the amendments made by the NTCE
Supplement.
Therefore, the Commission finds that the proposed rule change is
consistent with Rule 17Ad-22(d)(1).
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 \32\ and Rule 17Ad-22(d)(1) thereunder.\33\
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\32\ 15 U.S.C. 78q-1(b)(3)(F).
\33\ 17 CFR 240.17Ad-22(d)(1).
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It is therefore ordered pursuant to Section 19(b)(2) of the Act
\34\ that the proposed rule change (SR-ICC-2019-013), be, and hereby
is, approved.\35\
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\34\ 15 U.S.C. 78s(b)(2).
\35\ 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).
\36\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\36\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-00915 Filed 1-21-20; 8:45 am]
BILLING CODE 8011-01-P