[Federal Register Volume 85, Number 21 (Friday, January 31, 2020)]
[Notices]
[Pages 5744-5746]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-01517]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88021; File No. SR-LCH SA-2019-011]
Self-Regulatory Organizations; LCH SA; Notice of Filing of
Partial Amendment No. 1 and Order Granting Accelerated Approval of
Proposed Rule Change, as Modified by Partial Amendment No. 1, Relating
to Amendments to CDS Clearing Supplement To Reflect the ISDA NTCE
Protocol and Supplement
January 23, 2020.
I. Introduction
On November 21, 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 to amend its CDS
Clearing Supplement (``LCH SA CDS Supplement'') to: (1) Implement the
2019 Narrowly Tailored Credit Event Supplement to the 2014 ISDA Credit
Derivatives Definitions (the ``NTCE Supplement'') and (2) make certain
clarifications as to the defined term ``Outstanding Principal
Balance''. The proposed rule change was published for comment in the
Federal Register on December 9, 2019.\3\ The Commission did not receive
comments on the proposed rule change. On January 6, 2020, LCH SA filed
Partial Amendment No. 1 to the proposed rule change.\4\ The Commission
is publishing this notice to solicit comments on Partial Amendment No.
1 from interested persons and is approving the proposed rule change, as
modified by Partial Amendment No. 1 (hereinafter, ``proposed rule
change'') on an accelerated basis.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 87649 (Dec. 3, 2019), 84
FR 67325 (Dec. 9, 2019) (SR-LCH-SA-2019-011) (``Notice'').
\4\ Partial Amendment No. 1 clarifies the proposed rule change
by modifying certain references in the CDS Clearing Supplement.
Currently, the CDS Clearing Supplement refers to certain supplements
to the standard contract terms as published by ISDA on certain
dates. Rather than referring to the supplements as published by ISDA
on certain dates, Partial Amendment No. 1 modifies the CDS Clearing
Supplement to refer to the latest versions of the supplements in
force. In other words, Partial Amendment No. 1 amends the CDS
Clearing Supplement to incorporate whichever versions of the ISDA
supplements are most recent and therefore currently effective,
rather than referring to multiple supplements with specific dates.
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II. Description of the Proposed Rule Change
A. Background
Following certain events in the credit default swap (``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, 84 FR at 67325. Capitalized terms not
otherwise defined herein have the meanings assigned to them in the
LCH SA rulebook or LCH SA CDS Supplement.
\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 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 a Failure
to Pay Credit Event satisfies the Credit Deterioration Requirement. As
would be the case with other Failure to Pay Credit Events under CDS
contracts, the relevant Credit Derivatives Determinations Committee
would, in the normal course, make the determination as to whether a
Failure to Pay Credit Event satisfies the Credit Deterioration
Requirement.
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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 issues 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 LCH SA CDS Supplement
Because LCH SA 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 LCH SA's relevant Rules by making substantially
similar amendments to both Part B of
[[Page 5745]]
the CDS Supplement, which applies to single-name CDS contracts and
components of index CDS contracts that incorporate the 2014 ISDA Credit
Derivatives Definitions, and Part C of the CDS Supplement, which
applies to swaptions transactions. The proposed rule change would do so
by amending the CDS Clearing Supplement to incorporate the versions of
the ISDA supplement and confirmations that are currently in-force.
After the NTCE Supplement becomes effective, the latest versions of the
ISDA supplement and confirmations will incorporate the NTCE Supplement
and by default specify that the two concepts described above--the
Credit Deterioration Requirement and Fallback Discounting--are
applicable. Thus, in specifying that the versions of the ISDA
supplement and confirmations that are currently in-force would apply to
single-name CDS contracts and components of index CDS contracts that
incorporate the 2014 ISDA Credit Derivatives Definitions and swaptions,
the proposed rule change would automatically apply the NTCE Supplement
to such transactions.
The proposed rule change would also specify that the amendments
resulting from the NTCE Supplement to the 2014 ISDA Credit Derivatives
Definitions would only be applicable where the Protocol Effectiveness
Condition, as defined in the ISDA 2019 Narrowly Tailored Credit Event
Protocol, is satisfied. Because ISDA has already determined that the
Protocol Effectiveness Condition is satisfied, effectively the proposed
rule change would apply the amendments resulting from the NTCE
Supplement to all single-name CDS contracts and components of index CDS
contracts that incorporate the 2014 ISDA Credit Derivatives Definitions
and all swaptions transactions currently in place or that are entered
into on or after January 27, 2020 (the implementation date determined
by ISDA).\11\
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\11\ See ISDA 2019 NTCE Protocol, available at https://www.isda.org/protocol/isda-2019-ntce-protocol/.
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C. Outstanding Principal Balance
Unrelated to the changes discussed above, the proposed rule change
would also harmonize the use of the term ``Outstanding Principal
Balance'' throughout the LCH SA CDS Supplement by ensuring that the
term is only used with capital letters. Section 1.1 of the LCH SA CDS
Supplement specifies that capitalized terms not otherwise defined
therein shall have the meaning given pursuant to, among other
documents, the ISDA 2003 and 2014 Credit Derivatives Definitions, and
explicitly incorporates into the LCH SA CDS Supplement such defined
terms. The term ``Outstanding Principal Balance'' is defined in the
ISDA 2003 and 2014 Credit Derivatives Definitions, and according to LCH
SA is intended to be incorporated into the LCH SA CDS Supplement.
However, the term ``Outstanding Principal Balance'' is not consistently
capitalized throughout the current version of the LCH SA CDS
Supplement. Accordingly, because LCH SA intends that the term
``Outstanding Principal Balance'' should be an incorporated defined
term as defined in Section 1.1 of the LCH SA CDS Supplement, the
proposed rule change would amend the LCH SA CDS Supplement by
capitalizing the term ``Outstanding Principal Balance'' where not
already capitalized.
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.\12\ For the reasons given below, the Commission finds
that the proposed rule change is consistent with Section 17A(b)(3)(F)
of the Act \13\ and Rule 17Ad-22(e)(1) thereunder.\14\
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\12\ 15 U.S.C. 78s(b)(2)(C).
\13\ 15 U.S.C. 78q-1(b)(3)(F).
\14\ 17 CFR 240.17Ad-22(e)(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 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, and, in
general, to protect investors and the public interest.\15\
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\15\ 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 and swaptions 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 determined that the Protocol
Effectiveness Condition is satisfied and set an implementation date of
January 27, 2020, the NTCE Supplement will apply to all swaptions and
single-name CDS contracts and components of index CDS contracts that
incorporate the 2014 ISDA Credit Derivatives Definitions currently in
place or entered into on or after that date.
As noted above, because LCH SA will clear and settle CDS contracts
and swaptions that are subject to the changes being made by the NTCE
Supplement, the proposed rule change would amend the LCH SA CDS
Supplement to incorporate the amendments resulting from the NTCE
Supplement, thereby ensuring that LCH SA's Rules accurately reflect and
appropriately apply the legal terms and conditions applicable to such
CDS contracts and swaptions. Separately, to help clarify and ensure
that the term ``Outstanding Principal Balance'' is and remains an
incorporated defined term pursuant to Section 1.1 of the CDS
Supplement, the proposed rule change would amend the CDS Supplement to
capitalize the term ``Outstanding Principal Balance'' consistently
throughout the document.
In the Commission's view, a lack of clarity in the underlying legal
terms and conditions applicable to the transactions that LCH SA clears
and settles could hinder LCH SA'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 LCH
SA's ability to safeguard such margin. Accordingly, by making the
changes described above, and in particular by ensuring LCH SA's Rules
accurately reflect and appropriately apply the legal terms and
conditions applicable to the CDS contracts and swaptions that are
cleared and settled by LCH SA, the Commission believes that the
proposed rule change would help ensure that LCH SA's Rules continue to
promote the prompt and accurate clearance and settlement of such the
CDS contracts and swaptions and assure the safeguarding of securities
and funds in LCH SA'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.
[[Page 5746]]
Therefore, the Commission finds that the proposed rule change is
consistent with Section 17A(b)(3)(F) of the Act.\16\
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\16\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(1)
Rule 17Ad-22(e)(1) requires that LCH SA 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.\17\ As discussed above, the proposed rule
change would help to clarify and ensure that LCH SA's Rules accurately
reflect and appropriately apply the legal terms and conditions
applicable to the CDS contracts and swaptions that are cleared and
settled by LCH SA. The Commission believes that this, in turn, would
help ensure that the LCH SA CDS Supplement provides a consistent and
enforceable legal basis for clearing and settling CDS contracts and
swaptions to which the NTCE Supplement applies in light of the
amendments made by the NTCE Supplement.
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\17\ 17 CFR 240.17Ad-22(e)(1).
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Therefore, the Commission finds that the proposed rule change is
consistent with Rule 17Ad-22(e)(1).\18\
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\18\ Id.
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change, as modified by Partial Amendment No. 1, 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-2019-011 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-2019-011. 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/rules-and-regulations/proposed-rule-changes-0. 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-2019-011 and should
be submitted on or before February 21, 2020.
V. Accelerated Approval of the Proposed Rule Change, as Modified by
Partial Amendment No. 1
The Commission finds good cause, pursuant to Section 19(b)(2) of
the Act,\19\ to approve the proposed rule change prior to the 30th day
after the date of publication of Partial Amendment No. 1 in the Federal
Register. As discussed above, Partial Amendment No. 1 amends the CDS
Clearing Supplement so that, instead of referring to the specific date
for various ISDA supplements, it explicitly refers to and incorporates
whichever versions of the supplements to the standard contract terms
are currently effective. By providing this additional clarity, Partial
Amendment No. 1 provides for a more clear and comprehensive
understanding of the estimated application of the proposed rule change,
which helps to improve the Commission's review of the proposed rule
change for consistency with the Act and helps market participants
understand the impact of the proposed rule change.
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\19\ 15 U.S.C. 78s(b)(2).
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Additionally, because Partial Amendment No. 1 would help clarify
and ensure that the appropriate legal terms and conditions are applied
to the CDS contracts and swaptions cleared and settled by LCH SA, and
for similar reasons as discussed above, the Commission finds that
Partial Amendment No. 1 is designed to promote the prompt and accurate
clearance and settlement of securities transactions, help assure the
safeguarding of securities and funds which are in the custody or
control of LCH SA, and, in general, to protect investors and the public
interest, consistent with Section 17A(b)(3)(F) of the Act.\20\
Accordingly, the Commission finds good cause for approving the proposed
rule change, as modified by Partial Amendment No. 1, on an accelerated
basis, pursuant to Section 19(b)(2) of the Exchange Act.\21\
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\20\ 15 U.S.C. 78q-1(b)(3)(F).
\21\ 15 U.S.C. 78s(b)(2).
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VI. 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 \22\ and Rule 17Ad-22(e)(1) thereunder.\23\
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\22\ 15 U.S.C. 78q-1(b)(3)(F).
\23\ 17 CFR 240.17Ad-22(e)(1).
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It is therefore ordered pursuant to Section 19(b)(2) of the Act
\24\ that the proposed rule change, as modified by Partial Amendment
No. 1 (SR-LCH-SA-2019-011), be, and hereby is, approved on an
accelerated basis.\25\
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\24\ 15 U.S.C. 78s(b)(2).
\25\ 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.\26\
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\26\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2020-01517 Filed 1-30-20; 8:45 am]
BILLING CODE 8011-01-P