[Federal Register Volume 85, Number 20 (Thursday, January 30, 2020)]
[Notices]
[Pages 5489-5491]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-01649]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88039; File No. SR-LCH SA-2019-007]
Self-Regulatory Organizations; LCH SA; Order Approving Proposed
Rule Change Relating to Amendments to LCH SA's Liquidity Risk Modelling
Framework
January 24, 2020.
I. Introduction
On December 3, 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 (``Proposed Rule
Change'') to amend its Liquidity Risk Modeling Framework (the
``Framework''). The Proposed Rule Change was published for comment in
the Federal Register on December 10, 2019.\3\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Securities Exchange Act Release No. 87655 (Dec. 4, 2019), 84
FR 67488 (Dec. 10, 2019) (SR-LCH-SA-2019-007) (``Notice'').
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II. Description of the Proposed Rule Change
LCH SA is proposing to amend its Framework, which describes the
Liquidity Stress Testing framework by which the Collateral and
Liquidity Risk Management department of LCH Group Holdings Limited
(``LCH Group'') assures that LCH SA has enough cash available to meet
any financial obligations, both expected and unexpected, that may arise
over the liquidation period for each of the clearing services that LCH
SA offers.\4\ The Framework identifies LCH SA's sources of liquidity
and corresponding liquidity risks; identifies LCH SA's liquidity
requirements with respect to its members and its interoperable central
counterparty; describes the metrics and limits that LCH SA monitors;
and describes the scenarios under which these metrics are computed.\5\
The proposed rule change would make revisions to three aspects of the
Framework related to physically-settled options, Fixed Income Clearing
System, and stress tests.
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\4\ The following description is substantially excerpted from
the Notice.
\5\ Notice, 84 FR at 67488.
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A. Physically-Settled Options
LCH SA is proposing to amend the Framework in order to address more
accurately its liquidity requirements in the event of the assignment
and exercise of physically-settled options involving a defaulting
clearing member during the liquidation period of such clearing
member.\6\ Specifically, the amended Framework will address LCH SA's
liquidity requirements in the event options that are in the money are
exercised either on the day (``T''), or on the business day immediately
following the day (``T+1''), on which the clearing member that is a
seller of the options defaults.\7\
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\6\ Id.
\7\ Notice, 84 FR at 67488-67489.
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If a defaulting clearing member is a seller of a Call option that
is in the money, LCH SA would have to purchase the underlying
securities in the market at a stressed price and await payment at the
strike price from the non-defaulting purchaser of the Call option at
settlement.\8\ If such defaulting clearing member is a seller of a Put
option that is in the money, LCH SA would have to purchase the
underlying securities at the strike price from the non-defaulting
purchaser of the Put option.\9\ Although margins should cover any
potential loss, liquidity outflows as a result of the sales' proceeds
are included as liquidity requirements, in each case.\10\
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\8\ Notice, 84 FR at 67489.
\9\ Id.
\10\ Id.
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In the current Framework, there is no liquidity provision related
to the risk of assignment and exercise of options at expiration.\11\ In
order to address this concern, the amended Framework will anticipate,
prior to the expiration dates, the amount of liquidity funding that may
arise from options that may be exercised, in the event of the default
of LCH SA's two largest members (``Cover 2'').\12\ On a daily basis,
LCH's liquidity coverage ratio (``LCR'') calculation will identify all
of the potential positions that are in the money or at the money on
that day and the next business day.\13\ Given the potential option
exercise, the LCR calculation will generate a liquidity need.\14\ The
additional liquidity amount that LCH SA could potentially need will be
equal to the sum of the equities to source following the option
assignments at expiration and/or the difference between the underlying
securities and the strike price or the strike price minus the asset in
the event of a cash settlement.\15\
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\11\ Id.
\12\ Id.
\13\ Id.
\14\ Id.
\15\ Id.
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In practice, the process would work as follows on a daily basis:
The liquidity needs arising from the options that are in
the money or at the money, having their expiries on T or T+1, will be
computed by applying no market stress to the equities.
The liquidity needs arising from the options that are in
the money or at the money, having their expiries on T or T+1, will be
computed by applying a stress scenario to the equities.
LCH SA will select the positions consistent with the Cover
2 for both modes described above and will retain the most punitive one.
This amount would be added to the current cash equity amount in the
LCR calculation, which LCH would then retain through qualified liquid
resources.\16\
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\16\ Id.
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B. Fixed Income Clearing System
LCH SA is proposing to amend the Framework to take into account the
expansion of sovereign debt for which LCH SA provides clearing services
through its Fixed Income Clearing System.\17\ LCH SA initially provided
clearing services only with respect to French sovereign debt.\18\ The
Fixed Income Clearing service subsequently added the sovereign debt of
Italy, Spain, Germany, and Belgium.\19\ More recently, the Fixed Income
Clearing System has been extended to eight additional Euro markets:
Austria, Netherlands, Finland, Ireland, Portugal, Slovakia, Slovenia
and Supranationals.\20\
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\17\ Id.
\18\ Id.
\19\ Id.
\20\ Id.
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In this regard, therefore, the Framework would be revised to
provide that all securities resulting from the settlement of all
repurchase contracts (``repos'') on behalf of a defaulting clearing
member, not just repos on the sovereign debt of France, Italy and
Spain, may be used to generate liquidity
[[Page 5490]]
at the Banque de France.\21\ The amended Framework would also clarify
that, in the event that a Central Bank Guarantee (``CBG'') is triggered
by the default of a clearing member posting the CBG, the relevant
Central Bank will pay the liabilities of the defaulting clearing member
in cash.\22\
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\21\ Id.
\22\ Id.
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Further, the Framework would be revised to (i) identify the
relevant central securities depository (``CSD'') through which
transactions in the sovereign debt of the different jurisdictions may
settle, (ii) describe the manner by which LCH SA injects liquidity into
each settlement platform, in particular, Euroclear Bank and Clearstream
Luxembourg, and (iii) modify the limits by settlement platform on the
main liquidity drivers (i.e., cash injected into the platforms, auto-
collateralization and gross fails).\23\
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\23\ Id.
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C. Stress Tests
The proposed rule change would make clarifications with respect to
certain aspects of its stress tests.\24\ With respect to the
operational liquidity target, which is a metric allowing LCH SA to
confirm that the business as usual liquidity sources are sufficient for
a five day period in stressed situations, consistent with the LCR time
horizon, the Framework would note that LCH SA uses a three-day window
with regard to margin reduction.\25\ The Framework would further
clarify that, in calculating liquidity resources, LCH SA deducts funds
required to facilitate settlements, cover end of day fails at Euroclear
Bank and Clearstream Luxembourg, and avoid Target 2 Securities
fails.\26\ In addition, the Framework assumes that members allowed to
post CBGs will switch from cash or ECB-eligible non-cash collateral to
CBGs (although the Framework does not currently take such switches into
account, since all eligible members, i.e., Dutch and Belgian members,
have already done so).\27\ Moreover, the amended Framework would
confirm that, in calculating required variation margin payments to
CC&G, LCH SA assumes a theoretical 5-day holding period.\28\
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\24\ Id.
\25\ Id.
\26\ Id. Target 2 Securities is a Eurosystem technical platform
to which CSDs assign the management of securities settlement in
central bank money.
\27\ Id.
\28\ Id.
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The amended Framework would also clarify how stressed liquidity
requirements and impact are calculated for each clearing member, in
particular with respect to the cash equity settlement requirement for
options.\29\ These calculations are used to determine the two clearing
members that would potentially cause the largest aggregate liquidity
exposure for the CCP in extreme but plausible market conditions.\30\
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\29\ Id.
\30\ Id.
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Finally, the Framework would clarify how LCH SA conducts reverse
stress tests in order to determine if there is a combination of changes
in LCH SA's liquidity that could lead to a liquidity shortfall.\31\ In
particular, the amended Framework would consider whether there is a
combination of changes in LCH SA's liquidity resources that could lead
to a liquidity shortfall, even in the absence of stress in the
market.\32\
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\31\ Id.
\32\ Id.
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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.\33\ For the reasons given below, the Commission finds
that the proposed rule change is consistent with Section 17A(b)(3)(F)
of the Act \34\ and Rule 17Ad-22(e)(4)(ii) thereunder.\35\
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\33\ 15 U.S.C. 78s(b)(2)(C).
\34\ 15 U.S.C. 78q-1(b)(3)(F).
\35\ 17 CFR 240.17Ad-22(e)(4)(ii).
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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.\36\
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\36\ 15 U.S.C. 78q-1(b)(3)(F).
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As described above, the proposed rule change would amend the
Framework to anticipate, prior to expiration dates, the need for LCH SA
to step in and meet a defaulter's obligation in the event of the
assignment or exercise of physically-settled options involving a
defaulting clearing member by utilizing the LCR calculation, on a daily
basis, to identify all of the potential positions that are in the money
or at the money on that day and the next business day. LCH SA will then
be able to calculate the additional need and ensure it holds sufficient
qualified liquid resources to meet that need. The Commission believes
that, by anticipating and ensuring that it meets its liquidity needs in
this manner, the proposed rule change would help ensure that LCH SA is
able to meet its financial obligations in stressed situations, which in
turn would allow LCH SA to continue to meet its obligation to promptly
and accurately clear and settle securities transactions in such
situations.
Further, as noted above, the proposed rule change would amend the
Framework to take into account the expansion of sovereign debt for
which LCH SA provides clearing services through its Fixed Income
Clearing System. Specifically, LCH SA would revise the Framework to
provide that all securities resulting from the settlement of all repos
on behalf of a defaulting clearing member, not just repos on the
sovereign debt of France, Italy and Spain, may be used to generate
liquidity at the Banque de France, and clarify that, in the event that
a CBG is triggered by the default of a clearing member posting the CBG,
the relevant Central Bank will pay the liabilities of the defaulting
clearing member in cash. The Commission believes that, through these
changes, the proposed rule change would enhance LCH SA's sources of
liquidity and thus LCH SA's financial condition, which in turn would
support LCH SA's ability to continue to promptly and accurately clear
and settle securities transactions. Additionally, the Commission
believes that by specifying the CSD through which transactions in the
identified foreign sovereign debt may settle and describing the manner
by which LCH SA injects liquidity into each settlement platform, the
proposed rule change would strengthen LCH SA's procedures for
safeguarding securities and funds for which it is responsible and
facilitate prompt and accurate clearance and settlement by clarifying
procedures for interacting with such platforms.
For the reasons stated above, the Commission believes that the
proposed rule change is consistent with Section 17A(b)(3)(F) of the
Act.\37\
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\37\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(4)(ii)
Rule 17Ad-22(e)(4)(ii) requires that, among other things, LCH SA
establish, implement, maintain and enforce written policies and
procedures reasonably designed to, as applicable, effectively identify,
measure, monitor, and manage its credit exposures to
[[Page 5491]]
participants and those arising from its payment, clearing, and
settlement processes, including by maintaining 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.\38\
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\38\ 17 CFR 240.17Ad-22(e)(4)(ii).
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As described above, the proposed rule change would amend the
Framework to clarify certain aspects of LCH SA's stress tests.
Specifically, the proposed rule change would clarify how stressed
liquidity requirements and impact are calculated for each clearing
member. Because these calculations would then be used by LCH SA to
determine the two clearing members that would potentially cause the
largest aggregate liquidity exposure for LCH SA in extreme but
plausible market conditions, the Commission believes that the proposed
rule change would support LCH SA's ability to effectively identify,
measure, monitor, and manage its credit exposures to participants, and
ultimately 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. Further, by clarifying how LCH SA conducts reverse stress
tests in order to determine if there is a combination of changes in LCH
SA's liquidity that could lead to a liquidity shortfall even in the
absence of stress in the market, the Commission believes that the
proposed rule change would enhance LCH SA's ability to manage its
credit exposures and maintain additional resources.
Finally, as discussed above, under the proposed rule change the
Framework would anticipate, prior to expiration dates, the need for LCH
SA to step in and meet a defaulter's obligation in the event of the
assignment or exercise of physically-settled options involving a
defaulting clearing member. The Commission believes that this change as
well would enhance LCH SA's ability to manage its credit exposures and
maintain additional financial resources to cover foreseeable stress
scenarios involving Cover 2 by identifying the liquidity need ahead of
time and then retaining the amounts through qualified liquid resources.
For the reasons stated above, the Commission believes that the
proposed rule changes are consistent with Rule 17Ad-22(e)(4)(ii).\39\
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\39\ 17 CFR 240.17Ad-22(e)(4)(ii).
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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 \40\ and Rule 17Ad-22(e)(4)(ii) thereunder.\41\
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\40\ 15 U.S.C. 78q-1(b)(3)(F).
\41\ 17 CFR 240.17Ad-22(e)(4)(ii).
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It is therefore ordered pursuant to Section 19(b)(2) of the Act
\42\ that the proposed rule change (SR-LCH SA-2019-007) be, and hereby
is, approved.\43\
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\42\ 15 U.S.C. 78s(b)(2).
\43\ 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.\44\
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\44\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-01649 Filed 1-29-20; 8:45 am]
BILLING CODE 8011-01-P