Notice2023-05271
Self-Regulatory Organizations; LCH SA; Order Approving Proposed Rule Change Relating to the Liquidity Risk Model Framework
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Published
March 15, 2023
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 88 Issue 50 (Wednesday, March 15, 2023)</title>
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[Federal Register Volume 88, Number 50 (Wednesday, March 15, 2023)]
[Notices]
[Pages 16040-16042]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-05271]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-97100; File No. SR-LCH SA-2023-001]
Self-Regulatory Organizations; LCH SA; Order Approving Proposed
Rule Change Relating to the Liquidity Risk Model Framework
March 9, 2023.
I. Introduction
On January 4, 2023, 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
amend its Liquidity Risk Modelling Framework (the ``Framework''). The
Proposed Rule Change was published for comment in the Federal Register
on January 24, 2023.\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. 96694 (Jan. 18, 2023),
88 FR 4227 (Jan. 24, 2023) (File No. SR-LCH-2023-001) (``Notice'').
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II. Description of the Proposed Rule Change
LCH SA is a clearing agency registered with the Commission for the
purpose of clearing security-based swaps (also known as credit-default
swaps or ``CDS''). LCH SA provides clearing services for eligible CDS
contracts, including both European and US Indices and Single Names
Index constituents, and clearing services for eligible options on
European Index CDS. In offering clearing services for these CDS
contracts, LCH SA acts as a central counterparty (``CCP''). Being a CCP
means that LCH SA, in clearing a trade, becomes a counterparty to, and
responsible for, the corresponding trade obligations arising from the
original bilateral trade between its clearing members. In other words,
as a CCP, LCH SA acts functionally as the buyer to every seller and the
seller to every buyer.
As a CCP providing clearing services, LCH SA is subject to
liquidity risk in that it may not have enough cash in the relevant
currency to meet its payment obligations when they become due, in
particular upon the default of a clearing member. For example, LCH SA
would be unable to make a payment in United States Dollars (``USD'')
if, at the time the payment were due, all of LCH SA's resources were
held in securities or British Pounds Sterling. To comprehensively
measure, monitor, and manage its liquidity risk, LCH SA has
established, among other policies and procedures, \4\ the Framework.
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\4\ For example, as described in the Notice, LCH SA, as a
subsidiary of LCH Group, manages its liquidity risk pursuant to,
among other policies and procedures, the LCH Group Liquidity Risk
Policy and the LCH Group Liquidity Plan. Id. at 4228.
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The Framework supports LCH SA's management of liquidity risk by
identifying LCH SA's sources of liquidity and corresponding liquidity
risks, identifying LCH SA's liquidity requirements with respect to its
members and its interoperable central counterparty,\5\ describing the
metrics and limits that LCH SA monitors, and describing the scenarios
under which these metrics are computed.\6\
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\5\ LCH SA has an interoperability agreement with Cassa di
Compensazione e Garanzia (``CC&G''), an Italian CCP, pursuant to
which LCH SA's clearing members and CC&G's clearing members are able
to benefit from common clearing services without having to join the
other CCP. Each CCP is a clearing member of the other one with a
particular status when accessing the clearing system of the other
counterparty.
\6\ For additional information regarding the Framework, see
Self-Regulatory Organizations; LCH SA; Order Approving Proposed Rule
Change Relating to Liquidity Risk Management, Exchange Act Release
No. 83691 (July 24, 2018), 83 FR 36635 (July 30, 2018) (SR-LCH SA-
2018-003).
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Broadly, the Proposed Rule Change seeks to amend the Framework in
four ways: (1) more accurately describe how LCH SA currently manages
its liquidity requirements and operational target \7\ calculation when
there is a scheduled reduction to LCH SA's Default Fund \8\ or when LCH
SA needs to provide an extraordinary liquidity injection to facilitate
settlement of transactions during a business day; (2) reflect changes
to two of LCH SA's committed credit lines; (3) add a list of LCH SA's
existing options to address default situations in which there is a
liquidity shortfall in a currency different from EUR; \9\ and (4) make
two changes relating to LCH SA's existing processes for injecting
liquidity in the settlement system to ease settlement flow at
International Central Securities Depositories (``ICSDs''). Each of
these proposed changes is discussed in turn below.
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\7\ The operational target ``represents the amount of liquidity
to be held to satisfy the liquidity needs related to the operational
management of the CCP in a stressed environment that does not lead
to a member's default.'' Notice, 88 FR at 4228, n.6.
\8\ LCH SA maintains a Default Fund for its CDS clearing
service. The Default Fund consists of financial resources that LCH
SA can use to cover losses in the event of a default by a clearing
member, in accordance with its rules and procedures. LCH SA requires
clearing members to contribute to the Default Fund, and Article
4.4.1.3 of the LCH SA CDS Clearing Rulebook explains how LCH SA
determines the amount of each clearing member's contribution.
Generally, LCH SA calculates the amount of the Default Fund and each
clearing member's contribution thereto each month. If a clearing
member's contribution decreases for a given month, LCH SA could be
obligated to return cash to that clearing member in the amount of
the reduction in its contribution. Such a return of cash to a
clearing member would decrease the amount of liquidity available to
LCH SA.
\9\ As described below, LCH SA did not propose adopting new
authorities, but rather, specified existing options to conform the
Framework to the LCH SA Liquidity Plan and the LCH SA CDS Clearing
Rulebook. See LCH SA CDS Clearing Rule Book Chapter 3 Article
1.3.1.7, Appendix 1 Article 8.2, Appendix 1 Article 8.10.
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A. Liquidity Requirements and Operational Target
Based on a recommendation from its independent risk model
validation department, LCH SA proposes to amend the Framework to
address more fully its liquidity requirements in the event of a Default
Fund scheduled reduction or an extraordinary intraday liquidity
injection in the settlement platform.
A Default Fund scheduled reduction refers to an instance where LCH
SA returns Default Fund contributions to its clearing members. As
background, at the start of each month, LCH SA determines the amount of
its Default Fund according to its internal procedures.\10\ If the new
amount for a given clearing member is lower than the current amount,
then LCH SA will return the appropriate difference to that clearing
member. Before a Default Fund
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reduction takes place, a latency period occurs between the final
approval of the new Default Fund amount and the settlement of the new
contributions. LCH SA is proposing changes to the Framework in order to
properly reflect the Default Fund reduction in the operational target
calculation until the settlement of the new contributions occurs.\11\
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\10\ Notice, 88 FR at 4228, n.8.
\11\ Id. at 4228.
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In the Framework, LCH SA proposes additional text to describe
enhancements to the operational target calculation. The additional
content includes (1) a statement that the Default Fund recomputed is
compared to the Default Fund actually paid and in the account of LCH
SA, (2) a description of the reported amount of the Default Fund,
including adjustments made to the calculation of the operational
target, and (3) a detailed description of the operational steps in the
calculation.
Moreover, LCH SA proposes to make conforming changes to another
section of the Framework to reflect the significance of a Default Fund
reduction. The Framework currently lists five different reasons for LCH
SA's operational liquidity needs, including repayment of excess cash
and non-cash collateral to members, the substitution of cash collateral
upon members' request, and LCH SA's provision of liquidity to
facilitate settlement, among others. LCH SA proposes to add the planned
reduction of Default Fund amounts as another reason for its operational
liquidity needs.
LCH SA also proposes various Framework changes to more fully
address the impact of intraday liquidity injections into the settlement
platform. According to LCH SA, when volumes in the settlement platform
are particularly high, additional liquidity may need to be injected
during the day to ensure the smooth function of the settlement
flows.\12\
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\12\ Id. at 4228, n.9.
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The Proposed Rule Change would add governance details regarding the
provision of intraday liquidity injections. In particular, the Proposed
Rule Change would add language to note that LCH SA has delegated to its
Fixed Income Operations team authority to provide up to one billion
euros in additional liquidity intraday for settlement. LCH SA's Chief
Risk Officer and Head of Collateral and Liquidity Management, or their
delegates, would need to approve any intraday amounts greater than one
billion euros.\13\
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\13\ An injection of more than $1 billion euro would also
trigger certain internal reporting requirements.
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LCH SA proposes changes to the Framework that would require the
recalculation of LCH SA's operational liquidity target in response to
an intraday injection of more than 1 billion euros. The Framework does
not currently take into consideration extraordinary liquidity
injections in the settlement system in the daily operational target
calculation.
In addition, LCH SA proposes to add a footnote to provide
additional context for LCH SA's provision of liquidity in order to
facilitate settlement.\14\ The proposed footnote would indicate that
the provision of liquidity to facilitate settlement includes both
beginning-of-day liquidity injections as well as intraday injections
above one billion euros.
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\14\ See Article 1.3.3.5 of LCH SA's rules (stating that ``LCH
SA ensures the delivery of Securities or the payment of cash, in
accordance with the Clearing Rule Book . . .''). Further, LCH SA
injects liquidity in the settlement platforms or lodges non-cash
collateral at ICSDs to facilitate settlement, including fails. LCH
SA handles these injections since they represent one of the main
intraday liquidity needs for the CCP. See LCH SA Liquidity Risk
Modelling Framework Section 4.2.1.4.
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B. Committed Credit Lines
As part of its liquidity resources, LCH SA maintains different
credit lines that it can draw upon as needed to obtain liquid financial
resources.\15\ LCH SA proposes changes to the Framework to reflect that
(1) one such credit line, with KAS Bank to cover non-euro variation
margin payments for listed derivatives activity, is no longer active,
and (2) LCH SA has established a flexible, intraday credit line with
Norges Bank to cover non-euro variation margin payments for listed
derivatives activity. Specifically, LCH SA proposes to update the
Framework to delete outdated references to the KAS Bank credit line and
add references to the Norges Bank credit line.
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\15\ For example, LCH SA has a multi-currency overdraft facility
of [euro]10 million with an international bank and a secured,
committed, intraday credit line with a different bank. Notice, 88 FR
at 4229.
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C. Liquidity Shortfall Options
LCH SA's Liquidity Plan and CDS Clearing Rulebook identify and
define a set of tools, or options, that LCH SA can utilize to address a
Clearing Member default that leads to a liquidity shortfall in a
currency different from EUR, including the following:
<bullet> Non-euro cash deposited as collateral;
<bullet> The sale of the non-euro securities of the defaulting
member;
<bullet> Bilateral repo transactions (non-euro cash taker and non-
euro collateral giver);
<bullet> Cross-currency bilateral repo (non-euro cash taker and
euro collateral giver);
<bullet> Cross-currency triparty repo (non-euro cash taker and euro
collateral giver);
<bullet> LCH SA's multicurrency overdraft facility with an
International Bank;
<bullet> FX spot market transactions;
<bullet> ECB weekly tender in USD (last resort); and
<bullet> Replacing LCH SA's liabilities in non-euros by euros as
per clearing rulebook.\16\
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\16\ See LCH SA CDS Clearing Rule Book Chapter 3 Article
1.3.1.7, Appendix 1 Article 8.2, Appendix 1 Article 8.10; see LCH SA
Liquidity Plan Section 6.2.2.2.
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Currently, the Framework does not identify these tools as the
options LCH SA has to address default situations in which there is a
liquidity shortfall in a currency different from EUR. The Proposed Rule
Change would update the Framework to include the list of tools that LCH
SA may use.
D. Injection of Liquidity To Ease Settlement Flow
The current Framework describes LCH SA's requirements and process
for injecting liquidity into settlement platforms of various ICSDs to
facilitate settlement related to certain sovereign debt, such as
French, Spanish, German, Belgian, and Italian debt. It includes a table
that describes the settlement platforms, the debt activities covered by
those settlement platforms, and an associated maximum level of
liquidity. LCH SA is proposing two specific changes to this portion of
the Framework. First, LCH SA proposes to reduce the maximum level of
liquidity to be injected daily in the settlement system to ease
settlement flow at an Italian ICSD. This change is being proposed to
ensure the maximum level of liquidity specifically related to Italian
debt is appropriate given actual settlement activity related to Italian
debt observed by LCH SA's Operations Team. Second, LCH SA proposes to
include additional text to specify the dates of its most recent tests
to successfully transfer securities related to settlement for Italy,
Spain, Germany, and Belgium transactions.
III. Discussion and Commission Findings
Section 19(b)(2)(C) of the Act requires 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
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the organization.\17\ For the reasons given below, the Commission finds
that the Proposed Rule Change is consistent with Section 17A(b)(3)(F)
of the Act \18\ and Rule 17Ad-22(e)(7) thereunder.\19\
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\17\ 15 U.S.C. 78s(b)(2)(C).
\18\ 15 U.S.C. 78q-1(b)(3)(F).
\19\ 17 CFR 240.17Ad-22(e)(7).
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A. Consistency With Section 17A(b)(3)(F) of the Act
Under Section 17A(b)(3)(F) of the Act, LCH SA's rules, among other
things, must be ``designed to promote the prompt and accurate clearance
and settlement of . . . derivative agreements, contracts, and
transactions . . . .'' \20\ Based on its review of the record, and for
the reasons discussed below, the Commission believes that LCH SA's
changes are consistent with Section 17A(b)(3)(F) of the Act because
they contribute to LCH SA's management of its liquidity risk.
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\20\ 15 U.S.C. 78q-1(b)(3)(F).
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LCH SA relies on the Framework to support its management of
liquidity risk arising from a potential member default, default of
CC&G, and operational liquidity requirements. Managing such risks, such
as through the maintenance of liquid resources sufficient to meet
payment obligations, reduces the likelihood that LCH would fail to make
payments when due, thereby avoiding disruptions to the settlement of
transactions for which such payments are due. Thus, the Framework, as a
rule of LCH SA, supports the prompt and accurate clearance and
settlement of the derivatives transactions LCH SA clears, including
security-based swaps.
Certain of the changes LCH SA proposes would update and clarify
existing aspects of the Framework. These include changes meant to
accurately portray LCH SA's banking relationships, changes describing
the options LCH SA has to address default situations in which there is
a liquidity shortfall in a currency different from EUR, and changes
reflecting that LCH SA has successfully tested the transfer of
securities coming from settlement for Italy, Spain, Germany, and
Belgium transactions. These updates and clarifications contribute to
the effectiveness of the Framework as a tool supporting LCH SA's
management of liquidity risk arising from a potential member default,
default of CC&G, and operational liquidity requirements, which
facilitates prompt and accurate clearance and settlement.
LCH SA proposes changes designed to control and more accurately
quantify LCH SA's liquidity risk with regard to its operational
liquidity needs, including changes to the Framework that would take
into account decreases in the Default Fund, adding arrangements
governing how extraordinary intraday liquidity injections are approved
and considered in the operational target, and updating the maximum
level of liquidity to be injected daily in the settlement system to
ease settlement flow for ICSDs. Control over and accurate measurement
of liquidity risk is necessary to ensure that LCH SA's exposure does
not exceed its resource so that LCH SA can meet its payment obligations
on time without disrupting settlement. Thus, these changes promote
prompt and accurate clearance and settlement.
The Commission believes, therefore, that the Proposed Rule Change
is consistent with the requirements of Section 17A(b)(3)(F) of the
Act.\21\
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\21\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(7) Under the Act
Rule 17Ad-22(e)(7) requires covered clearing agencies to establish,
implement, maintain, and enforce written policies and procedures
reasonably designed to measure, monitor, and manage the liquidity risk
that arises in or is borne by the covered clearing agency.\22\ In
adopting Rule 17Ad-22(e)(7), the Commission provided guidance that a
covered clearing agency should consider in establishing and maintaining
policies and procedures that address liquidity risk. Specifically, the
Commission stated that a covered clearing agency should generally
consider whether it has a robust framework to manage its liquidity
risks from its participants and other entities.\23\
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\22\ 17 CFR 240.17Ad-22(e)(7).
\23\ Securities Exchange Act Release No. 78961 (Sept. 28, 2016),
81 FR 70786, 70823 (Oct. 13, 2016) (File No. S7-03-14).
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LCH SA proposes changes that would make the Framework more robust
by broadening the description of potential sources of liquidity risk
and describing internal processes governing when prior approval must be
obtained for an intraday liquidity injection. For example, LCH SA
proposes to expand the list of actions that may cause liquidity needs
to arise, and would adjust how LCH SA considers decreases in the
Default Fund and intraday liquidity injections with regard to its
operational target. These proposed changes would provide LCH SA with a
more accurate understanding of both its liquidity needs and its
operational target. LCH SA's increased ability to measure its liquidity
risk due to these changes makes the Framework more robust.
Additionally, as noted above, LCH SA proposes changes that would
describe internal processes governing when prior approval must be
obtained for an intraday liquidity injection. These changes provide for
stronger internal controls regarding liquidity risk management. The
Commission believes that the proposed changes to LCH SA's Framework
described in Section II A above are consistent with Rule 17Ad-22(e)(7)
because they are strengthening changes to the Framework and thus
support LCH SA's ability to measure, monitor, and manage its liquidity
risk.
The Commission believes, therefore, that the Proposed Rule Change
is consistent with the requirements of Rule 17Ad-22(e)(7) under the
Act.\24\
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\24\ 17 CFR 240.17Ad-22(e)(7).
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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, Section 17A(b)(3)(F) of the Act \25\ and Rule 17Ad-
22(e)(7) thereunder.\26\
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\25\ 15 U.S.C. 78q-1(b)(3)(F).
\26\ 17 CFR 240.17Ad-22(e)(7).
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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-2023-001) be, and hereby is,
approved.\27\
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\27\ 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.\28\
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\28\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2023-05271 Filed 3-14-23; 8:45 am]
BILLING CODE 8011-01-P
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