Notice2023-16389
Self-Regulatory Organizations; LCH SA; Order Approving Proposed Rule Change Relating to Triparty Collateral Mechanism
Primary source
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Published
August 2, 2023
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 88 Issue 147 (Wednesday, August 2, 2023)</title>
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[Federal Register Volume 88, Number 147 (Wednesday, August 2, 2023)]
[Notices]
[Pages 50923-50926]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-16389]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-98009; File No. SR-LCH SA-2023-004]
Self-Regulatory Organizations; LCH SA; Order Approving Proposed
Rule Change Relating to Triparty Collateral Mechanism
July 27, 2023.
I. Introduction
On May 30, 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 (``Proposed Rule Change'') to
amend its Credit Default Swap Clearing Procedures (``Procedures'') and
Credit Default Swap Clearing Rule Book (``Rule Book'') to reflect the
introduction of a triparty collateral mechanism to the CDSClear
service. The Proposed Rule Change was published for comment in the
Federal Register on June 16, 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. 97706 (June 12, 2023),
88 FR 39492 (June 16, 2023) (File No. SR-LCH-2023-004) (``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 (specifically, credit-default
swaps or ``CDS''). LCH SA has procedures in place to deal with the
default of a clearing member who participates in its CDS clearing
business. In order to minimize the contagion risk of such a default,
LCH SA calculates margin requirements for each clearing member and
requires each member to transfer collateral to LCH SA to meet their
respective margin requirements.
Currently, LCH SA requires members participating in its CDSClear
service
[[Page 50924]]
(the ``Clearing Members'') to manage the pledging and transfer of
collateral to LCH SA on a bilateral basis. For LCH SA's non-U.S.
business lines (e.g., its repo clearing business), LCH SA offers a
``triparty collateral'' mechanism where LCH SA and a clearing member
may authorize an agent to enter settlement instructions on the clearing
member's behalf into the LCH SA's securities settlement system.\4\ LCH
SA states that members benefit because such a triparty process is more
efficient operationally.\5\ LCH SA members requested that LCH SA
harmonize collateral management processes across business lines by
introducing a triparty collateral management process into LCH SA's CDS
business.\6\
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\4\ The agent's ability to enter settlement instructions on the
clearing member's behalf would be done for the purposes of
transferring collateral to LCH SA or releasing such collateral, and
would affect movements of securities between a clearing member
account and LCH SA by the relevant triparty agent on a full title
transfer basis.
\5\ See Notice, 88 FR at 39493.
\6\ To facilitate the use of a triparty collateral mechanism,
the clearing member, the relevant triparty agents, and LCH SA must
enter into a specific contractual arrangement.
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LCH SA now proposes to offer the triparty collateral mechanism to
its members participating in CDSClear.\7\ LCH SA is not changing
collateral eligibility or concentration limits, but rather, is merely
providing for a different process for posting acceptable collateral. To
effectuate the change, LCH SA proposes the following changes to its
rules.
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\7\ LCH SA is proposing to offer the triparty collateral
mechanism as an optional collateral management tool, but does not
intend to obligate its members to use the tri-party mechanism.
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A. Amendments to Rule Book
LCH SA is proposing to modify Section 1.1.1 (Terms defined in the
CDS Clearing Rule Book) to include a new term, ``Triparty
Documentation,'' which refers to the documentation of the agreement
entered into between LCH SA, the relevant triparty agent, and a
Clearing Member having exercised its option to transfer Eligible
Collateral \8\ on a full title transfer basis to LCH SA through a
Triparty Documentation pursuant to Section 3 of the Procedures. Section
3 includes procedures related to collateral, variation margin, and cash
payment.
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\8\ Eligible Collateral is defined by LCH as ``Such securities
and other types of non Cash Collateral as are set out in Section 3
of the Procedures as being acceptable by LCH SA for the purposes of
satisfying a Clearing Member's Margin Requirements and/or novating
Original Transactions, as applicable.''
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LCH SA also proposes to amend section 2 of its Rule Book to add a
new subsection (xxiv) to Section 2.2.1.1, to provide for a new
membership requirement where the triparty applicant shall accept to
comply with the performance of its obligations pursuant to a Triparty
Documentation. Further, LCH SA proposes to amend Section 2.2.2.1 to add
a new subsection (vii) to require a Clearing Member to comply with the
performance of the obligations pursuant to a Triparty Documentation.\9\
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\9\ The subsequent subsections would also need to be renumbered
for both amendments.
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LCH SA proposes to make several amendments to Section 4 of the Rule
Book, which addresses risk management and collateral requirements.
Since the Triparty Documentation will provide for the haircut that will
apply to the relevant collateral, LCH SA proposes to add a reference to
the Triparty Documentation in Section 4.2.6.4 which currently provides,
among others, that LCH SA may apply haircuts to Eligible Collateral as
set out on the LCH SA website. LCH SA also proposes to add the failure
of a Clearing Member to perform its obligations in accordance with, or
a breach of, any Triparty Documentation to the list of Events provided
for in Section 4.3.1.1, which describes events that might constitute a
Clearing Member default, as this is currently the case in respect of
the CDS Clearing Documentation and the Pledge Agreement.
LCH SA also proposes to make the following conforming Rule Book
changes that are not related to the implementation of the Triparty
Documentation solution for the CDSClear service. Specifically, the
definition of ``Pledged Eligible Collateral'' in Section 1.1.1 (Terms
defined in the CDS Clearing Rule Book) would be amended by removing a
reference to a Clearing Notice, because the list of Eligible Currencies
and collateral is already set out in Section 3 of the Procedures in
accordance with Section 4.2.6.1, and the proposed amended Section 3 of
the Procedures would provide where the list of collateral (including
Pledged Eligible Collateral) could be found. Section 2.2.2.1 would be
amended to correct a cross-reference in subsection (iv). Finally, LCH
SA would amend Section 4.2.6.1 by making a reference to Section 3 of
the Procedures regarding the conditions that will govern the
notification of any change in eligible currencies and collateral.
B. Amendments to Procedures
LCH SA proposes to modify Section 3 of the Procedures, which covers
the topics of collateral, variation margin, and cash payments, to
incorporate terms for implementing the triparty collateral mechanism.
The Proposed Rule Change amends Section 3.10 (Eligible Collateral
transferred with full title) to include securities transferred pursuant
to a Triparty Documentation, by adding a new paragraph to Section
3.10.2 (Eligible Collateral provided pursuant to a Triparty
Documentation) and a new introductory paragraph stating that Eligible
Collateral transferred with full title may be provided by a Clearing
Member either on a bilateral basis or pursuant to a Triparty
Documentation in accordance.
The Proposed Change will move current Section 3.10 under a new
paragraph in Section 3.10.1 entitled ``Eligible Collateral provided on
a bilateral basis,'' and any reference to collateral provided with full
title transfer in this new paragraph in Section 3.10.1 will be
clarified by adding that such Eligible Collateral is provided on a
bilateral basis. LCH SA proposes to replace any cross-reference to
Section 3.10 in Section 3 of the Procedures with a cross-reference to a
new paragraph in Section 3.10.1 where necessary. As a result of the new
paragraph in Section 3.10.2, a cross-reference to subsection (d) will
be added to each section referring to the return of any type of
collateral. This cross-reference allows for Eligible Collateral to be
transferred with full title pursuant to a Triparty Documentation.
The new paragraph in Section 3.10.2, as further described below,
will mainly replicate the paragraph in Section 3.10.1, but will amend
the content to refer to the Triparty Documentation. The new amendments
would include the requirement for a Clearing Member to enter into the
Triparty Documentation, as set out in a new sub-paragraph (a) and the
reference to triparty accounts to be used by LCH SA. However, due to
the use of a triparty agent for managing Clearing Member Collateral
posted with LCH SA, there will be some differences in the timelines
applicable to the Clearing Member for the purposes of transferring, or
requesting return of, securities subject to the Triparty Documentation,
as described below.
Subsection (a) of Section 3.10.2 (General information) states that
the Clearing Member, a triparty agent (either Euroclear Bank or
Euroclear France), and LCH SA may enter into the relevant Triparty
Documentation, whose documentation is available upon request to the
CDSClear Business Development & Relationship Management team. Under the
Triparty Documentation, the relevant triparty agent will be authorized
by LCH SA and the Clearing
[[Page 50925]]
Member to enter settlement instructions on their behalf into the
relevant securities settlement system to transfer with full title
securities as Eligible Collateral between LCH SA and the Clearing
Member.
Sub-paragraph (b) (Securities accounts) states that LCH SA will
hold collateral in security accounts at the relevant triparty agent(s)
as applicable for the Clearing Member's house activity, and separately,
client activity (excluding any FCM Clients, since the provision of
securities pursuant to this triparty collateral solution will not be
permitted for FCM Clients pursuant to new sub-paragraph (c) of new
paragraph 3.1.0.2, indent (ii)).\10\
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\10\ LCH SA may invest eligible collateral provided to LCH SA
with full title pursuant to a triparty arrangement in accordance
with Paragraph 3.11(b).
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Sub-paragraph (c) will include provisions describing the transfer
of Eligible Collateral pursuant to a Triparty Documentation; the
purpose of such transfer is either for transferring additional
collateral or substituting such collateral for any alternative
collateral recorded in its collateral accounts. To transfer collateral
on a specific business day, a Clearing Member would need to notify LCH
SA of its request to transfer such Eligible Collateral pursuant to a
Triparty Documentation by no later than 16:00 CET on the prior business
day. If the Clearing Member notifies LCH SA that the collateral will
move client accounts, the member must specify which client account
shall record Eligible Collateral; otherwise, LCH SA will not accept the
transfer request.\11\
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\11\ LCH SA makes intra-day margin calls throughout the day.
Whether the collateral will be taken into account with regard to a
specific intra-day margin call is dependent on when LCH SA received
confirmation from a Clearing Member's triparty agent. Proposed
section 3.10.02(c) describes how confirmation timing affects margin
calculations in more detail.
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Sub-paragraph (d) addresses the applicable conditions for returning
collateral to a Clearing Member. A Clearing Member must request a
return of collateral no later than 12:00 CET on the business day before
they want to receive the collateral. LCH SA would transfer the
requested collateral between 12:25 and 12:55 CET on the requested
day.\12\ Any return request received by LCH SA shall be deemed firm and
irrevocable. By 12:00 CET on the day the collateral is returned, LCH SA
will re-calculate the value of the Eligible Collateral to be returned
(the ``Eligible Triparty Collateral Value''). If LCH SA holds
sufficient collateral (other than that which is to be returned) to
cover the relevant margin requirement, it will return the collateral.
If LCH SA does not hold sufficient collateral (other than that which is
to be returned) to cover the relevant margin requirement, LCH SA will
attempt to debit an amount of Euros equal to the Eligible Triparty
Collateral Value from the TARGET2 \13\ Account(s) of the Clearing
Member (or its TARGET2 Payment Agent), after which LCH SA would return
the collateral.\14\ LCH SA would instruct the triparty agent(s) to
return the collateral between 13:00 and 15:00 CET, in advance of the
relevant Central Securities Depository/International Central Securities
Depository cut-off time (except in exceptional circumstances, as
determined in an objective and commercially reasonable manner). The
last paragraph of new paragraph 3.10.2 will provide for exceptional
time limits for notification of transfer and return requests in cases
of atypical market conditions.
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\12\ Section 3.7(c) of the Procedures defines the timing of
collateral calls, and specifies the 12:25 to 12:55 CET period as a
window to be use for the purpose of collateral substitutions upon a
Clearing Member's request, which LCH SA refers to as the
``Additional Specific Collateral Slot.''
\13\ TARGET2 is the system known as Trans-European Automated
Real-time Gross Settlement Express Transfer 2.
\14\ If LCH SA cannot debit the required amount of Euros, it
would not return the requested collateral.
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Current Section 3.9 of the Procedures addresses Eligible
Collateral. In this section, LCH SA proposes to insert language stating
that additional eligibility criteria and concentration limits apply for
Triparty Documentation.\15\ LCH SA also proposes to insert language
stating that it may amend the list of eligible securities by
publication of a Clearing Notice, and add new eligibility criteria and
concentration limits for Eligible collateral transferred with full
title pursuant to a Triparty Documentation, subject to the prior
consent of the relevant triparty agent. As a result, the reference to a
Clearing Notice mentioned in Section 3.13 applicable to Eligible
Collateral pursuant to the Pledge Agreement will be removed, as there
will be no Clearing Notice which describes such Eligible Collateral;
all relevant information will be found on the LCH SA website.
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\15\ The triparty documentation would only be able to add
requirements, and could not reduce the eligibility criteria or
concentration limits specified in LCH SA's rules.
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LCH SA also proposes changes to Section 3.9 to clarify that
Eligible Collateral transferred with full title may be provided on a
bilateral or trilateral basis, where necessary. LCH SA is proposing to
amend sub-paragraph (c) (Events affecting the eligibility of Eligible
Collateral) to exclude securities transferred pursuant to the triparty
collateral solution from the current management process applicable to
Collateral Events.\16\ Such Collateral Events will be managed by the
relevant triparty agent in accordance with the Triparty Documentation.
Consequently, the scope of Section 3.12 is reduced to Eligible
Collateral transferred with full title on a bilateral basis.
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\16\ A ``Collateral Event'' is defined as either a suspension
from trading of such security by an exchange or the public
announcement of a take-over bid, public exchange offer, split or
reverse split involving the entity issuing such security.
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LCH SA proposes other amendments to Section 3 of the Procedures in
order to correct some cross-references or typographical errors.
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 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)(21) 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)(21).
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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 LCH
SA is offering an additional clearing mechanism to its members.
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\20\ 15 U.S.C. 78q-1(b)(3)(F).
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LCH SA is proposing to allow CDSClear Clearing Members to cover
their margins with eligible securities through the use of a triparty
agent. Clearing Members are under no obligation to use this solution.
This change will broaden the solutions for Clearing Members to manage
collateral posted to LCH SA. The introduction of the triparty mechanism
would align collateral management practices for members across LCH SA
business lines and enable the transfer of securities as collateral in a
more efficient and automated way than on a bilateral basis. Offering a
more efficient and automated
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process may, for members who choose to use it, reduce the overall cost
of clearing. Reducing the overall cost of clearing could, in turn, lead
Clearing Members to clear more products. Thus, these changes would
contribute to the prompt and accurate clearance process and settlement
of securities transactions and derivative agreements, contracts, and
transactions and to assure the safeguarding of securities, which is
consistent with the requirements of Section 17(A)(b)(3)(F).\21\
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\21\ 15 U.S.C. 78q-1(b)(3)(F).
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The Commission believes, therefore, that the Proposed Rule Change
is consistent with the requirements of Section 17A(b)(3)(F) of the
Act.\22\
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\22\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(21) Under the Act
Rule 17Ad-22(e)(21) requires covered clearing agencies to
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to be efficient and effective in meeting
the requirements of its participants and the markets it serves, and
have the covered clearing agency's management regularly review the
efficiency and effectiveness of its clearing and settlement
arrangements; operating structure, including risk management policies,
procedures, and systems; scope of products, cleared or settled; and use
of technology and communication procedures.\23\ In adopting Rule 17Ad-
22(e)(21), the Commission provided guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address efficiency and effectiveness,
stating that it should consider whether its design meets the needs of
its participants, particularly with regard to choice of operating
structure and use of technology and procedures.\24\
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\23\ 17 CFR 240.17Ad-22(e)(21).
\24\ See Standards for Covered Clearing Agencies, Securities
Exchange Act Release No. 78961 (Sept. 28, 2016), 81 FR 70786, 70841
(Oct. 13, 2016).
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LCH SA's members expressed interest in using the triparty mechanism
to the CDSClear business to harmonize their operational process across
all clearing services of LCH SA.\25\ The triparty collateral mechanism
is an optional solution that would reduce the number of manual actions
necessary in the processing of non-cash collateral deposit and release
for both the clearing agency and the Clearing Members. Reliance on the
triparty mechanism could reduce the manual steps necessary for a
Clearing Member to allocate a basket of securities in LCH SA's system
with an automatic process for the settlement of margin calls and
handling of coupons. Such automation would increase efficiency and
allows for additional use of technology with the settlement of margin
call.
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\25\ See Notice, 88 FR at 39493.
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The Commission believes, therefore, that the Proposed Rule Change
is consistent with the requirements of Rule 17Ad-22(e)(21) under the
Act.\26\
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\26\ 17 CFR 240.17Ad-22(e)(21).
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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 \27\ and Rule 17Ad-
22(e)(21) thereunder.\28\
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\27\ 15 U.S.C. 78q-1(b)(3)(F).
\28\ 17 CFR 240.17Ad-22(e)(21).
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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-2023-004) be, and hereby is,
approved.\29\
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\29\ 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.\30\
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\30\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-16389 Filed 8-1-23; 8:45 am]
BILLING CODE 8011-01-P
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