Notice2024-01752
Self-Regulatory Organizations; LCH SA; Order Approving Proposed Rule Change, as Modified by Partial Amendment No. 1, Relating to Recovery and Resolution
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Published
January 30, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 89 Issue 20 (Tuesday, January 30, 2024)</title>
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[Federal Register Volume 89, Number 20 (Tuesday, January 30, 2024)]
[Notices]
[Pages 5949-5951]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-01752]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-99423; File No. SR-LCH SA-2023-008]
Self-Regulatory Organizations; LCH SA; Order Approving Proposed
Rule Change, as Modified by Partial Amendment No. 1, Relating to
Recovery and Resolution
January 24, 2024.
I. Introduction
On November 24, 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 to amend its CDS
Clearing Rule Book (``Rule Book'') to make amendments relating to
recovery and resolution. On December 5, 2023, LCH SA filed Partial
Amendment No. 1 to the proposed rule change to make certain changes to
the Exhibit 5 to File No. LCH SA-2023-008.\3\ The proposed rule change,
as
[[Page 5950]]
modified by Partial Amendment No. 1 (hereinafter, the ``Proposed Rule
Change'') was published for comment in the Federal Register on December
13, 2023.\4\ 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\ Partial Amendment No. 1 updates the pagination throughout
Exhibit 5 to File No. LCH SA-2023-008 and the Table of Contents in
Exhibit 5 to File No. LCH SA-2023-008 to reflect the revised
pagination. Partial Amendment No. 1 would also remove two references
to field codes in Chapter 1 of Exhibit 5 to File No. LCH SA-2023-
008.
\4\ Securities Exchange Act Release No. 99109 (Dec. 7, 2023), 88
FR 86389 (Dec. 13, 2023) (File No. SR-LCH-2023-008).
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II. Description of the Proposed Rule Change
LCH SA is a clearing agency that offers clearing of, among other
things, credit-default swaps (``CDS'').\5\ LCH SA is registered with
the Commission for clearing CDS that are security-based swaps (``SBS'')
and with the Commodity Futures Trading Commission (``CFTC'') for
clearing CDS that are swaps. In addition to being registered with the
Commission and CFTC, LCH SA is authorized to offer clearing services in
the European Union pursuant to rules established under European Markets
Infrastructure Regulation (``EMIR'') for Central Counter Parties
(``CCP''). LCH SA is required to amend its rules to remain in
compliance with the CCP Recovery and Resolution Regulation under
EMIR.\6\ The goal of the CCP Recovery and Resolution Regulation is to
ensure that both CCPs and national authorities in the European Union
have the means to act decisively in a crisis scenario. LCH SA is
proposing to amend its Rule Book to comply with Article 9(6) and
Article 9(14) of the CCP Recovery and Resolution Regulation.\7\ The
Proposed Rule Change would amend Title I, Title II, Title IV, and
Appendix 1 of the Rule Book.
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\5\ Capitalized terms used but not defined herein have the
meanings specified in the LCH CDS Rule Book as applicable.
\6\ Regulation (EU) No 648/2012 of the European Parliament and
of the Council of 4 July 2012 on OTC derivatives, central
counterparties and trade reporting, Title III, Chapter 1, Section 1,
Article 9.
\7\ Id.
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Article 9(14) of the CCP Recovery and Resolution Regulation
requires that, following a default event in respect of a clearing
member, each CCP shall use an additional amount of its pre-funded,
dedicated own resources (the ``second skin-in-the-game'') prior to the
requirement of non-defaulting clearing members to make a contribution
in cash to the CCP amounting to at least each clearing member's
contribution to the default fund. This second skin-in-the-game is
required in addition to the prefunded resources required in accordance
with EMIR (the ``first skin-in-the-game''),\8\ which will be used by
the CCP before the use of each non-defaulting clearing member's initial
contribution to the default fund.\9\ On November 25, 2022, the European
Commission adopted a delegated act specifying the methodology for
calculation and maintenance of the second skin-in-the-game to be used
in accordance with Article 9(14) of the CCP Recovery and Resolution
Regulation (the ``Commission-Delegated Regulation'').\10\ Separately,
Article 9(6) of the CCP Recovery and Resolution Regulation requires
that CCPs provide in their rules that they may deviate from their
recovery plan measures and, in such circumstances, they shall notify
their competent authority designated in accordance with EMIR.\11\
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\8\ Article 9(14) of Regulation (EU) 2021/23 of the European
Parliament and of the Council of 16 December 2020 on a framework for
the recovery and resolution of central counterparties. <a href="http://data.europa.eu/eli/reg/2021/23/oj">http://data.europa.eu/eli/reg/2021/23/oj</a>.
\9\ Regulation (EU) 2021/23 of the European Parliament and of
the Council of 16 December 2020 on a framework for the recovery and
resolution of central counterparties, Article 9(14). <a href="http://data.europa.eu/eli/reg/2021/23/oj">http://data.europa.eu/eli/reg/2021/23/oj</a>.
\10\ Commission Delegated Regulation (EU) 2023/840 of 25
November 2022 supplementing Regulation (EU) 2021/23 of the European
Parliament and of the Council with regard to regulatory technical
standards specifying the methodology for calculation and maintenance
of the additional amount of pre-funded dedicated own resources to be
used in accordance with Article 9(14) of that Regulation. <a href="http://data.europa.eu/eli/reg_del/2023/840/oj">http://data.europa.eu/eli/reg_del/2023/840/oj</a>.
\11\ Regulation (EU) 2021/23 of the European Parliament and of
the Council of 16 December 2020 on a framework for the recovery and
resolution of central counterparties, Article 9(6). <a href="http://data.europa.eu/eli/reg/2021/23/oj">http://data.europa.eu/eli/reg/2021/23/oj</a>.
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A. Defined Terms
Title I of LCH SA's Rule Book addresses general provisions and
legal framework, including a set of defined terms in Chapter 1. LCH SA
proposes to add two new defined terms to Chapter 1. First, LCH SA would
add the term ``CCP Recovery and Resolution Regulation,'' which would be
defined as Regulation (EU) 2021/23 of the European Parliament and of
the Council of 16 December 2020 on a framework for the recovery and
resolution of central counterparties. Second, LCH SA would add the term
``ACPR,'' which would be defined as the Autorit[eacute] de
Contr[ocirc]le Prudentiel et de R[eacute]solution and any successor
organization. The ACPR is one of LCH SA's national competent
authorities.\12\ LCH SA also proposes to replace each reference to
Autorit[eacute] de Contr[ocirc]le Prudentiel et de R[eacute]solution in
the Rule Book with the new defined term ACPR.
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\12\ EMIR requires that each EU member state designate the
competent authority responsible for, inter alia, supervision of CCPs
established in its territory. See Regulation (EU) No 648/2012 of the
European Parliament and of the Council of 4 July 2012 on OTC
derivatives, central counterparties and trade repositories, Title
III, Chapter 2, Section 1, Article 22 (Competent Authority).
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B. Recovery Plan
Title I of LCH SA's Rule Book includes provisions related to
membership in LCH SA, including terms related to the suspension and
termination of membership in Chapter 4 of Title II. LCH SA proposes to
add a new section 2.4.4 to Chapter 4 that pertains specifically to
recovery. LCH SA maintains a recovery plan. The recovery plan includes
certain quantitative and qualitative indicators to identify the
circumstances under which LCH SA may take specific measures, which are
also specified in the recovery plan, in the case of a default or non-
default event. The goal of such measures is the restoration of LCH SA's
financial resources so it can continue providing critical functions in
all relevant scenarios. As required by Article 9(6), proposed Article
2.4.4 would provide for an additional scenario in which LCH SA either
takes measures provided for in its recovery plan despite the fact that
the relevant indicators have not been met, or refrains from taking
measures provided for in the recovery plan despite the fact that the
relevant indicators have been met. In either event, the proposed rule
change would require any such proposal to be submitted to the LCH SA
board of directors for approval, and LCH to submit to the ACPR without
delay any subsequent decision taken by the board of directors.
C. Default Waterfall
Title IV of LCH SA's Rule Book includes provisions related to risk
management, including terms related to events of default in Chapter 3
of Title IV. LCH SA proposes to amend the default waterfall provisions
in Article 4.3.3.1 of Chapter 3. Article 4.3.3.1 defines the waterfall
of resources that LCH SA would apply to cover losses arising out of a
member default. LCH SA proposes to add LCH SA's second skin-in-the-game
as a new loss mitigation resource to its default waterfall.\13\ The
second skin-in-the-game would be applied immediately before the
collateral deposited by the non-defaulting clearing members. The
proposed amendment to the waterfall provisions will also provide that,
in accordance with Article 9(14) of the CCP Recovery and Resolution
[[Page 5951]]
Regulation and Article 1 of the Commission-Delegated Regulation, the
LCH SA additional dedicated own resources, as determined from time to
time, will be (a) up to the amount of such dedicated own resources
allocated to the CDS Default Fund in proportion to the size of the CDS
Default Fund; and (b) in the case of an Event of Default occurring
after a previous Event of Default, but before LCH SA has reinstated
such dedicated own resources in accordance with Article 3(2) of the
Commission Delegated Regulation, up to the residual amount of such
dedicated own resources in the CDS Default Fund.
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\13\ The new resource would be added as the sixth resource on
the list, requiring LCH SA to renumber items (vi) and (vii) of the
current list.
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In the penultimate paragraph of Article 4.3.3.1, LCH SA proposes to
clarify that the LCH SA second skin-in-the-game could be up to the
amount of LCH SA's own resources allocated to the CDS Default Fund.\14\
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\14\ LCH SA also proposes conforming edits in Section 7 of
Appendix 1 to the Rule Book, which deals with loss distributions in
the context of the CDS default management process. Specifically, LCH
SA proposes to add a reference in Section 7 of the appendix to
section 4.3.3.1 as well as language consistent with the amended
language of 4.3.3.1.
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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.\15\ For the reasons given below, the Proposed Rule Change
is consistent with Section 17A(b)(3)(F) of the Act \16\ and Rule 17Ad-
22(e)(2) \17\ thereunder.
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\15\ 15 U.S.C. 78s(b)(2)(C).
\16\ 15 U.S.C. 78q-1(b)(3)(F).
\17\ 17 CFR 240.17Ad-22(e)(2).
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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 assure the safeguarding of
securities and funds which are in the custody or control of LCH SA or
for which it is responsible.\18\ As discussed in more detail below, the
Proposed Rule Change is consistent with Section 17A(b)(3)(F) of the
Act.\19\
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\18\ 15 U.S.C. 78q-1(b)(3)(F).
\19\ 15 U.S.C. 78q-1(b)(3)(F).
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The Commission continues to regard skin-in-the-game as a potential
tool to align the various incentives of a covered clearing agency's
stakeholders, including management and clearing members.\20\ LCH SA
proposes to add a second skin-in-the-game as a resource to be used to
cover the losses resulting from the implementation of the CDS Default
Management Process before the collateral deposited by the non-
defaulting clearing members as an additional contribution to the CDS
Default Fund. Adding a second skin-in-the-game resource would create
additional incentive for LCH SA to maintain the appropriate amount of
resources to manage clearing member default because failure to do so
would result in a direct cost to LCH SA. Creating additional incentive
for LCH SA to maintain an appropriate amount of resources, in turn,
could reduce the potential losses charged to the CDS Default Fund
contributions of non-defaulting clearing members in the event of a
clearing member default, which in turn would help assure the
safeguarding of the CDS Default Fund contributions of non-defaulting
clearing members.
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\20\ Securities Exchange Act Release No. 78961 (Sep. 28, 2016),
81 FR 70786, 70806 (Oct. 13, 2016) (S7-03-14) (``Covered Clearing
Agency Standards'').
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As discussed above, LCH SA proposes to change its Rule Book so that
it can either take measures provided for in its recovery plan even if
relevant indicators have not been met, or refrain from taking measures
provided for in the recovery plan even though the relevant indicators
have been met, provided it obtains board approval and promptly notifies
the ACPR of the board's decision. This too would provide LCH SA with
additional flexibility to take actions to safeguard funds for which it
is responsible.
Based on the foregoing, the Commission finds 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)(2) Under the Act
Rule 17Ad-22(e)(2) under the Act requires that a covered clearing
agency establish, implement, maintain, and enforce written policies and
procedures reasonably designed to provide for governance arrangements
that, among other things, support the public interest requirements of
the Act.\22\ In adopting Rule 17Ad-22(e)(2), the Commission stated that
``the proper alignment of incentives is an important element of a
covered clearing agency's risk management practices,'' and noted that
skin-in-the-game ``may play a role in those risk management practices
in many instances.'' \23\ And, as noted above, the Commission continues
to regard skin-in-the-game as a potential tool to align the various
incentives of a covered clearing agency's stakeholders, including
management and clearing members.\24\
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\22\ 17 CFR 240.17Ad-22(e)(2)(iii).
\23\ Covered Clearing Agency Standards, 81 FR at 70806.
\24\ Securities Exchange Act Release No. 78961 (Sep. 28, 2016),
81 FR 70786, 70806 (Oct. 13, 2016) (S7-03-14) (``Covered Clearing
Agency Standards'').
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As described above, LCH SA proposes to amend its Rule Book so that
the second skin-in-the-game will be used to cover the losses resulting
from the implementation of the CDS Default Management Process
immediately before the collateral deposited by the non-defaulting
clearing members. This would mean that, following a default event in
respect of a clearing member, LCH SA would apply its own resources to
mitigate losses before applying resources provided by non-defaulting
clearing members. As discussed above, adding a second skin-in-the-game
resource would help to create incentive for LCH SA to mitigate, manage,
and maintain the appropriate amount of resources to manage clearing
member default because failure to do so would result in a direct cost
to LCH SA. Such mitigation of risk in the clearance and settlement of
securities would be consistent with supporting the public interest
because it helps reduce market disruptions. Accordingly, the Commission
finds that that the Proposed Rule Change is consistent with Rule 17Ad-
22(e)(2) under the Act.\25\
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\25\ 17 CFR 240.17Ad-22(e)(2).
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IV. Conclusion
On the basis of the foregoing, the Proposed Rule Change is
consistent with the requirements of the Act, and in particular, Section
17A(b)(3)(F) of the Act \26\ and Rule 17Ad-22(e)(2) \27\ thereunder.
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\26\ 15 U.S.C. 78q-1(b)(3)(F).
\27\ 17 CFR 240.17Ad-22(e)(2).
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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-2023-008), as modified by
Partial Amendment No. 1, be, and hereby is, approved.\28\
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\28\ 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.\29\
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\29\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-01752 Filed 1-29-24; 8:45 am]
BILLING CODE 8011-01-P
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</html>Indexed from Federal Register on January 30, 2024.
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