Notice2024-15401
Self-Regulatory Organizations; LCH SA; Order Approving Proposed Rule Change Relating to Liquidity Risk Modelling Framework
Primary source
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Published
July 15, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 89 Issue 135 (Monday, July 15, 2024)</title>
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[Federal Register Volume 89, Number 135 (Monday, July 15, 2024)]
[Notices]
[Pages 57467-57479]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-15401]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-100470; File No. SR-LCH SA-2023-007]
Self-Regulatory Organizations; LCH SA; Order Approving Proposed
Rule Change Relating to Liquidity Risk Modelling Framework
July 9, 2024.
I. Introduction
On December 22, 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
[[Page 57468]]
of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule
change (``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 11, 2024.\3\ On February
21, 2024, pursuant to Section 19(b)(2) of the Act,\4\ the Commission
designated a longer period within which to approve, disapprove, or
institute proceedings to determine whether to approve or disapprove the
Proposed Rule Change, from February 25, 2024 to April 10, 2024.\5\ On
April 8, 2024, the Commission instituted proceedings, pursuant to
Section 19(b)(2)(B) of the Act,\6\ to determine whether to approve or
disapprove the Proposed Rule Change.\7\ 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\ Exchange Act Release No. 99277 (Jan. 5, 2024), 89 FR 1952
(Jan. 11, 2024) (File No. SR-LCH SA-2023-007) (``Notice'').
\4\ 15 U.S.C. 78s(b)(2).
\5\ Self-Regulatory Organizations; LCH SA; Notice of Designation
of Longer Period for Commission Action on Proposed Rule Change
Relating to the Liquidity Risk Modelling Framework, Exchange Act
Release No. 99569 (Feb. 21, 2024), 89 FR 14538 (Feb. 27, 2024) (File
No. SR-LCH SA-2023-007).
\6\ 15 U.S.C. 78s(b)(2)(B).
\7\ Self-Regulatory Organizations; LCH SA; Order Instituting
Proceedings to Determine Whether to Approve or Disapprove a Proposed
Rule Change Relating to Liquidity Risk Modeling Framework, Exchange
Act Release No. 99922 (Apr. 8, 2024), 89 FR 25906 (Apr. 12, 2024)
(File No. SR-LCH SA-2023-007).
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II. Description of the Proposed Rule Change
(i) Background
LCH SA is a clearing agency that offers clearing of, among other
things, credit-default swaps (``CDS'').\8\ LCH SA is registered with
the Commission for clearing CDS that are security-based swaps and with
the Commodity Futures Trading Commission for clearing CDS that are
swaps. As part of its clearing business, LCH SA maintains cash and
other liquid financial resources to meet its financial obligations. The
Framework and other procedures describe how LCH SA maintains these
resources and manages its liquidity risk, meaning the risk that LCH SA
will not have enough liquid financial resources to meet its financial
obligations.\9\ The Framework specifically describes how LCH SA's
Collateral and Liquidity Risk Management department (``CaLRM'') 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 LCH SA's clearing services.
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\8\ Capitalized terms used but not defined herein have the
meanings specified in the LCH SA Rule Book or Framework as
applicable.
\9\ LCH SA, a subsidiary of LCH Group and an indirect subsidiary
of the London Stock Exchange Group plc (``LSEG''), manages its
liquidity risk pursuant to, among other policies and procedures, the
Group Liquidity Risk Policy and the Group Liquidity Plan applicable
to each entity within LCH Group. In addition to its CDSClear
service, LCH SA provides clearing services in connection with cash
equities and derivatives listed for trading on Euronext
(EquityClear), commodity derivatives listed for trading on Euronext
(CommodityClear), and tri-party Repo transactions (RepoClear).
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The Framework describes LCH SA's liquidity in terms of sources and
needs. The Framework lists various sources of liquidity for LCH SA,
such as cash and non-cash collateral provided by Clearing Members to
meet their margin and default fund requirements. With respect to needs
for liquidity, the Framework places these into three broad categories:
(i) those arising from LCH SA's business-as-usual operations; (ii)
those arising from Clearing Members' defaults; and (iii) those arising
from the default of LCH SA's interoperating central counterparty
(``CCP'').
Section 1 of the Framework describes the scope, purpose, and use of
the Framework. Sections 2 and 3 describe certain limitations to, and
justifications for, how LCH SA models its liquidity sources and needs.
Section 4 details how LCH SA models its liquidity sources and needs.
Section 5 describes how LCH SA tests and monitors the performance of
these models. Finally, Section 6 contains certain additional
information relevant to the Framework, presented as appendices to the
Framework.
The purpose of the Proposed Rule Change is to make a variety of
updates to the Framework. These updates are described below according
to the section of the Framework where they appear. In general, these
changes will: (a) revise the manner in which settlement obligation
liquidity requirements are calculated; (b) revise the way LCH SA
determines the potential value of liquidity obtained from pledging
securities to the Banque de France (``BdF''); (c) extend the length of
time for which LCH SA must maintain liquidity resources sufficient to
meet its liquidity requirements; (d) include the liquidity needs
generated by the expiration of physically settled stock futures in
determining overall liquidity needs; and (e) require LCH SA, in
calculating its required liquidity resources, to consider that Clearing
Members may switch from depositing non-cash collateral in a Full Title
Transfer Account (``FTTA'') to depositing non-cash collateral instead
in a Single Pledged Account (``SPA'').
(ii) Section 1 Changes to the Framework
Section 1 of the Framework details the scope, purpose, and use of
the Framework. The Proposed Rule Change would make various updates to
this section, as described below.
Currently, Section 1.1, titled Model Objective, Business Scope and
Intended Use, states that the Framework is owned by CaLRM and is
reviewed on at least a quarterly basis. Currently, Section 1.1 provides
that the Framework is reviewed at least on a quarterly basis. LCH SA is
proposing to change the frequency the Framework is reviewed from
quarterly to annually. LCH SA is making this change to align the review
of the Framework with the frequency of the review of the Group
Liquidity Risk Policy.
Section 1.1.1, titled Reminder of SA's activities, contains an
overall description of LCH SA's activities as a clearing agency. Among
other things, Section 1.1.1 currently explains that LCH SA maintains
default funds which aim to cover the two largest losses that may exceed
the losses covered by initial margins. LCH SA is proposing to revise
this description slightly by deleting the phrase ``two largest,'' and
noting instead that default funds are calibrated on the assumption of
default of the two most exposed groups of affiliated Clearing Members
(``Clearing Member Groups'').
The Proposed Rule Change would next amended Section 1.1.2, titled
Investment Activities. To ensure that the Framework provides an
accurate description of the Collateral and Liquidity Management
(``CaLM'') Front Office team, LCH SA is clarifying the description of
this team in this section. LCH SA's CaLM team manages LCH SA's
investment activities, among other responsibilities, and the current
Framework describes CaLM's tasks related to investment activities as
liquidity management, non-cash collateral settlement in case of a
Clearing Member's default, and investment management of cash margins,
default funds, and other financial resources. The Proposed Rule Change
would revise this description to state that CaLM's task is non-cash
collateral liquidation, rather than settlement, in addition to
liquidity and investment management.
Section 1.1.3, titled Interoperability of CC&G, describes the
interoperability link that LCH SA maintains with another CCP, Cassa di
Compensazione e
[[Page 57469]]
Garanzia, or ``CC&G,'' which has been renamed ``Euronext Clearing.''
The proposed rule change would reflect the renaming by replacing
references to CC&G with references to Euronext Clearing, including in
the title to this section.
LCH SA is also making changes to reflect the other policies and
procedures, in addition to the Framework, that it employs to manage its
liquidity risk. As noted above, LCH SA is a subsidiary of LCH Group and
an indirect subsidiary of LSEG. As such, LCH SA manages its liquidity
risk using the Group Liquidity Risk Policy and the Group Liquidity Plan
(which are applicable to each entity within LCH Group). LCH SA uses
these other policies in addition to the Framework. The Proposed Rule
Change would update Section 1.3, titled Model dependency and
interconnectivity, to include summaries of these other policies,
including the LCH SA Liquidity Plan, Group Liquidity Risk Policy, Group
Financial Resource Adequacy Policy, Group Collateral Risk Policy, Group
Investment Risk Policy, LCH SA Collateral Control Framework, and Group
Risk Policy: Default Management.
The Proposed Rule Change would next amend Section 1.4, titled Model
Governance. Here the Proposed Rule Change would add a footnote to
clarify that the core liquidity reserve stress tests are performed
monthly according to the Liquidity Risk Policy. LCH is making this
change to align the Framework with LCH SA's Liquidity Risk Policy.
Section 1.6.1, titled Liquidity Sources, describes LCH SA's sources
of liquidity. These sources include, among others, cash posted by
Clearing Members to meet margin and default fund requirements and non-
cash collateral posted by Clearing Members. Section 1.6.1 also
describes the tools that CaLM would use to meet LCH SA's non-Euro
liquidity requirements in case of a Clearing Member's default. Section
1.6.1 currently describes these tools as committed liquidity lines
pledged with assets from margin collateral or investments and a rule
book arrangement that allows LCH SA to pay its obligations in Euros.
The Proposed Rule Change would add further explanation of the tools
available to CaLM to meet LCH SA's non-Euro liquidity requirements in
the event of a default. At a broad level, these tools include non-Euro
cash deposited as collateral at creditworthy commercial banks; the sale
of non-Euro securities of the defaulting member; repo transactions; the
use of LCH SA's multicurrency overdraft facility; the use of FX spot
market transactions; ECB weekly tender in U.S. dollars; and the
replacement of LCH SA's liabilities in non-Euro by Euro. This
description would be the same as what is currently found in Appendix 5
of the Framework.\10\
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\10\ The Proposed Rule Change would not amend this description
as currently found in Appendix 5.
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The Proposed Rule Change next would make two changes in Section
1.6.1.1, titled Collateral transfer to the 3G pool, which is related to
non-cash collateral posted by Clearing Members. LCH SA permits Clearing
Members to deposit non-cash collateral either through a FTTA or through
a SPA. LCH SA maintains FTTAs at various central securities
depositories and maintains SPAs at Euroclear Bank and Bank of New York
Mellon (for U.S. Treasuries). As currently described in Section
1.6.1.1, LCH SA can pledge certain of this non-cash collateral--mostly
Euro-denominated securities, referred to herein as ``Eligible
Collateral''--at BdF to obtain a liquidity line on an intraday basis
and overnight if needed. Securities denominated in other, non-Euro
currencies are generally not considered Eligible Collateral under the
Framework,\11\ and LCH SA can only pledge Eligible Collateral that is
deposited through a FTTA. LCH SA cannot pledge securities that a
Clearing Member deposits via a SPA, regardless of whether they are
Eligible Collateral. Section 1.6.1.1 currently states that all non-cash
collateral received is deposited via FTTA by LCH SA in various CSDs,
except where collateral is deposited via SPA. The Proposed Rule Change
would revise this description to clarify that Clearing Members can
deposit either via FTTA or SPA, thus better reflecting Clearing
Members' ability to choose between the two accounts. Second, the
Proposed Rule Change would add a note to explain that there are limits
to the amount of pledge collateral that can be deposited for LCH SA's
RepoClear, EGC Plus, and EquityClear business lines, and a note to
explain that Clearing Members deposit most of their collateral via
FTTAs.
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\11\ For example, the Framework notes that Gilts, US Treasuries,
and securities denominated in Danish Krone, Norwegian Krone, Swedish
Krona, Japanese Yen, Swiss Franc, Canadian Dollar, and Australian
Dollar are not eligible for pledge at BdF.
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Section 1.6.1.2, titled Assessment of Assets Liquidity, describes
how LCH SA categorizes its collateral in terms of how liquid that
collateral is. LCH SA assigns collateral to a liquidity tiering scale,
ranging from 1 to 3. Tier 1 assets are the most liquid and Tier 3 are
the least liquid. Currently, Section 1.6.1.2 contains a table that
lists out collateral by tier. This table includes, as Tier 1 assets,
all Eligible Collateral, UK Gilts and US Treasury Bills, and Dutch and
Belgian central bank guarantees (only for the defaulting member that
posted the guarantee). The Proposed Rule Change would add to this
table, as Tier 3 assets, non-cash collateral denominated in Danish
Krone, Norwegian Krone, Swedish Krona, Japanese Yen, Swiss Franc,
Canadian Dollar, and Australian Dollar. As noted, such collateral is
not Eligible Collateral. The Proposed Rule Change also would note,
elsewhere in Section 1.6.1.2, that Tier 1 Assets include Gilt US
securities and the central bank guarantee of the defaulter if the
member is based in the same country as the central bank providing the
guarantee. This additional language would be consistent with what is
currently found in the table regarding Tier 1 assets.
Section 1.6.1.3, titled Synthesis, contains a table that
synthesizes information about LCH SA's various liquidity sources. This
table categorizes each source as cash, non-cash collateral from
Clearing Members, collateral from investment activities, and other. In
this table the Proposed Rule Change would replace references to CC&G
with references to Euronext Clearing, to reflect the name change noted
above. Currently, this table also explains that LCH SA retains the
right of collateral re-hypothecation for all Eligible Collateral, but
not for collateral deposited under the pledge regime and CDS. The
Proposed Rule Change would remove the reference specific to CDS.
Because pledge is now available at LCH SA's CDS service, the disclaimer
for pledge also applies to CDS, and therefore the CDS business line
does not need to be mentioned separately.
In addition, the table currently notes that LCH SA has demonstrated
an ability to raise Euro cash using non-Euro, non-cash collateral,
based on exercises performed in 2017. The Proposed Rule Change would
clarify that CaLM demonstrated in 2021 and 2022 the ability to raise
Euro liquidity from non-Euro non-cash collateral in USD and GBP. The
table currently notes that when valuing non-Euro non-cash collateral as
a liquidity source, LCH SA applies an arbitrary buffer of ten percent
as a haircut. The Proposed Rule Change also would revise the
description of this buffer from ``arbitrary'' to ``conservative'' and
would note it is applied to absorb market stress that may occur beyond
the volatility already captured by the all-in haircut.
Finally, the table currently identifies as a source of liquidity
guarantee letters
[[Page 57470]]
from central banks, but only for Belgian and Dutch clearing members.
The Proposed Rule Change would confirm that these guarantees can be
considered for liquidity purposes only if the relevant Clearing Member
posting them is in default, because only in this specific situation
would LCH SA acquire full ownership of the guarantee provided by the
central bank.
Section 1.6.2, titled Liquidity Needs, describes LCH SA's liquidity
needs. As noted, the Framework identifies three broad categories of
liquidity needs: (i) those arising from LCH SA's business-as-usual
operations; (ii) those arising from Clearing Members' defaults; and
(iii) those arising from the default of LCH SA's interoperating CCP.
Section 1.6.2.1, titled Liquidity needs arising from members'
defaults, further identifies liquidity needs arising from Clearing
Member defaults. These needs include, among others, settlement cash
outflows and the value of Eligible Collateral pledged at BdF. With
respect to settlement cash outflows, Section 1.6.2.1 provides that cash
outflows are generated when LCH SA must step in on behalf of the
defaulted member to post cash to non-defaulting member(s) and take in
the underlying collateral. The Proposed Rule Change would revise this
description, from ``underlying collateral'' to ``underlying
securities.'' Section 1.6.2.1 specifies that LCH SA obtains liquidity
based on the value of the Eligible Collateral that it pledges. Given
that a Clearing Member's default likely would result in (or result
from) stress market conditions, and given that such conditions could
lower the value of Eligible Collateral, the Proposed Rule Change would
specify that LCH SA would consider stress market conditions in
determining the value of Eligible Collateral pledged.
Finally, Section 1.6.2.2, titled Liquidity needs arising from
interoperating CCPs' defaults, identifies the liquidity needs arising
from the default of LCH SA's interoperating CCP. In Section 1.6.2.2,
the Proposed Rule Change would replace references to CC&G with
references to Euronext Clearing, consistent with the name change noted
above.
(iii) Section 2 and Section 3
Section 2, titled Limitations and Compensating Controls, and
Section 3, titled Justification of Modelling Approach, describe certain
limitations to, and justifications for, how LCH SA models its liquidity
sources and needs. The Proposed Rule Change would not make any
amendments to Sections 2 and 3.
(iv) Section 4 Changes to the Framework
Section 4, titled Model Specification, explains how LCH SA models
its liquidity sources and needs. Section 4 is organized according to
LCH SA's three broad categories of liquidity needs: (i) those arising
from LCH SA's business-as-usual operations; (ii) those arising from
Clearing Members' defaults; and (iii) those arising from the default of
LCH SA's interoperating CCP.
Operational Liquidity Needs
Section 4.1, titled Operational Target, describes how LCH SA
determines its liquidity needs arising from business-as-usual
operations. LCH SA values its operational liquidity needs by
determining the amount of its sources of liquidity from its operations
and the amount of its requirements for liquidity from its operations.
LCH SA then subtracts the total of its requirements from the total of
its sources, to determine whether it has sufficient resources to meet
its requirements. As described in Section 4.1.3, titled Model Outputs,
LCH SA's CaLRM team generates reports daily to check that operational
liquidity sources are sufficient to cover operational liquidity
requirements.
The Proposed Rule Change would first amend Section 4.1.2, titled
Model Inputs and Variable Selection, to clarify that the repayment of
excess cash as well as excess ECB eligible securities deposited to
cover margin requirements are considered in the liquidity requirements
of the Operational Target. Operational liquidity requirements currently
include, among other items, repayment of excess cash collateral, which
is cash that Clearing Members provided to meet their margin and default
fund requirements, but that is no longer needed to meet such
requirements. This could occur, for example, when a Clearing Member's
margin and default fund requirements decrease due to a change in the
Clearing Member's positions or risk associated with those positions,
and Clearing Members request the return of such excess cash collateral.
Like excess cash, Clearing Members may request the return of Eligible
Collateral that is no longer needed to meet margin and default fund
requirements. Because LCH SA considers Eligible Collateral as a
potential source of liquidity, the return of Eligible Collateral
represents a potential liquidity requirement for LCH SA. Accordingly,
the Proposed Rule Change would note that the return of excess Eligible
Collateral represents a potential liquidity requirement.
The Proposed Rule Change also would update a related footnote,
which explains that LCH SA excludes certain securities from its
liquidity assets, and therefore, LCH SA does not consider these
securities as potential excess Eligible Collateral. These include
securities denominated in Danish Krone, Norwegian Krone, Swedish Krona,
Japanese Yen, Swiss Franc, Canadian Dollar, and Australian Dollar.
These securities are not Eligible Collateral because LCH SA is not able
to pledge them for a liquidity line. Here the Proposed Rule Change
would specify that Portuguese and Finnish government bonds posted via
the triparty solution are excluded from the liquid assets because LCH
SA cannot pledge these securities at BdF due to operational
constraints.
The Proposed Rule Change would next amend Section, 4.1.4, titled
Mathematical Formula, Derivation and Algorithm, and Numerical
Approximation. This section explains the mathematical formula LCH SA
uses to confirm that its sources of operational liquidity are
sufficient to meet its needs. As noted, LCH SA determines the total of
its sources and the total of its operational liquidity requirements and
then subtracts the total of its requirements from the total of its
sources. LCH SA refers to the resulting figure as its ``Operational
Target.'' The Proposed Rule Change would not alter this formula, but it
would add language to note that, after subtracting operational
liquidity requirements from liquidity resources, the remaining amount
must always be greater than zero.
The Proposed Rule Change would next amend Section 4.1.5, titled
Model Assumptions, 4.1.5, which details how LCH SA determines the
amounts of its operational liquidity resources and needs, and the
period for which LCH SA seeks to maintain sufficient liquidity
resources. Currently, LCH SA seeks to maintain sufficient liquidity
sources for five days in stressed situations. The Proposed Rule Change
would revise this time horizon to provide that liquidity resources must
be sufficient to meet LCH SA's liquidity requirements for seven days in
stressed situations. Additionally, details related to the management of
the former horizon have been removed to state that the horizon is seven
days and results will be displayed without any aggregation. LCH SA is
making this change to ensure that the time horizon is the same for all
business lines. Specifically, this change would make the time horizon
for LCH SA's business lines consistent with the time horizon for its
RepoClear business
[[Page 57471]]
line, which uses a seven-day period for considering the sufficiency of
its liquidity sources.
Section 4 contains descriptions of the various components of LCH
SA's operational liquidity requirements, which the Framework calls
``liquidity requirements drivers.'' One of these drivers is the
potential requirement to repay excess collateral. As noted, excess cash
collateral is a potential liquidity need because Clearing Members may
request the return of such excess cash collateral. The Proposed Rule
Change would add a description of the return of excess Eligible
Collateral as a related liquidity need.\12\ The Proposed Rule Change
also would update a reference to the period for which LCH SA seeks to
maintain sufficient liquidity sources. As with the change described
above, the Proposed Rule Change would extend this period from five to
seven days. Specifically, the assumptions that the two largest
individual Clearing Members will withdraw their excess on day one (T)
and that the third and fourth largest Clearing Members will withdraw
their excess on day two (T+1) will be revised to clarify that (a) the
two Clearing Member Groups that have the largest amount of excess
collateral will withdraw their excess on T, and (b) the third and
fourth Clearing Member Groups that have the next largest amount of
excess collateral will withdraw their excess on T+1. In each case, LCH
SA would assume the remaining Clearing Members will withdraw their
excess on the third day (T+2).
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\12\ Similar to the change described above, the Proposed Rule
Change also would specify that Portuguese and Finnish government
bonds posted via the triparty solution are excluded from the liquid
assets because LCH SA cannot pledge these securities at BdF due to
operational constraints.
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Another liquidity driver is the operational liquidity need created
when Clearing Members switch cash collateral with non-cash collateral,
or switch Eligible Collateral with other non-cash collateral. LCH SA
currently considers the impact of such switches over five days. Under
the Proposed Rule Change, LCH SA would consider the switches over seven
days rather than five, consistent with the changes described above. To
facilitate this change, the Proposed Rule Change would add two
additional definitions for the amounts of such switches, corresponding
to T+5 and T+6.
This section also currently explains that with respect to switches
from cash to Eligible Collateral, LCH SA assumes that it can pledge the
Eligible Collateral within the same day. The Proposed Rule Change would
clarify that, to confirm this assumption, in quarter 3 of 2022, the
CaLM demonstrated the ability to transfer Eligible Collateral to BdF
within 30 minutes. The Framework currently lists the countries for
whose securities CaLM demonstrated this ability, in other words, the
countries whose sovereign securities are Eligible Collateral. The
Proposed Rule Change would remove this list from the Framework because
it is subject to change and depends on the collateral that LCH SA
itself accepts from Clearing Members. This section also notes that,
with respect to the amount of equity lodged, LCH SA takes the maximum
amount of switch observed (currently 100 million Euro) and that this
assumption is very conservative because the amount of equities lodged
over the past 3 years did not exceed 400,000 Euro. The Proposed Rule
Change would keep this sentence but delete the reference to the actual
amounts (100 million and 400,000 Euro) because, as LCH SA takes the
maximum amount of switched observed, both figures are subject to
change.
Another liquidity driver is the need created when LCH SA must
provide liquidity to facilitate settlement, including fails resulting
from delays in posting securities by Clearing Members. Currently, LCH
SA determines the amount of this liquidity need based on the historical
amount of EOD securities carried overnight, using a two-year lookback
period. LCH SA is also making changes that will clarify the specific
amount that is calibrated will be determined using the maximum EOD
securities carried overnight over the whole time series available,
rather than just a two-year lookback period. The Proposed Rule Change
would delete the reference to the two-year lookback period and instead
note that the estimate is based on the entire time series that is
available to LCH SA.
Another liquidity driver is the need created when Clearing Members'
stressed margin requirements decrease. If a Clearing Member's margin
requirement goes down, then the Clearing Member may request the return
of collateral that it provided to cover that requirement, and therefore
a reduction in margin could generate a liquidity need for LCH SA. The
Proposed Rule Change would modify the targeted estimated margin
reduction of non-defaulting Clearing Members to be consistent with the
changes described above. Specifically, the estimated margin reduction
will be calculated over seven consecutive days rather than the current
three days. To reflect this change, a detailed table and related
clarifying footnotes that describe the margin reduction rate per day of
the horizon period would be added to the Framework.
The liquidity need generated by LCH SA paying variation margin to
its interoperable CCP is also a driver of operational liquidity. As
with the changes discussed above, the Proposed Rule Change would
replace references to CC&G in this section with references to Euronext
Clearing. The Proposed Rule Change also would clarify that LCH SA
estimates the variation margin payment based on the Initial Margin
posted at LCH SA to cover a 5-day holding period to be spread out over
a 5-day period according to a simulated market stress based on
historical yield shifts.
Finally, the Proposed Rule Change would make a minor amendment to
Section 4.1.5.i, titled Model assumptions, Planned Default Fund (DF)
reductions, which discusses how a decrease in the default fund would
affect LCH SA's operational liquidity needs. The Proposed Rule Change
would clarify that default fund is abbreviated as ``DF'' in the
discussion accompanying Section 4.1.5.i.
Default Liquidity Needs
Section 4.2 of the Framework, titled LCR, describes how LCH SA
determines its liquidity needs arising from the default of a Clearing
Member. As described, LCH SA must ensure that it has enough liquidity
to satisfy a ``Cover 2'' requirement, meaning default of the two
largest Clearing Member Groups at the same time.
This section details the sources of liquidity and needs for
liquidity that would arise in the event of a Clearing Member's default.
The Framework refers to these liquidity sources as ``Total Available
Assets'' and liquidity needs as ``Total Default Liabilities.'' To
determine how well it is covering its liquidity needs arising from the
potential default of a Clearing Member, LCH SA divides its Total
Available Assets by its Total Default Liabilities. LCH SA refers to the
resulting figure as its ``Liquidity Coverage Ratio'' or ``LCR.'' LCH SA
calculates, monitors, and reviews the LCR daily.
The Proposed Rule Change would revise this section to provide that
the purpose of the LCR Cover 2 scenario is to allow LCH SA to ensure
that it has enough liquidity in the case of default of the two largest
Clearing Member Groups during the seven days following the default,
rather than five days, as is currently provided. This change would be
consistent with the other changes noted above, extending the time
horizon for maintaining liquidity resources from five to seven days.
[[Page 57472]]
Model Inputs and Variable Selection
With respect to the components that make up the LCR, Section 4.2.2,
titled Model Inputs and Variable Selection, identifies four categories
of Total Available Assets: (i) margin collateral; (ii) cash in the
default fund; (iii) Eligible Collateral that LCH SA has pledged; and
(iv) liquidity raised from investment activities. With respect to Total
Default Liabilities, Section 4.2.2 identifies four categories: (i) the
operational liquidity needs discussed above, which will continue during
the default of a Clearing Member; (ii) contractual settlements related
to LCH SA's RepoClear, EGCPlus, and EquityClear business lines; (iii)
the cost of financing those contractual settlements; and (iv) variation
margin paid to non-defaulting Clearing Members.
The Proposed Rule Change would add to Section 4.2.2 language
regarding the treatment of assets belonging to clients of FCM/BD
Clearing Members. As reflected currently in the Framework, LCH SA
segregates margin provided by FCM/BD Clearing Members on behalf of
their clients. This means that LCH SA can only use a particular
Clearing Member's client's margin to cover a shortfall arising from
that particular client's default, and not to cover a shortfall arising
from a Clearing Member's default or another client's default. The
Proposed Rule Change would add language to further clarify LCH SA's
treatment of margin provided by FCM/BD Clearing Members on behalf of
their clients. This new language would specify that, in the context of
default and monitoring of the LCR, LCH SA treats a specific FCM/BD
Clearing Member's client's collateral as an available liquidity
resource only if the specific client defaults and generates a liquidity
need. Otherwise, LCH SA does not treat a specific FCM/BD client's
resources as available liquidity assets for any other FCM/BD client,
the client's FCM/BD Clearing Member, or any other Clearing Member.
The Proposed Rule Change also would make an amendment regarding LCH
SA's Total Available Assets. As noted above, the Framework identifies
four categories of Total Available Assets. The Proposed Rule Change
would amend the description of the third category, Eligible Collateral
pledged at BdF. Currently, Section 4.2.2 describes this as the amount
of liquidity that can be provided by BdF when pledging securities and
including the haircut effect on the resulting figures. The Proposed
Rule Change would revise this description to explain that LCH SA would
be pledging the securities at stressed market prices.\13\ As noted
above, LCH SA may pledge Eligible Collateral to obtain a liquidity
line. LCH SA therefore treats this Eligible Collateral as a source of
liquidity, the amount of which is based on the value of the collateral
at the time of the pledge, minus an applicable haircut. The Proposed
Rule Change would therefore amend the Framework to ensure that LCH SA
considers the potential stress market conditions (which could decrease
the value of the collateral), as well as the applicable haircut, when
valuing Eligible Collateral as part of its liquidity resources.
---------------------------------------------------------------------------
\13\ The proposed rule change would make the same change to
Section 4.2.4, which describes the mathematical formula that LCH SA
uses to calculate its total available assets. The proposed rule
change also would make a similar change to Appendix 4, which
presents a synthesis of LCH SA's liquidity reports. Here the
proposed rule change would note that LCH SA would consider stressed
market prices and the haircut when pledging securities.
---------------------------------------------------------------------------
The Proposed Rule Change would make an amendment regarding LCH SA's
Total Default Liabilities. As noted above, the Framework identifies
four categories of Total Default Liabilities. The Proposed Rule Change
would amend the description of the fourth category, the cost of paying
variation margin to non-defaulting Clearing Members. The Framework
currently describes this liability as the stressed variation margin
impact for cash, derivatives, and CDS markets, on top of which is added
the market stress risk impact on the contractual settlements for
RepoClear. The Proposed Rule Change would describe this instead as the
stressed variation margin impact for cash, derivatives, RepoClear, EGC,
and CDS markets and would delete the phrase ``on top of which is added
the market stress risk impact on the contractual settlements for
RepoClear.'' Thus, under the Proposed Rule Change, LCH SA would
consider as a liability the general stressed variation margin impact
for RepoClear but not include the specific market stress risk impact on
the contractual settlements for RepoClear. LCH SA is excluding this
component because it will instead treat the market stress risk impact
as a decrease in the value of liquidity obtained from pledging Eligible
Collateral at BdF. As noted above, under the Proposed Rule Change, LCH
SA would use stressed market prices to determine the amount of
liquidity that it could obtain from pledging Eligible Collateral at BdF
Mathematical Formula Derivation and Algorithm and Numerical
Approximation
The Proposed Rule Change next would amend Section 4.2.4, titled
Mathematical Formula Derivation and Algorithm and Numerical
Approximation, which describes the mathematical formula that LCH SA
uses to calculate its LCR. The Proposed Rule Change would make
conforming revisions to the description of the mathematical formula in
Section 4.2.4 to carry through the changes from elsewhere in the
Framework described herein. For example, the description of the
mathematical formula would be revised to clarify that securities
pledged at the BdF and included among Total Available Assets will be
valued at stressed market prices and will include the ECB haircut
effect on the resulting figures, to incorporate the revisions discussed
above in Section 4.2.2. Similarly, the Proposed Rule Change would
revise the description of the mathematical formula in Section 4.2.4 to
incorporate the clarification of LCH SA's treatment of margins provided
by FCM/BD Clearing Members on behalf of their clients discussed above.
Specifically, the description of the mathematical formula would be
revised to clarify that, in the event of default by a specific FCM/BD
Clearing Member's client (and for the purpose of LCR monitoring), LCH
SA would treat that FCM/BD Clearing Member's client's collateral as
available liquidity resources only if that specific FCM/BD client
defaults and generates a liquidity need. Consistent with the changes
discussed above, the description would also be revised to clarify that
LCH SA would not consider these resources as available liquidity assets
for any other FCM/BD clients, the FCM/BD Clearing Member, or any other
Clearing Member.
Model Assumptions
Section 4.2.5, titled Model Assumptions, describes the various
risks and assumptions that LCH SA considers when calculating the LCR.
Section 4.2.5 describes these assumptions per LCH SA business line,
beginning with LCH SA's RepoClear business. To clarify that LCH SA must
consider certain risks for each business line in determining liquidity
requirements, the Proposed Rule Change would change the title of
section 4.2.5.1 to ``Description of risks per Business Line.''
RepoClear
Section 4.2.5.1.1, titled RepoClear, describes the liquidity needs
associated
[[Page 57473]]
with RepoClear. Section 4.2.5.1.1 currently includes a table
summarizing the liquidity requirements according to the direction of
the repo transactions. The Proposed Rule Change would delete this
summary table and a related paragraph describing the specific treatment
of forward starting repo in the calculation of the settlement
obligation outflows. The Framework would replace the table with new
Sections 4.2.5.1.1.1 and 4.2.4.1.1.2 (discussed below).
Also in Section 4.2.5.1.1, the Proposed Rule Change would amend the
period for which LCH SA considers the cash needs associated with
purchasing securities on behalf of a defaulting RepoClear clearing
member. Currently, LCH SA calculates this liquidity need, which the
Framework calls ``settlement cash outflows,'' over a five-day time
horizon. The Proposed Rule Change would extend this to seven days,
consistent with the changes discussed above. This change also would
align this monitoring period to the RepoClear new maximum holding
period to manage a default (five days holding period of margin plus two
days of settlement convention).
The Proposed Rule Change also would amend Section 4.2.5.1.1 to
clarify that LCH SA will not offset the liquidity needs arising from
the defaults of related Clearing Members. As noted above, LCH SA's
Clearing Members may be part of an affiliated Clearing Member Group. As
described in Section 4.2.5.1.1, LCH SA calculates these settlement
outflows on a gross basis for each Clearing Member. For those Clearing
Members that are part of a Clearing Member Group, LCH SA aggregates the
gross outflows for each Clearing Member in that group. To facilitate
the prohibition of netting between entities of the same group, the
Proposed Rule Change would clarify that settlement cash outflows will
be calculated over a period of 7 days and on a gross basis, aggregated
by ISIN, settlement date, and Clearing Member level. LCH SA would then
aggregate the final settlement outflows at the Clearing Member Group
level without allowing any netting across members of the same Clearing
Member Group.
The Proposed Rule Change would add a new Section 4.2.5.1.1.1,
titled Liabilities Contractual Obligations on Physical Delivery. This
section would describe how LCH SA would estimate the liquidity needs
associated with the physical settlement of transactions on behalf of a
defaulting Clearing Member. In the case of default, LCH SA will assume
and honor the obligations of the defaulted Members. In the event of
securities with physical settlement, LCH SA might need to source
securities to complete a defaulting Clearing Member's transaction,
which could represent a substantial liquidity need for LCH SA. This
section would describe the way LCH SA would navigate this scenario, and
would describe how LCH SA's pledge of Eligible Collateral to obtain
liquidity would affect its ability to source securities to settle
transactions.
The Proposed Rule Change also would add a new Section 4.2.5.1.1.2,
titled Assets: Settlement Securities Pledged at Central Bank. This new
section would describe how LCH SA would estimate the value of liquidity
it could raise through pledging settlement securities withdrawn from
the settlement system on behalf of a defaulting Clearing Member. This
new section would describe in detail how LCH SA would determine the
value of the liquidity it could raise, including the relevant
mathematical formulas and assumptions. As would be described, LCH SA
would consider the potential reduction in market price of the
securities during unfavorable market conditions. In other words, LCH SA
would consider the stressed market prices of the securities, in line
with similar changes described above. LCH SA would also consider the
haircut that BdF would apply when lending cash to LCH SA in exchange
for the securities. Finally, to remain consistent with the calculation
of settlement obligations, as described in this section, after
calculating the Liquidity retrieved from the BdF for all dates in the
LCR period at Member level, the amounts are aggregated at the Clearing
Member Group level.
The Proposed Rule Change would revise Section 4.2.5.1.1.3
(renumbered from 4.2.5.1.1.1), titled Market Risk. This section
describes the liquidity need generated by the requirement that LCH SA
pay variation margin to non-defaulting Clearing Members on behalf of
the defaulting Clearing Member. The Proposed Rule Change would clarify
that, in addition to the liquidity flows driven by settlement
obligations, the position of the defaulter may generate a liquidity
drain for LCH SA in the form of negative mark-to-market to be paid to
non-defaulting members. The Proposed Rule Change also would revise the
formula that LCH SA uses to estimate the value of this liquidity need.
Under the Proposed Rule Change, LCH SA would consider the worst stress
loss of the defaulter position according to the relevant RepoClear
stress test scenario and add additional margin to model any
concentration or market liquidity issues. The Proposed Rule Change
further would add a footnote to explain that Appendix 6.7 to the
Framework contains a list of stress scenarios.
EGCPlus
Dection 4.2.5.1.2, titled EGCPlus, describes the liquidity needs
arising from EGCPlus. These liquidity needs could arise from the
securities purchased on behalf of a defaulting Clearing Member. LCH SA
aggregates these needs by ISIN of the securities and maturity of the
contracts. The Proposed Rule Change would revise this section to
clarify that, when calculating the settlement-driven cash outflows, the
aggregation is based on data provided by the triparty agent and that a
liquidity need is generated only by positions in which the defaulter is
a cash borrower in the first leg of the repo and the collateral taker
when the repo closes. The Proposed Rule Change would further add a
footnote that would explain which positions generate a liquidity upon a
default. Specifically, a liquidity need is generated by those positions
in which the defaulting Clearing Member is a cash borrower (collateral
giver) in the first leg of the repo and, therefore, the collateral
taker when the repo closes.
To incorporate a recommendation from LCH SA's Model Validation Team
to improve the liquidity needs estimation related to Market Risk in the
LCR, the Proposed Rule Change also would clarify that, for EGCPlus, the
additional liquidity needs generated by negative mark to market
payments to non-defaulting Clearing Members is estimated in line with
what is done for RepoClear. As noted above, this means LCH SA would
consider the worst stress loss of the defaulter position according to
the relevant stress test scenario and add any additional margin to
model any concentration or market liquidity issues.
EquityClear
Section 4.2.5.1.3, titled EquityClear, describes the liquidity
needs arising from EquityClear. In this section, the Proposed Rule
Change would incorporate amendments made elsewhere to the Framework.
For example, the Proposed Rule Change would update Section 4.2.5.1.3 to
clarify that the settlement cash outflows will be calculated on a gross
basis at the Clearing Member level and then aggregated at the Clearing
Member Group level without allowing any netting across the Clearing
Members of the same Clearing Member Group. Doing so would help to
ensure that there is no netting across Clearing Members in the same
Group, the same as the amendments discussed above. Further,
[[Page 57474]]
when determining the liquidity need generated by the requirement that
LCH SA pay variation margin to non-defaulting Clearing Members on
behalf of the defaulting Clearing Member, under the Proposed Rule
Change LCH SA would consider the worst stress loss of the defaulter
position according to the relevant stress test scenario.
To address a recommendation from LCH SA's Model Validation Team,
the Proposed Rule Change would add the liquidity needs related to the
expiry of physically delivered single stock futures in the LCR. Where
the defaulting Clearing Member holds a long futures position which
expires during the LCR horizon, LCH SA will have to pay the future
price to the non-defaulting counterparty in order to settle the
physical underlying. Therefore, LCH SA would consider this as a
potential additional liquidity need.
Listed Derivatives
Section 4.2.5.1.3.2, titled Listed Derivatives, describes the
liquidity needs arising from LCH SA's listed derivatives business line.
Here the Proposed Rule Change would clarify that futures on equity
index contracts are included among the listed derivatives instruments
considered in the calculation of the LCR and that derivatives
expirations occur on a monthly basis rather than the previously stated
quarterly basis. Moreover, when determining the liquidity need
generated by the requirement that LCH SA pay variation margin to non-
defaulting Clearing Members on behalf of the defaulting Clearing
Member, under the Proposed Rule Change LCH SA would consider the worst
stress loss of the defaulter position according to the relevant stress
test scenario, consistent with changes elsewhere in the Framework.
CDSClear
Section 4.2.5.1.4, titled Credit Default Swaps, describes the
liquidity needs arising from LCH SA's CDSClear business line. Here the
Proposed Rule Change would clarify that the calculation of the
liquidity needs generated by negative mark-to-market payments to be
made to non-defaulting members is charged in line with what is done for
the other LCH SA services. Specifically, LCH SA will calculate this
need as the worst stress loss of the defaulter position according to
the relevant stress test scenario. The Proposed Rule Change further
would add a footnote to explain that Appendix 6.7 to the Framework
contains a list of stress scenarios.
Additional Components of LCR, Section 4.2.5.2
Section 4.2.5.2 of the Framework, titled Other Liquidity
Requirements, describes certain other components that LCH SA considers
as part of the LCR.
For example, LCH SA includes the liquidity requirement arising from
the operational target as a liquidity need in calculating the LCR. LCH
SA does so with two modifications. First, LCH SA removes the cost of
paying variation margin to its interoperable CCP. LCH SA makes this
modification because it assumes that where its two largest Clearing
Member Groups have defaulted, LCH SA would be collecting variation
margin from its interoperable CCP rather than paying out variation
margin. Second, LCH SA removes the impact of a margin reduction for
defaulting Clearing Members. As discussed above, LCH SA considers the
liquidity need created when Clearing Members' margin requirements
decrease. If a Clearing Member's margin requirement goes down, then the
Clearing Member may request the return of collateral that it provided
to cover that requirement, and therefore a reduction in margin
generates a liquidity need for LCH SA. The same is true when a Clearing
Member requests the return of excess cash collateral. For the sake of
accounting for the operational target in the LCR, LCH SA excludes this
component with respect to the two Clearing Member Groups that are
assumed to be in default. LCH SA does this because, where a Clearing
Member is in default, LCH SA has the right to use the collateral of the
defaulting Clearing Member, including any excess collateral. LCH SA is
already reducing the impact of these two components of the operational
target in the current version of the Framework, and the Proposed Rule
Change would make clarifying edits to the description of these
components.
LCH SA includes margin collateral in its available assets when
calculating the LCR. LCH SA does this because, as discussed, LCH SA can
obtain liquidity for margin collateral, by pledging Eligible Collateral
and otherwise engaging in investment transactions. In doing so, LCH SA
considers potential losses to the market value of non-cash collateral
because such losses could decrease the amount of liquidity that LCH SA
is able to obtain. The Proposed Rule Change would clarify that LCH SA
would consider these potential losses by applying the same set of
stress scenarios used by LCH SA in the calibration of the default fund
for its RepoClear service, and choosing the one that generates the
biggest liquidity exposure in terms of Cover 2.
As part of the LCR, LCH SA also considers potential losses related
to investment activities involving a defaulting Clearing Member's non-
cash collateral. LCH SA does so because it may use the proceeds of its
investment activities as a liquidity resource when a Clearing Member
defaults, and losses would decrease the amount of these proceeds. The
Proposed Rule Change would clarify that LCH SA would consider these
potential losses by applying the same set of stress scenarios used by
LCH SA in the calibration of the default fund for its RepoClear
service, and choosing the one that generates the biggest liquidity
exposure in terms of Cover 2.
The Proposed Rule Change would add a new Section 4.2.5.2.4, titled
Collateral Pledge modelling. This new section would describe, in
detail, how pledged collateral is modelled when calculating the LCR. As
noted, LCH SA may pledge Eligible Collateral deposited via FTTA to
obtain a liquidity line, but not collateral deposited via SPA. If
Clearing Members switch from depositing Eligible Collateral via FTTA to
SPA, that could reduce the amount of liquidity that LCH SA is able to
obtain. To account for this, LCH SA would assume that Clearing Members
with an active SPA would pledge collateral near the maximum allowed on
each LCH SA business line. LCH SA would therefore subtract this amount
of Eligible Collateral from its liquidity resources. LCH SA will
calculate the expected additional pledge as the difference between the
maximum pledge allowed on the business line scaled by a parameter to
capture Clearing Member's expected use of pledge and the actual pledge
used by Clearing Members. Currently, LCH SA would assume that each
Clearing Member with an active SPA would pledge 100% of the securities
that it is allowed to pledge.
For Clearing Members without an active SPA, LCH SA would include
all Eligible Collateral deposited via FTTA in its liquidity resources.
As noted, certain securities, like those denominated in Danish Krone,
Norwegian Krone, Swedish Krona, Japanese Yen, Swiss Franc, Canadian
Dollar, and Australian Dollar are not considered Eligible Collateral.
LCH SA would therefore exclude these securities from its liquidity
resources. The Proposed Rule Change would add a notation to that effect
in Section 4.2.5.2.4.
[[Page 57475]]
Market Risk Stress Scenario Selection, Section 4.2.5.3
Section 4.2.5.3, titled Stress scenario selection, describes the
scenarios that LCH SA uses to factor the effect on market values that
could occur in a stressed environment, including a Cover 2 default.
Such a situation could, for example, lead to a decrease in the value of
the defaulting Clearing Members' non-cash collateral and/or require
that LCH SA pay variation margin on behalf of the defaulting Clearing
Members. Thus, such a scenario would impact LCH SA's liquidity, both in
terms of the amount of liquidity it is able to obtain from non-cash
collateral, and the amount of liquidity it may need to pay out in the
form of variation margin.
As described, LCH SA uses separate scenarios for each of its
clearing services, taken from the set of scenarios used to calibrate
the amount of Default Fund for the different services. The Proposed
Rule Change would clarify that the stress test scenarios selected for
each LCH SA service would be consistent with a market state resulting
from Cover 2 default as assumed by the LCR. Moreover, the Proposed Rule
Change would update the list of scenarios to include only those most
relevant given the LCR assumptions.
Section 4.2.5.3 also contains a table describing the haircuts that
would be applied when LCH SA pledges Eligible Collateral. These
haircuts reduce the value of collateral that LCH SA can pledge, and
therefore ultimately reduce the amount of liquidity that LCH SA is able
to obtain. The Proposed Rule Change would update this table to reflect
the current haircuts.
Cover 2 Selection, Section 4.2.5.4
Section 4.2.5.4, titled Cover 2 selection, describes how LCH SA
calculates the liquidity requirements for each Clearing Member in a
stressed environment, which it then uses to determine its Cover 2
requirement by Clearing Member Group (i.e., the two largest liquidity
exposures).
The Proposed Rule Change will revise this section to specify that
LCH SA will determine its Cover 2 requirement in the following manner:
LCH SA will first calculate certain liquidity requirements for each
individual Clearing Member and then aggregate these amounts per each
Clearing Member Group, to arrive at a total requirement for each
Clearing Member Group. The Cover 2 requirement would be the two largest
amounts per Clearing Member Group.
As would be described in revised Section 4.2.5.4, LCH SA first
would calculate the following requirements for each Clearing Member,
before determining the aggregate liquidity requirement per Clearing
Member Group:
<bullet> Stress Variation Margin--for all the services, these
variation margins would be modelled by applying the most punitive
scenario among the chosen sets and consistent with the LCR assumptions;
<bullet> Settlement liquidity requirements due to RepoClear and
Cash equity settlement obligations--LCH SA would value securities
pledged according to the scenario that would generate the highest loss;
<bullet> Non-cash Collateral stress losses--LCH SA would estimate
these losses by stressing the Eligible Collateral with the set of
scenarios consistent with the LCR assumptions;
<bullet> Investment stress losses over haircut--LCH SA would
estimate these losses by applying the stress scenarios to the
collateral received from the reverse repo activity with each specific
counterparty; and
<bullet> ECB Haircut--LCH SA would determine the impact by applying
the relevant haircut to all the Eligible Collateral received from a
specific clearing member.
LCH SA would use the scenarios relevant to each of its clearing
services to determine these requirements and then select the scenario
that generates the maximum loss of the sum of all of the above elements
for the two most exposed Clearing Member Groups. As noted, this sum
would determine LCH SA's Cover 2 requirement for purposes of
determining its LCR.
LCR for Euronext
Section 4.3 of the Framework, titled LCR Euronext Clearing,
describes how LCH SA calculates the liquidity impact resulting from the
potential default of its interoperable CCP. Throughout this section,
the Proposed Rule Change would change the name of the interoperable CCP
from CC&G to Euronext Clearing, including in the titke. The Proposed
Rule Change also would update the time horizon for which LCH SA would
consider this potential liquidity impact from five to seven days. These
changes would be consistent with the changes made in other sections of
the Framework, as described above.
(v) Section 5 Changes to the Framework
Section 5 of the Framework, titled Model Performance Testing and
Ongoing Monitoring, describes how LCH SA monitors and tests its
liquidity sources and requirements. Section 5.1, titled Ongoing
Monitoring, describes the metrics that LCH SA calculates each day,
notes the formula used to determine each metric, how LCH SA reports
that metric, the limit associated with the metric, and what action LCH
SA would take if the limit is breached. For example, Section 5.1
describes how LCH SA calculates its LCR, how LCH SA reports the LCR
daily, and the amount of LCR that would trigger an alert and further
actions. Throughout Section 5.1, the Proposed Rule Change would update
references to the length of time for which LCH SA must maintain
liquidity resources from five to seven days and change the name of LCH
SA's interoperable CCP to Euronext Clearing, consistent with changes
elsewhere in the Framework.
Section 5.1 also describes how LCH SA monitors the allocation
between cash and non-cash collateral and specifies that cash collateral
should represent at least 25% of LCH SA's available liquid resources
after the default of its most significant Clearing Member. The Proposed
Rule Change would revise this to state that cash collateral and non-
cash collateral that is eligible to be pledged at BdF (meaning Eligible
Collateral) should represent at least 25% of LCH SA's available liquid
resources after the default of its most significant Clearing Member.
LCH SA is making this change in recognition that it can pledge Eligible
Collateral for liquidity and further to conform the Framework with LCH
SA's Liquidity Policy.
The Proposed Rule Change next would amend Section 5.3, titled
Reverse Stress Test, which describes the reverse stress tests that LCH
SA performs. LCH SA performs these reverse stress tests using extreme
market conditions that go beyond what are considered plausible. As
described in the introduction to Section 5.3, LCH SA uses these extreme
market conditions to satisfy certain requirements of applicable law.
The Proposed Rule Change would add to the discussion of applicable law
a summary of Commission Rules 17Ad-22(e)(7)(vi)(B) and (C).\14\
Throughout Section 5.3 the Proposed Rule Change also would update
references to the length of time for which LCH SA must maintain
liquidity resources from five to seven days and change the name of LCH
SA's interoperable CCP to Euronext clearing, consistent with changes
elsewhere in the Framework.
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\14\ 17 CFR 240.17Ad-22(e)(7)(vi)(B) and (C).
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As described in Section 5.3, LCH SA conducts its reverse stress
tests using two approaches. First, LCH SA conducts reverse stress tests
using seven separate risk factors, with one single factor
[[Page 57476]]
stressed at a time. The Framework refers to these tests as ``single
factor reverse stress tests'' or ``core reverse stress tests.'' Second,
LCH SA tests the same risk factors together, under two different
overall combinations of risk factors, which the Framework refers to as
``combined scenarios.'' One combined scenario aims to stress the
structure of LCH SA's liquidity resources while the other combined
scenario aims to simulate the effect of a macro-economic shock on LCH
SA's liquidity resources.
Section 5.3.1, titled Independent stress of various risk factors,
describes each of the seven risk factors, and the Proposed Rule Change
would make various updates to this description. For example, the first
risk factor considers the effect on LCH SA's liquid resources arising
from a reduction in margin requirements. The description of this risk
factor currently notes that a primary source of liquidity is from
investment management by LCH SA's CaLM team. The Proposed Rule Change
would revise this to note that a primary source of liquidity is from
investment management performed by LCH SA's CaLM team. The Proposed
Rule Change also would add an explanation that another primary source
of liquidity for LCH SA is non-cash collateral that LCH SA can pledge
to obtain liquidity.
The second risk factor considers the effect on LCH SA's liquidity
resources arising from Clearing Members replacing Eligible Collateral
that LCH SA can pledge for liquidity at BdF with collateral that LCH SA
cannot pledge. The current Framework describes the collateral that LCH
SA cannot pledge as, among others, U.K. or U.S. bonds, equities, and
other non-Euro non-cash collateral. The Proposed Rule Change would add
to this list pledge collateral, meaning collateral deposited in a SPA.
As discussed above, LCH SA cannot use collateral deposited via SPA to
obtain liquidity at BdF, even if that collateral is Eligible
Collateral.
The third risk factor considers the impact from a downgrade in the
rating of countries in the Eurozone. Such a downgrade could increase
the haircut applied to Eligible Collateral when LCH SA pledges it at
BdF to obtain liquidity. Currently, the Framework describes this risk
factor as a reverse stress test that aims at modelling the downgrade of
the relevant countries and estimating the theoretical ECB haircuts
generating a liquidity shortfall. The Proposed Rule Change would revise
this description to modelling the downgrade of the relevant countries
and estimating the theoretical ECB haircuts needed to generate a
liquidity shortfall.
The Proposed Rule Change would not make any amendments to the
description of the fourth and fifth risk factors, which consider the
effects of the increase of the maturity of the securities from the
settlement of repo transactions and the effects of the market-to-market
drop of tier 1 assets.
For the sixth risk factor, the Proposed Rule Change would revise
the phrase ``the direction of the position'' to ``the direction of the
positions.''
The seventh risk factor considers how many defaults LCH SA can
sustain before experiencing a shortfall in liquidity. Here the
Framework currently includes the following question: given that
liquidity requirements are sized to a Cover 2 standard, is it plausible
that there are more than 2 members who could lead to a liquidity
deficit? The Proposed Rule Change would revise the phrasing of this
question to ``2 member Groups defaults'' instead of ``2 members.''
Further, the current Framework specifies that, to answer this question,
LCH SA rank orders Clearing Member Groups based on their internal
credit scores (``ICS''), starting from the ones with the worst ICS. The
Proposed Rule Change would revise the wording of this sentence to state
instead that to answer this question, LCH SA ranks Clearing Member
Groups on their ICS and starts with the one with the worst ICS.
Finally, the current Framework notes that, starting from the top of the
list, LCH SA assesses how many defaults have to take place to generate
a liquidity shortage. The Proposed Rule Change would revise this
slightly to state that, starting from the top of the list and
considering all member Group with ICS 6 or bigger, LCH SA assesses how
many defaults have to take place to generate a liquidity shortage.
Section 5.3.2, titled Combined reverse stress test scenarios,
describes the combined reverse stress test scenarios. Section 5.3.2.1
currently notes that LCH SA performs these additional combined reverse
stress tests quarterly. The Proposed Rule Change would revise this
language to at least quarterly.
Section 5.3.2.2, titled Behavioural scenario, describes the
combined scenario that stresses the structure of LCH SA's liquidity
resources, including the individual risk factors that LCH SA combines
to create this scenario. This section also describes the overall
question that LCH SA seeks to answer with this reverse stress test,
which is whether there is any combination of changes in the liquidity
resources that could lead to a liquidity shortfall without any stress
in the market. In addition to describing the risk factors tested and
the overall aim of the scenario, Section 5.3.2.2 also provides an
example of how LCH SA reports the results of the test. The Proposed
Rule Change would update this example to reflect a new layout for the
report.
Section 5.3.2.3, titled Macro-economic scenario, describes the
combined scenario that simulates the effect of a macro-economic shock
on LCH SA's liquidity resources. This section describes how LCH SA
combines the individual risk factors to create the overall scenario, as
well as the overall question that LCH SA seeks to answer with this
reverse stress test, which is how many multiple defaults LCH SA can
sustain until it experiences a liquidity shortfall in a shocked macro-
economic environment. To simulate the shocked macro-economic
environment, the Framework currently uses two macro-economic scenarios,
which are described in Section 5.3.2.3. The Proposed Rule Change would
remove these two scenarios and replace them with the same scenarios
that it uses to determine its LCR.\15\ The Proposed Rule Change would
update this section and references to the scenarios accordingly.
Throughout this section, the Proposed Rule Change also would change
references to Clearing Members to Clearing Member Groups to clarify
that this scenario considers Clearing Member Groups, rather than
individual members, consistent with the overall Cover 2 requirement.
Finally, the Proposed Rule Change would update the examples of the
reports that LCH SA uses to present the results of this scenario. The
Proposed Rule Change would update the layout of these examples to match
the current versions used by LCH SA.
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\15\ As noted above, these scenarios are set out in Appendix
6.7.
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Section 5.3.3.3, titled Frequency and Reporting, would be a new
section to describe how often LCH SA conducts testing, reviews the
results, and reviews the underlying scenarios. As would be specified in
Section 5.3.3.3, LCH SA would perform the core reverse stress tests
monthly and the combined reverse stress test scenarios quarterly.
Through its monthly core reverse stress tests, LCH SA would conduct a
comprehensive analysis of the existing stress testing scenarios,
models, and underlying parameters and assumptions used in evaluating
liquidity needs and resources. In certain circumstances, LCH SA also
would perform an ad hoc analysis of the existing stress testing
scenarios, models, and underlying parameters and assumptions used in
evaluating liquidity needs and resources. LCH SA would do so when
[[Page 57477]]
the products it clears or markets it serves display high volatility or
become less liquid; when the size or concentration of its Clearing
Members' positions held increase significantly; or in any other
appropriate circumstances that would lead to a liquidity coverage ratio
falling below LCH SA's alert threshold. In this last circumstance, the
ad hoc analysis would be reported to the LCH SA CRO, the Head of the
LCH SA Collateral and Liquidity Management division, and to the LCH SA
Risk Committee. Finally, Section 5.3.3 would require that the results
and findings of the reverse stress tests exercise be reported monthly
to LCH SA CRO and quarterly to LCH SA Risk Committee.
(vi) Section 6 Changes to the Framework
Section 6 of the Framework, titled Appendix, contains appendices to
the main document. There are currently six appendices to the Framework.
The Proposed Rule Change would revise Appendices two through five and
add new Appendices seven and eight.
Appendix two, titled Members behaviour analysis, describes how LCH
SA models the behavior of Clearing Members during a period of market
stress. This appendix considers behaviors that could affect LCH SA's
liquidity resources, such as replacing cash collateral with non-cash
collateral, withdrawing excess collateral, and reducing positions
(which in turn could reduce margin and guaranty fund requirements and
therefore the financial resources available to LCH SA). Throughout this
section the Proposed Rule Change would change relevant time horizons
from five to seven days, consistent with the changes to main body of
the Framework discussed above.
The Proposed Rule Change also would update the description of non-
cash collateral that LCH SA cannot pledge at the BdF to obtain a
liquidity line of credit. Appendix two currently describes this
collateral as mainly Gilts and Central Bank Guarantees. The Proposed
Rule Change would expand this list to include U.S. Treasuries, as well
as securities denominated in Danish Krone, Norwegian Krone, Swedish
Krona, Japanese Yen, Swiss Franc, Canadian Dollar, and Australian
Dollar, because LCH SA cannot pledge such securities at BdF. Appendix
two also currently notes that, although LCH SA cannot pledge this
collateral at BdF, the use of this collateral by Clearing Members would
not be material to LCH SA's liquidity resources. This is because, as
currently described in Appendix two, this collateral represents a small
percentage of total collateral, and LCH SA expects to limit use of this
collateral. The Proposed Rule Change would revise this description to
note that LCH SA has imposed concentration limits on collateral that it
cannot pledge at BdF, rather than LCH SA expecting to limit the use of
such collateral.
Appendix three, titled Reminder of SA's sources of liquidity and
related risk drivers, is a table that describes, in summary form, LCH
SA's sources of liquidity. For each source of liquidity, the table also
describes risks that could affect the amount of liquidity that LCH SA
can obtain for the source, as well as how LCH SA mitigates those risks.
Here the Proposed Rule Change would change the name of LCH SA's
interoperable CCP to Euronext. The Proposed Rule Change also would add
an additional risk to one of LCH SA's liquidity sources. Currently the
table lists non-cash collateral from Clearing Members as a source of
liquidity because LCH SA may obtain liquidity with such collateral
through investment transactions or by pledging Eligible Collateral at
BdF. The Proposed Rule Change would note that a Clearing Member's
ability to pledge non-cash collateral using a SPA is a risk to this
liquidity source. This is a risk because LCH SA cannot use collateral
deposited via a SPA to obtain liquidity, even if that collateral is
Eligible Collateral.
Appendix four, titled Liquidity risk drivers synthesis by reports,
is a table that describes, in summary form, LCH SA's liquidity needs.
This table presents the liquidity needs according to three broad
categories: (i) operational target (needs arising from LCH SA's
business-as-usual operations); (ii) LCR (needs arising from Clearing
Members' defaults); and (iii) Euronext LCR (needs arising from
interoperating CCP's defaults). Here the Proposed Rule Change would
change the name of LCH SA's interoperable CCP to Euronext and change
the time horizon from five to seven days.
Appendix five, titled Liquidity risk monitoring reports, shows
examples of the reports that LCH SA uses to monitor its liquidity. The
Proposed Rule Change would update the layout of these examples to match
the current versions used by LCH SA.
As noted, the Proposed Rule Change would add a new Appendix seven,
which would be titled Stress scenarios list. It would contain a list of
stress scenarios that LCH SA uses for each of its clearing services.
The Proposed Rule Change also would add a new Appendix eight, which
would be titled Pseudo-code of settlement and market risk calculation.
Appendix eight would explain the algorithm that LCH SA uses to
calculate the settlement obligation driven liquidity requirements in
the monitoring of the LCR and the resulting BdF liquidity raised by
pledging the securities withdrawn from the settlement systems. This
appendix would present the algorithm in pseudo-code format, meaning the
appendix would show how the algorithm would look when programmed into a
computer for calculation. This same algorithm would also be described
in Section 4.2.5.1.1.1 and Section 4.2.5.1.1.2 of the Framework.
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.\16\ For the reasons given below, the Commission finds
that the Proposed Rule Change is consistent with Section 17A(b)(3)(F)
of the Act,\17\ Rule 17Ad-22(e)(7) thereunder,\18\ and Rules 17Ad-
22(e)(7)(vi)(B) and (C) \19\ thereunder.
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\16\ 15 U.S.C. 78s(b)(2)(C).
\17\ 15 U.S.C. 78q-1(b)(3)(F).
\18\ 17 CFR 240.17Ad-22(e)(7).
\19\ 17 CFR 240.17Ad-22(e)(7)(vi)(B) and (C).
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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 the Proposed
Rule Change is consistent with Section 17A(b)(3)(F) of the Act because
it improves LCH SA's management of its liquidity risk.\21\
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\20\ 15 U.S.C. 78q-1(b)(3)(F).
\21\ 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 Clearing Member default,
default of Euronext Clearing, 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 SA 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
[[Page 57478]]
accurate clearance and settlement of the derivatives transactions LCH
SA clears, including security-based swaps.
Certain of the changes would update and clarify existing aspects of
the Framework. These include the updates to overall scope, purpose, and
use of the Framework in Section 1. Throughout the Framework, the
Proposed Rule Change also would update the name of LCH SA's
interoperable CCP to Euronext Clearing. 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 Euronext Clearing, and operational
liquidity requirements, which facilitates prompt and accurate clearance
and settlement.
In addition to updating and clarifying the Framework, the Proposed
Rule Change also would revise how LCH SA determines its liquidity
sources and needs under the Framework. With respect to sources of
liquidity, the Proposed Rule Change would require LCH SA to consider
Clearing Members' ability to switch from depositing collateral using
FTTAs to SPAs. Such switches could reduce the amount of liquidity that
LCH SA is able to obtain when pledging Eligible Collateral at BdF
because LCH SA cannot pledge any collateral deposited via SPAs.
Similarly, the Proposed Rule Change would require LCH SA to consider
stressed market prices when determining the amount of liquidity that it
could obtain by pledging Eligible Collateral at BdF. The amount of
liquidity that LCH SA could obtain is based on the value of the
collateral at the time of the pledge, minus an applicable haircut, and
potential stress market conditions could decrease the value of the
collateral or increase the haircut.
With respect to LCH SA's liquidity needs, the Proposed Rule Change
would prevent netting between Clearing Members of the same group.
Eliminating netting potentially could increase the liquidity needs
generated among a group of related Clearing Members. The Proposed Rule
Change also would extend to seven days (from five days) the time
horizon for which LCH SA must maintain liquidity resources sufficient
to meet its liquidity requirements. Doing so could potentially increase
the amount of LCH SA's liquidity requirements. Finally, the Proposed
Rule Change would require that LCH SA consider the liquidity
requirements generated by the expiration of physically settled stock
futures, adding another potential liquidity need to LCH SA's existing
liquidity needs.
These changes, taken together, would improve LCH SA's ability to
determine the amount of its liquidity needs and the amount of its
resources to satisfy those liquidity needs. More accurately determining
the amount of LCH SA's liquidity needs and resources would thereby
improve LCH SA's ability to control and quantify its liquidity risk.
Control over and accurate measurement of liquidity risk is necessary to
ensure that LCH SA's liquidity needs do not exceed its resources so
that LCH SA can meet its payment obligations on time without disrupting
settlement. Thus, the proposed changes to the Framework promote prompt
and accurate clearance and settlement.
The Commission finds, 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)(7) Under the Act
Rule 17Ad-22(e)(7) requires LCH SA to establish, implement,
maintain, and enforce written policies and procedures reasonably
designed to effectively measure, monitor, and manage the liquidity risk
that arises in or is borne by LCH SA, including measuring, monitoring,
and managing its settlement and funding flows on an ongoing and timely
basis, and its use of intraday liquidity.\23\ As noted above, LCH SA
uses the Framework to measure, monitor, and manage its liquidity risk.
The Proposed Rule Change would improve the Framework by more accurately
determining the amount of LCH SA's liquidity needs and resources. In
doing so, the Proposed Rule Change would help ensure that the Framework
is designed to effectively measure, monitor, and manage the liquidity
risk that arises in or is borne by LCH SA. The Commission therefore
finds that the Proposed Rule Change is consistent with rule 17Ad-
22(e)(7).\24\
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\23\ 17 CFR 240.17Ad-22(e)(7).
\24\ 17 CFR 240.17Ad-22(e)(7).
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C. Consistency With Rules 17Ad-22(e)(7)(vi)(B) and (C) Under the Act
Rules 17Ad-22(e)(7)(vi)(B) and (C) \25\ require LCH SA to
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to determine the amount and regularly
testing the sufficiency of the liquid resources held for purposes of
meeting the minimum liquid resource requirement under Rule 17Ad-
22(e)(7)(i) by, at a minimum: (i) conducting a comprehensive analysis
on at least a monthly basis of the existing stress testing scenarios,
models, and underlying parameters and assumptions used in evaluating
liquidity needs and resources, and considering modifications to ensure
they are appropriate for determining its identified liquidity needs and
resources in light of current and evolving market conditions and (ii)
conducting a comprehensive analysis of the scenarios, models, and
underlying parameters and assumptions used in evaluating its liquidity
needs and resources more frequently than monthly when the products
cleared or markets served display high volatility or become less
liquid, when the size or concentration of positions held by its
participants increases significantly, or in other appropriate
circumstances described in such policies and procedures. The Proposed
Rule Change would add to the Framework a new Section 5.3.3.3, which
would require that LCH SA perform its core reverse stress tests
monthly, through which LCH SA would conduct a comprehensive analysis of
the existing stress testing scenarios, models, and underlying
parameters and assumptions used in evaluating liquidity needs and
resources. Section 5.3.3 also would require that an ad-hoc analysis of
the existing stress testing scenarios, models, and underlying
parameters and assumptions used in evaluating liquidity needs and
resources in certain circumstances. LCH SA would do so when the
products it clears or markets it serves display high volatility or
become less liquid; when the size or concentration of its clearing
members' positions held increase significantly; or in any other
appropriate circumstances that would lead to a liquidity coverage ratio
falling below LCH SA's alert threshold. These changes would be
consistent with the requirements of Rules 17Ad-22(e)(7)(vi)(B) and
(C).\26\ The Commission therefore finds that the Proposed Rule Change
is consistent with Rules 17Ad-22(e)(7)(vi)(B) and (C).\27\
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\25\ 17 CFR 240.17Ad-22(e)(7)(vi)(B) and (C).
\26\ 17 CFR 240.17Ad-22(e)(7)(vi)(B) and (C).
\27\ 17 CFR 240.17Ad-22(e)(7)(vi)(B) and (C).
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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,\28\ Rule 17Ad-
22(e)(7) thereunder,\29\
[[Page 57479]]
and Rules 17Ad-22(e)(7)(vi)(B) and (C) \30\ thereunder.
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\28\ 15 U.S.C. 78q-1(b)(3)(F).
\29\ 17 CFR 240.17Ad-22(e)(7)
\30\ 17 CFR 240.17Ad-22(e)(7)(vi)(B) and (C).
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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.\31\
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\31\ 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.\32\
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\32\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2024-15401 Filed 7-12-24; 8:45 am]
BILLING CODE 8011-01-P
</pre></body>
</html>Indexed from Federal Register on July 15, 2024.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.