Notice2025-14564
Self-Regulatory Organizations; LCH SA; Notice of Filing of Proposed Rule Change Relating to LCH SA's Risk Governance Framework and Collateral, Financial, Credit, Operational and Third Party Risk Policies
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
August 1, 2025
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 90 Issue 146 (Friday, August 1, 2025)</title>
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[Federal Register Volume 90, Number 146 (Friday, August 1, 2025)]
[Notices]
[Pages 36257-36269]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2025-14564]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-103573; File No. SR-LCH SA-2025-007]
Self-Regulatory Organizations; LCH SA; Notice of Filing of
Proposed Rule Change Relating to LCH SA's Risk Governance Framework and
Collateral, Financial, Credit, Operational and Third Party Risk
Policies
July 29, 2025.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4,\2\ notice is hereby given that on July
15, 2025, Banque Centrale de Compensation, which conducts business
under the name LCH SA (``LCH SA''), filed with the Securities and
Exchange Commission (``Commission'') the proposed rule change, as
described in Items I, II and III below, which Items have been prepared
primarily by the clearing agency. The Commission is publishing this
notice to solicit comments on the proposed rule change from interested
persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change
LCH SA is submitting several risk policies (``Risk Policies'')
which LCH SA has adopted, including: (i) the Collateral Risk Policy;
(ii) the Financial Resource Adequacy Policy; (iii) the Counterparty
Credit Risk Policy; (iv) the Operational Risk Management Policy; (v)
the Third Party Risk Management Policy; and (vi) the Risk Governance
Framework. The Risk Policies have been issued by LCH Group Holdings
Limited (``LCH Group'') \3\ and adopted by the LCH SA Risk Committee
and LCH SA Board.\4\
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\3\ LCH Group Holdings Limited is an indirect wholly owned
subsidiary of the London Stock Exchange Group plc. In addition to
LCH SA, LCH Group also owns LCH Limited, a recognized central
counterparty supervised in the United Kingdom by the Bank of England
and a derivatives clearing organization (``DCO'') registered with
the Commodity Futures Trading Commission.
\4\ The Risk Policies have been elaborated in common with LCH
Ltd. in order to ensure risk management consistency within LCH
Group. Identical risk policies have been approved by LCH Ltd.'s
governance.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change
In its filing with the Commission, LCH SA included statements
concerning the purpose of and basis for the Risk Policies and discussed
any comments it received on the Risk Policies. The text of these
statements may be examined at the places specified in Item IV below.
LCH SA has prepared summaries, set forth in sections A, B, and C below,
of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Risk Policies have been adopted by LCH SA in order to set out
the specific risk management requirements that govern its operations as
a clearing agency. Moreover, the Risk Policies clarify the roles and
responsibilities within LCH SA for compliance with the Risk Policies.
Finally, the Risk Policies have been designed to ensure consistency
with all relevant laws and regulations, including the European Markets
Infrastructure Regulation (``EMIR'') and Section 17A of the Act \5\ and
the regulations thereunder.\6\
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\5\ 15 U.S.C. 78q-1.
\6\ The Risk Policies generally identify the relevant provisions
of law and regulation applicable to that policy.
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a. Collateral Risk Policy
The Collateral Risk Policy (``CRP'') sets out the LCH Group
standards for the management of collateral risk at LCH SA, subject to
the risk appetite defined in the Risk Governance Framework. The goal of
the policy is to ensure that LCH SA has a robust mechanism in place to
process and control the collateral posted by its members.
The CRP applies to collateral accepted by LCH SA to cover margin
requirements and default fund contributions.\7\ The CRP also clarifies
the roles and responsibilities within LCH SA for compliance with the
CRP. The policy owner is the LCH SA Chief Risk Officer (``CRO''). In
addition:
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\7\ Collateral accepted by LCH SA to cover risks associated with
(i) securities accepted as part of the clearing services such as in
RepoClear and Equity Clear; and (ii) secured cash investments
(reverse repurchase agreements or outright purchases) conducted as
part of CaLM's investment activities, are outside the scope of the
CRP and are covered by the Financial Resource Adequacy Policy (see
paragraph below) and Investment Risk Policy, respectively.
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<bullet> LCH SA Collateral and Liquidity Management team (``CaLM'')
has a number of responsibilities under the CRP. CaLM's primary
responsibilities include: (i) daily monitoring of the pool of
collateral lodged by its members in accordance with the policy; \8\
(ii) calibrating collateral haircuts and performing daily monitoring in
accordance with the CRP; (iii) supervising the delegated team LCH Ltd
First Line Risk RepoClear with the sourcing and assessment \9\ of
collateral prices based on guidelines by CaLM First Line Risk SA,
subject to the standards set out in the LCH Contract and Market
Acceptability Policy; (iv) implementing collateral concentration limits
on its members and monitoring against these on a daily basis; (v)
handling general enquiries from members regarding collateral risk
methodology; (vi) performing collateral stress testing in accordance
with the CRP; and (vii) realizing the cash value of the collateral
lodged by a defaulted
[[Page 36258]]
member during the Default Management Process (``DMP''); \10\
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\8\ Such monitoring encompasses working with external
stakeholders (e.g., International Central Securities Depositories
(``ICSDs''), Central Securities Depositaries (``CSDs'')) and
internal stakeholders (e.g., Collateral Operations, as defined
below) to update the list of eligible collateral in line with the
acceptance criteria set out in the CRP.
\9\ For example, this includes assessing the prices of
collateral lodged bilaterally and collateral lodged via tri-party
providers against published market prices. In addition, it assesses.
In addition, where a material change in the collateral market is
identified, CaLM will escalate the issue to CaLM Risk (as defined
herein) and LCH SA senior management.
\10\ The governance of the DMP is laid out in the LCH Default
Management Policy.
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<bullet> LCH SA Risk Collateral and Liquidity Risk Management team
(``CaLM Risk'') is responsible for daily monitoring and managing risks
associated with collateral activities and positions in line with the
requirements of the CRP. This includes, inter alia, conducting
independent assessments of the eligibility of collateral received and
validating collateral haircuts in accordance with the policy; \11\
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\11\ CaLM Risk is also responsible for: (i) the independent
assessment of the prices of collateral lodged bilaterally and the
collateral market value lodged via tri-party providers against the
published market prices, in line with second-line risk
responsibilities for pricing set out in the LCH Contract and Market
Acceptability Policy; (ii) validating and monitoring the collateral
concentration limits on members; and (iii) the production of regular
reports and management information for circulation with LCHA Risk
Department, CaLM, and senior management, including escalation if
there are material changes in the market value, credit quality or
liquidity of collateral lodged (bilaterally or via tri-party).
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<bullet> LCH SA Collateral Operations team (``Collateral
Operations'') is responsible for ensuring that member margin
liabilities are covered with eligible non-cash collateral and/or cash
and managing the corresponding margin and collateral flows and related
investment flows. Most notably, Collateral Operations: (i) monitors
securities settlement and interoperability account balances; (ii)
tracks member requests to lodge and substitute collateral (seeking LCH
SA Risk Department and CaLM Risk approval as necessary); (iii) oversees
the system handling valuation of collateral lodged by members including
the application of relevant haircuts; (iv) communicates to members
changes in the population of acceptable collateral and haircuts; (v)
handles general inquiries from members regarding member collateral
pledged to cover margin requirements; and (vi) is responsible for
static data, collateral pricing, and adding new ISINs approved as
eligible collateral; \12\ and
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\12\ In addition, the CaLM team in Ltd is responsible for static
data, collateral pricing, and adding of new ISINs approved as
eligible non-cash collateral.
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<bullet> LCH SA Compliance is responsible for notifying regulators
of changes to collateral eligibility, limits and/or haircuts, where
relevant.
The CRP also sets out requirements for the approval of eligible
cash and non-cash collateral. In particular, the CRP establishes that
margin requirements can be covered by a mixture of cash and eligible
non-cash collateral (i.e., traded securities and bank guarantees),
subject to the criteria set out in the policy.
In respect of `cash', LCH SA accepts EUR, GBP and USD \13\ as the
primary currencies for margin cover and default fund contributions.
Further, the policy requires default fund contributions to be met by
cash \14\ in the primary currencies designated by each Clearing
Service.\15\
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\13\ LCH SA also accepts other currencies, subject to the
minimum criteria set out in the CRP, including that the currency is
used for clearing in LCH SA, has been approved for use by LCH SA
Credit Risk, can be invested in accordance with the Investment Risk
Policy, and CaLM Risk can manage the exchange risk associated with
the currency.
\14\ Default fund contributions can also be met by collateral
equivalent to cash in the case of default such as Central Bank
Guarantees, where authorized by the LCH SA Rulebook.
\15\ LCH SA currently maintains three separate Clearing
Services: (i) CDSClear, which provides clearing services for credit
default swaps; (ii) RepoClear SA, which provides clearing services
in respect of repo and cash transactions on Euro-denominated
government and supra-national debts across 13 markets (France,
Italy, Spain, Germany, Belgium, Austria, Finland, Ireland, The
Netherlands, Portugal, Slovakia, Slovenia and Supranational), as
well as a basket collateral service through the Euro GC+ clearing
service; and (iii) DigitalAssetClear SA, which provides clearing
services for cash-settled Bitcoin index futures and options
contracts traded on GFO-X, an FCA-regulated, centrally-cleared
multilateral trading facility dedicated to digital asset futures and
options.
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With regards to non-cash collateral, the CRP limits the assets
accepted as collateral to those with low credit, liquidity and market
risks as required by SEC Rule 17ad-22(e)(5).\16\ Specifically, in
respect of `traded securities,' the policy requires that all traded
securities meet certain credit, liquidity and market risk requirements
to be eligible as collateral for margin cover. For example, (i) the
issuer must be reviewed and assigned an internal credit score (``ICS'')
by LCH SA Credit Risk; (ii) the value of the securities must be
established daily using observed prices obtained from published
sources; (iii) the security must be in a currency that meets the
minimum criteria set out in the CRP, and must be reviewed by LCH SA
Credit Risk if such currency is not denominated in the domestic
currency of the home country; (iv) the value of the shares can be
established daily using observed prices obtained from published
resources; (v) the CCP has the operational infrastructure in place to
process the securities, market the positions, and apply appropriate
haircuts; (vi) CaLM has the expertise and the operational capability to
realize the value of the security in the event of a default, either
directly or via contractual arrangements with a third party service
provider; (vii) the CCP can hold and liquidate the securities without
legal challenge; and (viii) there must be sufficient market liquidity
available.\17\ The full list of traded securities that qualify as
eligible non-cash collateral \18\ are set out in Appendix II of the
CRP. In addition, the CRP provides a list of traded securities that are
not eligible as collateral for margin cover, including perpetual
bonds.\19\
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\16\ 17 CFR 240.17ad-22(e)(5).
\17\ The policy provides that fixed income securities where the
issuance size of a security is less than the minimum specified in
Appendix III, CaLM will provide evidence of market liquidity to CaLM
Risk and approval for eligibility will be required from the CRO (or
the CRO's delegate). Examples of such an issuance size include 800
mln for AUD and 5.5 bln for NOK.
\18\ Such eligibility remains subject to the eligibility
criteria for traded securities summarized above as well as to the
margin collateral haircut schedules published on LCH SA's website.
\19\ Other traded securities not eligible include (i) zero
coupon bond types (excluding treasury bills); (ii) strips (including
principal and coupon strips); (iii) securities issued by credit and
financial institutions; and (iv) securities which are close to
maturity, subject to specific corporate events, or have optionality.
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In respect of `bank guarantees', the policy provides that central
bank guarantees are eligible as collateral for margin cover if they are
issued by central banks in countries that are approved for investments
by CaLM. Commercial bank guarantees are not eligible.\20\
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\20\ Such investments must comply with the Investment Risk
Policy.
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The CRP also addresses changes to collateral eligibility. It
provides that, for new currencies and new issuers within an approved
collateral type to be accepted as collateral, approval from the LCH SA
Executive Committee (``ERCo'') is required.\21\ The ERCo also has the
discretion to declare that eligible collateral is no longer
acceptable.\22\ New types of collateral that pose new or novel risk
features, or that require a change to existing risk controls, require
(i) CaLM to submit such request to the ERCo and the LCH SA Risk
Committee; \23\ (ii) the ERCo and the LCH SA Risk Committee to review
such request; and (iii) the LCH SA Board to approve such request.\24\
If no changes are required to existing risk controls,\25\
[[Page 36259]]
CaLM Risk approval is sufficient. The CRP requires, where possible,
that LCH SA provide a notice period to its clearing members to allow
them sufficient time to adjust the portfolio of collateral lodged,
provided that this will not impair LCH SA's financial resources nor
liquidity position.
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\21\ In addition, the CRP requires appropriate regulatory
approval to be obtained prior to LCH SA accepting new currencies.
The ERCo may also request that new issuers be reviewed by the LCH SA
Risk Committee and approved by the LCH SA Board.
\22\ Such decisions are made upon the recommendation of CaLM and
CaLM Risk, following which the ERCo must notify the Risk Committee
of its decision.
\23\ The request must be accompanied by its rational and
supporting documentation.
\24\ Appropriate regulatory approval must also be obtained prior
to LCH SA's acceptance of new collateral types.
\25\ For example, adding new ISINs issued by sovereigns which
LCH SA already accepts, provided that the ISINs meet the minimum
eligibility requirements for non-cash collateral.
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The CRP also establishes a framework for monitoring market, credit,
concentration/liquidity, wrong way and FX risks (the ``Risks''). The
Risks are covered by baseline haircuts, haircut add-ons, limits and/or
price adjustments, detailed in the policy.\26\ The policy provides that
the ability of LCH SA to realize the value of a piece of collateral
lodged by its member within the assumed holding period is affected by
the collateral's market liquidity and the size of the position to be
liquidated. Details of and the rational for the holding period is
detailed in Appendix I. In line with SEC Rule 17ad-22(e)(5), the
framework aims to set and enforce appropriate conservative haircuts and
concentration limits.
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\26\ In addition, the CRP requires collateral haircuts to comply
with the FRAP.
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The policy provides that the ERCo may impose haircut add-ons and/or
impose new limits or price adjustments on certain types of non-cash
collateral based on their market liquidity, in particular, CaLM's
ability to realize the value of the securities in the event of a
default. In addition, the ERCo has the discretion to assess haircut
add-ons on clearing members, based on their exposures, domicile, or
portfolio of collateral posted, to protect LCH SA's financial resources
and liquidity position. Collateral haircuts are subject to daily stress
testing with any exceptions to be notified to the ERCo.\27\
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\27\ Under the CRP, the Stress Resting Regime must include the
following elements: (i) historical risk factor moves beyond the
99.7% level; (ii) theoretical scenarios which are extreme but
plausible are to be used to complement the historical scenarios and
provide better coverage of the tail losses of collateral portfolios.
To the extent that similar securities are cleared by LCH SA, the
same stress test scenarios applied on the clearing positions may be
used to stress test collateral haircuts.
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The CRO is responsible for ensuring the review of collateral
haircuts,\28\ and changes to published haircuts must be submitted to
the ERCo for approval.\29\ Material changes, as agreed by the ERCo, are
required under the CRP to be notified to the LCH SA Risk Committee.
Changes are required to be notified to the regulators, where
appropriate. In addition, the policy requires the appropriateness of
the CRP to be reviewed by the ERCo and the LCH SA Risk Committee on an
annual basis,\30\ and requires approval by the LCH SA Board.
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\28\ With quarterly reviews to be submitted to the ERCo for
approval; monthly reviews submitted to LCH SA CRO and/or the ERCo;
and more frequent reviews where appropriate.
\29\ Material changes (agreed by the ERCo) are to be notified to
the LCH SA Risk Committee. Changes are required to be notified to
the regulators where appropriate.
\30\ In line with SEC Rule 17ad-22(e)(5), the sufficiency of
collateral haircuts and concentration limits is performed no less
than annually.
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b. Financial Resource Adequacy Policy
The Financial Resource Adequacy Policy (``FRAP'') sets out the
standards governing the assessment of financial resources (initial
margins, margin add-ons and default funds) against the Latent Market
Risks \31\ in clearing member portfolios at LCH SA. The FRAP also sets
out the standards for addressing procyclicality in the risk frameworks
and models used by the LCH CCPs. In particular, the FRAP (i) details
the standards by which financial resources should be assessed against
member exposures; \32\ (ii) details the holding periods to be used for
each product in the assessment of margins, providing the justification
for each; (iii) articulates the rules governing the use of economic
offsets between products; (iv) presents the limit framework to be used
in assessing clearing exposures to members for each Clearing Service
and across Clearing Services; (v) details the standards to be used for
reverse stress testing the financial resources held against member
portions; (vi) details the standards to be used for ensuring that
procyclicality concerns are appropriately addressed in the risk
frameworks and models used by the LCH CCPs; and (vii) describes the
requirements for services within LCH Ltd that offer tiered
participation arrangements in accordance with the Tiering Risks
described in the Risk Governance Framework. Finally, the FRAP states
that the Board's appetite for Latent Market Risk and Procyclicality
Risk is low. The policy requires LCH SA to impose, call, and collect
margins at least daily on each day when its Clearing Services are open
and operating in order to limit its credit exposures \33\ to its
clearing members and, where relevant, from Central Clearing
Counterparties (``CCPs'') with which it has interoperability
arrangements.\34\ In addition, the policy sets out the LCH SA standards
for initial margin, margin add-ons, intraday margins and variation
margin.\35\ For example:
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\31\ `Latent Market Risk' is defined in the Risk Governance
Framework as the `risk that the exposure to a member's portfolio
value increases due to the impact of changing market factors on the
valuation of the portfolio'. This risk is described as latent, in
that LCH SA is only exposed in the event of the member's default.
\32\ This includes variation margins, initial margins, margin
add-ons for liquidity risk, concentration risk, wrong way risk where
appropriate, as well as the sizing and re-sizing of default funds.
\33\ Such margins shall be sufficient to cover potential
exposures that LCH SA estimates will occur until the liquidation of
the relevant positions.
\34\ The FRAP also requires LCH SA to assess a number of risks
prior to entering into any interoperating arrangements. For example,
legal risk arising from the link, including each party's rights and
obligations, cross border legal issues, netting arrangements,
enforceability of the LCH SA Rulebook, default procedures,
collateral arrangements and dispute resolution.
\35\ The standards for the calculation of variation margin
depend on whether the price discovery takes place on a public venue/
exchange or the price is determined via the ``OTC'' market. For
example: (i) for exchanges and venues where pricing is transparent,
each Clearing Service must have a well-documented routine for price
capture, price verification and data cleansing where required; (ii)
for OTC products, the model used to price instruments for variation
margin purposes must be subjected to an ``outputs'' review; (iii)
all inputs to the model must have a documented process for data
capture and data cleansing; and (iv) standards for adequate price
sources and controls should be equivalent to those described in the
Contract, Market and Acceptability Policy.
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<bullet> Initial margin levels for each of LCH SA's Clearing
Services must be calibrated to the 99.7% \36\ confidence level; \37\
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\36\ The rationale for the 99.7% confidence level is detailed in
Appendix 2 of the FRAP.
\37\ The policy explains that such levels ensure that enough
margins are held to cover the potential loss from any member
(including the clients of that member) to the defined service
confidence levels under normal market conditions, should LCH SA need
to close out that member's portfolio within the holding periods
prescribed by the policy. The FRAP also sets out a set of
expectations surrounding initial margin. For example, any
deterioration in backtesting results must be identified immediately
and flagged to the CRO and/or the ERCo to assess whether mitigation
actions are required.
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<bullet> Additional margins must be held (where appropriate) to
cover member specific portfolio risk arising from both house and client
activity of the following types: (i) concentration/liquidity risk; (ii)
sovereign risk; (iii) wrong way risk; and (iv) counterparty credit
risk; and
<bullet> Each Clearing Service is expected to monitor margin levels
intraday and to have the capacity to call for margin intraday should it
be necessary to address any issues with member exposures.
The FRAP also sets out the minimum governance standards applicable
to LCH SA's default fund arrangements, including the requirement for
all financial resources held by LCH SA (initial margins, additional
margins, and the default funds) to meet the so-called
[[Page 36260]]
``cover-2'' standard, i.e. the potential losses from a close-out in an
extreme event of the largest two (2) member portfolios and all clients
of both of these members. Moreover, the policy details: (i) the order
in which LCH SA must use its available resources to cover the losses
from a defaulting member; \38\ (ii) the predefined stress regime \39\
to be used to identify `extreme but plausible' \40\ tail losses in each
member portfolio beyond the applicable initial margin confidence level;
and (iii) the Stress Test Loss Over Additional Margin (``STLOAM'') \41\
to be imposed on members in order to limit exposure by LCH SA to a
single clearing member portfolio. The FRAP states that LCH SA applies a
daily Clearing Limit on member exposures such that the STLOAM may not
exceed 45% of the Default Fund for any member (the Daily Default Fund
Additional Margin, or ``DDFAM'' threshold), and that should a member
group breach the 45% limit, the excess amount must be called as DDFAM
from that member group and such margin must be held until the member
group's exposure falls back below the 45% limit.\42\
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\38\ The order is as follows: (i) defaulter's own financial
resources (initial margins, variation margins, additional margins,
default fund contributions); (ii) the Clearing House `skin in the
game'; (iii) the default fund contributions of the non-defaulting
members; (iv) second layer of skin in the game where required by
applicable regulation; (v) default fund assessments of the non-
defaulting members; (vi) service continuity and loss allocation
mechanisms; and (vii) if the resources at this stage are still not
enough to cover the losses, then a decision is made to either close
or partially close (if applicable) the service and allocate the
remaining losses, or raise more funds from the membership to
continue the service.
\39\ This includes Stress Test Loss Over Initial Margin (STLOIM)
and default fund additional margin (DFAM) calculations, the
frequency at which each default fund must be resized, and the
prescribed Stress Testing Regime to be followed.
\40\ The FRAP determines that a scenario is `plausible' if it
has happened over the last 30 years.
\41\ This term and some other capitalized terms in the FRAP are
defined in the glossary found in Appendix 4 thereof.
\42\ The 45% DDFAM threshold may be increased to up to 50% for
members with certain ICS scores, when additional risk management
tools are in place subject to ERCo approval and Risk Committee
notification.
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The FRAP states that each service is expected to monitor intraday
margin levels and have the capability to call for margin intraday
should it be necessary to address any issues with member exposure. In
addition, each service must calculate daily variation margin and such
standards for calculation differ depending on whether the price
discovery takes place on a public venue/exchange or the price is
determined via the OTC market.
The FRAP provides, in addition, that offsets or reductions are
allowed in the required margin, subject to certain conditions being met
e.g., where the economic offset must be demonstrably resilient during
stressed market conditions and must be subject to the stress test
regime. The policy also sets the standards to be applied to sources of
procyclicality and requirements that were set out in the former
Procyclicality Policy.\43\ Specifically, the FRAP discusses how LCH SA
manages the trade-off between increasing clearing member margins
following a market stress event, with the potential resulting liquidity
drain, which may be disruptive to the market. To address procyclicality
risk, LCH SA will employ specific standards for each of its clearing
services to comply with. This includes producing margin levels which
avoid disruptive step changes in financial resources held, ensuring
margin increases are driven by market pricing and not anticipatory of
market movements and adequately estimating volatility to prevent the
erosion of margin levels during quiet periods. The FRAP has a
supplemental appendix that describes the key sources of procyclicality
risk in more detail and specific considerations LCH SA will factor in
to avoid procyclicality risk when assessing clearing members.
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\43\ As part of its annual review process, LCH SA moved the
contents of its Procyclicality Policy into the FRAP and
decommissioned the Procyclicality Policy. Section 9 of the FRAP
includes detail on how LCH SA manages procyclicality risk, including
by assessing changes in margin requirements, collateral haircuts,
Clearing Member credit scoring and how LCH SA may assess Clearing
Members for additional default fund contributions.
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The FRAP sets out the limit framework for clearing exposures at the
member and member group level, with the primary limit being that no one
member or member group can use more than 45% of the default fund.\44\
For lower credit quality members (beginning at an ICS score of 5),
there is a limit of 25% usage of the Default Fund, progressively
decreasing to zero for a member with an ICS score of 8 or higher.
Finally, the FRAP provides that LCH SA will monitor these limits daily
for each member in each Default Fund.
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\44\ This may be increased up to 50% for members which have an
ICS of 1-4, for a given default fund, when additional risk
management tools are in place to mitigate a decrease in the 10%
buffer in financial resources held. This is subject to approval from
the ERCo followed by a notification to the Risk Committee, and the
approval from ERCo needs to be ratified annually. Any such increase
in the threshold to 50% is not automatic and each clearing service
will need to present and justify the request during the ERCo.
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To address the risk of clearing members that also have exposure as
CaLM counterparties, the FRAP establishes a concentration limit
framework at the counterparty level. That is, the FRAP defines a
Capital at Risk (``CAR'') amount for each member or member group which,
together with the aggregate risk exposure of that member or member
group, must not be greater than 30% of the entire LCH SA capital.
The FRAP, in addition, requires LCH SA to run liquidity stress
tests,\45\ collateral stress tests \46\ and exposure stress
testing.\47\ The policy also describes LCH SA's Reverse Stress Testing
Framework to ascertain the adequacy of financial resources held against
member positions.\48\ A supplemental appendix also describes LCH SA's
reverse stress testing and sensitivity analysis processes in accordance
with SEC regulations. Specifically, the appendix states that LCH SA
will conduct a comprehensive analysis of core stress testing scenarios,
models, and underlying parameters and assumptions more frequently than
the required monthly cadence when the products cleared or markets
served display high volatility or become less liquid, or when the size
or concentration of positions held by the participants increases
significantly. The results of which will go through LCH SA's internal
governance processes for the purposes of assessing the adequacy of and
adjusting, as necessary, its margin methodology, model parameters,
models used to generate clearing or guaranty fund requirements, and any
other relevant aspects of its margin framework. In addition to its
reverse stress testing processes, LCH SA will conduct a sensitivity
analysis of its margin models and a review of its parameters and
assumptions for back-testing on at least a monthly basis and consider
modifications to ensure its back-testing practices are appropriate for
determining the adequacy of margin resources. This may be performed
more frequently than monthly during periods of time when the products
cleared or markets served display high volatility or
[[Page 36261]]
become less liquid, or when the size or concentration of positions held
by the participants increases or decreases significantly. LCH SA will
bring the results of this analysis through internal governance in order
to evaluate the adequacy of its margin methodology, model parameters
and any other relevant aspects of its margin framework.
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\45\ These stresses are detailed in the Liquidity Risk Policy
and must be run daily and reviewed at least quarterly or when there
is a sudden change in liquidity conditions.
\46\ These stresses are described in the Collateral Risk Policy
and must be run daily. Collateral haircuts must be reviewed at least
quarterly.
\47\ This is the stress testing regime carried out in the
default fund sizing described above in the FRAP, which ensures that
the ``cover 2'' standard is being met relative to extreme but
plausible scenarios above the service initial margin confidence
level. These stress tests must be run daily.
\48\ The financial resources considered by the policy include
all margin coverage, default funds and liquidity resources.
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c. Counterparty Credit Risk Policy
The Counterparty Credit Risk Policy (``CCRP'') describes the
standards by which LCH Group and its entities manage and assess
counterparty credit risk via an ICS and limit frameworks to manage the
risk. Moreover, the policy clarifies the roles and responsibilities
within LCH SA for compliance with the CCRP. LCH SA Credit Risk is
responsible for monitoring \49\ and managing counterparty credit risk.
This includes: (i) assigning and maintaining the ICS; (ii) assigning,
maintaining and monitoring the applicable limits under the policy;
(iii) reporting to the responsible risk team of any change in the ICS
which triggers actions under the CCRP and other LCH SA risk policies;
and (iv) regular and ad-hoc reporting to other risk areas and senior
management. The policy is owned by the CRO.
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\49\ LCH SA Credit Risk is also required to escalate to the ERCo
if any concerns are raised as a result of the factors listed in
Annex I, regardless of whether it directly impacts the Implied ICS.
For example, where a counterparty reports a change to its external
rating letter category from A to BBB and vice versa.
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The CCRP requires an ICS to be assigned to all clearing members and
the sovereign of their country of risk (and that of their parent, if
different); and all other counterparties, including intermediaries and
countries which are subject to a minimum ICS as covered in other risk
policies. The main scoring frameworks for each counterparty type are
detailed in the ICS Frameworks Methodology Document (the ``IFMD'') and
are subject to annual model validation.
The CCRP and IFMD set out the factors to be used by LCH SA to
assign an ICS \50\ and derive the Implied ICS \51\ for corporates
(including banks, non-bank financial institutions and supranational
entities), sovereigns (including ``Government Related Entities''),
interoperating CCPs, pension funds, regulated funds, and insurance
funds.
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\50\ The frameworks assign an ICS between one (1) and ten (10),
whereby one (1) represents low default probability in line with the
AAA public ratings and ten (10) is equivalent to a defaulting
counterparty.
\51\ The ICS is calculated using quantitative and qualitative
factors, which are also scored on a one (1) to ten (10) scale based
on one or more metrics. Each factor is weighted and the sum of the
weighted factors produces an ``Implied ICS''. The Implied ICS can be
adjusted up or down to arrive at the ``Final ICS'' based on specific
``Adjustment factors'' which capture: (i) third party guarantees or
support; (ii) country risk: a sovereign ceiling applies to all
corporates unless there is a demonstrated degree of diversification.
Due to the high regulatory oversight, the country ceiling does not
apply to interoperating CCPs; and (iii) specific reasons which make
one of the factors over/under stated or particularly significant to
dominate all other factors for the final score. The factors, metrics
and adjustments are reviewed by the ERCo on at least an annual basis
and independently validated in accordance with the Model Governance,
Validation and Review Policy.
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The CCRP also requires all applicable counterparties, including
``Dormant Sponsored Members,'' to be subject to a formal documented ICS
assessment before on-boarding, and then at least once a year.
Prospective clearing members and interoperating CCPs for all markets
must meet the minimum entry ICS detailed in the policy.\52\ For
example, Clearing Members, including Interoperating CCPs, must have at
least an ICS five (5) rating.
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\52\ All other counterparties must meet the minimum eligibility
criteria detailed in the relevant LCH risk policies and Rulebooks.
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The policy requires a Credit Assessment Review and ICS
recommendation to be performed for all new clearing member
applications, including the sovereign credit assessment and ICS
recommendation of the prospective clearing member and its parent
jurisdiction. The ERCo has the discretion to reject any member
application regardless of the ICS assigned.
The CCRP and Annex I thereof detail the exposure monitoring
thresholds, limits and tolerances applied to each clearing member. This
includes: (i) STLOAM plus Default Fund Contribution/Net Capital ratio;
(ii) T-ratio; and (iii) credit tolerances. All thresholds are monitored
daily, and LCH SA Credit Risk decide on any action to be taken when a
breach has occurred.
The CCRP also provides that the aim of additional margin is to
ensure that as a clearing member's credit quality deteriorates to below
its entry requirement, more resources are called progressively so that
the stress losses are fully covered by eligible resources. Moreover, it
ensures the relevant service confidence level, as detailed in the FRAP,
continues to be met. Additional margin will be applied to house
positions and, in general, additional margin will also be applied to
client accounts.
The CCRP provides that, where appropriate, LCH SA Credit Risk and
the business line may agree to separate procedures to apply additional
margin to client accounts on a discretionary basis. Such procedures may
include an assessment of the ability of a client to port and its
underlying credit quality. Such procedures need to be approved by the
ERCo upon LCH SA Credit Risk's recommendation. If such discretion is
applied, the LCH SA Risk Committee will be notified of the ERCo's
approval and the rationale for the decision.
d. Operational Risk Management Policy
The Operational Risk Management Policy (``ORMP'') sets out (i) the
LCH Group Board's \53\ risk appetite and expectations for the
management of operational risk (defined as the risk of loss arising
from inadequate or failed internal processes, people and systems or
from external events); \54\ and (ii) the key features of the
operational risk management framework for identifying, assessing,
monitoring, mitigating and managing operational risk. The policy
applies to all operations within LCH SA, including all LCH SA
employees,\55\ regardless of the basis or term of their employment. The
standards of the OMRP must also be applied where business functions are
outsourced to third parties, including intra-Group.
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\53\ In accordance with the Risk Governance Framework and unless
otherwise stated, ``LCH Group Board'' refers to each respective
Group entity board, including that of LCH SA, LCH Ltd. and SwapAgent
Ltd.
\54\ The policy acknowledges that regulations applicable to
local entities may specify a more detailed definition of
`operational risk'.
\55\ An ``employee'' is defined as a permanent, temporary and
contract member of staff, consultant and secondee, intern and any
other such individual.
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The ORMP clarifies and expands upon the roles and responsibilities
within LCH SA for compliance with the ORMP. The LCH SA Board is
responsible for: (i) determining risk appetite; (ii) overall compliance
of the risk management framework; and (iii) ensuring that management
maintains an adequate system of internal controls appropriate to LCH
SA, and the risks to which it is exposed.\56\ Moreover, the ORMP
details the three lines of defence model, as defined in the Risk
[[Page 36262]]
Governance Framework, operated by LCH SA:
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\56\ The OMRP sets out the LCH SA Board's expectations,
including that (i) risks be identified, assessed, monitored and
managed in a proactive manner to minimize the impact to the LCH
Group; (ii) risk assessments be carried out using the risk severity
matrix contained in Annex A; and (iii) each operational risk be
identified as either `outside appetite', `near limit (within
appetite)' or `within appetite'. Where risks are assessed as near or
outside appetite, or where control weaknesses are identified, the
First Line of Defence must develop solutions and implementation
plans with clear interim milestones to address the weaknesses and
bring the risks back to within appetite. The policy requires issues
and actions to be raised at least for all risks assessed as near or
outside appetite.
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<bullet> All services and functions responsible for business as
usual and change activities are responsible for ensuring adherence to
the ORMP and being accountable for identifying, assessing, monitoring,
mitigating and managing operational risk \57\ (the ``First Line of
Defence'').
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\57\ This includes responsibility for the day-to-day management
of risk by designing, operating and maintaining an effective system
of internal controls and for promoting the development of a strong
risk culture. The ORMP provides that business and department heads
are responsible for ensuring all material risks, controls and
mitigating actions are up to date and reflect the current risk
assessment. In addition, all staff are responsible for the day-to-
day management of risk by designing, operating and maintaining an
effective system of internal controls.
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<bullet> LCH SA Risk Department \58\ are responsible for (i)
providing oversight, support, and challenge to the First Line of
Defence; \59\ (ii) ensuring that the ORMP is aligned to the LCH SA
Board's risk appetite; (iii) defining the risk management process and
policy framework; (iv) assessing risks against policy standards; and
(v) reporting to the Board and sub-committees on risk exposure (the
``Second Line of Defence''). The Second Line of Defence is also
responsible for providing appropriate training \60\ on the risk
management framework at least annually to relevant staff.\61\
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\58\ The LCH SA Risk Department is also responsible for
approving all changes to appetite assessment, and reporting to the
LCH SA Board and sub-committees on risk exposure.
\59\ The Second Line of Defence must ensure that the First Line
of Defence provides evidence of compliance with the principles and
standards outlined in the ORMP in an appropriately frequent and
detailed manner, having regard to the importance of the business and
the services provided.
\60\ In line with Annex D of the ORMP, LCH SA Compliance
performs face-to-face training for new joiners on compliance topics,
and at least every 2 years with critical staff. The purpose of risk
management training is to (i) ensure the consistent application of
the Operational Risk Management framework, including the tools and
reporting processes; (ii) enhance the clarity of roles and
responsibilities for risk management and embed these across the
three lines of defense; and (iii) embed an effective risk culture
for the group which maintains high standards or risk awareness,
transparency and accountability.
\61\ Compliance is also included as a Second Line of Defence,
providing oversight, support and challenge to the First Line in
addition to ensuring that this policy is aligned to the Board risk
appetite and complies with all the applicable financial rules and
regulations.
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<bullet> LCH SA Internal Audit team (``Internal Audit'') is
responsible for developing and delivering a program of assurance aimed
at validating that the control environment is operating in alignment
with the LCH SA Board's risk appetite and the policies approved by the
LCH SA Board (``Third Line of Defence'').\62\
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\62\ In doing so, the Third Line of Defence provides independent
assurance to the LCH SA Board and other key stakeholders over the
effectiveness of the systems of internal controls and the Risk
Governance Framework.
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The ORMP requires the LCH Group to have a defined risk taxonomy for
operational risks, as set out in Appendices 3 and 7 of the Risk
Governance Framework (the ``Risk Taxonomy''). Specifically, (i) the
First Line of Defence must identify applicable operational risks and
define associated controls applicable to their business or function, in
line with the Risk Taxonomy; and (ii) any changes must be approved by
the Second Line of Defence, in accordance with Annex C of the ORMP.
The policy confirms that the LCH SA risk assessment tools and
processes must include the following minimum requirements:
<bullet> risk and control assessments \63\ (``RCAs'') to be
performed by the First Line of Defence \64\ on an annual basis, and
reviewed by the Second Line of Defence; \65\
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\63\ Such assessments must consider a number of factors such as
(i) critical and significant audit findings; (ii) policy breaches;
and (iii) external events that may give rise to increased
vulnerabilities. Change activities (including new products,
processes and system changes), which, if not deployed correctly
would have a material impact on LCH SA's business activities or risk
profile, must follow the defined change management process detailed
in the ORMP and Annex E thereof.
\64\ In carrying out its RCAs, the First Line of Defence must
refer to the Risk Taxonomy and Control Guidance set in a dedicated
Standard as set forth in the Risk Governance Framework in order to:
(i) identify risks and controls which are applicable to their
business or function; (ii) assess the inherent risk (i.e., before
considering mitigating controls); (iii) perform a control
environment assessment; and (iv) assess the residual impact and
likelihood of the risk after considering the control assessment.
\65\ The Second Line of Defence must have a process in place to
review and challenge First Line of Defence RCAs.
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<bullet> a control assurance process,\66\ covering key controls
\67\ in appropriate depth and frequency;
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\66\ Control assurance is an assessment of controls by a person
independent of the day-to-day operation of those controls to confirm
the control environment is adequately designed and operating
effectively, providing a systematic view of which controls are
effective in mitigating risk, which ones are not and where controls
are missing. The control assurance also focuses on providing
objective evidence that key controls are designed and operating
effectively. This provides management the opportunity to respond
where controls are not managing risks sufficiently. For the purposes
of this control framework, `control' is defined as `an action taken
(including verification action) to mitigate risk by either reducing
the likelihood and/or the impact of an unwanted outcome'.
\67\ The term `key control' is defined as a control that
`[p]revents a risk from materializing, detects it in a timely manner
or significantly mitigates the consequences. The failure of the key
control could have a material impact; financial, non-financial,
reputational, regulatory, lead to service disruption and increase
risk exposure for the entity'. Any key controls being assessed as
being absent or ineffective must be reported to the Second Line of
Defence with a remediation plan.
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<bullet> deep dives \68\ to be conducted by the First, Second and
Third Lines of Defence in response to concerns, themes, management
focus, triggers or external drivers; and
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\68\ Deep dives assess the controls and governance over a
particular process. Any changes to risk profile or actions required
as a result of a deep dive must be reported to Second Line of
Defence, with a remediation plan.
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<bullet> a list of extreme but plausible operational risk scenarios
relevant to the business or function, incorporating expert opinion \69\
and data evaluating exposure to high severity events.
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\69\ The ORMP provides that such scenario analysis should draw
on the knowledge of experienced business managers and subject matter
experts to derive reasoned assessments of plausible severe losses
and impacts. As part of the RCA review, the Second Line of Defence
will review and challenge the scenarios selected by First Line to
ensure they are reflective of the key risks the business or function
is exposed to. Over time, the ORMP requires such assessments to be
validated and reassessed through comparison to actual loss
experience to ensure their reasonableness.
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The ORMP also details the process to be followed when the following
risk events occur triggering a re-assessment of risks and controls: (i)
incidents and actual losses; \70\ (ii) audit \71\ or risk and
compliance issues, and external reviews; \72\ (iii) key risk and
control indicator breaches; \73\ (iv) control weakness; (v) other
internal events including process changes or restructuring; \74\ and
(vi) external events arising outside of LCH SA and LCH
[[Page 36263]]
Group's control (e.g., natural disasters, pandemics, political changes,
etc.).
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\70\ A process must be in place to monitor and manage all types
of incidents including IT system failures, failure or delays in key
business processes, in order to minimize interruptions to business
services. The ORMP requires all incidents to be classified in
accordance with their materiality under Annex B and recorded in an
appropriate system to facilitate the immediate escalation and
resolution of the incident.
\71\ Any audit issue rated `critical' or `significant' may
impact the risk profile of the business/function and the risk must
be re-assessed accordingly.
\72\ External reviews can be initiated by LCH SA's regulators or
management where a third party is engaged to perform a specific
review and will include for example management recommendations
arising as part of the annual external audit process.
\73\ Key Risk Indicators (``KRI'') and Key Control Indicators
(``KCI'') are metrics with thresholds designed for management to use
in order to effectively identify, assess and monitor their current
and emerging risks against risk appetite. All businesses and
functions must implement them based on the operational risk library
and control guidance.
\74\ Changes such as process redesign or organizational
restructuring may impact the risk profile and require re-assessment
of relevant risks, as could a threat assessment triggered by senior
management or the LCH SA Board.
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Finally, the ORMP requires businesses and functions to maintain
complete and accurate risk registers; risk indicators and evidence that
supports the assessment of risk, including scenario testing, and ensure
regular management information is available for reporting on the status
of operational risk.
e. Third Party Risk Management Policy
The Third Party Risk Management Policy (``TPRMP'') and the
associated Standard set forth in the Risk Governance Framework set out
LCH Group's minimum requirements for managing potential risks when
entering into and managing all third party relationships across the
following four (4) phases of the Third Party \75\ lifecycle: (i)
identify the need to leverage third party services and select the most
appropriate third party provider (``Plan and Select''); (ii) set the
conditions for the third party relationship (``Contract and Onboard'');
(iii) ensure that the service, relationship and risks are effectively
managed (``Manage and Monitor''); and (iv) ensure orderly exit and
transition at the completion of an engagement or an early termination
(``Terminate and Exit'').
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\75\ ``Third Party'' is defined in the TPRMP to mean a third
party entity, whether internal or external, that provides goods or
services to LSEG. The definition includes: (i) External service
providers (also known as suppliers and vendors) where LSEG negotiate
contractual terms and pay through invoiced arrangements; (ii)
External Partners including Financial Market Utilities (FMUs)/
Financial Market Institutions (FMIs)/Banks, etc. remunerated through
indirect payments (e.g., settlements/deductions). These include
CCPs; (iii) Internal Third Party: intragroup services provided from
one LSEG entity to another. This definition does not include
affiliates, charities, brokers, or joint ventures.
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The Plan and Select section explain how a Risk Assessment must be
performed on all new Third Party engagements.\76\ Such assessment
evaluates the importance and criticality of the third party
dependencies across all dimensions and drives subsequent due diligence
and procurement activities. Moreover, the policy requires due diligence
conducted to be proportionate to the inherent risk and nature of the
engagement prior to determining if the Third Party is an appropriate
choice for LSEG and within the defined appetite, including
concentration. Due diligence must include, but is not limited to,
business facts,\77\ know your third party,\78\ due diligence \79\ and
conflicts of interest.\80\ The TPRMP provides a detailed list of the
events that trigger notification to the relevant regulators e.g., when
an existing arrangement turns from `non-critical' to `critical', and
when there are changes \81\ to the list of existing Critical
Outsourcing Arrangements.\82\
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\76\ In the event of a ``Critical Outsourcing'' arrangement,
appropriate risk and LCH SA Board approval, including regulated
entity boards, must be obtained prior to execution, including for
the use of any subcontractors. In addition, where a third party
provides details on its extended supply chain, LCH SA should
establish if any of those parties meet the definition of `critical'.
Where identified, these should be managed in line with the relevant
requirements in the TPRM Standards. `Extended Supply Chain' is
defined as `Equivalent to 4th and nth suppliers. Aligns with the
expectation that entities take steps to understand critical
dependencies in their extended supply chain as far as they extend
into the supply chain'. Moreover, Appendix D of the TPRMP provides
that where LCH SA identifies an FMI, FMU or other entity directly
regulated by a competent authority (regulator) as `critical', the
requirements of this policy and the associated TPRM standards will
be applied on a best endeavors basis.
\77\ For example, a check to ascertain that the Third Party is a
valid entity registered in the jurisdiction(s) in which it operates
and/or a check of the Third Party's capability to deliver the
desired goods/services.
\78\ For example, compliance and financial crime screening,
including sanctions, anti-bribery & corruption, anti-money
laundering, country risk and fraud, as appropriate.
\79\ The TPRMP provides that such due diligence is to be carried
out in accordance with the risk profile of the service, e.g.,
information and cyber security, data privacy, financial crime, and
business continuity/resilience.
\80\ All conflicts of interest relating to each third party
arrangement must be identified, captured and managed in line with
the Group Conflict of Interest Policy.
\81\ This would include material changes, exits or replacements.
\82\ A ``Critical or Important Outsourcing Arrangement'' is
defined as a Third Party arrangement which meets both the definition
of `Outsourcing' and delivers services which meet the definition of
`Critical Service'. Outsourcing is defined as an engagement of any
form between LSEG and a service provider by which that service
provider performs a service, function or an activity that would
otherwise be undertaken by LSEG itself. A sub-set of Third Party
provided services (either internal or external) where certain
regulatory requirements are triggered based on the type and
materiality of the service. Example regulatory requirements include
increased governance, more frequent risk assessment and regulatory
notification. The policy lists the circumstances and factors to be
considered by LCH Group to deem a service a `Critical Service'.
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The Contract and Onboard section requires LCH SA to have
appropriate written agreements \83\ with the Third Party (including
Intragroup engagements) that are commensurate with the nature, scale
and complexity of the services and in line with the financial approval
policy. The TPRMP also provides that the written agreement must
consider the dependencies from the third party across all dimensions
including technology and the potential impact on the continuity and
availability of financial services and activities.\84\ In addition and
for engagements or Outsourcing contracts with Critical Third
Parties,\85\ the TPRMP requires LCH SA to engage with subject matter
experts from Legal, the Business, Risk and Compliance during the
contracting phase and the subsequent approval process.
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\83\ A Written Agreement is defined as a binding, auditable
commitment between LSEG, or an LSEG entity and a Third Party. It
includes, but is not limited to, contracts, LSEG Legal preapproved
standard Master Service Agreements (``MSA'') or other type of
framework agreement along with Purchase Orders (``PO''), Statements
of Work (``SoW''), Order Forms (``OF''), Access or Membership
Agreement.
\84\ The TPRMP requires written arrangements related to critical
outsourcing or critical services to ensure the service provider
grants LSEG and its competent authorities certain access (e.g., head
offices and operation centers) and rights of inspection and
auditing, to enable them to monitor such outsourcing arrangement,
and to ensure compliance with all applicable regulatory and
contractual requirements. Where the outsourcing of services is not
critical, LCH Group should ensure the access and audit rights are
appropriate taking a risk-based approach. The policy lists the
circumstances and factors to be considered by LCH Group to deem a
service a `Non-Critical Service'.
\85\ A Critical Third Party is defined in the TPRM as a Third
Party where the continuous, secure and efficient delivery of their
services to the regulated entity is critical to the operation of
that regulated entity.
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The Manage and Monitor \86\ section requires an updated register of
all current relationships with the third parties and outsourcing
arrangements \87\ to be regularly maintained. Moreover, Third Party
performance,\88\ together with that of any permitted subcontractors
\89\ (for example 4th and nth parties) supporting the delivery of
services, must be monitored \90\ on an
[[Page 36264]]
ongoing basis using a risk-based, proportionate approach \91\ and in
line with the TPRM Manage and Monitor Standard to ensure the Third
Party is delivering on their obligations under the written agreement.
The policy also requires LSEG to exercise and apply audit rights (and
supplier testing) in full to Critical Third Party arrangements and on a
risk-based basis to non-critical outsourcing arrangements where
required.\92\
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\86\ The TPRMP provides that the following key principles
underpin LSEG's approach to the management of Third Party
arrangements: (i) a risk-based approach, with the highest level of
oversight and due diligence on Critical Third Party services (which
includes third parties which meet the regulatory definitions
Critical Outsourcing Arrangements and Critical Third Parties); (ii)
overall accountability by the Accountable Executive for overall
resilience and any risks associated with it and for any activities
conducted via an outsourcing arrangement; and (iii) standard
processes and tools must be leveraged wherever possible to achieve
consistency and efficiency.
\87\ This includes critical 4th and nth parties where details of
these are provided.
\88\ The TPRMP sets out what the performance monitoring for
Critical Third Parties should include. For example, Day-to-day
monitoring of the Third Party's performance and delivery against the
measures defined in the written agreement and to ensure appropriate
action is taken to resolve any operational issues that may arise
with the Third Party.
\89\ A subcontractor is defined as a provisioning party to whom
the Third Party subsequently delegates all or part of the provision
of a service (e.g., 4th+ party).
\90\ Monitoring of Third Party arrangements must also include
the appropriate assessment and management of changes to, and within,
the arrangement in line with organizational change processes.
Moreover, the policy provides that it is important that Business
Continuity Plans and reviewed and where relevant testing in line
with the Business Continuity Management Policy.
\91\ Further detail on this approach can be found in the TPRMP
and Appendix D thereto.
\92\ For regulated areas, this may include third party
certifications and pool audits, where appropriate. A full table of
requirements is set out in the Risk Methodology document.
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The Termination and Exit section requires LCH SA to plan for both a
`stressed' (e.g., a third party becoming insolvent) and unstressed
(e.g., termination for convenience/end of a contract) exit from each of
its third party arrangements.\93\ The policy states that the
Accountable Executive \94\ and Relationship Owner \95\ for each Third
Party arrangement is responsible for ensuring records and documentation
are maintained in line with local regulatory records management
requirements, in order to demonstrate ongoing compliance with the TPRMP
and the associated standards.\96\
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\93\ Irrespective of the reason for exiting a Third Party
relationship, LSEG aims to do so: without undue disruption to its
business activities with minimal impact on the services provided to
customers; and without limiting its compliance with legal or
regulatory requirements.
\94\ An Accountable Executive is defined as responsible for
ensuring that the risks associated with the Third Party are managed
as per this policy: (i) retain overall responsibility for the Third
Party engagement; (ii) monitor Third Party engagement: (iii) manage
incidents and disputes and oversee change control process'.
\95\ A Relationship Owner is defined as a nominated individual
within the Business Function who assumes responsibility for the
ownership of goods or services from a designated Third Party. They
are responsible for implementing and executing oversight and
management activities across the Third Party lifecycle (i.e., from
selection, contracting and onboarding service delivery through to
exit activities). This role is limited to full time employees.
\96\ The policy sets out the relevant LCH Group policies and
guidelines, or equivalent entity policies and guidelines, that must
be read in conjunction with the TPRMP. For example, the Anti-Bribery
and Corruption Policy, the Business Continuity Policy, the Code of
Conduct and Ethics, and the Conflicts of Interest Policy.
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The TPRMP also sets out the roles and responsibility for
implementing the above standards within LCH SA.\97\ In this regard, LCH
Group follows a third lines of defense model. The first line of
defense, made up of the LCH SA Third Party Management Risk team and
Procurement team, is responsible and accountable for identifying,
assessing, monitoring, and managing third party risk. Moreover, it must
ensure there are appropriate controls designed, implemented and
assessed to ensure LCH SA can operate within the agreed risk appetite.
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\97\ Further detail on these roles and responsibilities can be
found in Appendix E of the TPRMP. Please note that Appendix A has
not been referred to as it is not applicable to LCH SA.
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The Second Line of Defence, including Second Line Risk and
Compliance team, is responsible for the oversight, support, and
challenge in addition to ensuring that the policy is aligned to the LCH
SA Board appetite.\98\ The Third Line of Defence, made up of the
Internal Audit function, is responsible for developing and delivering a
program of assurance aimed at validating that the control environment
is operating in alignment with the LCH SA Board's risk appetite and the
policies approved by the LCH SA Board. In doing so, Third Line of
Defence provides independent assurance to the LCH SA Board and other
key stakeholders over the effectiveness of the systems of controls and
the Risk Governance Framework.
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\98\ The Second Line of Defence, including Compliance, must
ensure that the First Line of Defence provides evidence of
compliance with the principles and requirements outlined in this
policy in an appropriately frequent and detailed manner, having
regard to the importance of the business and the services provided.
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f. Risk Governance Framework
The Risk Governance Framework (the ``RGF'') identifies the Key
Risks (as defined below) faced by LCH SA and sets out: (i) the LCH SA
Board's appetite across the Key Risks; (ii) the taxonomy of the Key
Risks; (iii) the roles and responsibilities within LCH SA for managing
each identified Key Risk; (iv) the standards to be met by LCH SA when
managing its business activities within the determined risk appetite;
and (v) the indicators and tolerance thresholds by which each Key Risk
is meant to be measured and reported.
The RGF aims to ensure that the risks assumed in executing LCH SA's
business strategy are adequately understood and managed across all
levels within LCH SA. Moreover, the framework supports LCH SA's Board
and Executive Management in discharging their regulatory and corporate
responsibilities.\99\
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\99\ The RGF provides that this is done through robust
governance arrangements with (i) well-defined, transparent, and
consistent lines of responsibility; (ii) effective processes to
identify, manage, monitor and report the risks to which it is or
might be exposed; and (iii) adequate internal control mechanisms.
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The RGF establishes a hierarchical risk taxonomy comprising of
levels zero (0), one (1) and two (2). The key risks are set out at
level zero (0) and include: (i) financial and model risks associated
directly with clearing activities; (ii) risks relating to operational
resilience; (iii) strategic risks; (iv) people and culture risks; and
(v) regulatory compliance, legal and corporate disclosure risks
(together, the ``Key Risks''). Within the Key Risks, the RGF identifies
31 level one (1) risks, and a number of level two (2) sub-risks where
additional granularity is appropriate.\100\ Moreover, the framework
provides that LCH SA's appetite for the Key Risks is generally
low,\101\ and in some cases, very low, due to its core mission as a
regulated clearing house that plays a vital role in ensuring the
stability of the financial markets in which it operates.\102\
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\100\ Details on the taxonomy with level two (2) risk
definitions can be found in Appendix 3 of the RGF.
\101\ The framework establishes four levels of risk appetite:
very low, low, medium and high. Moreover, each level is defined as
follows: (i) `very low' means LCH SA is not willing to accept risks
in most circumstances. The LCH SA Board should decide if the
benefits outweigh the costs and the risk is worth taking; (ii) `low'
means LCH SA is willing to accept risk in some circumstances whereby
successful delivery is likely with an acceptable level of reward.
Such risks should be managed at business unit level (as set out in
the RGF), but escalated if the impact and/or probability of
occurrence is increasing; and (iii) `moderate' means LCH SA is eager
to innovate or choose options based on potential higher rewards.
Risks in the `moderate' category should be monitored in accordance
with the RGF to ensure that the cost/effort applied in managing such
risks is appropriate given the potential downside. In relation to
the `high' risk appetite, the framework provides that while LCH SA
does not expect to have a high-risk appetite for any risk, in
exceptional circumstances, it may temporarily tolerate short periods
of exposure to this risk level.
\102\ Section C of the RGF expands upon each of the risks
identified in the risk taxonomy, including the relevant risk
appetite, a definition of each risk, the high level standards
expected to be in place to manage such risks, as well as the
relevant risk indicators and associated tolerance thresholds for
assessing the management of each risk.
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The RGF also identifies a range of quantitative and qualitative
indicators and thresholds \103\ tailored for specific risks, which are
used to measure the extent to which a risk is considered within the LCH
SA Board's appetite.\104\ In addition to these indicators, the CRO, as
owner of the RGF, will utilize the risk assessment grid \105\ and
process to
[[Page 36265]]
compile LCH SA Board's appetite reports.\106\
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\103\ The framework provides that the thresholds should be
considered risk tolerances (i.e., an `outside' appetite threshold
indicates the maximum tolerance for a particular risk). The LCH SA
Board expects that such tolerance levels should be specific to each
risk, and capable of quantitative measurement where possible, so
that an accurate report can be made of the status of each risk
against the LCH SA Board's appetite and maximum tolerance.
\104\ The CRO will include these indicators and thresholds in
his regular risk reporting to the LCH SA Board.
\105\ The assessment of a risk being reported as `within'
(green), `near' (amber), or `outside' appetite (red) may be made by
using the risk indicators described above and by comparing residual
risk severity with the LCH SA Board's appetite, using the tables
detailed in Section A3 and Appendix 6 of the RGF.
\106\ The CRO may exercise judgement, both in the method
utilized and in the final assessment e.g., taking into account the
existence of any appetite-related actions. The CRO's assessment will
be validated through review at the Resilience Committee (ResCo) and
the ERCo.
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The framework highlights that risk culture is a vital element of
the overall culture of the LCH SA organization. LCH SA values, as
adopted by the LCH SA Board and Executive Management, communicated to
all employees, and reflected in the LSEG Code of Conduct, provide the
basis for measuring and assessing LCH SA's culture, and support the
measurement of risk against appetite. For example, the RGF requires (i)
senior management and employees at all levels to operate in a
transparent way, and be held accountable for their behavior; \107\ and
(ii) mandatory training to be provided to employees to reinforce LCH
SA's key cultural, behavioral, legal and regulatory obligations across
all important topics.\108\
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\107\ The RGF provides that the culture of transparency and
accountability is embedded through establishing, monitoring and
adhering to risk appetite, which is implemented through the
framework and suite of LCH SA policies.
\108\ The training is refreshed and rolled out throughout the
year, requiring an assessment to be completed by all the staff to
confirm that the materials have been understood. Non-completion is
monitored and escalated to ensure that the training has been
delivered to all intended recipients.
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The framework requires LCH SA to follow the three lines of defense
model (as described above). Like the ORMP,\109\ LCH SA Function Heads
and Business Heads (excluding the CRO, LCH SA Chief Compliance Officer
(``CCO'') and Head of Internal Audit) manage the risks of all LCH SA's
business activities and therefore constitute the First Line of Defence.
The CRO,\110\ as part of the Second Line of Defence, is responsible
for: (i) measuring, monitoring and reporting the risks identified in
the RGF and ORMP; and (ii) setting policies \111\ consistent with the
standards identified in the RGF. LCH SA Human Resources, Compliance,
Finance and Legal are responsible for corporate risks and for setting
policies consistent with the RGF and for the management, monitoring and
reporting of any policy noncompliance within their specific areas.
Internal Audit is the Third Line of Defence.
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\109\ The RGF details a specific Operational Risk Taxonomy in
Appendix 7 thereof.
\110\ The CRO has a dual reporting line to the LCH SA Chief
Executive Officer (``CEO'') and to the Chair of the LCH SA Risk
Committee. For compliance and regulatory risks, the CCO is
responsible for the second-line risk function, supported by the CRO.
\111\ The full list of LCH SA's Risk Policies can be found in
Appendix 4 of the RGF.
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The RGF details, in table format, each of the Key Risks, including:
(i) the LCH SA Board's risk appetite and standards; (ii) relevant risk
indicators and tolerance thresholds to assist with the assessment of
whether each risk should be assessed as `within', `near' or `outside'
appetite; \112\ (iii) the internal LCH SA stakeholders responsible for
each risk and associated policy; and (iv) the LCH SA policy detailing
how the LCH SA Board standards are applied across the business.\113\
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\112\ Holistically, at each level, such risk status assessment
will also take account of qualitative factors, tolerance thresholds,
policies and culture.
\113\ Such details can be found in Section C of the RGF.
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In relation to reputational risk, the framework:
(i) defines reputational risk as ``the risk of a failure to meet
stakeholders' expectations or the risk of unfavorable public
perceptions of the LCH SA business and brand;''
(ii) identifies stakeholder perceptions, brand risk and media
engagement as level two (2) risks;
(iii) describes the LCH SA Board risk appetite as `low' and
expresses that LCH SA will actively protect its brand by maintaining
the integrity of services and actively review initiatives to ensure
that its brand is protected;
(iv) defines the CEO and Business Heads as the First Line of
Defence, and the CRO as the Second Line of Defence;
(v) states that this risk is covered by brand, media and
communication policies;
(vi) identifies `negative/damaging press coverage' as a risk
indicator;
(vii) identifies `up to three (3) days of national/``trade'' press
coverage' as the near appetite threshold; and
(viii) identifies `more than three (3) days of national/``trade''
press coverage as a proxy for maintaining a good reputation' as the
outside appetite tolerance limit.
Appendix 1 of the RGF details additional standards in relation to
the subject of recovery, resolution and wind-down \114\ (``RRW'') and
Important Business Services. For example and in relation to RRW, the
framework requires LCH SA to have a pre-arranged recovery plan which:
(i) has been agreed with LCH SA clearing members and regulators; (ii)
has been fully documented and gone through the appropriate internal
governance; (iii) lists the recovery tools available to be used in the
recovery process; and (iv) lists the decision points which trigger LCH
SA to go into recovery mode.
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\114\ Appendix 1 of the RGF defines such risk as ``The risk
stemming from LCH Ltd. or LCH SA not having in place a proper
[r]ecovery [p]lan having identified and pre-agreed recovery tools to
handle a loss event, remain solvent and to continue to operate
smoothly in performing its central clearing role. Examples of such
recovery tools can include member assessments, variation margin
haircutting, cash settlement, etc.''
---------------------------------------------------------------------------
The RGF is reviewed and signed off by the LCH SA Board at least
annually, providing assurance that all risks continue to be
appropriately identified and mapped, that the statement of risk
appetite is clear and defined at the appropriate level of granularity,
that ownership and responsibilities are clear, and that there is an
appropriate process for monitoring and reporting on all risks against
LCH SA's appetite.
2. Statutory Basis
LCH SA has determined that the Risk Policies are consistent with
the requirements of Section 17A of the Act \115\ and regulations
thereunder applicable to it, including Commission Rule 17ad-22(e).\116\
In particular, Section 17A(b)(3)(F) \117\ of the Act requires, inter
alia, that the rules of a clearing agency ``promote the prompt and
accurate clearance and settlement of . . . derivatives agreements,
contracts, and transactions'' and ``to protect investors and the public
interest.''
---------------------------------------------------------------------------
\115\ 15 U.S.C. 78q-1.
\116\ 17 CFR 240.17ad-22(e).
\117\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
In this regard, the CRP sets out more clearly LCH SA's standards
for the management of risks associated with LCH SA's collateral
activities, including collateral accepted to cover margin requirements
and to satisfy default fund contributions. The policy establishes
robust criteria for collateral eligibility, including concentration
limits, as well as a rigorous oversight and monitoring framework to
ensure that collateral is appropriately valued on an ongoing basis. In
addition, the FRAP establishes a robust framework to ensure that the
financial resources held by LCH SA against member exposures--including,
most importantly, margin requirements--is sufficient to cover any
potential losses of a defaulting clearing member. Insufficient
financial resources, including margin, would impede LCH SA's ability to
promptly accept trades for clearing, hence the CRP and FRAP are
consistent with Section 17A(b)(3)(F) of the Act.\118\
---------------------------------------------------------------------------
\118\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
The CCRP is designed to identify, and manage, LCH SA's counterparty
credit risk, principally through the ICS framework applicable to
members and
[[Page 36266]]
the sovereign of their country of risk (as well as their parent entity,
if different) as well as to all other investment and other
counterparties. Applicants for clearing membership must meet a minimum
ICS; a member's ICS is monitored on an ongoing basis and the policy
sets out a framework for responding to deteriorating credit risk. The
CCRP is therefore an integral part of LCH SA's arrangements to mitigate
the risk of a clearing member default, which serves to protect
investors as well as the public interest. The CCRP is therefore
consistent with the requirements of Section 17A(b)(3)(F) of the
Act.\119\
---------------------------------------------------------------------------
\119\ Id.
---------------------------------------------------------------------------
To clear trades promptly and accurately, LCH SA must ensure that
its systems, including those operated by third parties, are resilient.
In this regard, the ORMP sets out LCH SA's arrangements for minimizing
the risks of disruption to LCH SA's services and to LCH SA's ability to
carry out its obligations to members, clients and other stakeholders.
The ORMP therefore implements a suite of risk assessment controls and
procedures, including a control framework, deep dive, and scenario
analysis, to address operational risks. These arrangements are
supported by a change control framework as well as a set of procedures
to undertake an ex-post review of risk incidents. The TPRMP is designed
to manage the risks of using third party service providers in relation
to outsourcing critical or important functions. By establishing a risk
control framework across the outsourcing life-cycle--from contracting/
onboarding, to monitoring and managing performance, to exit/
termination--the TPRM minimizes the risks that the use of third party
service providers will impact LCH SA's ability to accept trades for
clearing promptly and accurately. The ORMP and the TPRMP are therefore
consistent with Section 17A(b)(3)(F) of the Act.\120\
---------------------------------------------------------------------------
\120\ Id.
---------------------------------------------------------------------------
The RGF sits above the CRP, FRAP, CCRP, ORMP and TPRMP, and
identifies the key risks faced by LCH SA as well as the associated
indicators and tolerance thresholds by which each such risk is to be
measured and reported. By providing the wider risk governance framework
within which the CRP, FRAP, CCRP, ORMP and TPRMP have been designed and
adopted, the RGF supports how such risk policies facilitate the prompt
and accurate settlement of transactions and protect investors and the
public interest and is therefore consistent with Section 17A(b)(3)(F)
of the Act.\121\
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\121\ Id.
---------------------------------------------------------------------------
Commission Rule 17ad-22(e)(2)(i) provides that each covered
clearing agency must establish, implement, maintain, and enforce
written policies and procedures reasonably designed to provide for
governance arrangements that are clear and transparent.\122\ As
discussed above, each of the Risk Policies expands on and clarifies the
standards by which LCH SA manages the various risks to which it is
exposed as a CCP. Importantly, each Risk Policy clearly describes the
roles and responsibilities of the various units within LCH SA or LCH
Group, as applicable, responsible for compliance with each policy. For
example, the CCRP specifies that LCH SA Credit Risk is responsible for
monitoring and managing counterparty credit risk, including: (i)
assigning and maintaining the ICS; (ii) assigning, maintaining and
monitoring the applicable limits under the policy; (iii) reporting to
the responsible risk team of any change in the ICS which triggers
actions under the CCRP and other LCH SA risk policies; and (iv) regular
and ad-hoc reporting to other risk areas and senior management. The
CCRP also identifies the CRO as policy owner.
---------------------------------------------------------------------------
\122\ 17 CFR 240.17ad-22(e)(2)(i).
---------------------------------------------------------------------------
Similarly, the three lines of defense model set out in the TPRMP
identifies the first line of defense as the LCH SA Third Party
Management Risk and Procurement team Function Heads and Business Heads,
which is responsible and accountable for identifying, assessing,
monitoring, and managing third party risk and for ensuring that LCH SA
can operate within the agreed risk appetite. Second Line Risk is
responsible for the oversight, support, and challenge in addition to
ensuring that the policy is aligned to the LCH SA Board risk appetite.
The Internal Audit function, as the third line of defense, is
responsible for developing and delivering a program of assurance aimed
at validating that the control environment is operating in alignment
with the LCH SA Board's risk appetite and the LCH SA Board's approved
policies. For its part, the RGF specifies the internal LCH SA
stakeholders responsible for each Key Risk and the associated policy
framework generated to address such Key Risk.
By expanding on and clarifying the standards by which LCH SA
manages the various risks to which it is exposed as a CCP and more
clearly describing the roles and responsibilities of the various units
within LCH SA or LCH Group responsible for compliance with each Risk
Policy, the Risk Policies provide for governance arrangements that are
clear and transparent. As such, the Risk Policies are consistent with
Commission Rule 17ad-22(e)(2)(i).\123\
---------------------------------------------------------------------------
\123\ Id.
---------------------------------------------------------------------------
Commission Rule 17ad-22(e)(2)(v) \124\ provides that each covered
clearing agency must establish, implement, maintain, and enforce
written policies and procedures reasonably designed to specify clear
and direct lines of responsibility. As discussed in detail immediately
above, each Risk Policy clearly describes the roles and
responsibilities of the various units within LCH SA or LCH Group
responsible for compliance with each policy. By more clearly describing
the roles and responsibilities of the various units within LCH SA or
LCH Group, as applicable, responsible for compliance with each Risk
Policy, the Risk Policies specify clear and direct lines of
responsibility. As such, the Risk Policies are consistent with
Commission Rule 17ad-22(e)(2)(v).
Commission Rule 17ad-22(e)(3) \125\ requires a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain a sound risk management
framework for comprehensively managing legal, credit, liquidity,
operational, general business, investment, custody, and other risks
that arise in or are borne by the covered clearing agency, which
includes, inter alia, (i) risk management policies, procedures, and
systems designed to identify, measure, monitor, and manage the range of
risks that arise in or are borne by the covered clearing agency, that
are subject to review on a specified periodic basis and approved by the
LCH SA Board annually; and (ii) plans for the recovery and orderly
wind-down of the covered clearing agency necessitated by credit losses,
liquidity shortfalls, losses from general business risk, or any other
losses.\126\
---------------------------------------------------------------------------
\125\ 17 CFR 240.17ad-22(e)(3).
\126\ Id.
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In this regard, the RGF is a framework that: (i) identifies and
categorizes Key Risks faced by LCH SA; (ii) sets out the roles and
responsibilities within LCH SA for managing each identified Key Risk;
(iii) provides the standards to be met by LCH SA when managing its
business activities within the determined risk appetite; and (iv)
establishes the indicators and tolerance thresholds by which each Key
Risk is meant to be measured and reported. For example, and as noted
above, the RGF identifies the standards that are specific
[[Page 36267]]
to LCH SA in relation to the subject of RRW to ensure LCH SA has a
proper recovery plan to handle a loss event, remain solvent and
continue to operate smoothly in performing its central clearing role.
The RGF also expects that the LCH SA Board establish a wind-down plan
for non-critical services, to be tested annually and on a selected
service. The RGF is signed off by the LCH SA Board at least annually.
By providing (i) an overall risk management framework to
comprehensively manage the Key Risks, subject to the LCH SA Board's
annual review and sign-off; and (ii) a plan for the recovery and
orderly wind-down of LCH SA, the RGF is consistent with Commission Rule
17ad-22(e)(3).\127\
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\127\ Id.
---------------------------------------------------------------------------
Commission Rule 17ad-22(e)(4)(i) requires a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to effectively identify, measure,
monitor, and manage its credit exposures to participants and those
arising from its payment, clearing, and settlement processes by
maintaining sufficient financial resources to cover its credit exposure
to each participant fully with a high degree of confidence.\128\
---------------------------------------------------------------------------
\128\ 17 CFR 240.17ad-22(e)(4)(i).
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The CCRP sets out the standards by which LCH SA manages and
assesses counterparty credit risk. Specifically, the policy requires
LCH SA Credit Risk to assign an ICS to: (i) all clearing members and
the sovereign of their country of risk (and that of their parent, if
different); and (ii) all counterparties, including intermediaries and
countries which are subject to a minimum ICS as covered in other risk
policies. In addition, the CCRP imposes credit exposure monitoring
thresholds, limits and tolerances on each clearing member. the CCRP
ensures LCH SA maintains sufficient financial resources (including
prefunded financial resources) to cover its credit exposure to each
participant by: (i) assigning an ICS to each counterparty based on an
assessment of quantitative and qualitative factors; and (ii) detailing
the policy on exposure monitoring thresholds, limits and tolerances
applicable to each clearing member. The CCRP is therefore consistent
with Commission Rules 17ad-22(e)(4)(i).\129\
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\129\ Id.
---------------------------------------------------------------------------
Commission Rule 17ad-22(e)(4)(iii) requires a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to effectively identify, measure,
monitor, and manage its credit exposures to participants and those
arising from its payment, clearing, and settlement processes, including
by maintaining additional financial resources at the minimum to enable
it to cover a wide range of foreseeable stress scenarios that include,
but are not limited to, the default of the participant family that
would potentially cause the largest aggregate credit exposure for the
covered clearing agency in extreme but plausible market
conditions.\130\ In addition, Commission Rule 17ad-22(e)(4)(v) requires
that such financial resources be maintained in combined or separately
maintained clearing or guarantee funds.\131\
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\130\ 17 CFR 240.17ad-22(e)(4)(iii).
\131\ 17 CFR 240.17ad-22(e)(4)(v).
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The FRAP describes the standards governing the assessment of
financial resources (initial margins, margin add-ons and default funds)
against Latent Market Risks in clearing portfolios at LCH SA.
Specifically, the policy requires additional margins to be held (where
appropriate) to cover member specific portfolio risk arising from house
and client activity of the following types: (i) concentration/liquidity
risk; (ii) sovereign risk; (iii) wrong way risk; and (iv) counterparty
credit risk. The FRAP details the stress regime to be used to identify
`extreme but plausible' tail losses in each member portfolio beyond the
applicable initial margin confidence level. For instance, it requires
liquidity stress tests, collateral stress tests, and exposure stress
tests to be run daily. The policy also details the maximum credit
tolerances to be applied per LCH SA clearing member every day. By
confirming: (i) the requirements for LCH SA to impose, call and collect
daily margins; (ii) the methodology for stress testing; and (iii) the
allocation of financial resources per clearing member, the FRAP is
consistent with Commission Rules 17ad-22(e)(4)(iii) \132\ and 17ad-
22(e)(4)(v).\133\
---------------------------------------------------------------------------
\132\ 17 CFR 240.17ad-22(e)(4)(iii).
\133\ 17 CFR 240.17ad-22(e)(4)(v).
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Commission Rule 17ad-22(e)(4)(vi) \134\ requires a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to effectively identify, measure,
monitor, and manage its credit-exposures to participants and those
arising from its payment, clearing, and settlement processes, including
testing the sufficiency of its total financial resources available to
meet its minimum financial resource requirements by: (i) conducting
stress testing of its total financial resources once each day using
standard predetermined parameters and assumptions; (ii) conducting a
comprehensive analysis on at least a monthly basis of the existing
stress testing scenarios, models, and underlying parameters and
assumptions, and considering modifications to ensure they are
appropriate for determining the covered clearing agency's required
level of default protection in light of current and evolving market
conditions; (iii) conducting a comprehensive analysis of stress testing
scenarios, models, and underlying parameters and assumptions more
frequently than monthly when the products cleared or markets served
display high volatility or become less liquid, or when the size or
concentration of positions held by the covered clearing agency's
participants increases significantly; and (iv) reporting the results of
its analyses under items (ii) and (iii) above to appropriate decision
makers at the covered clearing agency, including but not limited to,
its Risk Management Committee or LCH SA Board, and using these results
to evaluate the adequacy of and adjust its margin methodology, model
parameters, models used to generate clearing or guaranty fund
requirements, and any other relevant aspects of its credit risk
management framework, in supporting compliance with the minimum
financial resources requirements set forth in paragraphs (e)(4)(i) and
(iii) of this section.\135\
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\134\ 17 CFR 240.17ad-22(e)(4)(vi).
\135\ Id.
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The FRAP (i) details the standards by which financial resources
should be assessed against member exposures; (ii) details the holding
periods to be used for each product in the assessment of margins,
providing justification for each; (iii) articulates the predefined
stress regime to be used by LCH SA to identify `extreme but plausible'
tail losses in each member portfolio beyond the applicable initial
margin confidence level; (iv) sets the standards to be used for reverse
stress testing the financial resources held against member positions;
and (v) establishes the required daily liquidity stress, collateral
stress and exposure stress testing. The policy also details a
comprehensive process for LCH SA to monitor, analyze and resize each
default fund on a monthly basis.
The FRAP also complements the Model Governance, Validation and
Review Policy by adding further standards to be included in the testing
and validation of margin models. For instance, it requires LCH SA to
(i) list and justify its critical model assumptions and modelling
methodology; and (ii) calculate and
[[Page 36268]]
monitor the sensitivities of model outputs to key parameter changes.
Moreover, the FRAP provides that the appropriateness of the policy
relative to the LCH SA Board's risk appetite and regulatory
requirements should be reviewed on an annual basis by ERCo with any
significant findings reported to the LCH SA Risk Committee and LCH SA
Board. The FRAP is therefore consistent with Commission Rule 17ad-
22(e)(4)(vi).\136\
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\136\ Id.
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Commission Rule 17ad-22(e)(5) \137\ requires a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to limit the assets it accepts as
collateral to those with low credit, liquidity, and market risks, and
set and enforce appropriately conservative haircuts and concentration
limits if the covered clearing agency requires collateral to manage its
or its participants' credit exposures.
---------------------------------------------------------------------------
\137\ 17 CFR 240.17ad-22(e)(5).
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The CRP sets out the standards for the management of LCH SA's
collateral risks. As noted above, the policy identifies the acceptance
criteria for cash and non-cash collateral posted by its members to
cover margin requirements and default fund contributions to those with
low credit, liquidity and market risks. With regards to cash, as
explained in the CRP and noted above, LCH SA limits the primary
currencies accepted by LCH SA to EUR, GBP, and USD. In relation to non-
cash collateral, the policy limits the assets to certain traded
securities and central bank guarantees. Moreover, the CRP requires LCH
SA to apply a defined haircut methodology and mandates additional
haircuts and concentration limits to manage its or its participants'
credit exposures when certain events are triggered. For instance,
issuers are subject to a credit risk add-on where they are assigned an
ICS of four or below.
By confirming (i) the principles and factors that will be applied
when considering whether an asset can be accepted by LCH SA as
collateral for margin cover; and (ii) the base haircuts, haircut add-
ons, limits and/or price adjustments, the CRP is consistent with
Commission Rule 17ad-22(e)(5).\138\
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\138\ Id.
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Commission Rule 17ad-22(e)(6) \139\ requires a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to cover, if the covered clearing
agency provides central counterparty services, its credit exposures to
its participants by establishing a risk-based margin system that, at a
minimum, inter alia: (i) considers, and produces margin levels
commensurate with, the risks and particular attributes of each relevant
product, portfolio, and market; (ii) marks participant positions to
market and collects margin, including variation margin or equivalent
charges if relevant, at least daily and includes the authority and
operational capacity to make intraday margin calls in defined
circumstances; (iii) uses reliable sources of timely price data and
uses procedures and sound valuation models for addressing circumstances
in which pricing data are not readily available or reliable; and (iv)
uses an appropriate method for measuring credit exposure that accounts
for relevant product risk factors and portfolio effects across
products.
---------------------------------------------------------------------------
\139\ 17 CFR 240.17ad-22(e)(6).
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The FRAP sets out the standards governing the assessment of
financial resources (initial margins, margin add-ons and default funds)
against the Latent Market Risks in clearing member portfolios at LCH
SA. As noted above, the FRAP requires LCH SA to impose, call and
collect margins at least daily on each day when its Clearing Services
are open and operating to limit its credit exposures to its clearing
members and, where relevant, from CCPs with which it has
interoperability arrangements. In addition, the policy sets out the LCH
SA standards for initial margin, margin add-ons, intraday margins and
variation margin. For instance, additional margins must be held (where
appropriate) to cover member specific portfolio risk arising from both
house and client activity of the following types: (i) concentration/
liquidity risk; (ii) sovereign risk; (iii) wrong way risk; and (iv)
counterparty credit risk. In addition, each Clearing Service is
expected to monitor margin levels intraday and to have the capacity to
call for margin intraday should it be necessary to address any issues
with member exposures. The FRAP also details the standard for the
calculation of margin, including the methods of price capture and
verification.
By confirming: (i) the policy requiring LCH SA to impose, call and
collect daily margins; (ii) the methods for calculating margins; and
(iii) the ability for Clearing Services to call for intraday margin,
where necessary, the FRAP is consistent with Commission Rule 17ad-
22(e)(6).\140\
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\140\ Id.
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Commission Rule 17ad-22(e)(18) requires a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to establish objective, risk-based, and
publicly disclosed criteria for participation, which, inter alia: (i)
require participants to have sufficient financial resources and robust
operational capacity to meet obligations arising from participation in
the clearing agency; and (ii) monitor compliance with such
participation requirements on an ongoing basis.\141\
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\141\ 17 CFR 240.17ad-22(e)(18).
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The CCRP describes the standards by which LCH SA manages and
assesses counterparty credit risk via an ICS and limit frameworks. In
addition to clarifying the roles and responsibilities within LCH SA for
compliance with the policy, noted above, the CCRP requires LCH SA
Credit Risk to: (i) assign and maintain the ICS for each counterparty;
(ii) assign, maintain and monitor the applicable limits under the
policy; (iii) report to the responsible risk team of any change in the
ICS which triggers actions under the CCRP and other LCH SA risk
policies; and (iv) provide regular and ad-hoc reporting to other risk
areas and senior management. The CCRP requires an ICS to be assigned to
all clearing members and the sovereign of their country of risk (and
that of their parent, if different); and all other counterparties,
including intermediaries and countries which are subject to a minimum
ICS as covered in other risk policies. Furthermore, the CCRP sets out
the factors used by LCH SA to assign an ICS and Implied ICS for each of
the counterparty types it deals with. The CCRP also details the
exposure monitoring thresholds, limits and tolerances applied to each
clearing member; all thresholds are monitored daily, and LCH SA Credit
Risk decide on any action to be taken when a breach has occurred.
By providing for the assignment, maintenance and monitoring of an
ICS applied to each counterparty that LCH SA interacts with, as well as
the monitoring of related counterparty credit risk thresholds, the CCRP
is consistent with Commission Rule 17ad-22(e)(18).\142\
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\142\ Id.
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Commission Rule 17ad-25(i) requires a covered clearing agency to
manage risks from relationships with its service providers for core
services.\143\ The TPRMP states that LCH SA consider a risk-based and
proportionate approach to onboarding third parties (including service
providers for core services). LCH SA adopts the highest level of
oversight and due diligence for critical third party services. Third
parties deemed critical in accordance with the TPRMP will
[[Page 36269]]
have a high or very-high inherent risk rating and require more
heightened due diligence (monitoring and testing) and approval by the
LCH SA Board for any changes to the relationship with any critical
third party engagements. By considering this risks borne from its
relationships with service providers of core services and applying a
more stringent due diligence process for such service providers, LCH SA
believes its TPRMP is consistent with Commission Rule 17ad-25(i).\144\
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\143\ 17 CFR 240.17ad-25(i).
\144\ Id.
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Rule 1001 of Regulation System Compliance and Integrity (``Reg
SCI'') \145\ requires SCI entities (which include registered clearing
agencies), to: (i) establish, maintain, and enforce written policies
and procedures reasonably designed to ensure that its SCI systems and,
for purposes of security standards, indirect SCI systems, have levels
of capacity, integrity, resiliency, availability, and security,
adequate to maintain the SCI entity's operational capability and
promote the maintenance of fair and orderly markets; and (ii)
establish, maintain, and enforce written policies and procedures
reasonably designed to ensure that its SCI systems operate in a manner
that complies with the Act and the rules and regulations thereunder and
the entity's rules and governing documents, as applicable.
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\145\ 17 CFR 242.1001.
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The ORMP sets out (i) LCH SA's appetite and expectations for the
management of operational risk (defined as the risk of loss arising
from inadequate or failed internal processes, people and systems or
from external events); and (ii) the key features of the operational
risk management framework for identifying, assessing, monitoring,
mitigating and managing operational risk. In addition to clarifying the
roles and responsibilities within LCH SA for compliance with the
policy, noted above, the ORMP requires LCH SA to have a defined risk
taxonomy for operational risks, and sets out the risk assessment tools
and processes to be used, including RCAs, control assurance processes,
and deep dives. Furthermore, the ORMP details the process to be
followed when the following risk events occur triggering a re-
assessment of risks and controls: (i) incidents and actual losses; (ii)
audit or risk and compliance issues, and external reviews; (iii) key
risk and control indicator breaches; (iv) control weakness; (v) other
internal events including process changes or restructuring; and (vi)
external events arising outside of LCH SA and LCH Group's control
(e.g., natural disasters, pandemics, political changes, etc.).
By providing for the overall operational risk management framework
of LCH SA, including the controls detailed thereunder, the ORMP is
designed to ensure that LCH SA's systems and indirect systems have
levels of capacity, integrity, resiliency, availability, and security,
adequate to maintain LCH SA's operational capability and ensure that
its systems operate in a manner that complies with the Act and the
rules and regulations thereunder. The ORMP is therefore consistent with
Rule 1001 of Reg SCI.\146\
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\146\ Id.
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B. Clearing Agency's Statement on Burden on Competition
Section 17A(b)(3)(I) of the Act requires that the rules of a
clearing agency not impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Act.\147\ LCH SA does
not believe the Risk Policies would have any impact or impose any
burden on competition. The Risk Policies do not address any competitive
issue or have any significant impact on the competition among central
counterparties. LCH SA operates an open access clearing model, and the
Risk Policies will have no direct effect on this access model subject
to the regulatory requirements, our clearing rules provisions and our
governance process on the clearing membership criteria and eligibility
including the appropriate credit risk assessment.
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\147\ 15 U.S.C. 78q-1(b)(3)(I).
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C. Clearing Agency's Statement on Comments on the Proposed Rule Change
Received From Members, Participants or Others
Written comments relating to the Risk Policies have not been
solicited or received. LCH SA will notify the Commission of any written
comments received by LCH SA.
III. Date of Effectiveness of the Proposed Rule Change
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) by order approve or disapprove such proposed rule change, or (B)
institute proceedings to determine whether the proposed rule change
should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="http://www.sec.gov/rules/sro.shtml">http://www.sec.gov/rules/sro.shtml</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#c5b7b0a9a0e8a6aaa8a8a0abb1b685b6a0a6eba2aab3"><span class="__cf_email__" data-cfemail="4f3d3a232a622c2022222a213b3c0f3c2a2c61282039">[email protected]</span></a>. Please include
file number SR-LCH SA-2025-007 on the subject line.
Paper Comments
Send paper comments in triplicate to Vanessa Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549.
All submissions should refer to file number SR-LCH SA-2025-007. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (<a href="https://www.sec.gov/rules/sro.shtml">https://www.sec.gov/rules/sro.shtml</a>). Copies of the filing will be available for inspection and
copying at the principal office of LCH SA and on LCH SA's website at:
(<a href="https://www.lch.com/resources/rulebooks/proposed-rule-changes">https://www.lch.com/resources/rulebooks/proposed-rule-changes</a>).
Do not include personal identifiable information in submissions;
you should submit only information that you wish to make available
publicly. We may redact in part or withhold entirely from publication
submitted materials that is obscene or subject to copyright protection.
All submissions should refer to file number SR-LCH SA-2025-007 and
should be submitted on or before August 22, 2025.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\148\
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\148\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2025-14564 Filed 7-31-25; 8:45 am]
BILLING CODE 8011-01-P
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