82 FR 18515 - Self-Regulatory Organizations; LCH SA; Notice of Proposed Rule Change, Security-Based Swap Submission, or Advance Notice Relating to CDS Margin and Extreme Credit Spread Curves

SECURITIES AND EXCHANGE COMMISSION

Federal Register Volume 82, Issue 74 (April 19, 2017)

Page Range		18515-18516
FR Document		2017-07873

Federal Register, Volume 82 Issue 74 (Wednesday, April 19, 2017)

[Federal Register Volume 82, Number 74 (Wednesday, April 19, 2017)]
[Notices]
[Pages 18515-18516]
From the Federal Register Online [www.thefederalregister.org]
[FR Doc No: 2017-07873]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-80451; File No. SR-LCH SA-2017-004]

Self-Regulatory Organizations; LCH SA; Notice of Proposed Rule
Change, Security-Based Swap Submission, or Advance Notice Relating to
CDS Margin and Extreme Credit Spread Curves

April 13, 2017.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on April 4, 2017, 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
described in Items I, II, and III below, which Items have been prepared
primarily by LCH SA. 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 proposing to amend its CDS margin framework, in order to
promote operational efficiency and improve operational risk management,
to provide for an approximation-based method to replace the algorithm
that is currently used in the event that the International Swaps and
Derivatives Association (``ISDA'') standard model for pricing (``ISDA
Pricer'') credit default swaps (``CDS'') fails as a result of extreme
spread curves, as further described herein.

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 proposed rule change and
discussed any comments it received on the proposed rule change. 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 these statements.

A. Clearing Agency's Statement of the Purpose of, and Statutory Basis
for, the Proposed Rule Change

1. Purpose
Spread margin is a component in LCH SA's margin methodology. LCH SA
currently uses the ISDA Pricer to calibrate credit spread curves. In
the case of ``extreme'' credit spread curves, however, it is not
possible to calibrate credit spread curves using the ISDA Pricer.
Currently, in the event that the ISDA Pricer fails, LCH SA uses a
dichotomy-based algorithm to adjust the spread input and to perform
repeated calibration of the spread curve between two tenors until it
identifies (x) the tenor which has caused the calibration to fail and
(y) the level of the spread closest to input for the tenor that allows
the curve to calibrate. In practice, applying this algorithm is time
consuming and may lead to lengthy system processing, because it
necessitates repetition of a dichotomy analysis until the tenor that is
responsible for the failure is identified. This, in turn, could result
in delay in performing LCH SA's margin calculation. In addition,
because the spread curve will be replicated in subsequent simulation
runs as part of the spread margin calculation, it is very likely that
the calibration failure that occurs when obtaining the mark-to-market
price for a CDS contract will also occur in subsequent simulation runs,
which means that the dichotomy algorithm would need to be used many
times, which accounts for significant processing time in CDSClear's
overnight batch. Therefore, to promote operational efficiency and
improve operational risk management while maintaining a sound pricing
mechanism, LCH SA is proposing to replace its existing dichotomy-based
algorithm with a new approximation-based method to price CDS contracts
in the event of extreme spread curves that cause the ISDA Pricer to
fail.
Text is added to Section 2.2 ``CDS Pricing'' in ``Reference Guide:
CDS Margin Framework'' to describe the new approximation-based method,
which specifies that in the event the ISDA Pricer fails, LCH SA would
use an approximation-based method to calibrate credit spread curves.
The new method consists of three steps: (i) Constructing a piecewise
constant hazard rate curve, (ii) constructing a piecewise constant
interest rate curve, and (iii) defining the average hazard rate and
average interest rate over the period considered and applying them to
price the CDS using the usual mark-to-market pricing formula in any
market conditions, under the assumption of continuous coupon payment.
LCH SA has performed analysis comparing its approximation method to
the ISDA Pricer and the results indicate that its approximation method
provides a reliable pricing estimate. The proposed rule change would,
therefore, simplify LCH SA's margin methodology and would significantly
reduce operational risk while simultaneously providing a sound pricing
method for extreme curves.
2. Statutory Basis
LCH SA believes that the proposed rule change is consistent with
the requirements of the Act and the rules and regulations thereunder
applicable to LCH SA. Specifically, in accordance with Section
17(A)(b)(3)(F),\3\ LCH SA believes that the proposed rule change will
promote the prompt and accurate clearance and settlement of securities
transactions, derivatives agreements, contracts, and transactions and
to assure the safeguarding of securities and funds which are in the
custody or control of the clearing agency or for which it is
responsible, in that the proposed rule change is designed to promote
operational efficiency and reduce operational risk caused by the
existing dichotomy-based algorithm, which is used in the event of
extreme spread curves that cause the ISDA Pricer to fail, while
maintaining a sound pricing mechanism for LCH SA's margin calculation.
In addition, the proposed rule change is consistent with the relevant
requirements of Rule 17Ad-22(d)(4), which requires a clearing agency to
establish and maintain policies and procedures that identify sources of
operational risk and to minimize such risk through development of
procedures that are reliable,\4\ as well as Rule 17Ad-22(e)(17), which
requires a covered clearing agency to establish and maintain policies
and procedures reasonably designed to manage the covered clearing
agency's operational risks by identifying the plausible sources of
operational risk and mitigating their impact through the use of
appropriate systems, policies, procedures and controls.\5\ LCH SA has

[[Page 18516]]

identified its current dichotomy-based algorithm as a source of
operational risk, based on its observation of the algorithm as an
operationally intensive and time consuming practice. LCH SA believes
that the new pricing method as described in the proposed rule change is
reasonably designed to minimize operational risk and eliminate possible
delays existing in the current overnight batch process as a result of
the dichotomy-based algorithm in the event of extreme spread curves
that cause the ISDA Pricer to fail. In addition, LCH SA has performed
analysis comparing its approximation method to the ISDA Pricer and the
results indicate that its approximation method provides a reliable
pricing estimate. Therefore, LCH SA believes that the proposed rule
change is reasonably designed to minimize or mitigate the operational
risk identified by LCH SA through the use of appropriate systems and
policies, consistent with Rule 17Ad-22(d)(4) and Rule 17Ad-22(e)(17).
The proposed rule change is also consistent with Rule 17Ad-22(b)(1) and
(2),\6\ which require a clearing agency to maintain margin and limit a
clearing agency's exposures to potential losses from participants'
defaults under normal market conditions, and Rule 17Ad-22(e)(4),\7\
which requires a covered clearing agency to manage credit exposures to
participants by maintaining sufficient financial resources to cover its
credit exposure to each participant fully with a high degree of
confidence. LCH SA has performed analysis to support the new pricing
method for extreme spread curves as a reliable pricing tool to use in
its margin methodology in the event of extreme spread curves that cause
the ISDA Pricer to fail, and, therefore, believes that the proposed
rule change would continue to cause LCH SA to maintain margin to cover
its credit exposure to, and to limit its exposures to potential losses,
each Clearing Member's defaults [sic] under normal market conditions
with a high degree of confidence.
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\3\ 15 U.S.C. 78q-1(b)(3)(F).
\4\ 17 CFR 240.17Ad-22(d)(4).
\5\ 17 CFR 240.17Ad-22(e)(17).
\6\ 17 CFR 240.17Ad-22(b)(1)-(2).
\7\ 17 CFR 240.17Ad-22(e)(4).
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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.\8\ The proposed
rule change is part of the spread margin calculation, which will
uniformly apply across all participants and, as noted above, is
consistent with the applicable requirements of the Act, eliminates
operational risk and provides reliable pricing of CDS in the event that
the ISDA Pricer fails. Therefore, LCH SA does not believe the proposed
rule change will impose any burden on competition that is not necessary
or appropriate in furtherance of the purposes of the Act.
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\8\ 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 proposed rule change 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 and Timing for
Commission Action

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

Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to rule-comments@sec.gov. Please include
File Number SR-LCH SA-2017-004 on the subject line.

Paper Comments

Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-LCH SA-2017-004. 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 Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. Copies of such filings will also be available
for inspection and copying at the principal office of LCH SA and on LCH
SA's Web site at http://www.lch.com/asset-classes/cdsclear.
All comments received will be posted without change; the Commission
does not edit personal identifying information from submissions. You
should submit only information that you wish to make available
publicly. All submissions should refer to File Number SR-LCH SA-2017-
004 and should be submitted on or before May 10, 2017.

For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\9\
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\9\ 17 CFR 200.30-3(a)(12).
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Brent J. Fields,
Secretary.
[FR Doc. 2017-07873 Filed 4-18-17; 8:45 am]
BILLING CODE 8011-01-P

Federal Register / Vol. 82, No. 74 / Wednesday, April 19, 2017 / Notices 18515

For the Commission, by the Division of may be examined at the places specified piecewise constant interest rate curve,
Trading and Markets, pursuant to delegated in Item IV below. LCH SA has prepared and (iii) defining the average hazard rate
authority.24 summaries, set forth in sections A, B, and average interest rate over the period
Brent J. Fields, and C below, of the most significant considered and applying them to price
Secretary. aspects of these statements. the CDS using the usual mark-to-market
[FR Doc. 2017–07870 Filed 4–18–17; 8:45 am] pricing formula in any market
A. Clearing Agency’s Statement of the
BILLING CODE 8011–01–P conditions, under the assumption of
Purpose of, and Statutory Basis for, the
continuous coupon payment.
Proposed Rule Change
LCH SA has performed analysis
SECURITIES AND EXCHANGE 1. Purpose comparing its approximation method to
COMMISSION Spread margin is a component in LCH the ISDA Pricer and the results indicate
[Release No. 34–80451; File No. SR–LCH SA’s margin methodology. LCH SA that its approximation method provides
SA–2017–004] currently uses the ISDA Pricer to a reliable pricing estimate. The
calibrate credit spread curves. In the proposed rule change would, therefore,
Self-Regulatory Organizations; LCH case of ‘‘extreme’’ credit spread curves, simplify LCH SA’s margin methodology
SA; Notice of Proposed Rule Change, however, it is not possible to calibrate and would significantly reduce
Security-Based Swap Submission, or credit spread curves using the ISDA operational risk while simultaneously
Advance Notice Relating to CDS Pricer. Currently, in the event that the providing a sound pricing method for
Margin and Extreme Credit Spread ISDA Pricer fails, LCH SA uses a extreme curves.
Curves dichotomy-based algorithm to adjust the 2. Statutory Basis
April 13, 2017. spread input and to perform repeated
calibration of the spread curve between LCH SA believes that the proposed
Pursuant to Section 19(b)(1) of the
two tenors until it identifies (x) the rule change is consistent with the
Securities Exchange Act of 1934
tenor which has caused the calibration requirements of the Act and the rules
(‘‘Act’’) 1 and Rule 19b–4 thereunder,2
to fail and (y) the level of the spread and regulations thereunder applicable to
notice is hereby given that on April 4,
closest to input for the tenor that allows LCH SA. Specifically, in accordance
2017, Banque Centrale de
the curve to calibrate. In practice, with Section 17(A)(b)(3)(F),3 LCH SA
Compensation, which conducts
applying this algorithm is time believes that the proposed rule change
business under the name LCH SA (‘‘LCH
consuming and may lead to lengthy will promote the prompt and accurate
SA’’), filed with the Securities and
system processing, because it clearance and settlement of securities
Exchange Commission (‘‘Commission’’)
necessitates repetition of a dichotomy transactions, derivatives agreements,
the proposed rule change described in
analysis until the tenor that is contracts, and transactions and to assure
Items I, II, and III below, which Items
responsible for the failure is identified. the safeguarding of securities and funds
have been prepared primarily by LCH
This, in turn, could result in delay in which are in the custody or control of
SA. The Commission is publishing this
performing LCH SA’s margin the clearing agency or for which it is
notice to solicit comments on the
calculation. In addition, because the responsible, in that the proposed rule
proposed rule change from interested
spread curve will be replicated in change is designed to promote
persons.
subsequent simulation runs as part of operational efficiency and reduce
I. Clearing Agency’s Statement of the the spread margin calculation, it is very operational risk caused by the existing
Terms of Substance of the Proposed likely that the calibration failure that dichotomy-based algorithm, which is
Rule Change occurs when obtaining the mark-to- used in the event of extreme spread
LCH SA is proposing to amend its market price for a CDS contract will also curves that cause the ISDA Pricer to fail,
CDS margin framework, in order to occur in subsequent simulation runs, while maintaining a sound pricing
promote operational efficiency and which means that the dichotomy mechanism for LCH SA’s margin
improve operational risk management, algorithm would need to be used many calculation. In addition, the proposed
to provide for an approximation-based times, which accounts for significant rule change is consistent with the
method to replace the algorithm that is processing time in CDSClear’s overnight relevant requirements of Rule 17Ad–
currently used in the event that the batch. Therefore, to promote operational 22(d)(4), which requires a clearing
International Swaps and Derivatives efficiency and improve operational risk agency to establish and maintain
Association (‘‘ISDA’’) standard model management while maintaining a sound policies and procedures that identify
for pricing (‘‘ISDA Pricer’’) credit pricing mechanism, LCH SA is sources of operational risk and to
default swaps (‘‘CDS’’) fails as a result proposing to replace its existing minimize such risk through
of extreme spread curves, as further dichotomy-based algorithm with a new development of procedures that are
described herein. approximation-based method to price reliable,4 as well as Rule 17Ad–
CDS contracts in the event of extreme 22(e)(17), which requires a covered
II. Clearing Agency’s Statement of the spread curves that cause the ISDA Pricer clearing agency to establish and
Purpose of, and Statutory Basis for, the to fail. maintain policies and procedures
Proposed Rule Change Text is added to Section 2.2 ‘‘CDS reasonably designed to manage the
In its filing with the Commission, Pricing’’ in ‘‘Reference Guide: CDS covered clearing agency’s operational
LCH SA included statements concerning Margin Framework’’ to describe the new risks by identifying the plausible
approximation-based method, which
jstallworth on DSK7TPTVN1PROD with NOTICES

the purpose of and basis for the sources of operational risk and
proposed rule change and discussed any specifies that in the event the ISDA mitigating their impact through the use
comments it received on the proposed Pricer fails, LCH SA would use an of appropriate systems, policies,
rule change. The text of these statements approximation-based method to procedures and controls.5 LCH SA has
calibrate credit spread curves. The new
24 17 CFR 200.30–3(a)(12). method consists of three steps: (i) 3 15 U.S.C. 78q–1(b)(3)(F).
1 15 U.S.C. 78s(b)(1). Constructing a piecewise constant 4 17 CFR 240.17Ad–22(d)(4).
2 17 CFR 240.19b–4. hazard rate curve, (ii) constructing a 5 17 CFR 240.17Ad–22(e)(17).

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18516 Federal Register / Vol. 82, No. 74 / Wednesday, April 19, 2017 / Notices

identified its current dichotomy-based above, is consistent with the applicable Internet Web site (http://www.sec.gov/
algorithm as a source of operational risk, requirements of the Act, eliminates rules/sro.shtml). Copies of the
based on its observation of the algorithm operational risk and provides reliable submission, all subsequent
as an operationally intensive and time pricing of CDS in the event that the amendments, all written statements
consuming practice. LCH SA believes ISDA Pricer fails. Therefore, LCH SA with respect to the proposed rule
that the new pricing method as does not believe the proposed rule change that are filed with the
described in the proposed rule change is change will impose any burden on Commission, and all written
reasonably designed to minimize competition that is not necessary or communications relating to the
operational risk and eliminate possible appropriate in furtherance of the proposed rule change between the
delays existing in the current overnight purposes of the Act. Commission and any person, other than
batch process as a result of the those that may be withheld from the
dichotomy-based algorithm in the event C. Clearing Agency’s Statement on public in accordance with the
of extreme spread curves that cause the Comments on the Proposed Rule provisions of 5 U.S.C. 552, will be
ISDA Pricer to fail. In addition, LCH SA Change Received From Members, available for Web site viewing and
has performed analysis comparing its Participants or Others printing in the Commission’s Public
approximation method to the ISDA Written comments relating to the Reference Room, 100 F Street NE.,
Pricer and the results indicate that its proposed rule change have not been Washington, DC 20549, on official
approximation method provides a solicited or received. LCH SA will business days between the hours of
reliable pricing estimate. Therefore, notify the Commission of any written 10:00 a.m. and 3:00 p.m. Copies of such
LCH SA believes that the proposed rule comments received by LCH SA. filings will also be available for
change is reasonably designed to inspection and copying at the principal
III. Date of Effectiveness of the office of LCH SA and on LCH SA’s Web
minimize or mitigate the operational
risk identified by LCH SA through the Proposed Rule Change and Timing for site at http://www.lch.com/asset-
use of appropriate systems and policies, Commission Action classes/cdsclear.
consistent with Rule 17Ad–22(d)(4) and Within 45 days of the date of All comments received will be posted
Rule 17Ad–22(e)(17). The proposed rule publication of this notice in the Federal without change; the Commission does
change is also consistent with Rule Register or within such longer period not edit personal identifying
17Ad–22(b)(1) and (2),6 which require a up to 90 days (i) as the Commission may information from submissions. You
clearing agency to maintain margin and designate if it finds such longer period should submit only information that
limit a clearing agency’s exposures to to be appropriate and publishes its you wish to make available publicly. All
potential losses from participants’ reasons for so finding or (ii) as to which submissions should refer to File
defaults under normal market the self-regulatory organization Number SR–LCH SA–2017–004 and
conditions, and Rule 17Ad–22(e)(4),7 consents, the Commission will: should be submitted on or before May
which requires a covered clearing (A) by order approve or disapprove 10, 2017.
agency to manage credit exposures to such proposed rule change, or For the Commission, by the Division of
participants by maintaining sufficient (B) institute proceedings to determine Trading and Markets, pursuant to delegated
financial resources to cover its credit whether the proposed rule change authority.9
exposure to each participant fully with should be disapproved. Brent J. Fields,
a high degree of confidence. LCH SA IV. Solicitation of Comments Secretary.
has performed analysis to support the [FR Doc. 2017–07873 Filed 4–18–17; 8:45 am]
new pricing method for extreme spread Interested persons are invited to
BILLING CODE 8011–01–P
curves as a reliable pricing tool to use submit written data, views, and
in its margin methodology in the event arguments concerning the foregoing,
of extreme spread curves that cause the including whether the proposed rule SECURITIES AND EXCHANGE
ISDA Pricer to fail, and, therefore, change is consistent with the Act. COMMISSION
believes that the proposed rule change Comments may be submitted by any of
the following methods: [Release No. 34–80448; File No. SR–
would continue to cause LCH SA to
BatsEDGA–2017–06]
maintain margin to cover its credit Electronic Comments
exposure to, and to limit its exposures Self-Regulatory Organizations; Bats
to potential losses, each Clearing • Use the Commission’s Internet
comment form (http://www.sec.gov/ EDGA Exchange, Inc.; Notice of Filing
Member’s defaults [sic] under normal and Immediate Effectiveness of a
market conditions with a high degree of rules/sro.shtml); or
• Send an email to rule-comments@ Proposed Rule Change Related to Fees
confidence. for Use on Bats EDGA Exchange, Inc.
sec.gov. Please include File Number SR–
B. Clearing Agency’s Statement on LCH SA–2017–004 on the subject line. April 13, 2017.
Burden on Competition Pursuant to Section 19(b)(1) of the
Paper Comments
Section 17A(b)(3)(I) of the Act Securities Exchange Act of 1934 (the
requires that the rules of a clearing • Send paper comments in triplicate ‘‘Act’’),1 and Rule 19b–4 thereunder,2
agency not impose any burden on to Secretary, Securities and Exchange notice is hereby given that on March 31,
competition not necessary or Commission, 100 F Street NE., 2017, Bats EDGA Exchange, Inc. (the
appropriate in furtherance of the Washington, DC 20549–1090. ‘‘Exchange’’ or ‘‘EDGA’’) filed with the
All submissions should refer to File
jstallworth on DSK7TPTVN1PROD with NOTICES

purposes of the Act.8 The proposed rule Securities and Exchange Commission
change is part of the spread margin Number SR–LCH SA–2017–004. This (‘‘Commission’’) the proposed rule
calculation, which will uniformly apply file number should be included on the change as described in Items I, II and III
across all participants and, as noted subject line if email is used. To help the below, which Items have been prepared
Commission process and review your
6 17 CFR 240.17Ad–22(b)(1)–(2). comments more efficiently, please use 9 17 CFR 200.30–3(a)(12).
7 17 CFR 240.17Ad–22(e)(4). only one method. The Commission will 1 15 U.S.C. 78s(b)(1).
8 15 U.S.C. 78q–1(b)(3)(I). post all comments on the Commission’s 2 17 CFR 240.19b–4.

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Document Created: 2018-11-14 09:44:07
Document Modified: 2018-11-14 09:44:07

Category		Regulatory Information
Collection		Federal Register
sudoc Class		AE 2.7: GS 4.107: AE 2.106:
Publisher		Office of the Federal Register, National Archives and Records Administration
Section		Notices
FR Citation		82 FR 18515