2013-24242. Self-Regulatory Organizations; Chicago Mercantile Exchange Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Related to the Liquidity Factor of CME's CDS Margin Methodology  

  • Start Preamble September 30, 2013.

    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Exchange Act” or “Act”),[1] and Rule 19b-4 thereunder,[2] notice is hereby given that on September 19, 2013, Chicago Mercantile Exchange Inc. (“CME”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change described in Items I and II below, which Items have been prepared primarily by CME. CME filed the proposal pursuant to Section 19(b)(3)(A) of the Act,[3] and Rule 19b-4(f)(4)(ii) thereunder,[4] so that the proposal was effective upon filing with the Commission. The Commission is publishing this notice to solicit comments on the proposed rule change for interested persons.

    I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

    CME proposes to make an adjustment to one particular component of its current CDS margin model. The proposed rule change is described below. Italicized text indicates additions; bracketed text indicates deletions.

    * * * * *

    CME CDS Liquidity Margin Factor Calculation Methodology

    The Liquidity Factor will be calculated as the sum of two components:

    (1) A concentration charge for market exposure as a function of absolute Spread DV01 (a portfolio sensitivity to 1% par spread shock); and

    (2) A concentration charge for portfolio basis exposure as a function of Residual Spread DV01 (which is the difference between the Gross Spread DV01 and the Net Spread DV01 of the portfolio).

    CME will also establish a floor component to the Liquidity Factor using the current Gross Notional Function with the following modifications: (1) the concentration scalar will be removed; and (2) the maximum DST would be replaced by series-tenor specific DST values based on the series and tenor of the relevant HY and IG positions, as applicable.

    * * * * *

    II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, CME included statements concerning the purpose 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. CME 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

    CME's currently approved credit default swap margin methodology utilizes a “multi-factor” portfolio model to determine margin requirements for the credit default swap (“CDS”) index products accepted for clearing at CME. The model incorporates risk-based factors that are designed to represent the different risks inherent to CDS products. The factors are aggregated to determine the total amount of margin required to protect a portfolio against exposures resulting from daily changes in CDS spreads. For both total and minimum margin calculations, CME evaluates each CDS contract held within a portfolio. These positions are Start Printed Page 61438distinguished by the single name of the underlying entity, the CDS tenor, the notional amount of the position, and the fixed spread or coupon rate. For consistency, margins for CDS indexes in a portfolio are handled based on the required margin for each of the underlying components of the index.

    CME proposes to make an adjustment to one particular component of its current CDS margin model, the liquidity risk factor. This CDS margin model component is designed to capture the risk that concentrated positions may be difficult or costly to unwind following the default of a CDS clearing member. The adjustment will only affect the margining of CDS index products at CME which are under the exclusive jurisdiction of the Commodity Futures Trading Commission (“CFTC”).

    The Liquidity Risk Factor in CME's Current CDS Margin Model

    The current liquidity/concentration factor (the “Liquidity Factor”) of CME's margin methodology for a portfolio of CDS indices is the product of (1) the gross notional amount for each family (i.e., CDX IG or CDX HY) of CDS positions in a portfolio (2) the current bid/ask of the 5 year tenor of the “on the run” (OTR) contract (3) the Duration/Series/Tenor (“DST”) factor and (4) a concentration factor based upon the gross notional for each of the CDX IG and CDX HY contracts (the “Gross Notional Function”). The associated margin for a CDS portfolio attributed to the Liquidity Factor is the sum of the Liquidity Factor calculations for each family of CDS positions in the portfolio.

    The calculation of the Liquidity Factor is based on the premise that the 5-year OTR index is the most liquid CDS index product. As such, the methodology is designed to evaluate the liquidity exposure of each position in a CDS portfolio relative to the 5-year OTR index.

    For each index family (i.e., CDX IG and CDX HY), a DST matrix is calculated based on the historical bid-ask averages of each cleared position relative to the OTR 5-year historical bid-ask averages. Then, the maximum DST values are used as the DST factors. Such maximum DST factors are then applied to the product of 5-year OTR bid-ask spread (adjusted for duration for CDX IG only) and the Gross Notional of all positions within each index family. The resulting products are further scaled by concentration factors in order to account for oversized (as measured by Gross Notional) portfolios. The concentration factors are based on exponential functions of the Gross Notional of each index family in a given portfolio.

    Proposed Changes to the Liquidity Risk Factor

    As liquidation costs are dependent on the risk in a portfolio, CME is proposing to use an index portfolio's market risk rather than its gross notional as the basis for determining the margins associated with the Liquidity Factor. The proposed changes would calculate the Liquidity Factor as the sum of two components:

    (1) A concentration charge for market exposure as a function of absolute Spread DV01 (a portfolio sensitivity to 1% par spread shock); and

    (2) A concentration charge for portfolio basis exposure as a function of Residual Spread DV01 (which is the difference between the Gross Spread DV01 and the Net Spread DV01 of the portfolio).

    CME expects that these proposed changes would not generally impact smaller portfolios whose liquidation costs are driven by the market bid/ask spread rather than by the cost of hedging, and are therefore adequately captured by the existing Liquidity Factor methodology. To account for the risks associated with such smaller portfolios, CME also proposes to establish a floor component to the Liquidity Factor using the current Gross Notional Function described above with the following modifications: (1) The concentration scalar would be removed as concentration risk would already be accounted for by the concentration charge component outlined above; and (2) the maximum DST would be replaced by series-tenor specific DST values based on the series and tenor of the relevant HY and IG positions, as applicable. CME expects that large (by notional amount) portfolios will be impacted by the proposed changes more than smaller portfolios.

    The changes only affect CME's broad-based CDS index clearing offering and do not materially impact CME's security-based swap clearing business. The proposed liquidity risk factor model adjustments do not require any changes to rule text in the CME rulebook and do not necessitate any changes to CME's CDS Manual of Operations. The change will be announced to CDS market participants in an advisory notice that will be issued prior to implementation. CME also notes that it has also submitted the proposed rule changes that are the subject of this filing to its primary regulator, the CFTC, in a separate filing.

    CME believes the proposed rule changes are consistent with the requirements of the Exchange Act including Section 17A of the Exchange Act.[5] The proposed rule changes involve enhancements to CME's current CDS margin methodology and are therefore designed to promote the prompt and accurate clearance and settlement of securities transactions and, to the extent applicable, derivatives agreements, contracts, and transactions, 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, and, in general, to protect investors and the public interest consistent with Section 17A(b)(3)(F) of the Exchange Act.[6] The proposed rule changes accomplish these objectives because the changes are intended to incorporate how the liquidity risk factor is affected by not only portfolio concentration based on gross notional, but also the composition of the portfolio based on an underlying strategy. The proposed rule changes help to better align CME's margin methodology with the liquidity profile of the actual instruments in a given portfolio and as such contribute to the safeguarding of securities and funds in CME's custody or control or for which CME is responsible and the protection of investors.

    Furthermore, the proposed changes are limited in their effect to swaps products offered under CME's authority to act as a derivatives clearing organization. These products are under the exclusive jurisdiction of the CFTC. As such, the proposed CME changes are limited to CME's activities as a derivatives clearing organization clearing swaps that are not security-based swaps; CME notes that the policies of the CFTC with respect to administering the Commodity Exchange Act are comparable to a number of the policies underlying the Exchange Act, such as promoting market transparency for over-the-counter derivatives markets, promoting the prompt and accurate clearance of transactions and protecting investors and the public interest.

    Because the proposed changes are limited in their effect to swaps products offered under CME's authority to act as a derivatives clearing organization, the proposed changes are properly classified as effecting a change in an existing service of CME that:

    (a) Primarily affects the clearing operations of CME with respect to products that are not securities, including futures that are not security futures, and swaps that are not security-based swaps or mixed swaps; and

    (b) Does not significantly affect any securities clearing operations of CME or Start Printed Page 61439any rights or obligations of CME with respect to securities clearing or persons using such securities-clearing service.

    As such, the changes are therefore consistent with the requirements of Section 17A of the Exchange Act [7] and are properly filed under Section 19(b)(3)(A) [8] and Rule 19b-4(f)(4)(ii) [9] thereunder.

    B. Self-Regulatory Organization's Statement on Burden on Competition

    CME does not believe that the proposed rule change will have any impact, or impose any burden, on competition. The proposed rule changes simply involve enhancements to CME's current CDS margin methodology.

    C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received from Members, Participants, or Others

    CME has not solicited comments regarding this proposed rule change. CME has not received any unsolicited written comments from interested parties.

    III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action

    The foregoing rule change has become effective upon filing pursuant to Section 19(b)(3)(A) of the Act [10] and Rule 19b-4(f)(4)(ii) [11] thereunder. At any time within 60 days of the filing of the proposed rule change, the Commission summarily may temporarily suspend such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act.

    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:

    Paper Comments:

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

    All submissions should refer to File Number SR-CME-2013-22. 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 or 10:00 a.m. and 3:00 p.m. Copies of such filing also will be available for inspection and copying at the principal office of CME and on CME's Web site at http://www.cmegroup.com/​market-regulation/​rule-filings.html.

    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-CME-2013-22 and should be submitted on or before October 24, 2013.

    Start Signature

    For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.[12]

    Kevin M. O'Neill,

    Deputy Secretary.

    End Signature End Preamble

    Footnotes

    [FR Doc. 2013-24242 Filed 10-2-13; 8:45 am]

    BILLING CODE 8011-01-P

Document Information

Published:
10/03/2013
Department:
Securities and Exchange Commission
Entry Type:
Notice
Document Number:
2013-24242
Pages:
61437-61439 (3 pages)
Docket Numbers:
Release No. 34-70558, File No. SR-CME-2013-22
EOCitation:
of 2013-09-30
PDF File:
2013-24242.pdf