2018-13378. Self-Regulatory Organizations; LCH SA; Notice of Filing of Proposed Rule Change Relating to Liquidity Risk Management

June 18, 2018.

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 June 4, 2018, 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 (the “Proposed Rule Change”) described in Items I, II and III below, which Items have been primarily prepared by LCH SA. The Commission is publishing this notice to solicit comments on the Proposed Rule Change from interested persons.

I. Clearing Agency's Statement of the Terms of Substance of the Proposed Rule Change

LCH SA is proposing to amend its Risk Management Procedures (the “Procedures”) to adopt a Liquidity Risk Modelling Framework (the “Framework”), which describes the Liquidity Stress Testing framework by which the Collateral and Liquidity Risk Management department (“CaLRM”) of LCH Group Holdings Limited (“LCH Group”) assures that LCH SA has enough cash available to meet any financial obligations, both expected and unexpected, that may arise over the liquidation period for each of the clearing services that LCH SA offers.^[3]

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 such statements.

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

1. Purpose

LCH SA currently maintains a number of well-developed policies and procedures designed to manage its liquidity risk, i.e., the risk that LCH SA will not have enough cash available, in extreme but plausible circumstances, to settle margin payments or delivery obligations when they become due, in particular upon the default of a clearing member. Such policies and procedures include, among others: (i) The Group Liquidity Risk Policy; (ii) the Group Liquidity Plan; (iii) the Group Financial Resource Adequacy Plan; (iv) the Group Collateral Risk Policy; (v) the Group Investment Risk Policy; and (vi) the LCH SA Collateral Control Framework. As described below, the proposed Framework would complement these existing policies and procedures and develop further the Group Liquidity Risk Policy.

In brief, the Framework: (i) Identifies LCH SA's sources of liquidity and corresponding liquidity risks; (ii) identifies LCH SA's liquidity requirements with respect to its members and its interoperable central counterparty (“CCP”); ^[4] (iii) describes the metrics and limits that LCH SA monitors; and (iv) describes the scenarios under which these metrics are computed.

The proposed Framework first identifies the main sources of liquidity available to LCH SA, cash and non-cash collateral, and assigns non-cash collateral to one of three tiers.^[5] Tier 1 assets are limited to those securities that are deemed to be of sufficient quality and demand to generate liquidity at little or no loss in the event of a default of a clearing member or a major market stress. LCH SA is able to pledge these securities to the Banque de France to generate cash on the same day. Only Tier 1 assets are included as liquidity resources in liquidity stress testing.^[6]

The proposed Framework then highlights the three principal events under which LCH SA would require liquidity: (i) The default of one or more clearing members; (ii) the default of CC&G; and (iii) operational liquidity needs (each defined below).

The proposed Framework also examines liquidity needs arising from members' defaults, liquidity needs arising from an interoperating central counterparty's default (currently CC&G), and the manner in which operational liquidity requirements are determined. Liquidity needs arising from members' defaults are those needs arising from fulfilment of the settlement of the securities of the defaulted clearing member; posting of variation margin to non-defaulting members on the positions held by the defaulted clearing member(s); the value of bonds pledged at the Banque de France; haircuts by the European Central Bank on securities posted by the defaulting Clearing Member; and investment losses. Liquidity needs arising from interoperating CCPs' defaults are those needs arising from the service closure of the Italian Clearing activity (e.g. reimbursement of the margins and default funds related to the Italian clearing activity, cash settlement of the Italian repo positions). Operational liquidity is defined as the amount of liquidity that LCH SA is required to hold to satisfy liquidity needs related to the operational management of LCH SA in a stressed environment that does not lead to a member's default. Such liquidity requirements arise from a number of factors, including the need to repay excess cash posted by members, the need to repay margin when margin requirements are reduced, and the substitution of cash collateral and European Central Bank eligible securities.

The proposed Framework next describes the metrics used to determine LCH SA's liquidity needs that are calculated each day over a five-day period. Such metrics include: (i) The liquidity coverage ratio; (ii) a monthly rolling average liquidity buffer; (iii) a daily minimum liquidity buffer; and (iv) required cash collateral.

With respect to the liquidity coverage ratio, the proposed Framework explains how the liquidity coverage ratio is determined for each of the clearing services that LCH SA offers in a Cover 2 scenario, i.e., the liquidity risk arising from the default of at least two clearing group members to which LCH SA has the largest exposures during the 5 days following default. The Cover 2 amount is computed by aggregating the liquidity risks related to clearing members within the same group across all of LCH SA's services. The two largest group members are chosen according to the liquidity needs related to these members. The liquidity requirements are generated by three risk drivers: The settlement risk, market risk and the ECB haircut. For the CDSClear service, LCH SA determines the liquidity risk by considering variation margin modelled at member level by applying the most punitive CDS spread widening stress scenario for both ITraxx Main and CrossOver (currently the historical scenario considering the 2007 crisis). The Framework focuses on the principal risks for which LCH SA must assure that it has sufficient liquidity.

Finally, the Framework describes the reverse stress test that LCH SA runs at least quarterly. The reverse stress test is designed to help determine the limits of the models and of the liquidity risk management framework by modelling extreme market conditions that go beyond what are considered plausible market conditions over a 5-day time horizon. LCH SA stresses seven risk factors independently, and also considers these risk factors together in two combined reverse stress test scenarios, the Behavioural and Macro-economic.

2. Statutory Basis

LCH SA has determined that the Proposed Rule Change is consistent with the requirements of Section 17A of the Act ^[7] and regulations thereunder applicable to it. The Framework implements the provisions of Section 17A(b)(3)(F) of the Act,^[8] which require, inter alia, that the rules of a clearing agency “assure the safeguarding of securities and funds that are in its custody or control or for which it is responsible.” Further, Regulation 17dA-22(e) requires a clearing agency to maintain and enforce written policies and procedures reasonably designed to “measure, monitor, and manage the liquidity risk that arises in or is borne by the covered clearing agency.” ^[9] Consistent with these provisions, the Framework assures that the clearing agency maintains sufficient liquid resources to effect the settlement of payment obligations with a high degree of confidence under a wide range of foreseeable stress scenarios.^[10]

B. Clearing Agency's Statement on Burden on Competition

LCH SA does not believe the Proposed Rule Change would have any impact, or impose any burden, on competition. The Proposed Rule Change does not address any competitive issue or have any impact on the competition among central counterparties. LCH SA operates an open access model, and the Proposed Rule Change will have no effect on this model.

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 [e-mail]. Please include File Number SR-LCH SA-2018-003 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-2018-003. 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 (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 website 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 website at http://www.lch.com/​asset-classes/​cdsclear.

All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-LCH SA-2018-003 and should be submitted on or before July 12, 2018.

For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.^[11]

Eduardo A. Aleman,

Assistant Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  LCH SA, a wholly owned subsidiary of LCH Group, manages its liquidity risk pursuant to, among other policies and procedures, the Group Liquidity Risk Policy and the Group Liquidity Plan applicable to each entity within LCH Group.

In addition to its CDSClear service, LCH SA provides clearing services in connection with cash equities and derivatives listed for trading on Euronext (EquityClear), commodity derivatives listed for trading on Euronext (CommodityClear), and tri-party Repo transactions (RepoClear).

4.  LCH SA has an interoperability agreement with Cassa di Compensazione e Garanzia (“CC&G”), an Italian CCP, pursuant to which LCH SA's clearing members and CC&G's clearing members are able to benefit from common clearing services without having to join the other CCP. Each CCP is a clearing member of the other one with a particular status when accessing the clearing system of the other counterparty.

5.  Securities comprising non-cash collateral are comprised of the following components: (i) Margin collateral, i.e., non-cash collateral pledged by clearing members for margin cover; (ii) Collateral and Liquidity Management (“CaLM”) collateral, i.e., direct securities holdings that are part of the CaLM's investment activities; and (iii) clearing settlement collateral, i.e., collateral resulting from the physical settlement of contracts on behalf of a defaulting clearing member.

6.  Tier 2 assets are those securities that have a market and may be financed but are of lesser quality than Tier 1 assets. Tier 3 assets are deemed to have little or no liquidity value in the event of a default or major market stress or are deemed to be too illiquid to be converted in the timeframe that a CCP would require.

7.  15 U.S.C. 78q-1.

8.  15 U.S.C. 78q-1(b)(3)(F).

9.  17 CFR 240.17Ad-22(e)(7).

10.  The proposed Framework is also consistent with LCH SA's obligations under the European Markets Infrastructure Regulation (“EMIR”); Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade reporting.

In particular, EMIR Article 44 provides, in part:

“A CCP shall at all times have access to adequate liquidity to perform its services and activities. . . . A CCP shall measure, on a daily basis, its potential liquidity needs [taking] into account the liquidity risk generated by the default of at least the two clearing members to which it has the largest exposures.”

11.  17 CFR 200.30-3(a)(12).