[Federal Register Volume 89, Number 20 (Tuesday, January 30, 2024)]
[Notices]
[Pages 5949-5951]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-01752]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-99423; File No. SR-LCH SA-2023-008]


Self-Regulatory Organizations; LCH SA; Order Approving Proposed 
Rule Change, as Modified by Partial Amendment No. 1, Relating to 
Recovery and Resolution

January 24, 2024.

I. Introduction

    On November 24, 2023, Banque Centrale de Compensation, which 
conducts business under the name LCH SA (``LCH SA''), filed with the 
Securities and Exchange Commission (``Commission''), pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ 
and Rule 19b-4 thereunder,\2\ a proposed rule change to amend its CDS 
Clearing Rule Book (``Rule Book'') to make amendments relating to 
recovery and resolution. On December 5, 2023, LCH SA filed Partial 
Amendment No. 1 to the proposed rule change to make certain changes to 
the Exhibit 5 to File No. LCH SA-2023-008.\3\ The proposed rule change, 
as

[[Page 5950]]

modified by Partial Amendment No. 1 (hereinafter, the ``Proposed Rule 
Change'') was published for comment in the Federal Register on December 
13, 2023.\4\ The Commission has not received any comments on the 
Proposed Rule Change. For the reasons discussed below, the Commission 
is approving the Proposed Rule Change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Partial Amendment No. 1 updates the pagination throughout 
Exhibit 5 to File No. LCH SA-2023-008 and the Table of Contents in 
Exhibit 5 to File No. LCH SA-2023-008 to reflect the revised 
pagination. Partial Amendment No. 1 would also remove two references 
to field codes in Chapter 1 of Exhibit 5 to File No. LCH SA-2023-
008.
    \4\ Securities Exchange Act Release No. 99109 (Dec. 7, 2023), 88 
FR 86389 (Dec. 13, 2023) (File No. SR-LCH-2023-008).
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II. Description of the Proposed Rule Change

    LCH SA is a clearing agency that offers clearing of, among other 
things, credit-default swaps (``CDS'').\5\ LCH SA is registered with 
the Commission for clearing CDS that are security-based swaps (``SBS'') 
and with the Commodity Futures Trading Commission (``CFTC'') for 
clearing CDS that are swaps. In addition to being registered with the 
Commission and CFTC, LCH SA is authorized to offer clearing services in 
the European Union pursuant to rules established under European Markets 
Infrastructure Regulation (``EMIR'') for Central Counter Parties 
(``CCP''). LCH SA is required to amend its rules to remain in 
compliance with the CCP Recovery and Resolution Regulation under 
EMIR.\6\ The goal of the CCP Recovery and Resolution Regulation is to 
ensure that both CCPs and national authorities in the European Union 
have the means to act decisively in a crisis scenario. LCH SA is 
proposing to amend its Rule Book to comply with Article 9(6) and 
Article 9(14) of the CCP Recovery and Resolution Regulation.\7\ The 
Proposed Rule Change would amend Title I, Title II, Title IV, and 
Appendix 1 of the Rule Book.
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    \5\ Capitalized terms used but not defined herein have the 
meanings specified in the LCH CDS Rule Book as applicable.
    \6\ 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, Title III, Chapter 1, Section 1, 
Article 9.
    \7\ Id.
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    Article 9(14) of the CCP Recovery and Resolution Regulation 
requires that, following a default event in respect of a clearing 
member, each CCP shall use an additional amount of its pre-funded, 
dedicated own resources (the ``second skin-in-the-game'') prior to the 
requirement of non-defaulting clearing members to make a contribution 
in cash to the CCP amounting to at least each clearing member's 
contribution to the default fund. This second skin-in-the-game is 
required in addition to the prefunded resources required in accordance 
with EMIR (the ``first skin-in-the-game''),\8\ which will be used by 
the CCP before the use of each non-defaulting clearing member's initial 
contribution to the default fund.\9\ On November 25, 2022, the European 
Commission adopted a delegated act specifying the methodology for 
calculation and maintenance of the second skin-in-the-game to be used 
in accordance with Article 9(14) of the CCP Recovery and Resolution 
Regulation (the ``Commission-Delegated Regulation'').\10\ Separately, 
Article 9(6) of the CCP Recovery and Resolution Regulation requires 
that CCPs provide in their rules that they may deviate from their 
recovery plan measures and, in such circumstances, they shall notify 
their competent authority designated in accordance with EMIR.\11\
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    \8\ Article 9(14) of Regulation (EU) 2021/23 of the European 
Parliament and of the Council of 16 December 2020 on a framework for 
the recovery and resolution of central counterparties. http://data.europa.eu/eli/reg/2021/23/oj.
    \9\ Regulation (EU) 2021/23 of the European Parliament and of 
the Council of 16 December 2020 on a framework for the recovery and 
resolution of central counterparties, Article 9(14). http://data.europa.eu/eli/reg/2021/23/oj.
    \10\ Commission Delegated Regulation (EU) 2023/840 of 25 
November 2022 supplementing Regulation (EU) 2021/23 of the European 
Parliament and of the Council with regard to regulatory technical 
standards specifying the methodology for calculation and maintenance 
of the additional amount of pre-funded dedicated own resources to be 
used in accordance with Article 9(14) of that Regulation. http://data.europa.eu/eli/reg_del/2023/840/oj.
    \11\ Regulation (EU) 2021/23 of the European Parliament and of 
the Council of 16 December 2020 on a framework for the recovery and 
resolution of central counterparties, Article 9(6). http://data.europa.eu/eli/reg/2021/23/oj.
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A. Defined Terms

    Title I of LCH SA's Rule Book addresses general provisions and 
legal framework, including a set of defined terms in Chapter 1. LCH SA 
proposes to add two new defined terms to Chapter 1. First, LCH SA would 
add the term ``CCP Recovery and Resolution Regulation,'' which would be 
defined as Regulation (EU) 2021/23 of the European Parliament and of 
the Council of 16 December 2020 on a framework for the recovery and 
resolution of central counterparties. Second, LCH SA would add the term 
``ACPR,'' which would be defined as the Autorit[eacute] de 
Contr[ocirc]le Prudentiel et de R[eacute]solution and any successor 
organization. The ACPR is one of LCH SA's national competent 
authorities.\12\ LCH SA also proposes to replace each reference to 
Autorit[eacute] de Contr[ocirc]le Prudentiel et de R[eacute]solution in 
the Rule Book with the new defined term ACPR.
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    \12\ EMIR requires that each EU member state designate the 
competent authority responsible for, inter alia, supervision of CCPs 
established in its territory. See Regulation (EU) No 648/2012 of the 
European Parliament and of the Council of 4 July 2012 on OTC 
derivatives, central counterparties and trade repositories, Title 
III, Chapter 2, Section 1, Article 22 (Competent Authority).
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B. Recovery Plan

    Title I of LCH SA's Rule Book includes provisions related to 
membership in LCH SA, including terms related to the suspension and 
termination of membership in Chapter 4 of Title II. LCH SA proposes to 
add a new section 2.4.4 to Chapter 4 that pertains specifically to 
recovery. LCH SA maintains a recovery plan. The recovery plan includes 
certain quantitative and qualitative indicators to identify the 
circumstances under which LCH SA may take specific measures, which are 
also specified in the recovery plan, in the case of a default or non-
default event. The goal of such measures is the restoration of LCH SA's 
financial resources so it can continue providing critical functions in 
all relevant scenarios. As required by Article 9(6), proposed Article 
2.4.4 would provide for an additional scenario in which LCH SA either 
takes measures provided for in its recovery plan despite the fact that 
the relevant indicators have not been met, or refrains from taking 
measures provided for in the recovery plan despite the fact that the 
relevant indicators have been met. In either event, the proposed rule 
change would require any such proposal to be submitted to the LCH SA 
board of directors for approval, and LCH to submit to the ACPR without 
delay any subsequent decision taken by the board of directors.

C. Default Waterfall

    Title IV of LCH SA's Rule Book includes provisions related to risk 
management, including terms related to events of default in Chapter 3 
of Title IV. LCH SA proposes to amend the default waterfall provisions 
in Article 4.3.3.1 of Chapter 3. Article 4.3.3.1 defines the waterfall 
of resources that LCH SA would apply to cover losses arising out of a 
member default. LCH SA proposes to add LCH SA's second skin-in-the-game 
as a new loss mitigation resource to its default waterfall.\13\ The 
second skin-in-the-game would be applied immediately before the 
collateral deposited by the non-defaulting clearing members. The 
proposed amendment to the waterfall provisions will also provide that, 
in accordance with Article 9(14) of the CCP Recovery and Resolution

[[Page 5951]]

Regulation and Article 1 of the Commission-Delegated Regulation, the 
LCH SA additional dedicated own resources, as determined from time to 
time, will be (a) up to the amount of such dedicated own resources 
allocated to the CDS Default Fund in proportion to the size of the CDS 
Default Fund; and (b) in the case of an Event of Default occurring 
after a previous Event of Default, but before LCH SA has reinstated 
such dedicated own resources in accordance with Article 3(2) of the 
Commission Delegated Regulation, up to the residual amount of such 
dedicated own resources in the CDS Default Fund.
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    \13\ The new resource would be added as the sixth resource on 
the list, requiring LCH SA to renumber items (vi) and (vii) of the 
current list.
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    In the penultimate paragraph of Article 4.3.3.1, LCH SA proposes to 
clarify that the LCH SA second skin-in-the-game could be up to the 
amount of LCH SA's own resources allocated to the CDS Default Fund.\14\
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    \14\ LCH SA also proposes conforming edits in Section 7 of 
Appendix 1 to the Rule Book, which deals with loss distributions in 
the context of the CDS default management process. Specifically, LCH 
SA proposes to add a reference in Section 7 of the appendix to 
section 4.3.3.1 as well as language consistent with the amended 
language of 4.3.3.1.
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III. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act requires the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
the proposed rule change is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to the 
organization.\15\ For the reasons given below, the Proposed Rule Change 
is consistent with Section 17A(b)(3)(F) of the Act \16\ and Rule 17Ad-
22(e)(2) \17\ thereunder.
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    \15\ 15 U.S.C. 78s(b)(2)(C).
    \16\ 15 U.S.C. 78q-1(b)(3)(F).
    \17\ 17 CFR 240.17Ad-22(e)(2).
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A. Consistency With Section 17A(b)(3)(F) of the Act

    Section 17A(b)(3)(F) of the Act requires, among other things, that 
the rules of LCH SA be designed to assure the safeguarding of 
securities and funds which are in the custody or control of LCH SA or 
for which it is responsible.\18\ As discussed in more detail below, the 
Proposed Rule Change is consistent with Section 17A(b)(3)(F) of the 
Act.\19\
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    \18\ 15 U.S.C. 78q-1(b)(3)(F).
    \19\ 15 U.S.C. 78q-1(b)(3)(F).
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    The Commission continues to regard skin-in-the-game as a potential 
tool to align the various incentives of a covered clearing agency's 
stakeholders, including management and clearing members.\20\ LCH SA 
proposes to add a second skin-in-the-game as a resource to be used to 
cover the losses resulting from the implementation of the CDS Default 
Management Process before the collateral deposited by the non-
defaulting clearing members as an additional contribution to the CDS 
Default Fund. Adding a second skin-in-the-game resource would create 
additional incentive for LCH SA to maintain the appropriate amount of 
resources to manage clearing member default because failure to do so 
would result in a direct cost to LCH SA. Creating additional incentive 
for LCH SA to maintain an appropriate amount of resources, in turn, 
could reduce the potential losses charged to the CDS Default Fund 
contributions of non-defaulting clearing members in the event of a 
clearing member default, which in turn would help assure the 
safeguarding of the CDS Default Fund contributions of non-defaulting 
clearing members.
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    \20\ Securities Exchange Act Release No. 78961 (Sep. 28, 2016), 
81 FR 70786, 70806 (Oct. 13, 2016) (S7-03-14) (``Covered Clearing 
Agency Standards'').
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    As discussed above, LCH SA proposes to change its Rule Book so that 
it can either take measures provided for in its recovery plan even if 
relevant indicators have not been met, or refrain from taking measures 
provided for in the recovery plan even though the relevant indicators 
have been met, provided it obtains board approval and promptly notifies 
the ACPR of the board's decision. This too would provide LCH SA with 
additional flexibility to take actions to safeguard funds for which it 
is responsible.
    Based on the foregoing, the Commission finds that the Proposed Rule 
Change is consistent with the requirements of Section 17A(b)(3)(F) of 
the Act.\21\
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    \21\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(e)(2) Under the Act

    Rule 17Ad-22(e)(2) under the Act requires that a covered clearing 
agency establish, implement, maintain, and enforce written policies and 
procedures reasonably designed to provide for governance arrangements 
that, among other things, support the public interest requirements of 
the Act.\22\ In adopting Rule 17Ad-22(e)(2), the Commission stated that 
``the proper alignment of incentives is an important element of a 
covered clearing agency's risk management practices,'' and noted that 
skin-in-the-game ``may play a role in those risk management practices 
in many instances.'' \23\ And, as noted above, the Commission continues 
to regard skin-in-the-game as a potential tool to align the various 
incentives of a covered clearing agency's stakeholders, including 
management and clearing members.\24\
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    \22\ 17 CFR 240.17Ad-22(e)(2)(iii).
    \23\ Covered Clearing Agency Standards, 81 FR at 70806.
    \24\ Securities Exchange Act Release No. 78961 (Sep. 28, 2016), 
81 FR 70786, 70806 (Oct. 13, 2016) (S7-03-14) (``Covered Clearing 
Agency Standards'').
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    As described above, LCH SA proposes to amend its Rule Book so that 
the second skin-in-the-game will be used to cover the losses resulting 
from the implementation of the CDS Default Management Process 
immediately before the collateral deposited by the non-defaulting 
clearing members. This would mean that, following a default event in 
respect of a clearing member, LCH SA would apply its own resources to 
mitigate losses before applying resources provided by non-defaulting 
clearing members. As discussed above, adding a second skin-in-the-game 
resource would help to create incentive for LCH SA to mitigate, manage, 
and maintain the appropriate amount of resources to manage clearing 
member default because failure to do so would result in a direct cost 
to LCH SA. Such mitigation of risk in the clearance and settlement of 
securities would be consistent with supporting the public interest 
because it helps reduce market disruptions. Accordingly, the Commission 
finds that that the Proposed Rule Change is consistent with Rule 17Ad-
22(e)(2) under the Act.\25\
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    \25\ 17 CFR 240.17Ad-22(e)(2).
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IV. Conclusion

    On the basis of the foregoing, the Proposed Rule Change is 
consistent with the requirements of the Act, and in particular, Section 
17A(b)(3)(F) of the Act \26\ and Rule 17Ad-22(e)(2) \27\ thereunder.
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    \26\ 15 U.S.C. 78q-1(b)(3)(F).
    \27\ 17 CFR 240.17Ad-22(e)(2).
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    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
that the proposed rule change (SR-LCH SA-2023-008), as modified by 
Partial Amendment No. 1, be, and hereby is, approved.\28\
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    \28\ In approving the Proposed Rule Change, the Commission 
considered the proposal's impacts on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).

    For the Commission by the Division of Trading and Markets, 
pursuant to delegated authority.\29\
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    \29\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-01752 Filed 1-29-24; 8:45 am]
BILLING CODE 8011-01-P