Self-Regulatory Organizations; LCH SA; Notice of Filing of Proposed Rule Change Relating to Amendments to CDSClear Reference Guide To Allow Index Basis Packages Margining

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder notice is hereby given that on October 29, 2019, 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.

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

Banque Centrale de Compensation, which conducts business under the name LCH SA (“LCH SA”), is proposing to amend its (i) Reference Guide: CDSClear Margin Framework (the “CDSClear Risk Methodology”) in order to allow Index Basis Packages margining as a single instrument.

The text of the proposed rule change has been annexed as Exhibit 5.

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

LCH SA CDSClear is proposing to amend its CDSClear Risk Methodology in order to consider any relevant and identified Index Basis Packages identified as a single instrument.

(a) Index Basis Package Principles

LCH SA CDSClear currently clears CDS on a number of indices such as iTraxx Main, iTraxx Cross-over, iTraxx Senior Financials as well as all the Single Name constituents of these indices. The iTraxx Subordinated Financials indices will soon be made eligible for clearing as well. Indices and their constituents are currently managed and margined as independent instruments. However, market participants may execute Index Basis Packages consisting of an Index CDS trade and individual Single Name CDS trades on each of the reference entities constituents of such Index perfectly offsetting the index.

The following criteria would need to be required to constitute an Index Basis Package:

• The package is constituted of an Index CDS and Single Names CDS on all the entities constituting the index
• The position (Long/Short) on the Index offsets the positions on the Single Names (Short/Long).
• The notional of the Index and across all the Singles Names match exactly
• All the Single Names CDS trades to have the same currency, coupon and maturity as the Index CDS
• All the Single Name CDS trades to have the same Seniority, ISDA Definition and Restructuring Clause than as constituents of the Index

Clearing Members and/or Clients will be required to identify all trades being part of an Index Basis Package and to notify LCH SA CDSClear. CDSClear would then perform controls to ensure all principles and requirements stated above for qualifying the trades as an Index Basis Package are satisfied and would flag them with a common ID number. These trades will continue to be margined as different trades until these tasks and controls have been fully completed and the qualification as an Index Basis Package confirmed.

Once an Index Basis Package is validated as complete, the margin enhancement proposed in the current rule change would then be applied as part of the overnight margin calculation.

In order to ensure that the trades continue to meet the criteria of an Index Basis Package, controls will be performed every day at the start of the overnight batch process.

Index Basis Packages identified and flagged as such will be excluded from compression runs with the rest of the portfolio in order to avoid breaking any packages.

Index Basis Packages can be un-flagged as such at the Clearing Member and/or Client's request. The Index CDS and the Single Name CDS would then be treated and margined separately as per the current framework.

In case of a Clearing Member's default, CDSClear will have the ability to liquidate Index Basis Packages in a dedicated auction should it be advised to do so by the Default Management Group in order to minimize the liquidation costs.

(b) Proposed Changes to CDSClear Risk Methodology

In order to take into account the specific risk created by Index Basis Packages positions, LCH SA proposes to amend the calculation of the Spread Margin and the calculation of the Liquidity Charge Margin as described in its Reference Guide, CDSClear Margin Framework.

LCH SA CDSClear currently considers an Index Basis Package as multiple instruments in the calculation of its Spread Margin. In accordance with the portfolio margining requirements under Article 27 of Commission Delegated Regulation (EU) No 153/2013 (the “RTS”), LCH SA CDSClear applies a cap of 80% to the possible margin offsets reduction. Therefore the Spread Margin of an Index Basis Package is calculated as the maximum between the expected shortfall of the package and 20% of the sum of the expected shortfalls calculated for each components of the package.

Considering that this does not appropriately reflect the actual risk of an Index Basis Package meeting the criteria stated above, CDSClear is proposing to amend its CDSClear Risk Methodology in order to consider Index Basis Packages identified as such as a single instrument when calculating the amount of margins required. In particular, the 80% cap on offsets between the components of the Index Basis Package would not be applied in the calculation of the Spread Margin, but would be maintained between an Index Basis Package and all the other positions in the portfolio.

In the opinion published in April 2017 and clarifying the application of Article 27 of the RTS, the European Securities and Market Authority (“ESMA”), acknowledges the low level of risk presented by a package consisting in a future on an index and futures on each of the constituents of the index and allows a CCP to acknowledge margin reduction in excess of 80% in this specific case.

Considering that an Index Basis Package would likely be sold off in a dedicated auction in case of default of a Clearing Member, LCH SA also proposes to amend the calculation of the Liquidity Charge Margin described in the CDSClear Risk Methodology in order to better reflect the actual cost it would incur when liquidating an Index Basis Package. CDSClear proposes to charge a specific bid/ask spread for each Index family underlying an Index Basis Package identified as such rather than use the current Liquidity Charge Margin algorithm based on charging bid/ask spreads for each individual component in the package taken independently. The current Liquidity Charge Margin methodology will nevertheless remain in the calculation specific to Index Basis Packages identified as such by acting as a cap to the new calculation method.

Finally, Index Basis Packages flagged as such would be excluded from the Recovery Risk, Interest Risk, or Wrong Way Risk Margin calculations as by construction Index Basis Packages are immune to the risks these margins aim at capturing.

No other changes are made to the CDSClear Risk Methodology.

(c) Proposed Changes to CDSClear Risk Methodology

The CDS Clearing Rulebook, Supplement and Procedures will not need to be amended for the IBP initiative purposes. Only one new Clearing Notice is expected to be published, this notice defines what an IBP is and the procedure to be followed to request a set of Cleared Trades to be identified as an IBP.

2. Statutory Basis

LCH SA believes that the proposed rule change in connection with the specific margin calculations for Index Basis Packages identified as such is consistent with the requirements of Section 17A of the Securities Exchange Act of 1934 (the “Act”) and the regulations thereunder, including the standards under Rule 17Ad-22. In particular, Section 17(A)(b)(3)(F) of the Act requires, among other things, that the rules of a clearing agency be designed to promote the prompt and accurate clearance and settlement of securities transactions and 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.

As noted above, the proposed rule change is designed to apply specific margin calculations for Index Basis Packages flagged as such in order:

—To appropriately collect and maintain financial resources intended to cover the risks to which LCH SA is exposed in connection with offering clearing services for Index Basis Packages. As such, LCH SA will be able to minimize the risk that losses associated with the default of a participant (or participants) in the clearing service will extend to other participants in the service.

—To reflect the specific features of Index Basis Packages, notably the way that these are executed by market participants, which in turn promotes the prompt and accurate clearance and settlement of securities transactions, derivatives agreements, contracts and transactions and contributes to the safeguarding of securities and funds associated with security-based swap transactions in LCH SA's custody or control, or for which LCH SA is responsible.

For these reasons, LCH SA believes that the proposed rule change should help promote the prompt and accurate clearance and settlement of securities transactions, derivatives agreements, contracts and transactions. Similarly, it should enhance LCH SA's ability to help assure the safeguarding of securities and funds which are in the custody or control of LCH SA or for which it is responsible.

LCH SA believes that the proposed changes to the CDSClear Margin Framework and the Default Fund Methodology satisfy the requirements of Rule 17Ad-22(e).

Rule 17Ad-22(e)(4) requires a covered clearing agency 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, and Rule 17Ad-22(e)(6) requires a covered clearing agency that provides central counterparty services to cover its credit exposures to its participants by establishing a risk-based margin system that meets certain minimum requirements.

As described above, LCH SA proposes to amend its CDSClear Methodology Framework to manage the risks associated with the clearing of Index Basis Packages identified as such. Specifically, the proposed rule change amends the Spread Margin calculation for Index Basis Packages by not applying the 80% cap on offsets between the various instruments constituting the package. It also amends the Liquidity Charge Margin by applying a specific bid-ask spread per Index family underlying of an Index Basis Package identified as such in order to reflect the way that those packages trade in the market and would likely be auctioned off in the case of a default of a Clearing Member, as well as by capping the new Liquidity Charge Margin calculation by the amount calculated using the current Liquidity Charge framework based on an individual bid-ask spread per component of the Index Basis Package. Finally, all the other margins part of the CDSClear Risk Methodology will not be calculated on Index Basis Packages flagged as such as immune to those risks due to the complete offsets between the components of the package.

These changes are designed to use an appropriate risk-based model to set margin requirements and use such margin requirements to limit LCH SA's credit exposures to participants in clearing Index Basis Packages and/or other CDS and CDS Options under normal market conditions, consistent with Rule 17Ad-22(e)(3). LCH SA also believes that its risk-based margin methodology takes into account, and generates margin levels commensurate with the risks and particular attributes of each of Index Basis Packages, other CDS as well as CDS Options at the product and portfolio levels, appropriate to the relevant market it serves, consistent with Rule 17Ad-22(e)(6)(i) and (v). In addition, LCH SA believes that the margin calculation under the revised CDSClear Margin Framework would sufficiently account for the 5-day liquidation period for house account portfolios and 7-day liquidation period for client portfolios and therefore, is reasonably designed to cover LCH SA's potential future exposure to participants in the interval between the last margin collection and the close out of positions following a participant default, consistent with Rule 17Ad-22(e)(6)(iii).

Further, Rule 17Ad-22(e)(4)(ii) requires a covered clearing agency that provides central counterparty services for security-based swaps to maintain financial resources additional to margin to enable it to cover a wide range of foreseeable stress scenarios that include, but are not limited to, meeting the cover two standard. LCH SA believes that its Default Fund Methodology, not being impacted by the proposed rule change, will therefore still appropriately incorporate the risk of clearing Index Basis Packages, CDS, and CDS Options which, together with the proposed changes to the CDSClear Margin Framework, will be reasonably designed to ensure that LCH SA maintains sufficient financial resources to meet the cover two standard, in accordance with Rule 17Ad-22(e)(4)(ii).

LCH SA also believes that the proposed rule changes are consistent with the provisions of Rule 17Ad-22(e)(17) requiring a covered clearing agency to manage operational risks by (i) identifying the plausible sources of operational risk, both internal and external, and mitigating their impact through the use of appropriate systems, policies, procedures, and controls; (ii) ensuring that systems have a high degree of security, resiliency, operational reliability, and adequate, scalable capacity; and (iii) establishing and maintaining a business continuity plan that addresses events posing a significant risk of disrupting operations.

As stated above LCH SA will flag each component of an Index Basis Package using a common ID number to ensure complete identification of the package and perform checks to ensure all principles and requirements for qualifying as an Index Basis Package are satisfied. No margin enhancement will be given until the full Index Basis Package is complete. Once an Index Basis Package is validated as complete, the specific margin calculations will then be applied as part of the overnight margin calculation.

LCH SA will also implement additional automated controls in its systems performed daily to ensure all the requirements are met on a continuous basis.

Index Basis Packages will be excluded from compressions with the rest of the portfolio in order to avoid being broken up.

LCH SA will update its operational procedures and IT systems to ensure all the above is adequately implemented and operational risk reduced to a very minimum.

Rule 17Ad-22(e)(2) requires LCH SA to have governance arrangements that are clear and transparent to fulfill the public interest requirements in Section 17A of the Act.

LCH SA's governance arrangements clearly assign and document responsibility for risk decisions and require consultation with or approval from the LCH SA Board, Risk committees, or management. LCH SA's proposed rule change was decided in accordance with the LCH SA governance process, which included review of the changes to the CDSClear Margin Framework and related risk management considerations by the LCH SA Executive Risk Committee. These governance arrangements continue to be clear and transparent, such that information relating to the assignment of responsibilities for risk decisions and the requisite involvement of the LCH SA Board, committees, and management is clearly documented, consistent with the requirements of Rule 17Ad-22(e)(2).

For the reasons stated above, LCH SA believes that the proposed rule change is consistent with the requirements of prompt and accurate clearance and settlement of securities transactions, and assuring the safeguarding of securities and funds in the custody or control of the clearing agency or for which it is responsible, in accordance with Section 17A(b)(3)(F) of the Act, with the requirements of operational risk management in Rule 17Ad-22(e)(17), and with clear and transparent governance arrangements in Rule 17Ad-22(e)(2).

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, LCH SA does not believe that the proposed rule change would impose burdens on competition that are not necessary or appropriate in furtherance of the purposes of the Act. Specifically, the proposed changes to the CDSClear Margin Framework, would apply equally to all Clearing Members and Clients whose portfolios include Index Basis Packages as long as a request to identify them as such was received by LCH SA and the controls performed confirmed the completeness of the package. Because the margin methodology is risk-based, consistent with the requirements in Rule 17Ad-22(b)(2) and (e)(6), depending on a Clearing Member's portfolio, each Clearing Member would be subject to a margin requirement commensurate with the risk particular to its portfolio. Such margin requirement impose burdens on a Clearing Member but such burdens would be necessary and appropriate to manage LCH SA's credit exposures to its CDSClear participants consistent with the requirements under the Act as described above.

Therefore, LCH SA does not believe that the proposed rule change would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Act.

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-2019-009 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-2019-009. 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 the filing also will be available for inspection and copying at the principal office of LCH SA and on LCH SA's website at: https://www.lch.com/resources/rules-and-regulations/proposed-rule-changes-0. 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-2019-009 and should be submitted on or before December 10, 2019.