[Federal Register Volume 83, Number 146 (Monday, July 30, 2018)]
[Notices]
[Pages 36655-36658]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-16164]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-83690; File No. SR-ICC-2018-004]
Self-Regulatory Organizations; ICE Clear Credit LLC; Order
Approving Proposed Rule Change Relating To Formalization of the ICC
Model Validation Framework
July 24, 2018.
I. Introduction
On May 23, 2018, ICE Clear Credit LLC (``ICC'') 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 formalize the
ICC Model Validation Framework. The proposed rule change was published
in the Federal Register on June 12, 2018.\3\ 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\ Securities Exchange Act Release No. 34-83386 (June 6, 2018),
83 FR 27360 (June 12, 2018) (SR-ICC-2018-004) (``Notice'').
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II. Description of the Proposed Rule Change
The proposed rule change would formalize the ICC Model Validation
Framework (``Framework''), which sets forth ICC's model validation
procedures.\4\ Through the use of these model validation procedures,
ICC determines the effectiveness of the risk models underpinning ICC's
risk management system, considers new components and enhancements to
existing components of the risk models, and monitors and validates on
an ongoing basis the risk models. The Framework also describes the
personnel responsible for, and the governance process associated with,
the successful operation and maintenance of the model validation
procedures. Specifically, the Framework designates ICC's Risk Oversight
Officer (``ROO'') as the Framework owner and makes the ROO responsible
to the ICC President for the successful operation and maintenance of
the Framework.\5\
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\4\ Notice, 83 FR at 27361. Capitalized terms used herein but
not otherwise defined have the meaning set forth in the Framework
and ICE Clear Europe rulebook, which is available at https://www.theice.com/clear-europe/regulation#rulebook.
\5\ Notice, 83 FR at 27361.
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ICC has a proprietary risk management system that uses models to
assess the risk of the credit default swap-based portfolios that ICC
clears. ICC uses its risk management system to determine the
appropriate Initial Margin and Guaranty Fund requirements that offset
the risks of the credit default swap-based portfolios ICC clears. The
risk management system is composed of risk model components (``Model
Components''), which employ a combination of statistical analysis of
credit spread time series and stress test simulation scenarios to
address different sources of risk. These sources of risk addressed by
the Model Components constitute the foundation of total Initial Margin
and Guaranty Fund requirements for the credit default swap-based
portfolios that ICC clears.\6\
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\6\ Id.
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The Framework considers both new Model Components and enhancements
to existing Model Components (collectively, ``Model Change''). New
Model Components consider sources of risk that are not currently
included in the risk management system.\7\ Enhancements to existing
Model Components improve upon the methodologies already used by the
risk management system to consider a given source or sources of
risk.\8\ The Framework classifies Model Changes as either Materiality A
or Materiality B, depending on how substantially the Model Change
affects the risk management system's assessment of risk for the related
source or sources of risk.\9\ Materiality A Model Changes substantially
affect the risk management system's assessment of risk for the related
source or sources of risk. Materiality B Model Changes do not
substantially affect the risk management system's assessment of risk
for the related source or sources of risk. The Framework requires that
the ICC Chief Risk Officer (``CRO'') and the ROO review and determine
which enhancements to the risk management system qualify as Model
Changes and classify Model Changes as Materiality A or B.\10\ The
Framework requires that the ICC Risk Committee review the materiality
classifications and provide feedback as necessary.\11\ The Framework
also describes the Model Inventory which is maintained by the ICC Risk
Department and which contains key information about all Model
Components and Model Changes.\12\ The Framework requires that the ICC
ROO review the model
[[Page 36656]]
inventory at least quarterly to ensure that it contains accurate and up
to date information relating to Model Components and Model Changes.\13\
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\7\ Id.
\8\ Notice, 83 FR at 27361.
\9\ Id.
\10\ Id.
\11\ Id.
\12\ Id.
\13\ Id.
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To assure the effectiveness of ICC's risk management system, the
Framework employs four controls: Initial validation; ongoing monitoring
and validation; investigation; and independent periodic review.\14\
Before going live with any Model Change, the Framework requires an
initial validation of the conceptual soundness of the methodology and
the proposed ongoing monitoring and validation approach.\15\ In
addition, the Framework subjects Materiality A Model Changes to an
additional independent initial validation.\16\
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\14\ Notice, 83 FR at 27361.
\15\ Id.
\16\ Id.
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Ongoing monitoring and validation provides assurances that ICC has
appropriately configured and calibrated the risk management system,
including any recent Model Change, and that the risk management system
is achieving the desired level of performance.\17\ Ongoing monitoring
and validation consists of three areas: Parameter setting, execution
monitoring, and outcome analysis.\18\ Through execution monitoring ICC
reviews on a daily basis the changes generated by its risk management
system and explains them in relation to known changes in cleared
portfolios, prices, and market conditions.
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\17\ Id.
\18\ Id.
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If ongoing monitoring and validation identifies features of the
risk management system that might indicate weakness in a Model
Component, the Framework requires ICC to investigate and identify the
root cause.\19\ If weakness in a Model Component is discovered during
investigation, the Framework requires the ICC CRO to inform the ICC
Risk Committee of the results of the investigation.\20\ ICC must then
remediate the identified weakness through an appropriate Model Change,
which passes through the required steps of the Framework starting with
an Initial validation.\21\
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\19\ Notice, 83 FR at 27361.
\20\ Id.
\21\ Id.
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The Framework sets forth the process for selecting independent
validators and describes the independent validator criteria, including
technical expertise and independence requirements. The Framework
requires that the ICC CRO provide support and information to allow the
independent validators to perform periodic reviews of all Model
Components and related practices at least once in every calendar
year.\22\ At ICC's choosing, the scope of an independent periodic
review may cover all Model Components used by the risk management
system, or a subset of Model Components, as long as all Model
Components are included in one or more independent periodic reviews
each year.\23\ The independent periodic review must demonstrate that
the Model Components remain fit for purpose; that the assumptions
associated with the Model Components are still valid; that ICC has
adequately addressed any open items of medium priority \24\ from Model
Change initial validations and any other implementation conditions; and
that ICC has been complying with its ongoing monitoring and validation
requirements and the Model Components are performing without any
significant weakness.\25\ The ICC CRO must present the periodic review
to the ICC Risk Committee and describe ICC's plans in relation to any
open high or medium priority items in the report.\26\
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\22\ Id.
\23\ Id.
\24\ The Framework defines as medium priority those items that
reflect deficiencies in the Model Components, assumptions, usage, or
compliance with stated procedures that create risks that ICC can
mitigate with viable workarounds until it remediates them fully,
within a reasonable timeframe agreed with the Risk Committee.
\25\ Notice, 83 FR at 27361.
\26\ Id.
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III. Discussion and Commission Findings
Section 19(b)(2)(C) of the Act directs the Commission to approve a
proposed rule change of a self-regulatory organization if it finds that
such proposed rule change is consistent with the requirements of the
Act and the rules and regulations thereunder applicable to such
organization.\27\ For the reasons given below, the Commission finds
that the proposal is consistent with Section 17A(b)(3)(F) of the Act
\28\ and Rules 17Ad-22(b)(2), 17Ad-22(b)(3), 17Ad-22(b)(4), and 17Ad-
22(d)(8) thereunder.\29\
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\27\ 15 U.S.C. 78s(b)(2)(C).
\28\ 15 U.S.C. 78q-1(b)(3)(F).
\29\ 17 CFR 240.17Ad-22(b)(2)-(4), (d)(8).
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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 ICC be designed to promote the prompt and accurate
clearance and settlement of securities transactions and, to the extent
applicable, derivative agreements, contracts, and transactions, as well
as to assure the safeguarding of securities and funds which are in the
custody or control of ICC or for which it is responsible, and, in
general, to protect investors and the public interest.\30\
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\30\ 15 U.S.C. 78q-1(b)(3)(F).
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As described above, the Framework would provide a process for
reviewing and enhancing ICC's risk management system. The Framework
would also designate the personnel responsible for, and the governance
process associated with, the successful operation and maintenance of
the model validation procedures and would set forth the process and
criteria for selecting independent validators.
Taken together, the Commission believes these aspects of the
Framework would help ensure that ICC's risk management system
appropriately and effectively addresses the risks associated with
clearing security based swap-related portfolios by providing ICC a
means for reviewing and enhancing the risk management system as needed.
In providing for independent validators, the Commission believes the
Framework would help ensure that ICC receives unbiased and objective
views regarding its risk management system, which would improve such
review and enhancement. The Commission believes that both of these
aspects of the Framework would improve the effectiveness of ICC's risk
management system, thereby improving ICC's ability to manage the risks
associated with clearing security based swap-related portfolios. Given
that mismanagement of the risks associated with clearing security based
swap-related portfolios could cause ICC to realize losses on such
portfolios and disrupt ICC's ability to promptly and accurately clear
security based swap transactions, the Commission believes that the
Framework would promote the prompt and accurate clearance and
settlement of securities transactions. Similarly, given that
mismanagement of the risks associated with clearing security based
swap-related portfolios could cause ICC to realize losses on such
portfolios and threaten ICC's ability to operate, thereby threatening
access to securities and funds in ICC's control, the Commission
believes that the Framework would help assure the safeguarding of
securities and funds which are in the custody or control of the ICC or
for which it is responsible. Finally, for both of these reasons, the
Commission believes the Framework would, in general, protect investors
and the public interest.
Therefore, the Commission finds that the proposed rule change would
promote the prompt and accurate
[[Page 36657]]
clearance and settlement of securities transactions, assure the
safeguarding of securities and funds in ICC's custody and control, and,
in general, protect investors and the public interest, consistent with
the Section 17A(b)(3)(F) of the Act.\31\
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\31\ 15 U.S.C. 78q-1(b)(3)(F).
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B. Consistency With Rule 17Ad-22(b)(2)
Rule 17Ad-22(b)(2) requires that ICC establish, implement, maintain
and enforce written policies and procedures reasonably designed to use
margin requirements to limit its credit exposures to participants under
normal market conditions and use risk-based models and parameters to
set margin requirements and review such margin requirements and the
related risk-based models and parameters at least monthly.\32\
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\32\ 17 CFR 240.17Ad-22(b)(2).
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As described above, the Framework would describe how ICC would
review and enhance its risk management system, including the selection
and use of independent validators. In doing so, the Commission believes
that the Framework would help ensure that ICC's risk management system
is appropriate and effective for dealing with the risks associated with
clearing security based swap-related portfolios. The Commission
believes that the Framework would also enable ICC to improve its margin
requirements by allowing ICC to review and improve the models that
generate such margin requirements. The Commission believes that these
aspects of the Framework would improve ICC's use of margin requirements
to limit its credit exposures to participants under normal market
conditions and ICC's use of risk-based models and parameters to set
margin requirements.
In addition, the Framework would describe ICC's process for
execution monitoring, whereby ICC would review on a daily basis the
changes generated by its risk management system and would explain those
changes in relation to known changes in cleared portfolios, prices, and
market conditions. The Framework would require ICC to then investigate
any anomalies identified. In reviewing such changes and anomalies, the
Commission believes ICC would review its margin requirements and the
models that generate such requirements. Thus, the Commission believes
the Framework would enable ICC to review its margin requirements and
the models that generate such requirements on a daily basis.
Therefore, for the above reasons the Commission finds that the
proposed rule change is consistent with Rule 17Ad-22(b)(2).\33\
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\33\ 17 CFR 240.17Ad-22(b)(2).
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C. Consistency With Rule 17Ad-22(b)(3)
Rule 17Ad-22(b)(3) requires that ICC establish, implement, maintain
and enforce written policies and procedures reasonably designed to
maintain sufficient financial resources to withstand, at a minimum, a
default by the two participant families to which it has the largest
exposures in extreme but plausible market conditions, in its capacity
as a central counterparty for security-based swaps.\34\
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\34\ 17 CFR 240.17Ad-22(b)(3).
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As described above, the Framework would provide a process for
reviewing and enhancing ICC's risk management system and would set
forth the process and criteria for selecting independent validators. In
doing so, the Commission believes that the Framework would help ensure
that ICC's risk management system appropriately and effectively deals
with the risks associated with clearing security based swap-related
portfolios, including the risk associated with the default by the two
participant families to which ICC has the largest exposures in extreme
but plausible market conditions. The Commission believes that the
Framework would also help ICC improve its guaranty fund requirements by
allowing ICC to review and improve the models that generate such
requirements. The Commission believes that these aspects of the
Framework would help ensure that ICC effectively establishes and
maintains financial resources sufficient to withstand, at a minimum, a
default by the two participant families to which ICC has the largest
exposures in extreme but plausible market conditions.
Therefore, for the above reasons the Commission finds that the
proposed rule change is consistent with Rule 17Ad-22(b)(3).\35\
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\35\ 17 CFR 240.17Ad-22(b)(3).
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D. Consistency With Rule 17Ad-22(b)(4)
Rule 17Ad-22(b)(4) requires that ICC establish, implement, maintain
and enforce written policies and procedures reasonably designed to
provide for an annual model validation consisting of evaluating the
performance of its margin models and the related parameters and
assumptions associated with such models by a qualified person who is
free from influence from the persons responsible for the development or
operation of the models being validated.\36\
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\36\ 17 CFR 240.17Ad-22(b)(4).
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As discussed above, the Framework would require the ICC CRO to
provide support and information to allow independent validators to
perform periodic reviews of all Model Components and related practices
at least once in every calendar year. The Framework would further
provide that the scope of an independent periodic review may cover all
Model Components used by the risk management system, or a subset of
Model Components, as long as all Model Components are included in one
or more independent periodic reviews each year. The Framework would
also provide the process and criteria (including independence) for
selecting independent validators. Finally, the Framework would describe
the required components of an independent review and the documentation
required to be produced by the independent validators.
The Commission believes these aspects of the Framework would enable
ICC to validate the models underpinning its risk management system on
an annual basis including the related parameters and assumptions
associated with such models. The Commission also believes that by
setting out the process and criteria (including independence) for
selecting independent validators, the Framework would help ensure that
such validations are performed by qualified persons free from influence
from the persons responsible for the development or operation of the
models being validated.
Therefore, for the reasons described above the Commission finds
that the proposed rule change is consistent with Rule 17Ad-
22(b)(4).\37\
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\37\ 17 CFR 240.17Ad-22(b)(4).
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E. Consistency With Rule 17Ad-22(d)(8)
Rule 17Ad-22(d)(8) requires that ICC establish, implement, maintain
and enforce written policies and procedures reasonably designed to have
governance arrangements that are clear and transparent to fulfill the
public interest requirements in Section 17A of the Act \38\ applicable
to clearing agencies, to support the objectives of owners and
participants, and to promote the effectiveness of the clearing agency's
risk management procedures.\39\
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\38\ 15 U.S.C. 78q-1.
\39\ 17 CFR 240.17Ad-22(d)(8).
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As discussed above, the Framework would describe the personnel
responsible for, and the governance process associated with, the
successful operation and maintenance of the model validation
procedures. Specifically, the Framework would designate ICC's ROO
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as the Framework owner and would make the ROO responsible to the ICC
President for the successful operation and maintenance of the
Framework. The Framework would also designate certain responsibilities
to ICC's CRO and the Risk Committee. The Commission believes that in
doing so the Framework would allow ICC to establish clear and
transparent arrangements for governing the Framework and its model
validation procedures. The Commission further believes that these same
arrangements would contribute to ICC's fulfilling the public interest
requirements in Section 17A of the Act \40\ applicable to clearing
agencies, and the objectives of owners and participants. Finally, the
Commission believes that these procedures and arrangements would
promote the effectiveness of ICC's risk management procedures by
clarifying the process for, and responsibilities associated with, using
the Framework to improve ICC's risk management system.
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\40\ 15 U.S.C. 78q-1.
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Therefore, for the above reasons the Commission finds that the
proposed rule change is consistent with Rule 17Ad-22(d)(8).\41\
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\41\ 17 CFR 240.17Ad-22(d)(8).
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IV. Conclusion
On the basis of the foregoing, the Commission finds that the
proposal is consistent with the requirements of the Act, and in
particular, with the requirements of Section 17A(b)(3)(F) of the Act
\42\ and Rules 17Ad-22(b)(2), 17Ad-22(b)(3), 17Ad-22(b)(4), and 17Ad-
22(d)(8) thereunder.\43\
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\42\ 15 U.S.C. 78q-1(b)(3)(F).
\43\ 17 CFR 240.17Ad-22(b)(2)-(4), (d)(8).
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It is therefore ordered pursuant to Section 19(b)(2) of the Act
\44\ that the proposed rule change (SR-ICC-2018-004) be, and hereby is,
approved.\45\
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\44\ 15 U.S.C. 78s(b)(2).
\45\ In approving the proposed rule change, the Commission
considered the proposal's impact 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.\46\
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\46\ 17 CFR 200.30-3(a)(12).
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Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2018-16164 Filed 7-27-18; 8:45 am]
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