[Federal Register Volume 82, Number 160 (Monday, August 21, 2017)]
[Notices]
[Pages 39622-39629]
[FR Doc No: 2017-17546]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-81399; File No. SR-LCH SA-2017-007]

Self-Regulatory Organizations; LCH SA; Notice of Filing of
Proposed Rule Change Relating to Margin Framework and Default Fund
Methodology for Options on Index Credit Default Swaps

August 15, 2017.
    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 August 1, 2017, 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.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the
Proposed Rule Change

    LCH SA is proposing to amend its (i) Reference Guide: CDS Margin
Framework (``CDSClear Margin Framework'' or ``Framework'') and (ii)
CDSClear Default Fund Methodology (``Default Fund Methodology'') to
incorporate terms and to make conforming and clarifying changes to
allow options on index credit default swaps (``CDS Options'') to be
cleared by LCH SA.\3\ A separate proposed rule change has been
submitted concurrently (SR-LCH SA-2017-006) with respect to amendments
to LCH SA's rule book and other relevant procedures to incorporate
terms and to make conforming and clarifying changes to allow options on
index credit default swaps (``CDS'') to be cleared by LCH SA. The
launch of clearing CDS Options will be contingent on LCH SA's receipt
of all necessary regulatory approvals, including the

approval by the Commission of the proposed rule change described herein
and SR-LCH-SA-2017-006.
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    \3\ All capitalized terms not defined herein have the same
definition as the Framework or Default Fund Methodology, as
applicable.
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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
    In connection with the clearing of CDS Options, LCH SA proposes to
modify its CDSClear Margin Framework and Default Fund Methodology to
manage the risk arising from clearing CDS Options and to streamline the
descriptions in the existing CDSClear Margin Framework and Default Fund
Methodology to take into account CDS Options and improve the
organization and clarity of the CDSClear Margin Framework and Default
Fund Methodology.
(i). CDSClear Margin Framework
    The CDSClear Margin Framework will be reorganized to include a new
introductory section covering the overall new structure of the
Framework, which will include a description of the CDSClear pricing
methodology and margin methodologies for single-name CDS, index CDS,
and CDS Options. The margin methodologies used to calculate total
initial margin will consist of seven components, i.e., self-referencing
margin, spread margin, short charge, wrong way risk margin, interest
rate risk margin, recovery rate margin, and vega margin. In addition,
the Framework will also cover liquidity margin to account for
liquidation cost or potential losses as a result of concentrated or
illiquid positions, credit event margin to account for the risk of
recovery rate changes during the credit event processes, and variation
margin to account for observed mark-to-market changes as additional
margin charges. Finally, the methodology for FX rate adjustments that
are necessary for U.S. dollar denominated products cleared by LCH SA is
described in relevant sections of the Framework.
a. Pricing Methodology
    A new section on CDSClear pricing methodology is created as new
Section 2 in the Framework to cover both CDS pricing (section 2.1) and
CDS Options pricing (section 2.2). LCH SA does not propose any change
to the methodology currently used to price CDS under Section 2.1 but
because pricing is an input used by various margin components to
calculate total initial margin, LCH SA believes it is appropriate to
remove the CDSClear pricing methodology from the existing spread margin
section and incorporate it under the new Section 2.
    New section 2.2 describes the methodology that will be used to
price CDS Options. LCH SA proposes to adopt a market standard model
which makes certain adjustments to address the limitations of the
classic Black-Scholes model and that is made available on Bloomberg
(the ``Bloomberg Model'') and is commonly used by both dealers and buy-
side participants in order to facilitate communication on index
swaptions. The limitations of the classic Black-Scholes model include
the inability to reflect the contractual cash flow exchanged upfront
upon the exercise of the option. Neglecting the upfront cash flow
exchange would have a significant impact for deeply in-the-money payer
options because setting the underlying par spread curve flat at the
strike level would considerably reduce the risk duration and,
therefore, the potential profits and losses (``P&Ls'') resulting from
the option exercise with respect to such options. In addition, if a
credit event occurs with respect to the underlying index CDS after the
option was traded but before its expiry, the resulting loss would be
settled if and only if the option is exercised, and settlement would
occur on the day of exercise. Finally, the strike and spot for price-
based CDS Options are expressed in price terms rather than in spread
terms and, therefore, require price-to-spread conversion before using
the Bloomberg Model. LCH SA proposes to incorporate the upfront cash
flow amount to be exchanged upon exercise and the cash payment
resulting from the settlement of credit events that would occur between
the trade date and the expiry into the payoff amount at expiry in the
CDS Option price definition. In addition, consistent with the Bloomberg
Model, LCH SA also proposes to implement an adjusted spread in the log
normal distribution by calibrating the spread to match the implied
forward price, based on market quoted spreads, with certain assumptions
made to improve the calibration in order to be able to price CDS
Indices with a closed formula as the Bloomberg Model.
    Revised section 2.3 covers the market data for CDS and CDS Options.
Section 2.3.1 describes the market data LCH SA uses to build the
database for single-name CDS covering the 10-year look-back period,
which is the same as the description in the existing CDSClear Margin
Framework with very minor technical edits to improve headings and to
correct typographical errors.
    New section 2.3.2 addresses implied volatility in the pricing of
CDS Options. LCH SA proposes to rely on the stochastic volatility
inspired or ``SVI'' model to construct volatility surfaces and to use
the model to price or reprice a CDS Option as well as to interpolate
the various implied volatilities obtained from the Bloomberg Model
described above in a consistent manner. The choice of the SVI model is
based upon considerations that the model is an appropriate fit with the
historical data and that it guarantees a volatility surface free of
static arbitrage (such as calendar and butterfly arbitrage) if the
appropriate parameters are selected.
    New section 2.3.3 describes the sources of historical data for CDS
Option prices used by LCH SA to construct the database covering the 10-
year look-back period. These sources consist of Markit's history of
composite prices and specific dealers' history of prices. LCH SA will
then use this data to extract historical implied volatility. In order
to ensure that only SVI paramertizations that model the shape of the
volatility curves well would be used in the construction of the time
series, LCH SA would use a pre-defined coefficient of determination to
measure how well the data fits the statistical model. Section 2.3.3
also describes other data to be used for purposes of constructing
historical implied volatility in the case of missing at-the-money
(``ATM'') volatility and SVI data points in the historical time series.
If an option price cannot be obtained through members' contribution (as
described below) or Markit, LCH SA may use the price from the then on-
the-run series or use a proxy to determine the ATM volatility returns
from other similar options or from the index spread returns.
    Finally, new section 2.3.4 provides the source of new daily pricing
data for CDS Options that will be used to update implied volatility on
a daily basis. Similar to the current end-of-day pricing mechanism for
CDS, LCH SA will require members to contribute prices on options for
all strikes that are a multiple of five bps for iTraxx Europe Main or
25 bps for iTraxx Europe Crossover of a

given expiry when the members have at least an open position on one
strike for that expiry. Members' contributed prices will be used for
marking the options book if a quorum of three distinct contributions
(underlying, expiry, strike) is recorded per option. Otherwise, LCH SA
will fall back to Markit's composite prices or use pre-defined rules to
fill in missing data.
b. Total Initial Margin
    A new Section 3 is created to provide the total initial margin
framework. New section 3.1 provides a summary of the total initial
margin framework, including a brief description of each of the seven
components of the total initial margin.
    New section 3.2 provides an overview of the risks captured by each
margin component and the additional margin charges, as well as cash-
flow specific considerations and adjustments made to the margin
framework specific to U.S. dollar denominated CDS contracts. This re-
organized overview is substantively consistent with the description in
existing section 3.1.1 of the CDSClear Margin Framework except for the
addition of the new vega margin which is proposed in connection with
the clearing of CDS Options.
i. Self-Referencing Margin
    New Section 3.3 sets forth self-referencing margin, a component of
the total initial margin, for both CDS and CDS Options. In the case of
CDS, self-referencing margin is designed to cover the specific wrong
way risk relating to a Clearing Member selling protection on itself
through a CDS index or a client selling protection on the Clearing
Member. Self-referencing margin reflects the P&L impact resulting from
the Clearing Member defaulting on a sold-protection position in CDS
referencing its own name with zero recovery. In the case of CDS
Options, the P&L impact resulting from a Clearing Member defaulting on
a sold-protection position in CDS referencing its own name can be
calculated by taking the difference between the current option value
and the option value incorporating a loss amount in the underlying CDS
index.
ii. Spread Margin
    New Section 3.4 sets forth spread margin for both CDS and CDS
Options. There is no change proposed to the spread margin calculation
for CDS, which would continue to be calculated using a value-at-risk
model to build a distribution of potential losses from simulated
scenarios based on the joint credit spread and volatility variations
observed in the past. LCH SA then determines the expected shortfall
based on a quantile of the worst losses that could happen in the case
of unfavorable credit spread and volatility fluctuations within each 5-
day scenario and takes the difference in P&Ls of each portfolio between
the average of the prices beyond the 99.7 percent quantile of the
portfolio and the current mark-to-market price of the portfolio as the
expected shortfall. In addition, because the European Market
Infrastructure Regulation (EMIR) limits margin reduction from portfolio
margining to no greater than 80 percent of the sum of the margins for
each product calculated on an individual basis, LCH SA would determine
the spread margin to be the maximum between the expected shortfall of
the portfolio and 20 percent of the sum of the expected shortfalls
across instruments.
    The methodology for calculating spread margin would be the same for
CDS Options, with two adjustments. First, in addition to simulated
credit spreads, simulated volatilities would be calculated by defining
a shifted volatility curve for each option expiry date. Both simulated
credit spreads and simulated volatilities would be used to produce
simulated option values as an input in the value-at-risk model to
generate the expected shortfall. Second, in order to properly account
for the impact of CDS Options which expire within the 5-day margin
period of risk, LCH SA proposes to add to the Section 3.4 spread margin
provisions regarding an assessment of whether a CDS Option would be
exercised on expiry by considering the present value of an option on
the date of expiry. If the assessment determines that the option would
be exercised, LCH SA would take the resulting index CDS position into
account in the expected shortfall calculation for the following days
within the margin period of risk.
    LCH SA is also proposing to move the discussion of margin impact
related to clearing CDX IG/HY contracts to Section 3.4 without any
substantive change and to delete the current Section 3 on ``CDX IG/HY
Specificity'' in the CDSClear Margin Framework. This reorganization of
the CDSClear Margin Framework is intended to streamline the
presentation because the same spread margin methodology that applies to
European CDS contracts would equally apply to U.S. dollar denominated
contracts, with certain considerations given to the use of U.S.
interest rate benchmarks, FX adjustment, use of shifted FX rate for
computing historical expected shortfalls, and an FX haircut, as
described in Section 3 of the current CDSClear Margin Framework.
iii. Short Charge
    New Section 3.5 sets forth short charge for both CDS and CDS
Options, which replaces the former Section 4.1. As with the existing
Framework, the purpose of the short charge is to address the jump-to-
default risk, i.e., the P&L impact, when liquidating a defaulting
member's portfolio, as a result of one or more reference entities in
the portfolio experiencing a default. The definition of the short
charge remains the greater of (x) the ``global short charge,'' derived
from the Clearing Member's largest, or ``top,'' net short exposure (in
respect of any CDS contracts) and its top net short exposure amongst
the three ``riskiest'' reference entities (in respect of any entity
type) that are most probable to default in its portfolio, and (y) a
``high yield short charge,'' (``HY short charge'') derived from a
member's top net short exposure (in respect of high yield CDS) and its
top two net short exposures amongst the three ``riskiest'' reference
entities (in the high yield category) in its portfolio. In addition,
because wrong way risk margin considers the P&L impact as a result of
the Clearing Member's top two net short exposures in respect of senior
financial CDS, it is relevant to calculate a financial short charge to
reflect the jump-to-default P&L impact resulting from the default of
the two financial entities with the largest net short exposures.
    The steps for determining the net short exposure and default
probability per entity also remain the same with respect to CDS
portfolios. LCH SA would define the net short exposure at the portfolio
level, aggregating net notional by entity, applying a recovery rate and
subtracting the variation margin already collected with respect to each
entity, either as a single name or as part of an index. Because there
are various transaction types and contract terms based on different
ISDA definitions, LCH SA would calculate each reference entity's net
exposure based on transaction types and contract terms across various
possible scenarios, sum the exposures together according to the
scenarios, and retain the worst scenario as the reference entity's net
short exposure.
    With respect to the determination of the short exposure for CDS
Options, LCH SA believes that it would be appropriate to consider the
P&L impact of a credit event experienced by a constituent of an index
CDS underlying the CDS Option on the value of the option. Rather than
repricing the option each day based on the spread level of

the underlying index and the ATM volatility level, LCH SA proposes to
adopt an approximation approach to define the change in the option
price relative to the total loss in the underlying index so as to
expedite the calculation. The amount of such change would represent the
impact on the option premiums as a function of the loss amount to be
delivered at the option expiry if the option is exercised. Such change
in option price would then be calibrated on a loss interval for each
eligible option as a polynomial function and the calculation of this
loss function would be performed at the option instrument level.
    The total short exposures with respect to each reference entity
would be the sum of (i) the net short exposure for the CDS contracts
referencing such entity and (ii) the losses resulting from the CDS
Options on index CDS with such entity as a constituent. A total short
exposure will be calculated for each entity except for an entity
experiencing a credit event or an entity that is a member or member's
affiliate with respect to which a self-referencing margin is imposed.
LCH SA will then be able to select the entity or entities for purposes
of calculating the global short charge, HY short charge, and financial
short charge.
    In order to accommodate the addition of CDS Options to CDSClear's
clearing services, LCH SA proposes to make certain adjustments to the
short charge calculation. First, when calculating the total short
exposure for each reference entity, including an entity that is a
constituent of an index CDS underlying an option, the total short
exposure would be calculated for each day within the 5-day margin
period of risk using a simulated credit spread and ATM volatility data
for both CDS and CDS options, instead of using the current spread as is
the case for CDS only in the existing Framework.
    Second, after entities are selected for calculating the global
short charge, HY short charge and financial short charge, if a
portfolio includes CDS Options, as a result of the non-linearity of
options products, the total short exposure would not be the sum of the
P&L impacts of each individual entity's default. Therefore, LCH SA
proposes to calculate each of the global short charge, HY short charge
and financial short charge by considering the combined P&L impacts of
simultaneous defaults of the selected entities.
    Third, because the total short exposure for each reference entity
would be calculated using a simulated credit spread and ATM volatility
data for both CDS and CDS Options, the global short charge, HY short
charge and financial short charge derived from the selected entities'
total short exposures would represent the jump-to-default risk and the
market risk (i.e., spread moves) from both the CDS contracts and the
CDS Options contracts at the portfolio level on each day within the 5-
day margin period of risk in the simulated scenario. In order to
calculate the short charge margin that reflects the P&L impact of the
jump-to-default risk only at the portfolio level and the spread margin
that reflects the P&L impact that comes from spread and ATM volatility
moves, LCH SA would compare three expected shortfall amounts at the
portfolio level: (i) The expected shortfall reflecting the P&Ls
consisting of spread margin, the global short charge, the HY short
charge and the financial short charge (ES1), (ii) the
expected shortfall reflecting the P&Ls consisting of spread margin,
global short charge and HY short charge (ES2), and (iii) the
expected shortfall reflecting the P&Ls consisting of spread margin
(ES3). If ES1 exceeds ES2, the excess
amount would be the result of the financial short charge, which is the
jump-to-default component of the wrong way risk and should be allocated
to the wrong way risk margin. If ES2 exceeds ES3,
the excess amount would represent the jump to default risk and should
be allocated to the short charge margin. In addition, as stated above,
EMIR limits the effect of margin reduction from portfolio margining to
no greater than 80 percent of the sum of the margins for each product
calculated on an individual basis. Thus, LCH SA would also calculate an
expected shortfall reflecting the P&L impact of the spread and ATM
volatility moves (ES4) at a product level and then use 20
percent of ES4 as the minimum floor for the spread margin.
    Finally, new Section 3.5 will also consider the impact of option
expiry on the P&L as part of the short charge calculation. In this
respect, LCH SA would consider two cases: (i) The option exercise
decision occurs before the occurrence of two credit events, and
therefore, the credit events would have no impact on the option
exercise decision and would only impact the P&L if the option is
exercised upon expiry; and (ii) the two credit events occur before the
option exercise decision and therefore, would have impact on the option
exercise. LCH SA would use the worst case in the short charge
calculation.
iv. Interest Rate Risk Margin/Recovery Risk Margin/Wrong-Way Risk
Margin/Vega Margin
    New Section 3.6 sets forth interest rate risk margin for both CDS
and CDS Options, which replaces the former Section 7 in the existing
CDSClear Margin Framework. The methodology for calculating interest
rate risk margin remains the same, except to provide for repricing CDS
Option positions using the same ``bump'' parameters up and down
computed by taking the 99.7 quantile of the interest rate return based
on the same sample of dates in the spread historical database.
    New Section 3.7 sets forth recovery rate risk margin for CDS, which
replaces Section 6 in the existing CDSClear Margin Framework. The
methodology for calculating recovery rate risk margin is the same as
the existing Framework. Because recovery rate risk margin applies to
only single-name CDS, no adjustment or change is necessary to
accommodate the addition of CDS Options to the CDSClear services
because the options are on index CDS.
    New Section 3.8 sets forth wrong way risk margin, which replaces
Section 5 in the existing CDSClear Margin Framework. The methodology
for calculating wrong way risk margin is the same as the existing
Framework with minor revisions to streamline the description and to
improve readability.
    New Section 3.9 sets forth a new margin component, i.e., vega
margin, which would apply to CDS Options only. Because LCH SA uses ATM
options to calculate volatility returns in all volatility scenarios,
the derived expected shortfall would not fully capture the risk of
volatility changes in the options premium relative to the strikes,
i.e., the skew risk and the risk of changes in the volatility of
volatility. Therefore, LCH SA is proposing to add vega margin to the
total initial margin in order to capture the skew risk and the
volatility of volatility risk. The vega margin would first calculate
the risk of skew and volatility of volatility independently by
estimating option premium changes when the skew is shifted by an
extreme move, which is calibrated as a quantile of the distribution of
each parameter in the historical data set gathered by LCH SA, for each
time series of an available parameter. LCH SA would then define shifts
of the skew by multiplying a standard deviation of the returns of
historical skews by a percentile for a given probability threshold.
Then, LCH SA would also consider similar shocks on the volatility of
volatility alone. Finally, LCH SA would also consider

scenarios of combined risk of skew and volatility of volatility and
choose the worst P&L for the index family produced in these scenarios
as the total vega margin charge.
c. Additional Margins
    LCH SA proposes to create a new Section 4 in the CDSClear Margin
Framework, which would cover (i) liquidity and concentration risk
margin from Section 8 of the existing CDSClear Margin Framework, (ii)
accrued coupon liquidation risk margin from Section 9 of the existing
CDSClear Margin Framework, and (iii) credit event margin from Section
10 of the existing CDSClear Margin Framework.
i. Liquidity and Concentration Risk Margin
    New Section 4.1 sets forth liquidity and concentration risk margin,
which is moved from Section 8 of the existing CDSClear Margin
Framework. Liquidity and concentration risk margin is designed to
mitigate the P&L impact as a result of an illiquid or concentrated
position in a defaulting member's portfolio. The methodology for
calculating liquidity and concentration risk margin for CDS contracts
is the same as the existing Framework with minor revision to streamline
the description and to improve readability. In order to accommodate the
addition of CDS Options to the existing clearing services, LCH SA
proposes changes to the existing liquidity and concentration risk
margin methodology to cover portfolios containing CDS Options.
    To calculate the liquidity charge for portfolios including CDS
Options, LCH SA would consider the options separately from CDS in the
portfolio. Given that the market will require options to be liquidated
as a delta-hedged package, LCH SA would delta-hedge the positions
underlying the options and most likely auction the options as a package
separate from the remainder of the portfolio. LCH SA will attempt to
source the hedges from the CDS part of the defaulting member's
portfolio using a delta hedging algorithm to ensure minimal hedging
costs before sourcing the hedges from the market.
    After the options package is delta-hedged, from the bidders'
perspective, the pricing of the auction package would consist of
hedging the vega of the delta-neutral options package at different
resolutions consecutively until the portfolio is fully unwound. The
cumulative costs incurred in the successive vega hedging would reflect
the liquidity charge for the options.
    The liquidity charge for the entire portfolio will be the sum of
the liquidity charge computed for the CDS component of the portfolio
and the liquidity charge computed for the options component of the
portfolio.
ii. Accrued Coupon Liquidation Risk Margin
    New Section 4.2 sets forth accrued coupon liquidation risk margin
for both CDS and CDS Options. The accrued coupon liquidation risk
margin with respect to CDS remains the same as section 9 of the
existing CDSClear Margin Framework with minor edits to improve clarity
and readability. In addition, changes are proposed to address the
accrued coupon liquidation risk for CDS Options. Because accrued coupon
liquidation risk margin is designed to cover the accrued coupon payment
during the 5-day liquidation period, LCH SA would be exposed to a
coupon payment risk for an option only if the option expiry falls
within the 5-day liquidation period and the option is exercised.
Therefore, accrued coupon for options contracts with an expiry more
than 5 days away will be zero and accrued coupon for options contracts
with expiry falling within the 5-day liquidation period will be the
accrued coupon for 5 days if the options are exercised. LCH SA would
consider the option exercise decision based on the current spread level
+/- \1/2\ of the bid-offer on the underlying to reflect the cost of
monetizing an in-the-money option.
iii. Credit Event Margin
    New Section 4.3 sets forth credit event margin, which is moved from
section 10 of the existing CDSClear Margin Framework. The overall
approach to the calculation of the credit event margin remains the same
with certain revisions to streamline the presentation and to improve
clarity and readability. With respect to ``hard'' credit events,
because the recovery rate is unknown before the auction occurs, LCH SA
would impose credit event margin to cover an adverse 25 percent
absolute recovery rate move from the credit event determination date
to, and including, the auction date. After the auction, when the
recovery rate is known, Credit Event Margin is no longer required, and
cash flows are exchanged in advance through the Variation Margin to
extinguish any risk of the future payment not being made. However,
because of the addition of CDS Options, LCH SA proposes a number of
changes to the calculation of credit event margin. First, if several
credit events occur, LCH SA proposes to calculate the credit event
margin with respect to each affected CDS and CDS Option contract by
considering adverse recovery moves that could be a combination of
upwards, downwards and flat on the different entities depending on the
portfolio, instead of summing the credit event margin covering adverse
25 percent adverse recovery rate move for each reference entity as in
the case of linear CDS. The aggregation of the P&L at the affected CDS
and CDS Option contracts level would be the credit event margin at the
portfolio level. After the credit event margin is calculated for each
portfolio, the combination of adverse recovery rate moves retained for
a particular Clearing Member's portfolio would also be used in the
spread margin calculation in order to virtually shift the strikes of
all option contracts experiencing the credit event. Second, currently,
LCH SA separates credit event margin calculations with respect to the
portfolio of a Clearing Member that is the protection seller of the CDS
experiencing a credit event and the portfolio of a Clearing Member that
is the protection buyer of the CDS experiencing a credit event. The
protection seller would be required to pay a credit event margin and
the protection buyer would pay a so-called ``IM Buyer'', which
corresponds to a margin charged to the buyer in the event of a credit
event and is calculated in the same way as the calculation of the
credit event margin with the only difference being the change in the
direction of the shocks. With the addition of CDS Options, LCH SA
proposes to use one terminology ``credit event margin'' calculated
using the same methodology as the existing credit event margin
calculation with respect to a Clearing Member's portfolio containing a
contract affected by the credit event regardless of whether the
Clearing Member is a protection buyer or protection seller.
    Finally, with respect to restructuring events or so-called ``soft''
credit events, because different auctions may be held depending on the
maturity of the contracts and therefore, the recovery rate could be
different across all the contracts with various maturity dates, LCH SA
proposes to consider each maturity separately instead of netting all
positions with the same reference entity. For each given reference
entity experiencing a restructuring event with respect to a given
maturity, the calculation of the credit event margin is similar to that
used for hard credit events.

d. Cash Flows, Contingency Variation Margin and Extraordinary Margin
    New Sections 5, 6 and 7 set forth cash flow exchanges (in the form
of variation margin, price alignment interest, quarterly coupon
payments or upfront payments), contingency variation margin, and
extraordinary margin. These sections are moved from Sections 11, 12 and
3.4 of the existing CDSClear Margin Framework without substantive
change and with minor revisions to eliminate redundancy and improve
clarity and readability.
e. Appendix
    The new Section 8 Appendix sets forth the settlement agent and FX
provider, FX haircut and quanto with respect to CDX IG/HY contracts.
These are moved from Section 3.1.2, 3.3.2 and 3.3.3 of the existing
CDSClear Margin Framework without substantive change.
(ii). Default Fund Methodology
    LCH SA also proposes to modify its Default Fund Methodology to
incorporate terms for CDS Options and to make certain clarifying and
conforming changes to the Default Fund Methodology.
    Section 1 of the Default Fund Methodology, which outlines the
stress risk framework, would be amended in Sections 1.1, 1.2, 1.3, and
1.4 to make formatting changes and clarifying changes to the text for
readability.
    Section 2 of the Default Fund Methodology sets forth the
methodology used to calculate default fund, which is designed to cover
the potential impact of the default of two or more Clearing Members in
stressed market conditions in excess of initial margin held by LCH SA.
Section 2.1 currently provides an overview of the framework for such
methodology. The fundamental piece of the methodology is to identify
stress testing scenarios to introduce market moves in so-called
``extreme but plausible'' market conditions beyond those applied to the
margin calculation. Such stress testing scenarios would then be applied
to Clearing Members' portfolios to calculate the P&L impacts and the
sum of the two highest stress testing losses over initial margin
(``STLOIM'') across all Clearing Members' portfolios. From there, LCH
SA adds a 10 percent buffer to be the size of the default fund. Because
of the addition of CDS Options, LCH SA proposes to amend Section 2.1 to
take into account the new vega margin designed to address the skew risk
and volatility of volatility risk particular to CDS Options that are
not covered in the spread margin calculation. As a result, a stressed
vega margin (in addition to the existing stressed spread margin and
stressed short charge) would be calculated under the stress test
scenarios. LCH SA would then calculate stress test losses (i.e., the
sum of the stressed spread margin, stressed short charge and stressed
vega margin) over initial margin components designed to cover the
market risk and default risk (i.e., the spread margin, short charge,
wrong way risk margin and vega margin). Clarification changes are also
made to the explanation of stressed spread margin and stress short
charge.
    Section 2.2 of the Default Fund Methodology would be modified to
separate the description of the methodology for calculating P&L from
the description of the stress testing scenarios. The description of the
stress scenarios would be retained in Section 2.2 with certain
clarifying changes for readability, and the description of the
methodology for calculating the P&L for purposes of spread moves and
short charge would be removed from Section 2.2 and replaced with new
Sections 2.3 and 2.4. The various scenarios considered for the Default
Fund Methodology would also be renumbered under new subsections 2.2.1
(Standard Scenarios), 2.2.2 (Dislocation Scenarios), 2.2.3 (SPAN
Scenarios), 2.2.4 (2x Lehman Scenarios), 2.2.5 (Black Monday Scenario),
2.2.6 (Theoretical Scenarios), 2.2.7 (Theoretical 4x Bear Sterns
Scenario), and 2.2.8 (Correlation Breakdown). A new set of scenarios
would also be added in Section 2.2.9 (Volatility Scenarios), which
considers movements in the implied ATM volatilities of index families,
in both historical and theoretical stress scenarios.
    New Section 2.3 of the Default Fund Methodology sets forth the new
calculation of the stressed spread margin component of the STLOIM.
Consistent with the changes made to the CDSClear Margin Framework, the
new calculation of stressed spread margin would consider ATM implied
volatility moves for options and the stressed spread margin would be
calculated in two scenarios: (i) Historical scenarios covering credit
spread moves and ATM implied volatility movements in combination, and
(ii) theoretical scenarios covering credit spread movements and ATM
implied volatility moves independently. For CDS, only scenarios
covering spread moves would be considered.
    New Section 2.4 of the Default Fund Methodology would set forth the
stressed short charge component of the STLOIM calculation and would
incorporate terms to account for the addition of CDS Options. The new
stressed short charge calculation would follow the methodology of the
short charge calculation as part of the total initial margin to take
into account the non-linear nature of options, except that the number
of default entities assumed is higher for stressed short charge than
the number of defaults assumed for normal short charge. As under the
existing Default Fund Methodology, the stressed short charge will cover
the greater of (i) a ``Global Stressed Short Charge,'' which considers
the entity having the largest exposure and the two highest exposures
among the three entities most likely to default in the Clearing
Member's portfolio, (ii) a ``Financial Stressed Short Charge,'' which
considers the two entities having the largest exposure among senior
financial entities and the highest exposure among the three senior
financial entities most likely to default in the Clearing Member's
portfolio, and (iii) a ``High Yield Stressed Short Charge,'' which
considers the two entities having the largest exposure among entities
in the high yield index family and the two highest exposures among the
three entities among the high yield entities most likely to default in
the Clearing Member's portfolio.
    New Section 2.5 of the Default Fund Methodology would add a new
stressed vega margin component to the STLOIM calculation. As noted
above with respect to the CDSClear Margin Framework, vega margin is
included with respect to CDS Options to address skew risk and
volatility of volatility risk. The stressed vega margin component of
the STLOIM calculation would be calculated in the same manner as the
vega margin component of the CDSClear Margin Framework, but would use a
higher quantile than the regular vega margin calculation.
    New Section 2.6 of the Default Fund Methodology, entitled Exercise
Management, would account for the impact of CDS Options which expire
within the 5-day liquidation period. If the time to expiry with respect
to an option in a defaulting member's portfolio is less than or equal
to five days, LCH SA would consider the impact of option exercise in
four permutations for each stress scenario to account for the default
and extreme spread moves occurring before or after option expiry. LCH
SA would then select the permutation generating the largest loss for
any particular scenario. Section 2.6.1 of the Default Fund Methodology
then sets forth the calculations for the exercise decision in respect
of CDS Options and 2.6.2 describes the impact of the exercise

decision. For options that are expiring, if the option is deemed
exercised, the ``bumped'' price will not be calculated in respect of
the CDS option, but on the underlying index into which the CDS option
would be exercised. With respect to these options exercised and
converted to index CDS contracts, Section 2.6.3 of the Default Fund
Methodology then provides that the resulting index contracts will lead
to a change in the consideration of net short exposures and therefore,
the global, financial and HY stressed net short exposures need to be
calculated, which would affect the determination of the stressed short
charge.
    New Section 2.7 would set forth the P&L scenarios that are
considered as part of the Default Fund Methodology. New Section 2.7.1
would set forth the stressed spread margin calculation with respect to
specific products. In the case of CDS Options, the product is
identified with the index family and series of the underlying index,
such that the option P&L for each product can be added to the P&L for
linear contracts and offsets may be made between the two groups. If the
P&L at the product level is positive, a haircut is applied. Sections
2.7.2 then provides for a stressed short charge that is a component of
the stressed initial margin calculation in Section 2.7.3. Under Section
2.7.4, the stressed initial margin calculation is then compared across
historical scenarios, theoretical spread scenarios, and theoretical
implied volatility scenarios.
    Finally, the sections on Credit Quality Margin and Default Fund
Additional Margin would be renumbered as new sections 3.1 and 3.2,
respectively, and would be updated to incorporate terms for CDS Options
and to account for the imposition of vega margin in respect of CDS
Options.
2. Statutory Basis
    LCH SA believes that the proposed rule change in connection with
the clearing of CDS Options is consistent with the requirements of
Section 17A of the Act and the regulations thereunder, including the
standards under Rule 17Ad-22.\4\ Section 17(A)(b)(3)(F) \5\ 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 derivative 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 manage the risk arising from the clearing of CDS Options and to
streamline the description of the existing margin framework and default
fund methodology for CDS to take into account CDS Options and improve
the organization and clarity of the CDSClear Margin Framework and
Default Fund Methodology.
---------------------------------------------------------------------------

    \4\ 17 CFR 240.17Ad-22.
    \5\ 15 U.S.C. 78q-1(b)(3)(F).
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    LCH SA believes that the proposed changes to the CDSClear Margin
Framework and the Default Fund Methodology satisfy the requirements of
Rule 17Ad-22(b)(2), (b)(3), (e)(1), (e)(4) and (e)(6).\6\
---------------------------------------------------------------------------

    \6\ 17 CFR 240.17Ad-22(b)(2), (b)(3), (e)(1), (e)(4), and
(e)(6).
---------------------------------------------------------------------------

    Rule 17Ad-22(b)(2) requires a clearing agency to use margin
requirements to limit its credit exposures to participants under normal
market conditions and to use risk-based models and parameters to set
margin requirements.\7\ Rule 17Ad-22(b)(3) requires each clearing
agency acting as a central counterparty for security-based swaps to
maintain sufficient financial resources to withstand, at a minimum, a
default by the two participant families to which it has the largest
exposure in extreme but plausible market conditions (the ``cover two
standard''). 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,\8\
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.\9\
---------------------------------------------------------------------------

    \7\ 17 CFR 240.17Ad-22(b)(22).
    \8\ 17 CFR 240.17Ad-22(e)(4)(i).
    \9\ 17 CFR 240.17Ad-22(e)(6)(i).
---------------------------------------------------------------------------

    As described above, LCH SA proposes to amend its margin framework
to manage the risks associated with clearing CDS Options. Specifically,
the proposed rule change amends the existing spread margin and short
charge components of the total initial margin to take into account
implied volatility in the calculation of the spread margin and short
charge as well as updating interest rate risk margin, recovery rate
risk margin and wrong-way risk margin components of total initial
margin to incorporate CDS Options. In addition, the proposed rule
change adds the new vega margin to account for the skew risk and
volatility of volatility risk specific to CDS Options. These changes
are designed to use a risk-based model to set margin requirements and
use such margin requirements to limit LCH SA's credit exposures to
participants in clearing CDS and/or CDS Options under normal market
conditions, consistent with Rule 17Ad-22(b)(2). 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 the CDS and 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 portfolio and 7-day liquidation period for client
portfolio 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). LCH SA
also believes that the new pricing methodology with respect to CDS
Options, based on widely accepted and used Bloomberg Model with
appropriate adjustments, as supplemented by methodology for
circumstances in which pricing data are not readily available, would
generate reliable data set to enable LCH SA to calculate spread margin,
consistent with Rule 17Ad-22(e)(6)(iv).
    Further, Rule 17Ad-22(b)(3) requires a clearing agency acting as a
central counterparty for security-based swaps to establish policies and
procedures reasonably designed to maintain the cover two standard.\10\
Similarly, 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.\11\ LCH SA believes that
its Default Fund Methodology, with the modifications described herein,
will appropriately incorporate the risk of clearing 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(b)(3) and (e)(4)(ii).\12\
---------------------------------------------------------------------------

    \10\ 17 CFR 240.17Ad-22(b)(3).
    \11\ 17 CFR 240.17Ad-22(e)(4)(ii).
    \12\ 17 CFR 240.17Ad-22(b)(3) and (e)(4)(ii).
---------------------------------------------------------------------------

    LCH SA also believes that the proposed rule change is consistent
with Rule 17Ad-22(e)(1), which requires each covered clearing agency's
policies and procedures reasonably designed to provide for a well-
founded, clear, transparent, and enforceable legal basis for each
aspect of its activities in all relevant jurisdictions. As described
above, the proposed rule change would streamline the description of
margin methodology and default fund sizing methodology in CDSClear
Margin Framework and Default Fund Methodology. LCH SA believes that
these change would improve the organization and clarity of these
policies and provide for a clear and transparent legal basis for LCH
SA's margin requirements and default fund contributions, consistent
with Rule 17Ad-22(e)(1).
    For the reasons stated above, LCH SA believes that the proposed
rule change with respect to CDSClear Margin Framework and Default Fund
Methodology in connection with clearing of CDS Options are consistent
with the requirements of prompt and accurate clearance and settlement
of securities transactions and derivative agreements, contracts and
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 17(A)(b)(3)(F) of the Act.\13\
---------------------------------------------------------------------------

    \13\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

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.\14\ 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 CDSClear
Margin Framework and Default Fund Methodology would apply equally to
all Clearing Members whose portfolio includes CDS and/or CDS Options.
Because the margin methodology and default fund sizing methodology are
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 and default fund
contribution commensurate with the risk particular to its portfolio.
Such margin requirement and default fund contribution 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 and to
maintain sufficient financial resources to withstand a default of two
participant families to which LCH SA has the largest exposures in
extreme but plausible market conditions, 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.
---------------------------------------------------------------------------

    \14\ 15 U.S.C. 78q-1(b)(3)(I).
---------------------------------------------------------------------------

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<EMAIL_ADDRESS>Please include
File Number SR-LCH SA-2017-007 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-2017-007. 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 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 Web site at http://www.lch.com/asset-classes/cdsclear.
    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-LCH SA-2017-
007 and should be submitted on or before September 11, 2017.

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\15\
---------------------------------------------------------------------------

    \15\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2017-17546 Filed 8-18-17; 8:45 am]
 BILLING CODE 8011-01-P


[Federal Register Volume 81, Number 225 (Tuesday, November 22, 2016)]
[Notices]
[Pages 83886-83888]
[FR Doc No: 2016-28030]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79322; File No. SR-Phlx-2016-97)

Self-Regulatory Organizations; NASDAQ PHLX LLC; Order Granting
Approval of Proposed Rule Change To Delete Outdated or Unnecessary Rule
Language in Phlx Rule 1020

November 16, 2016.

I. Introduction

    On September 27, 2016, NASDAQ PHLX LLC (``Exchange'' or ``Phlx'')
filed with the Securities and Exchange Commission (``SEC'' or
``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 delete or amend its rules relating to
specialists. The proposed rule change was published for comment in the
Federal Register on October 14, 2016.\3\ The Commission received no
comment letters on the proposed rule change. This order approves the
proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 79073 (October 11,
2016), 81 FR 71153 (October 14, 2016) (``Notice'').
---------------------------------------------------------------------------

II. Description of the Proposal

    Phlx Rule 1020 contains provisions relating to the registration and
functions of options specialists.\4\ Section (b) provides that a member
registered as a specialist in one or more options has an obligation to
assist in the maintenance of a fair and orderly market, ``in addition
to the execution of orders entrusted to him in such options.'' The
Exchange proposes to delete the language in section (b) regarding
execution of entrusted orders. The Exchange represents that today,
specialists on the Exchange trade only for their own account and ``no
longer handle any agency orders whatsoever in their role as
specialists.'' \5\
---------------------------------------------------------------------------

    \4\ A ``specialist'' is an Exchange member who is registered as
an options specialist pursuant to Phlx Rule 1020(a). Specialists are
subject to quoting and registration obligations set forth in Phlx
Rules 1014(b), 1020 and 1080.02.
    \5\ See Notice, supra note 3, at 71154.

---------------------------------------------------------------------------

    Commentary .01 of Phlx Rule 1020 provides that in ``effecting
transactions'' for a specialist's own account for the purpose of
establishing or increasing a position, a specialist is to effect such
transactions in a reasonable and orderly manner in relation to the
condition of the general market, the market in the particular option,
and the adequacy of his position to the immediate and reasonably
anticipated needs of the options market. Commentary .01 sections (a)
through (d) provide that certain types of transactions to establish or
increase a position are not to be effected except when they are
reasonably necessary to render the specialist's position adequate to
such needs.\6\ The Exchange proposes to delete the last sentence of
Commentary .01 and sections (a) through (d). The Exchange represents
that today, specialists do not ``effect transactions'' in the sense of
matching bids and offers to cause a transaction execution, except in
rare cases.\7\ Instead, specialists submit bids and offers to be
matched by the PHLX XL trading system.\8\ Therefore, the Exchange
believes that the specialist may be unable to determine the price of
the last sale, which would be required for a specialist to comply with
the language Phlx proposes to be deleted.
---------------------------------------------------------------------------

    \6\ Specifically, Commentary .01 sections (a) through (d)
provide that the following types of transactions to establish or
increase a position are not to be effected except when they are
reasonably necessary to render the specialist's position adequate to
such needs: (a) A purchase at a price above the last sale in the
same trading session; (b) the purchase of all or substantially all
the options offered on the book at a price equal to the last sale,
when the option so offered represents all or substantially all the
options offered in the market; and when a substantial amount of an
option is offered at a price equal to the last sale price, the
purchase of more than 50% of all the options offered at the last
sale price; (c) the supplying of all or substantially all the
options bid for on the book at a price equal to the last sale, when
the option so bid for represents all or substantially all the
options bid for in the market; and when a substantial amount of the
options bid for at a price equal to the last sale price, the
supplying of more than 50% of all the options bid for at the last
sale price; (d) failing to re-offer or re-bid where necessary after
effecting transactions described in (a), (b), or (c). The rule
permits transactions of these types to be effected, however, with
the approval of an Options Exchange Official or in relatively
inactive markets where they are an essential part of a proper course
of dealings and where the amount of an option involved and the price
change, if any, are normal in relation to the market.
    \7\ See Notice, supra note 3, at 71154. The Exchange represents
that although a specialist may ``effect transactions'' with a market
maker on the Exchange's trading floor, the vast majority of
transactions are executed electronically by the trading system.
    \8\ See id.
---------------------------------------------------------------------------

    Commentary .02 of Phlx Rule 1020 provides that, for transactions of
a specialist for his own account that liquidate or decrease his
position in an option in which he is registered, such transactions are
to be ``effected'' in a reasonable and orderly manner in relation to
the condition of the general market, the market in the particular
option, and the adequacy of the specialist's positions to the immediate
and reasonably anticipated needs of the options market. Commentary .02
sections (a) through (c) describe certain restrictions on specialists
when liquidating or decreasing such positions.\9\ The Exchange proposes
to delete part of the last sentence of Commentary .02 and sections (a)
through (c). The Exchange represents that, as discussed above, a
specialist may be unable to determine the ``last different price'' as
required to comply with sections (a) and (c).\10\ The Exchange believes
also that section (b) is redundant to Rule 1020(b), which already
contains the ``fair and orderly'' requirement.\11\
---------------------------------------------------------------------------

    \9\ Commentary .02 sections (a) through (c) also provide that,
unless he has the prior approval of an Options Exchange Official, he
should avoid: (a) Liquidation of all or substantially all of a
position by selling options at prices below the last different price
or by purchasing options at prices above the last different price
unless such transactions are reasonably necessary in relation to the
specialist's overall position in the options in which he is
registered; (b) failing to maintain a fair and orderly market during
liquidations; or (c) failing to re-enter the market where necessary,
after effecting transactions described in (a) above.
    \10\ See Notice, supra note 3, at 71155.
    \11\ See id.
---------------------------------------------------------------------------

    Commentary .03 of Phlx Rule 1020 provides that a specialist's
quotation, made for his own account, should be such that a transaction
effected at his quoted price or within the quoted spread, whether
having the effect of reducing or increasing the specialist's position,
would bear a proper relation to preceding transactions and anticipated
succeeding transactions. The Exchange proposes to delete Commentary
.03. The Exchange represents that, due to the speed of trading that
occurs today on the Phlx XL trading system, specialists may not have
knowledge of preceding transactions and would not be able to adjust
quotes as needed to comply with Commentary .03 before the quotes are
accessed.\12\
---------------------------------------------------------------------------

    \12\ See id.
---------------------------------------------------------------------------

    Commentary .04 of Phlx Rule 1020 provides that a specialist should
avoid participating as a dealer in opening or reopening an option in
such a manner as to reverse the balance of public supply and demand as
reflected by market and limited price orders at or near the price of
the previous close or halt, unless the condition of the general market
or the specialist's position in light of the reasonably anticipated
needs of the market make it advisable to do so, or unless the
specialist has obtained the prior approval of an Options Exchange
Official to do so. The commentary provides that he may, however, buy or
sell an option as a dealer to minimize the disparity between supply and
demand at an opening or reopening. The Exchange proposes to delete
Commentary .04. The Exchange represents that a specialist no longer
manually opens options classes; the PHLX XL trading system handles the
opening and reopening of options.\13\
---------------------------------------------------------------------------

    \13\ See id.
---------------------------------------------------------------------------

    Commentary .05 of Phlx Rule 1020 prohibits a member acting as a
specialist from effecting transactions for the purpose of adjusting a
LIFO inventory in an option in which he is acting except as is
reasonably necessary to assist in the maintenance of a fair and orderly
market. The Exchange believes that Commentary .05 is no longer
necessary and proposes to delete it.\14\
---------------------------------------------------------------------------

    \14\ See id.
---------------------------------------------------------------------------

    Commentary .06 of Phlx Rule 1020 restricts a specialist from
assigning options in which he is registered to an investment account.
The Commentary states that a specialist may not add to a position in an
investment account unless reasonably necessary to permit the specialist
to assist in the maintenance of a fair and orderly market. Furthermore,
a specialist may not effect a transfer of options in which he is
registered from his dealer account to an investment account if the
transfer would result in a short position in the dealer account. The
Commentary also provides that in the maintenance of price continuity
with reasonable depth, it is commonly desirable for a specialist to
supply options to the market, even though he may have to sell short to
do so, to the extent reasonably necessary to meet the needs of the
market. The Exchange proposes to delete Commentary .06 because
investment accounts are no longer used by specialists.\15\
---------------------------------------------------------------------------

    \15\ See id.
---------------------------------------------------------------------------

III. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule
change is consistent with the requirements of the Act and rules and
regulations thereunder applicable to a national securities
exchange.\16\ In particular, the Commission finds that the proposed
rule change is consistent with Section

6(b)(5) of the Act,\17\ which requires, among other things, that the
rules of a national securities exchange be designed to promote just and
equitable principles of trade, to remove impediments to and perfect the
mechanism of a free and open market and a national market system, and,
in general, to protect investors and the public interest; and are not
designed to permit unfair discrimination between customers, issuers,
brokers, or dealers. The Commission believes that the deletion of Phlx
Rules 1020(b), Commentary .01, Commentary .02 (a) and (c), Commentary
.03, Commentary .04, and Commentary .06 should protect investors by
helping to ensure that the Phlx rules accurately describe the current
operations of the Exchange and obligations of its members. In addition,
the Commission notes that the deletion of Commentary .02 (b) to remove
redundant rule language should add clarity to Phlx's rules and that the
deletion of Commentary .05 and Commentary .06 should provide more
clarity regarding the obligations of specialists on the Exchange.
---------------------------------------------------------------------------

    \16\ In approving the proposed rule changes, the Commission has
considered their impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
    \17\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    Accordingly, for the reasons discussed above, the Commission finds
that the proposed rule change is consistent with Section 6(b)(5) of the
Act.

V. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) of the Act
\18\ that the proposed rule change (SR-PHLX-2016-97) be and hereby is
approved.
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    \18\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\19\
---------------------------------------------------------------------------

    \19\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Brent J. Fields,
Secretary.
[FR Doc. 2016-28030 Filed 11-21-16; 8:45 am]
 BILLING CODE 8011-01-P