LCH Limited

Decision

Headnote

NI 94-102 – derivatives – customer clearing and protection of customer collateral and positions – Applicant seeking to extend the exception in section 32(3) of the rule to apply to certain third-party permitted depositories – relief granted, subject to conditions.

Applicable Legislative Provisions

National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions, s. 32(3).

May 9, 2019

IN THE MATTER OF
THE SECURITIES LEGISLATION OF
ONTARIO AND QUEBEC
(the Jurisdictions)

AND

IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF
APPLICATIONS IN MULTIPLE JURISDICTIONS

AND

IN THE MATTER OF
LCH LIMITED
(the Filer)

DECISION

Background

The securities regulatory authority or regulator in each of the Jurisdictions (the Decision Maker) has received an application from the Filer for a decision under the securities legislation of the Jurisdictions (the Legislation) in Ontario pursuant to section 49 of National Instrument 94-102 Derivatives: Customer Clearing and Protection of Customer Collateral and Positions (NI 94-102) and in Québec pursuant to section 86 of the Derivatives Act (Québec), CQLR, c. I-14.01, for a relief from certain requirements on the use of customer collateral by a regulated clearing agency under Part 5, paragraph 32(3) of NI 94-102. More specifically, the Filer seeks to deposit initial margin con-sisting only of non-cash customer collateral delivered by a participant to the Filer with a permitted depository, which is subject to a lien in favour of the permitted depository as a condition for holding such customer collateral, and therefore requires the relief requested under paragraph 32(3) of NI 94-102 (the Exemptive Relief Sought).

Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a coordinated review application):

(a)           the Ontario Securities Commission (the OSC) is the principal regulator for this application, and

(b)           the decision is the decision of the principal regulator and evidences the decision of each other Decision Maker.

Interpretation

Terms defined in National Instrument 14-101 Definitions and NI 94-102 have the same meaning if used in this decision, unless otherwise defined.

Representations

This decision is based on the following facts represented by the Filer:

1.             The Filer is incorporated under the laws of England and Wales with its head office located in London, United Kingdom, where the Filer is recognized as a central counterparty and super-vised by the Bank of England and authorized (or otherwise recognised) as a central counterparty to offer services and activities in the European Union in accordance with the European Markets Infra-structure Regulation (EMIR).

2.             The Filer is recognized as a clearing agency by the OSC to offer SwapClear, ForexClear and RepoClear clearing services to Ontario-resident participants of the Filer. The Filer is also recognized as a clearing house by the Autorité des Marchés Financiers to offer SwapClear, RepoClear and ForexClear clearing services to Québec-resident participants of the Filer.

3.             Such clearing services, offered via the Filer, are also available to local customer in Ontario and in Québec accessing those services through clearing intermediaries.

4.             The Filer is a regulated clearing agency under NI 94-102.

5.             The Filer is not in default under the Legislation.

6.             The Filer offers clearing services in accordance with NI 94-102 under two types of clearing models: i) an English law governed service available in the SwapClear and ForexClear services (generally known as the international clearing model or the principal-to-principal clearing model) under which participants can clear non-US domiciled customer business; and ii) a New York law governed service available in the SwapClear and ForexClear services (generally known as the US model or the agency clearing model), under which participants can clear US domiciled and non-US domiciled customer business. Both models are available to local customers.

7.             Under the international clearing model, a local customer may elect to have its collateral segregated in accordance with ‘individual client segregation’ account structure, which offers additional protections pertaining to porting risk and enhanced segregation possibilities compared to the ‘omnibus client segregation’ account structure (also available under the international model). In addition, the local customer has the option to deposit initial margin consisting solely of non-cash customer collateral in a separate custody account in the name of the Filer at a permitted depository, which is accounted for separately from any other assets held for the Filer (the Filer’s custody account).

8.             Some of the permitted depositories used by the Filer under the international clearing model are located in jurisdictions where it is common place for such permitted depositories to have a lien over the Filer’s custody account regarding the custody account services provided by such permitted depositories.

9.             Part 5, paragraph 32(3) of NI 94-102 allows a regulated clearing agency to permit a lien on customer collateral in respect of a cleared derivative that secures an obligation resulting from the cleared derivative in favour of the regulated clearing agency or a clearing intermediary. This provision does not, however, extend to liens in favour of a permitted depository.

10.          Pursuant to an agreement between the Filer and each participant, and an agreement between the Filer and each permitted depository, the scope of any such lien over the Filer’s custody account described in paragraph 7 is limited to any unpaid fees owed by the Filer to the permitted depository arising from the provision of custody account services by such permitted depository in respect of the Filer’s custody account.

11.          In the event a permitted depository exercises its lien in respect of the Filer’s custody account, the Filer is obligated for any amount of any shortfall promptly to the local customer and is required to have sufficient liquid assets in order to do so. As part of its comprehensive risk management framework, the Filer maintains an appropriate
minimum amount of financial resources, as required by the applicable regulatory requirements and regularly monitors its performance against financial resource requirements. Under no circumstance, would the Filer distribute the shortfall across its customers, reflect a loss in a customer’s account, or require its customers to post additional margin to cover the shortfall.

12.          Further, the Filer’s custody account is consistent with the Principles for financial market infrastructures (the PFMI Principles) issued by the Bank for International Settlement’s Committee on Payments and Market Infrastructure and the International Organization of Securities Commis-sions and specifically with PFMI Principle 15 and with NI 94-102 in terms of risk management. In accordance with PFMI Principle 15, the Filer maintains 6 months of operating expenses in liquid assets in order to cover general business losses. Therefore, the Filer would be able to use its available financial resources to cover any fee payment to its permitted depository in respect of the Filer’s custody account.

13.          In order to fully comply with the applicable requirements of NI 94-102 and to ensure that the international clearing model is available to the current and prospective local customers, the Filer requests that the Exemptive Relief Sought be granted.

Decision

Each of the Decision Makers is satisfied that the decision meets the test set out in the Legislation for the Decision Maker to make the decision.

The decision of the Decision Makers under the Legislation is that the Exemptive Relief Sought is granted, provided that the lien placed by a permitted depository over the Filer’s Custody account in respect of non-cash collateral of local customers is exclusively limited to unpaid fees owed by the Filer to such permitted depository for custody account services provided by such permitted depository in respect of the Filer’s custody account.

“Kevin Fine”
Director, Derivatives Branch
Ontario Securities Commission