Letter concludes that it is permissible for a national bank to become a credit default swap self-clearing member of ICE Europe, provided the bank has established a comprehensive risk management framework to govern the risks associated with membership, and obtains a written examiner-in-charge ("EIC") supervisory no-objection as addressed in Interpretive Letter No. 1113 (March 4, 2009) (ICE Trust US)). The bank's exposure to ICE Europe is subject to the lending limit in 12 U.S.C. § 84 or any lower limit set by the EIC.

O

Comptroller of the Currency

Administrator of National Banks

Washington, DC 20219

July 30, 2009 Interpretive Letter #1122

August 2009

Subject: [ ] (“Bank”) Membership in ICE Clear Europe Limited

(“ICE Europe”) Credit Default Swap Clearinghouse

Dear [ ]:

This responds to your request that the Office of the Comptroller of the Currency (“OCC”)

confirm that it is permissible for the Bank to become a clearing member (“CM”) of ICE

Europe,1 to clear over-the-counter (“OTC”) credit default swaps (“CDS”). The parent

company of ICE Europe is The IntercontinentalExchange, Inc., which is also the parent

company of US ICE Trust.2

For the reasons discussed below, we conclude that the Bank may participate as a CDS

CM of ICE Europe, provided the Bank, prior to becoming a CM of ICE Europe,

establishes a comprehensive risk management framework3 to govern the risks associated

with its membership and receives a written supervisory no-objection from its examiner-

1 ICE Europe is incorporated in England and Wales as a private limited company.

2 The OCC addressed the permissibility of national banks becoming members of US ICE Trust, a

clearinghouse for CDS on North American indices, in OCC Interpretive Letter No. 1113 (March 4, 2009).

Membership in ICE Trust and ICE Europe are not reciprocal (i.e., membership is required by ICE Trust to

clear North American CDS products and membership is separately required by ICE Europe to settle

European CDS products).

3 The risk management framework should focus on the qualitative controls necessary to address the risks of

the Bank’s activities and, in addition, provide for the Bank’s compliance with quantitative restrictions

discussed below.

membership is required by ICE Trust to

clear North American CDS products and membership is separately required by ICE Europe to settle

European CDS products).

3 The risk management framework should focus on the qualitative controls necessary to address the risks of

the Bank’s activities and, in addition, provide for the Bank’s compliance with quantitative restrictions

discussed below.

in-charge (“EIC”).4 Banks’ exposures to ICE Europe are subject to 12 U.S.C. § 84

(“Section 84”) and thus must be limited to amounts equal to or below their Section 84

limits, as determined by their EIC.

Background

Currently, ICE Europe clears listed and over-the-counter energy products.5 ICE Europe

is expanding its clearing services to provide clearing for CDS index-based products in

Europe on iTraxx indices,6 and later intends to clear European single name CDS

contracts.

ICE Europe will provide CDS clearing services to its CMs.7 Membership is open to

market participants that meet ICE Europe’s membership criteria. The Bank proposes to

become an ICE Europe CDS self-clearing member.

ICE Europe will novate and clear the trades executed by its CDS CMs.8 Bilateral

contracts entered into by its CDS CMs will be replaced by two superseding CDS

contracts between ICE Europe and each party to the bilateral transactions. Under the new

contracts, ICE Europe will assume the counterparties’ obligations under the original

contracts and effectively become the central counterparty (i.e., the buyer to every seller

and the seller to every buyer) to CDS trades

ateral

contracts entered into by its CDS CMs will be replaced by two superseding CDS

contracts between ICE Europe and each party to the bilateral transactions. Under the new

contracts, ICE Europe will assume the counterparties’ obligations under the original

contracts and effectively become the central counterparty (i.e., the buyer to every seller

and the seller to every buyer) to CDS trades.

For admission to ICE Europe, a CM applicant or its parent must have a minimum

tangible net worth (Tier 1 capital) of $5 billion.9 At the time of admission, a CM or its

parent must also have a minimum long term rating of at least “A” or its equivalent from

designated or equivalent rating agencies (which may not fall below designated levels

after admission) or otherwise demonstrate to ICE Europe that it satisfies stringent credit

criteria (which it must continue to satisfy after admission).10 A CDS CM must

demonstrate operational competency in CDS contracts substantially similar to those

cleared by ICE Europe, including having a portfolio of bilateral CDS with an outstanding

4 This letter addresses the permissibility of national banks becoming self-clearing members of ICE Europe.

Before a national bank ICE Europe CDS CM may clear trades on ICE Europe for customers, the bank must

provide its EIC with prior written notice and obtain a written EIC supervisory no-objection.

5 The Bank’s affiliate, [ ], is an ICE Europe Energy CM.

6 CDS Clearing Solution: Explanatory Memorandum (May 12, 2009) (“EM”) VIII CDS Procedures @ §

8.1. The iTraxx indices are broad-based indices based on European reference names.

7 VIII CDS Procedures @ § 4.2.

8 Rule 401.

9 VIII CDS Procedures @ § 2.2(a); EM § 2.3(i).

10 VIII CDS Procedures @ §§ 2.2(b) and (c); EM §§ 2.3(ii) and (iii).

2

], is an ICE Europe Energy CM.

6 CDS Clearing Solution: Explanatory Memorandum (May 12, 2009) (“EM”) VIII CDS Procedures @ §

8.1. The iTraxx indices are broad-based indices based on European reference names.

7 VIII CDS Procedures @ § 4.2.

8 Rule 401.

9 VIII CDS Procedures @ § 2.2(a); EM § 2.3(i).

10 VIII CDS Procedures @ §§ 2.2(b) and (c); EM §§ 2.3(ii) and (iii).

2

notional amount of at least $500 billion.11 A CDS CM must belong to the International

Swaps and Dealers Association, Inc. (“ISDA”) and Deriv/SERV and other industry

organizations related to CDS as designated by ICE Europe.12 A CDS CM must execute

an ISDA Master Agreement with ICE Europe and agree to the ISDA’s March 2009

Supplement (“Supplement”).13 US CMs must be “eligible contract participants” under

Section 1(a)(12) of the Commodity Exchange Act.14 CMs must provide initial and mark-

to-market margin,15 and make contributions to ICE Europe’s CDS guaranty fund (“CDS

Fund”),16 which is available to cover CM defaults.17 A CM’s CDS Fund contribution is

based on the risk profile of the CM’s portfolio and subject to a 15 million minimum in

euros (“€ “).

ICE Europe maintains a separate Energy Guaranty Fund (“Energy Fund”) for energy

CMs.18 CDS CMs that are also Energy CMs are liable to make and maintain both CDS

Fund contributions and Energy Fund contributions.19 The total amount required in each

guaranty fund will be established by ICE Europe under its Procedures and published in a

Circular.20 The total amount of the Energy Fund is expressed in U.S. dollars and

reviewed by ICE Europe quarterly.21 The total amount of the CDS Fund will be

expressed in € and reviewed periodically by ICE Europe in advance of each CDS

11 VIII CDS Procedures @ § 2.2(d); EM § 2.3(iv).

12 VIII CDS Procedures @ § 2.2(e); EM § 2.3(v).

13 VIII CDS Procedures @ § 2.2(f); EM §§ 2.3 (vi) and (vii).

14 VIII CDS Procedures @ § 2.2(g)

y ICE Europe quarterly.21 The total amount of the CDS Fund will be

expressed in € and reviewed periodically by ICE Europe in advance of each CDS

11 VIII CDS Procedures @ § 2.2(d); EM § 2.3(iv).

12 VIII CDS Procedures @ § 2.2(e); EM § 2.3(v).

13 VIII CDS Procedures @ § 2.2(f); EM §§ 2.3 (vi) and (vii).

14 VIII CDS Procedures @ § 2.2(g).

15 ICE Europe Clearing Rules (“Rules”) 202 (viii), 301, 501, 502, 503 and 504.

16 Rules 202 (ix) and Part 11; EM §§ 3.9 and 4.2. The Fund is designed to provide adequate fund to cover

losses associated with the default of two members with the greatest potential losses.

17 Rules @ Part 11. The ICE CDS Fund includes a capital contribution from ICE Europe. ICE will

participate in the CDS Fund up to $50 million. ICE Europe's participation represents its commitment to

ensuring that the economic interests of the clearinghouse are aligned with the CMs. The ICE Contribution

will be of two types, each up to $25 million: (a) a first loss “ICE Europe CDS Initial Contribution” and (b)

a second loss “ICE Europe CDS Fund Contribution.”

18 Rule 1101(a).

19 Id.

20 The “Circular” is a publication issued by ICE Europe for the attention of all CMs and posted on its

website. Rules 101 and 109(f).

21 Rule 1101(a).

3

guaranty fund period (“GFP”).22 Each CM’s CDS Fund contributions at the start of each

CDS GFP will be calculated with reference to the total amount of the CDS Fund.23

ICE Europe reviews the level of CDS Fund Contributions on a monthly basis and, on a

daily basis, the performance of the CDS Fund.24 If a CM’s day-over-day required CDS

Fund Contribution exceeds either 5% of the CM’s prior day’s calculated contribution or

5% of the total CDS Fund requirement, ICE Europe will make a demand for additional

CDS Fund contributions for payment by the next business day.25

The Rules define acts that constitute CM defaults and describe the actions ICE Europe

may take once it decl

e CDS Fund.24 If a CM’s day-over-day required CDS

Fund Contribution exceeds either 5% of the CM’s prior day’s calculated contribution or

5% of the total CDS Fund requirement, ICE Europe will make a demand for additional

CDS Fund contributions for payment by the next business day.25

The Rules define acts that constitute CM defaults and describe the actions ICE Europe

may take once it declares a CM in default.26 In the event of a CM default, ICE Europe’s

use of a defaulting CDS CM’s margin and CDS Fund contributions will vary, depending

on whether the defaulting member is solely a CDS CM or both a CDS and an Energy

CM.27 Where there is a default by a CDS CM who is not an Energy CM, the defaulter’s

CDS Fund Contribution may be used to pay the costs of closing out the defaulting CDS

CM’s liabilities that exceed the defaulting member’s cash/collateral (margin accounts) or

guarantee.28 If such funds are insufficient to cover the CDS defaulter’s loss, ICE Europe

may use any other of the defaulter’s assets that the defaulter has any rights or claims

over.29 If a loss still remains, ICE Europe may liquidate the losses resulting from a CDS

CM’s default using this priority schedule: (1) the ICE Europe Initial Contribution;30

(2) the non-defaulting members’ contributions (including any surplus CDS Fund

Contribution, if two or more defaults take place concurrently and such surplus is

available); 31 and (3) ICE Europe’s CDS Fund Contribution.32 If a loss remains

outstanding, ICE Europe may exercise powers of assessment and call for an CDS

22 In general, the CDS GFP for the CDS Fund means a period for which the total amount of CDS Fund

contributions for the CDS Fund are fixed. Rules 101 and 1101(a).

23 Rules 1101 and 1102(a) and (b).

24 EM § 4.11.

25 Id

Fund Contribution.32 If a loss remains

outstanding, ICE Europe may exercise powers of assessment and call for an CDS

22 In general, the CDS GFP for the CDS Fund means a period for which the total amount of CDS Fund

contributions for the CDS Fund are fixed. Rules 101 and 1101(a).

23 Rules 1101 and 1102(a) and (b).

24 EM § 4.11.

25 Id.

26 A CM is in default if, for example, the CM is: (1) in breach of any ICE Europe Rule, Procedure, CM or

other agreement with ICE Europe; (2) unable or likely to be unable to meet the CM’s obligations with ICE

Europe; (3) unable to pay any margin, guaranty fund contribution or other amount due; or (4) insolvent.

Rule 901.

27 Rule 1103(c) and (d).

28 Rule 1103(c)(i) and (ii).

29 Rule 1103(c)(iii).

30 Rule 1103(c)(iv).

31 Rule 1103(c)(v)(A).

32 Rule 1103(c)(v)(B).

4

Assessment Contribution (“CAC”) payable by each CDS CM.33 The size of a CM’s

CAC is based pro rata on a multiple of the CM’s then current CDS Fund contributions

capped at one times the original CDS Fund contribution.34 The total CDS Assessment

Amount (“CAA”) is certified by ICE Europe and published in a Circular, at which time

the CDS CMs become liable to pay their CACs.35

If the CAA is not met by a CM (or CMs) for any reason, ICE Europe may direct that the

shortfall be re-assessed against all CDS CMs, as if the shortfall were the CAA, provided

that no CDS CM shall be liable to pay CACs for a single default in an amount greater

than its CDS Fund Contribution immediately prior to the relevant default.36 ICE Europe

may assess additional CACs until the entire CAA has been met in full by the CACs.37

After a CAC becomes payable, each CM has the option to terminate membership in ICE

Europe, effective immediately and prior to the time when CDS Fund Contribution

replenishments are payable.38 A Retiring Member must pay all required CAC relating to

defaults prior to resignation.39 A Retiring Member’s ob

e

may assess additional CACs until the entire CAA has been met in full by the CACs.37

After a CAC becomes payable, each CM has the option to terminate membership in ICE

Europe, effective immediately and prior to the time when CDS Fund Contribution

replenishments are payable.38 A Retiring Member must pay all required CAC relating to

defaults prior to resignation.39 A Retiring Member’s obligation to pay a CAC will apply

only with respect to events of CDS CM defaults occurring prior to the Retiring Member’s

Termination Date40 and any CDS CM defaults occurring after the Termination Date

provided the Retiring Member still has a CDS Fund Contribution with ICE Europe.41 A

Retiring Member’s aggregate CAC shall be capped at an amount equal to the Retiring

Member’s CDS Fund Contribution immediately prior to the first default event(s) being

declared which led to the application of CDS Fund contributions or an amount equal to

the Retiring Member’s CDS Fund Contribution on the date of service of the relevant

33 Rule 1106(a).

34 Rule 1106(h).

35 Rule 1106(b). The CAC is calculated by multiplying the CAA by the CM’s CDS Fund contribution

immediately preceding the relevant default event (less the defaulter’s CDS Fund contributions) and

dividing that number by the CDS Fund contribution of all CDS clearing members (“CGFALL”)

immediately preceding the relevant default event. Rule 1106.

36 Rule 1106(a) and (d).

37 Rule 1106(a), (c) and (d).

38 Rule 1106(h). A CM that elects to terminate its status as a CDS clearing member is referred to herein as

a “Retiring Member.”

39 Id.

40 “Termination date” means the date on which a CM’s membership in ICE Europe terminates. Rule 101.

41 Rule 1106(c).

5

ely preceding the relevant default event. Rule 1106.

36 Rule 1106(a) and (d).

37 Rule 1106(a), (c) and (d).

38 Rule 1106(h). A CM that elects to terminate its status as a CDS clearing member is referred to herein as

a “Retiring Member.”

39 Id.

40 “Termination date” means the date on which a CM’s membership in ICE Europe terminates. Rule 101.

41 Rule 1106(c).

5

notice of termination.42 A Retiring Member’s CACs are included for the purpose of

calculating the cap.43

In the event that a CM is both a CDS CM and an Energy CM, a default of the CM in

either of these products constitutes a default in both.44 Once any losses are determined,

and to the extent that there is any excess default margin or guaranty fund contributions

with respect to one membership, those excess assets may be applied to losses associated

with the other membership, i.e., following a default, the defaulter’s assets from its other

membership are applied before those of the non-defaulting CMs.

In general, ICE Europe will return a CM’s CDS Fund Contributions following

termination of the CM’s membership on the first date of the first new CDS GFP

beginning after the transfer or liquidation of all the CM’s positions at ICE Europe and the

payment of all other amounts due to ICE Europe.45

Upon termination of a CDS CM's membership, the relevant CM shall remain liable to

transfer, deposit, maintain and pay all margin, make CDS Fund contributions when due

and make all other payments due under contracts and shall be obliged to: (1) transfer,

liquidate, make settlement and delivery (as applicable) under contracts; and (2) take such

other actions as ICE Europe at its discretion deems appropriate or necessary.46

Discussion

The National Bank Act (“NBA”) permits national banks to engage in foreign and

domestic clearing activities, subject to safety and soundness limitations, as activities that

are part of the business of banking because the activities are functionally equivalent to

bank permissi

ts; and (2) take such

other actions as ICE Europe at its discretion deems appropriate or necessary.46

Discussion

The National Bank Act (“NBA”) permits national banks to engage in foreign and

domestic clearing activities, subject to safety and soundness limitations, as activities that

are part of the business of banking because the activities are functionally equivalent to

bank permissible credit and financial intermediation activities.47 The NBA also permits

national banks to join foreign and domestic clearinghouses that require members to cover

a portion of the losses arising from the default of other members, as bank permissible

guaranties, where the bank has a substantial interest48 in being a member and its liability

to the clearinghouse does not exceed Section 84 or lower EIC-established limits.49

42 Id.

43 Rule 1106(c) and (h).

44 EM § 4.6.

45 Rule 1102(g).

46 Rule 209(d).

47 See, e.g. OCC Interpretive Letter No. 1014 (Jan. 10, 2005) (“IL No. 1014”); IL No. 929 (Feb. 11, 2002)

(“IL No. 929”); OCC Interpretive Letter 892 (Sept. 8, 2000) and OCC Interpretive Letter No. 494 (Dec. 29,

1989) (“IL No. 494”).

48 Under 12 C.F.R. § 7.1017(a), a national bank is permitted to guarantee the obligations of another party if

the bank has a substantial interest of its own in the transaction. This regulation provides, in part, that “[a]

national bank may lend its credit, bind itself as a surety to indemnify another, or otherwise become a

guarantor . . . if: (a) The bank has a substantial interest in the performance of the transaction involved.” A

6

nk is permitted to guarantee the obligations of another party if

the bank has a substantial interest of its own in the transaction. This regulation provides, in part, that “[a]

national bank may lend its credit, bind itself as a surety to indemnify another, or otherwise become a

guarantor . . . if: (a) The bank has a substantial interest in the performance of the transaction involved.” A

6

Recently, the OCC addressed the ability of national banks to join US ICE Trust, a

domestic CDS clearinghouse.50 The OCC determined that a national bank had a

substantial interest in becoming a CM of the clearinghouse, where CMs were subject to

potentially unlimited liability for the defaults of other CMs. In the event that the CDS

clearing fund was not sufficient to cover a member default, the clearinghouse had the

right to require non-defaulting members to pay additional assessments sufficient to

restore each CM’s required contributions to the guaranty fund prior to the opening of

business the next business day. Although CMs could limit their liability to the

clearinghouse to an amount equal to their required fund contribution by terminating

membership in ICE Trust, ICE Trust Rules and Procedures did not expressly limit

member liability to the clearinghouse to Section 84 limits. Accordingly, in IL No. 1113,

the OCC clearly established that where a bank seeks to join a clearinghouse that does not

specifically limit member exposure to a set amount that is within a bank’s Section 84

limits, a bank must provide its EIC with prior written notice of its proposed clearinghouse

activities and obtain a written no-objection before becoming a member of the

clearinghouse. The written no-objection is based on the EIC’s evaluation of the adequacy

of a bank’s risk measurement and management systems and controls to enable the banks

to engage in CM activities on a safe and sound manner, and other supervisory

considerations

prior written notice of its proposed clearinghouse

activities and obtain a written no-objection before becoming a member of the

clearinghouse. The written no-objection is based on the EIC’s evaluation of the adequacy

of a bank’s risk measurement and management systems and controls to enable the banks

to engage in CM activities on a safe and sound manner, and other supervisory

considerations.

We conclude that it is permissible under the NBA for the Bank to become an ICE Europe

CDS CM, subject to the same criteria espoused in IL No. 1113. The Bank must establish

a comprehensive risk management framework and limit its exposures to ICE Europe to

its Section 84 limits or a lower exposure limit established by the EIC, in light of the size

of the Bank, the nature and volume of its activities, and the characteristics of the

nexus between a bank permissible transaction and a guaranty may provide the “substantial interest” for the

bank. See, e.g., IL No. 929, supra (bank’s provision of a default fund contribution/guaranty was incidental

to the business of bank’s clearing and execution activities and satisfied substantial interest needed for

issuance of a guarantee) and OCC Interpretive Letter No. 376 (Oct. 25, 1986) (national bank’s guarantee of

third party securities borrowers’ conduct was incidental to the bank’s securities lending program and

constituted a sufficient substantial interest). The OCC has determined that national banks have a

substantial interest in agreeing to cover a portion of the losses of defaulting members as a condition to

clearinghouse membership where this obligation in an integral part of bank permissible clearing activities.

See, e.g., IL No, 1113, supra; OCC Interpretive Letter No. 1102 (Oct. 14, 2008) and IL Nos. 1014 and 929,

supra.

49 See, e.g. OCC Interpretive Letter No. 1071 (Sept. 6, 2006) and IL Nos

ntial interest in agreeing to cover a portion of the losses of defaulting members as a condition to

clearinghouse membership where this obligation in an integral part of bank permissible clearing activities.

See, e.g., IL No, 1113, supra; OCC Interpretive Letter No. 1102 (Oct. 14, 2008) and IL Nos. 1014 and 929,

supra.

49 See, e.g. OCC Interpretive Letter No. 1071 (Sept. 6, 2006) and IL Nos. 1014 and 929, supra.

50 IL No. 1113, supra.

7

8

clearinghouse.51 The Bank’s membership in ICE Europe should enable the Bank to

reduce its counterparty credit risk and operational risk from CDS transactions because the

clearinghouse will act as the central counterparty and net self-clearing members’

positions. However, because each CM assumes obligations to cover losses from other

defaulting CMs, membership also can create a complex, contingent forward credit

exposure. Accordingly, prior to joining ICE Europe, the Bank should establish a

comprehensive risk management framework to measure and manage the risk arising from

these exposures. The attributes of such a comprehensive risk management framework are

addressed in IL No. 1113.

Conclusion

We conclude that the Bank may participate as a CDS CM of ICE Europe, provided the

Bank, prior to becoming a CM, establishes a comprehensive risk management framework

to govern the risks associated with its membership and receives a written supervisory no-

objection letter from its EIC. The Bank’s exposure to ICE Europe is subject to Section

84 and must not exceed Section 84 limits. Our conclusions are specifically based on the

Bank’s representations, and any change in facts or circumstances could result in a

different conclusion. If you have any questions concerning this letter, please contact

Tena M. Alexander, Senior Counsel, Securities and Corporate Practices Division, at

Bank’s exposure to ICE Europe is subject to Section

84 and must not exceed Section 84 limits. Our conclusions are specifically based on the

Bank’s representations, and any change in facts or circumstances could result in a

different conclusion. If you have any questions concerning this letter, please contact

Tena M. Alexander, Senior Counsel, Securities and Corporate Practices Division, at

(202) 874-4625.

Sincerely,

signed

Julie L. Williams

First Senior Deputy Comptroller

And Chief Counsel

51 Under the lending limit, 12 U.S.C. § 84 and 12 C.F.R. Part 32, a national bank’s loans and extensions of

credit to one borrower are limited to 15 percent of the bank’s capital and surplus, subject to certain

exceptions and with the application of certain loan combination rules. Additionally, a bank’s credit

exposures must be consistent with safe and sound banking practices. Accordingly, the Bank must limit its

exposure to ICE Europe so that amounts of funds advanced as margin or CDS Fund contributions do not

exceed an amount equal to, if not below, the Section 84 limits, in light of the size of the Bank, the nature

and volume of its activities, and the characteristics of the clearinghouse.